Measurement, evaluation and transparency are also fundamental elements of the framework, providing robust analysis of the materiality and likelihood of specific threats as well as supporting understanding and communication of the financial and nonfinancial risks RBS is exposed to.
RBS has a strong focus on defining the control environment to ensure the effective operation of policies and processes embedded in the customer-facing businesses, thus facilitating the management of the risks they take in the course of their day-today activities.
RBS’s strategy is informed and shaped by an understanding of the risks it faces
RBS has the appropriate policies and controls embedded in the business to manage the risks it takes
Defining the level of risk which RBS is willing to accept
RBS identifies the risks that arise as a result of running its business and delivering its strategy
Risk management framework (unaudited) continued RBS also has a strong focus on continually improving the way risk is managed, particularly in terms of how threats are anticipated or responded to, but also in terms of simplifying or enhancing existing controls, policies and practice.
Essential to this is the ability to scan both the medium- and longterm horizon for risks. Stress testing is used to quantify, evaluate and understand the potential impact that changes to risks may have on the financial strength of RBS, including its capital position. In turn, the results of stress tests can be used to inform and shape strategy.
Such a culture must be built on strong risk practices and appropriate risk behaviours must be embedded throughout the organisation.
To support a consistent tone from the top, senior management regularly communicate the importance of the required risk behaviours, linking them to the achievement of good customer outcomes.
Risk-based key performance indicators RBS-wide remuneration policy ensures that the remuneration arrangements for all employees reflect the principles and standards prescribed by the PRA rulebook and the FCA handbook.
Mandatory learning for all staff is focused on keeping employees, customers and RBS safe. This is easily accessed online and is assigned to each person according to their role and business area. The system allows monitoring at all levels to ensure completion.
Code of Conduct Aligned to RBS’s values is the Code of Conduct (Our Code). The code provides guidance on expected behaviour and sets out the standards of conduct that support the values. It explains the effect of decisions that are taken and describes the principles that must be followed.
Risk management framework (unaudited) continued These principles cover conduct-related issues as well as wider business activities. They focus on desired outcomes, with practical guidelines to align the values with commercial strategy and actions. The embedding of these principles facilitates sound decision-making and a clear focus on good customer outcomes. They are also consistent with the people management and remuneration processes and support a positive and strong risk culture through appropriate remuneration structures.
A simple decision-making guide – the “YES check” – has been included in the Code of Conduct. It is a simple set of five questions, designed to ensure RBS values guide day-to-day decisions:  Does what I am doing keep our customers and RBS safe and secure?  Would customers and colleagues say I am acting with integrity?  Am I happy with how this would be perceived on the outside?
 Is what I am doing meeting the standards of conduct required?
Acts on all material and/or enterprise‐ wide risk and control matters across RBS.
Responsible for approving the Significant Deterioration framework and data rules for missing variables.
In 2017, the Chief Risk Officer (CRO) led Risk, Conduct & Restructuring. The CRO reported directly to the Chief Executive and had a dotted reporting line to the Board Risk Committee, as well as a right of access, to the chairman of the Board Risk Committee. Risk, Conduct & Restructuring was a function independent of the franchises, structured by risk discipline to facilitate the effective management of risk. Risk, Conduct & Restructuring was organised into eight functional areas: Chief of Staff; Credit Risk; Restructuring; Enterprise-Wide Risk; Risk & Conduct Infrastructure; Operational Risk; Risk & Conduct Assurance; and Financial Crime. There were also Directors of Risk & Conduct/Chief Risk Officers for each of the franchises and for Services. Risk committees in the customer businesses and key functional risk committees oversaw risk exposures arising from management and business activities and focused on ensuring that they were adequately monitored and controlled.
Regulatory advisory support across all customer businesses and management of relationships with core regulators
Oversight and challenge to the business in their management of risk and conduct
Operational risk and control framework (including business processes, technology, data and organisation)
Risk and conduct capabilities (including information services, transformation, control room and surveillance, and whistleblowing)
Chief of Staff Proactive support to the Chief Risk Officer (including Risk, Conduct &
Head of Restructuring Manages RBS’s problem and potential problem Wholesale debt exposures
Risk management framework (unaudited) continued Three lines of defence RBS uses the three lines of defence model to articulate accountabilities and responsibilities for managing risk across the organisation. The three lines of defence model is adopted across the industry to support the embedding of effective risk management and is expressed through a set of principles as outlined below: First line of defence – Management and supervision The first line of defence includes customer franchises, Technology and Services as well as support and control functions such as Human Resources, Communications & Marketing and Finance. Responsibilities include:  Owning, managing and supervising, within a defined risk appetite, the risks which exist in business areas and support functions.
Second line of defence – Oversight and control The second line of defence includes Risk, Conduct & Restructuring, RBS Legal, and the financial control element of RBS’s Finance function. Responsibilities include:  Working with the businesses and functions to develop risk and control policies, limits and tools for the business to use in order to discharge its responsibilities.
 Providing independent assurance to the Financial Conduct Authority, Prudential Regulation Authority, Central Bank of Ireland and other key jurisdictional regulators on specific risks and controls.
To facilitate this, a detailed annual review of the framework is carried out. The review includes:  Assessing the adequacy of the framework when compared to internal and external expectations.  Ensuring the framework remains effective as a strong control environment for risk appetite.  Assessing the level of embedding of risk appetite across the organisation.
Risk appetite is communicated across RBS through risk appetite statements. The risk appetite statements provide clarity on the scale and type of activities that can be undertaken in a manner that is easily conveyed to staff.
The Board sets risk appetite for our most material risks to help ensure RBS is well placed to meet its priorities and long-term targets even under challenging economic environments. It is the basis on which RBS remains safe and sound while implementing its strategic business objectives.
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 in day-to-day risk management decisions. The risk control frameworks manage risk by expressing a clear tolerance for material risk types that is aligned to business activities.
 Assessment of trading and non-trading portfolios.  Review of potential risks in new business activities and processes.  Analysis of potential risks in any complex and unusual business transactions.
When evaluating possible strategies, costs and benefits, residual risks (risks that are retained) and secondary risks (those caused by the risk mitigation actions) are considered. Monitoring and review processes are in place to track results.
Information about regulatory developments and discussions is communicated to each customer-facing business and function. This helps identify and execute any required mitigating changes to strategy or to business models.
Risk and conduct assurance Risk & Conduct Assurance is an independent second line of defence function which provides assurance to both internal and external stakeholders including the Board, senior management, risk functions, franchises, Internal Audit and regulators.
Model Risk Management performs reviews of relevant risk and pricing 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.
Stress testing: capital management Stress testing is a key risk management tool and a fundamental component of RBS’s approach to capital management. It is used to quantify, evaluate and understand the potential impact of specified changes to risk factors on the financial strength of RBS, including its capital position. Stress testing includes:  Scenario testing, which examines the impact of a hypothetical future state to define changes in risk factors; and
 Sensitivity testing, which examines the impact of an incremental change to one or more risk factors.
Stress testing is used widely across RBS. Key areas are summarised in the diagram below: Specific areas that involve capital management include: 1) Strategic financial and capital planning: through assessing the impact of sensitivities and scenarios on the capital plan and capital ratios.
2) Risk appetite: through gaining a better understanding of the drivers of – and the underlying risks associated with – risk appetite.
4) Risk mitigation: through identifying actions that can be taken to mitigate risks, or could be taken, in the event of adverse changes to the business or economic environment. Risk mitigation is substantially supplemented through RBS’s recovery plan.
Regular reverse stress testing is also carried out. This examines circumstances that can lead to specific, defined outcomes such as business failure. Reverse stress testing allows RBS to examine potential vulnerabilities in its business model more fully.
The results of stress tests are not only used widely across RBS but also by the regulators to set specific capital buffers. RBS takes part in a number of stress tests run by regulatory authorities to test industry-wide vulnerabilities under crystallising global and domestic systemic risks. In 2017, RBS took part in the Bank of England stress test. Details of the stress test are set out on page 160.
Internal assessment of liquidity Under the liquidity risk management framework, RBS maintains the Individual Liquidity Adequacy Assessment Process (ILAAP). This includes assessment of net stressed liquidity outflows. RBS considers a range of extreme but plausible stress scenarios on its liquidity position over various time horizons, as outlined below.
A market stress event affecting all participants in a market through contagion, counterparty failure and other market risks. RBS is affected under this scenario but no more severely than any other participants with equivalent exposure.
The recovery plan sets out a range of triggers that activate the implementation of the recovery plan and sets out the operational plan for implementation of appropriate recovery options.
The recovery plan is prepared and updated annually and approved by the Board. Following Board approval it is also submitted to the PRA each year. The recovery plan is assessed for appropriateness on an ongoing basis, and is maintained in line with regulatory requirements.
The RBS Group is working with UK and global regulators to ensure that it is compliant with the principles of resolution planning. This includes, but is not limited to, establishing appropriate loss-absorbing capacity and ability to maintain operational continuity in resolution, across all of RBS Group’s main legal entities, including NatWest Bank Plc. Reflecting the degree of change required to ensure RBS Group is resolvable, a multi-year programme in place to develop resolution capability and meet regulatory requirements.
Non-traded market risk exposures are capitalised through the ICAAP. The process covers the following risk types: gap risk, basis risk, credit spread risk, pipeline risk, structural foreign exchange risk, prepayment risk and accounting volatility risk. The ICAAP is completed with a combination of value and earnings measures. The total non-traded market risk capital requirement is determined by adding the different charges for each sub risk type. The ICAAP methodology captures at least ten years of historical volatility, produced with 99% confidence level. Methodologies are reviewed by RBS Model Risk and the results are approved by the Capital Management & Stress Testing Committee.
RBS conducts historical, macroeconomic and vulnerability-based stress testing. Historical stress testing is a measure that is used for internal management. Using the historical simulation framework employed for value-at-risk, the current portfolio is stressed using historical data since 1 January 2005. This methodology simulates the impact of the 99.9 percentile loss that would be incurred by historical risk factor movements over the period, assuming variable holding periods specific to the risk factors and the businesses.
Vulnerability-based stress testing begins with the analysis of a portfolio and expresses its key vulnerabilities in terms of plausible, vulnerability scenarios under which the portfolio would suffer material losses. These scenarios can be historical, macroeconomic or forward-looking/hypothetical. Vulnerabilitybased stress testing is used for internal management information and is not subject to limits. However, the results for relevant scenarios are reported to senior management.
Risk management framework (unaudited) continued Regulatory stress testing In 2017, the Group participated in a regulatory stress test conducted by the Bank of England. The scenario is hypothetical in nature and does not represent a forecast of the Group’s future business or profitability. The results of the regulatory stress tests are carefully assessed by the Group and form part of the wider risk management of the Group.
 The 2017 stress test examined the impact over five years of deep simultaneous recessions in the UK and global economies, large falls in asset prices and a separate stress of misconduct costs. The economic scenario in the test is more severe than the global financial crisis.
 In light of the steps that RBS has already taken to strengthen its capital position during 2017, the regulator did not require RBS to submit a revised capital plan.
 The reduction in the CET1 ratio from the start point to the minimum stressed ratio before the impact of 'strategic' management actions or AT1 conversion has improved from 1,000 basis points last year to 700 basis points this year (pre-strategic management actions).
Capital, liquidity and funding risk Definitions (unaudited) Capital consists of reserves and instruments issued that are available that have a degree of permanency and are capable of absorbing losses. A number of strict conditions set by regulators must be satisfied to be eligible to count as capital.
Capital adequacy risk is the risk that there is or will be insufficient capital and other loss absorbing debt instruments to operate effectively including meeting minimum regulatory requirements, operating within Board approved risk appetite and supporting its strategic goals.
 Secondary liquid assets are eligible as collateral for local central bank liquidity facilities. These assets include ownissued securitisations or whole loans that are retained on balance sheet and pre-positioned with a central bank so that they may be converted into additional sources of liquidity at very short notice.
Key developments in 2017 (unaudited)  RBS continued to strengthen and de-risk its capital position; CET1 ratio remains ahead of the 13% target and increased by 250 basis points in the year end to 15.9% (40 basis points in Q4 2017), despite absorbing significant litigation and conduct costs, restructuring costs and disposal losses. IFRS 9 adoption on 1 January 2018 favourably impacts CET1 by 30 basis points. RWAs reduced by £27.3 billion to £200.9 billion reflecting the rundown of NatWest Markets legacy assets and reductions across other businesses. In addition, RBS was not required to submit a revised capital plan following the 2017 Bank of England (BOE) stress testing exercise.
leverage ratio improved to 6.1% (2016 – 5.6%) reflecting higher central bank balances which are excluded from the UK framework.
 The rise in primary liquidity resulted in higher liquidity coverage ratio (LCR) and stressed outflow coverage (SOC) of 152% (2016 – 123%) and 168% (2016 – 139%) respectively. The increase in LCR reflected preparations for the settlement of litigation, the rise in the minimum regulatory requirement from 90% to 100% on 1 January 2018 and preparations for ring-fencing.
 The net stable funding ratio rose to 132% (2016 – 121%), above the minimum target of 100%. The increase in NSFR was primarily driven by increased available stable funding.
 The regulatory agenda continues to rapidly evolve in the UK, Europe and internationally. RBS manages its capital, liquidity and funding to meet both current and future regulatory requirements whilst ensuring that we continue to serve customers well.
Capital management (unaudited) Capital management ensures that there is sufficient capital and other loss absorbing instruments to operate effectively including meeting minimum regulatory requirements, operating within Board approved risk appetite, maintaining its credit rating and supporting its strategic goals.
Capital management is critical in supporting the businesses and is enacted through an end to end framework across businesses and the legal entities.
Capital planning is integrated into the Group’s wider annual budgeting process and is assessed and updated at least monthly. Regular returns are submitted to the PRA which include a two year rolling forward view. Other elements of capital management, including risk appetite and stress testing, are set out on pages 154 and 157.
 Capital plans are developed to maintain capital of sufficient quantity and quality to support the Group’s business and strategic plans over the planning horizon within approved risk appetite, as determined via stress testing, and minimum regulatory requirements.
 Decisions on capital actions will be influenced by strategic and regulatory requirements, the cost and prevailing market conditions.
Capital planning is one of the tools that the Group uses to monitor and manage capital risk on a going and gone concern basis, including the risk of excessive leverage.
Liquidity and funding management follows a similar process to that outlined above for capital.
Capital, liquidity and funding risk continued RBS categorises its liquidity portfolio, including its locally managed liquidity portfolios, into primary and secondary liquid assets. The majority of the portfolio is centrally managed by RBS Treasury, for which the RBS Treasurer is responsible. This portfolio is held in the PRA regulated UK Domestic Liquidity Subgroup (UK DoLSub) comprising RBS’s five licensed deposit taking UK banks: The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co and Adam & Company PLC.
Two of RBS's significant operating subsidiaries, RBS N.V. and Ulster Bank Ireland DAC, hold locally managed portfolios that comply with local regulations that may differ from PRA rules.
The size of the liquidity portfolio to be held by the future NatWest Markets plc should not be considered comparable to that held by the current RBS plc.
For further information, please refer to RBS Group ring-fencing on page 109.
Funding risk management (unaudited) RBS manages funding risk through a comprehensive framework which measures and monitors the funding risk on the balance sheet.
The asset and liability types broadly match. Customer deposits provide more funding than customer loans utilise; repurchase agreements are largely covered by reverse repurchase agreements; interbank lending and funding largely nets off and derivative assets are broadly netted against derivative liabilities.
Capital, liquidity and funding risk continued Minimum requirements (unaudited) Capital adequacy ratios The Group is subject to minimum requirements in relation to the amount of capital it must hold in relation to its RWAs. The table below summarises the minimum ratios of capital to RWAs that the Group is expected to have to meet once CRR is fully implemented by 1 January 2019. These ratios apply at the consolidated group level. Different minimum capital requirements may apply to individual legal entities or sub-groups. Minimum requirements Type CET1 Total Tier 1 Total capital
Notes: (1) The countercyclical capital buffer (CCyB) applied to UK designated assets is set by the Financial Policy Committee (FPC). The UK CCyB may be set between 0% and 2.5% and is linked to the state of the UK economy. The Bank of England’s Financial Policy Committee (FPC) increased the UK CCyB from 0.0% to 0.5%, with effect from June 2018; subsequently in November 2017 the FPC announced a further increase to 1.0% effective November 2018. The estimated own funds impact for the Group, based on the CCyB rate of 1.0% and 31 December 2017 exposures, was £1,343 million. Foreign exposures may be subject to different CCyBs depending on the CCyB rate set in the jurisdiction of the foreign exposure.
(4) From 1 January 2015, RBS has been required to meet at least 56% of its Pillar 2A capital requirement with CET1 capital and with balance with Additional Tier 1 and/or Tier 2 capital. Additional capital requirements under Pillar 2A may be specified by the PRA as a ratio or as an absolute value. The table sets out an implied ratio to cover the full value of Pillar 2A requirements. The PRA has recently determined that the Pillar 2A capital requirement for 2018 remains unchanged.
(6) The capital conservation buffer, the countercyclical capital buffer, the G-SIB buffer and systemic risk buffer (where applicable) make up the combined buffer. If the Group fails to meet the combined buffer requirement, it is subject to restrictions on distributions on CET1 instruments, discretionary coupons on AT1 instruments and on payment of variable remuneration or discretionary pension benefits. These restrictions are calculated by reference to the Group’s Maximum Distributable Amount (MDA). The MDA trigger is below the PRA buffer and MDA restrictions are not automatically triggered if the Group fails to meet its PRA buffer. The MDA is calculated as the amount of interim or year-end profits not yet incorporated into CET1 capital multiplied by a factor ranging from 0 to 0.6 depending on the size of the CET1 shortfall against the combined buffer.
Liquidity and funding ratios The table below summarises the minimum requirements for key liquidity and funding metrics, under the relevant legislative framework.
Capital, liquidity and funding risk continued Measurement Capital and leverage: Key metrics (unaudited) Capital, RWAs and capital adequacy ratios, on the basis of end-point Capital Requirements Regulation (CRR) and transitional rules, calculated in accordance with PRA definitions, are set out below. 2017 2016
CRR basis (1) basis CRR basis (1) basis £bn £bn £bn £bn
Pillar 2 add-ons. RBS calculates the LCR using its own interpretations of the EU LCR Delegated Act, which may change over time and may not be fully comparable with those of other financial institutions.
Capital, liquidity and funding risk continued Capital and leverage: Capital resources
Qualifying instruments and related share premium subject to phase out — 3,416 — 5,416
Qualifying instruments issued by subsidiaries and held by third parties — 140 — 339
Note: (1) The Group’s Tier 1 grandfathering cap is set at £4.8 billion for 2017 (2016 - £5.8 billion). The table below analyses the movement in end-point CRR CET1, AT1 and Tier 2 capital for the year.
Other off-balance sheet items with 20% credit conversion factor (CCF) 0.6 0.9
value (1) value value (2) value (3) value (1) value value (2) value (3)
(4) Corresponding shareholders’ equity was £48.3 billion (2016 - £48.6 billion). (5) Regulatory amounts reported for AT1, Tier 1 and Tier 2 instruments are before grandfathering restrictions imposed by CRR.
Covered bonds - weighted average rate spread (bps) 125 137 — — 99 — 157
Note: (1) PD model changes relating to counterparty risks are included with risk parameter changes in line with EBA Pillar 3 Guidelines issued in December 2016.
Total RWAs UK PBB RoI Banking Banking RBSI Markets & other Total £bn £bn £bn £bn £bn £bn £bn £bn
At January 1 2017* 42.3 18.1 78.5 8.6 9.5 69.7 1.5 228.2 Foreign exchange movement — 0.5 (0.4) — — (1.3) — (1.2)
Notes: (1) Risk parameter changes relate to changes in credit quality metrics of customers and counterparties such as probability of default (PD) and loss given default (LGD) as well as
 The decrease in NatWest Markets primarily reflects reductions in the legacy business as it moved towards closure and lower counterparty credit risk resulting from mitigation activities.
 There has been a reduction in net lending in Commercial
 In both UK PBB and Private Banking there has been growth in mortgage lending which has increased RWAs.
 Risk metric improvements in Ulster Bank RoI have been offset by foreign currency movements.
Notes: (1) The PRA regulated UK DoLSub comprising RBS’s five licensed deposit-taking UK banks: The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited,
The table below shows the liquidity value of the liquidity portfolio by currency.
By product less than more than less than more than 1 year 1 year Total 1 year 1 year Total £m £m £m £m £m £m
Commercial paper and certificates of deposit 4,637 — 4,637 3,205 3 3,208
plc, bring the total issuance in 2016 and 2017 to £7.8 billion; o £2.4 billion of covered bonds by RBS plc, the first such issuance for RBS since 2012; and o £1.1 billion of senior unsecured notes issued by RBS plc to support the future standalone operations of NatWest Markets plc.
 Total reverse repos at 31 December 2017 were £1.1 billion lower at £40.7 billion (2016 - £41.8 billion). Fair value of securities received as collateral for reverse repos was £40.7 billion (2016 - £41.8 billion), of which £30.6 billion (2016 - £30.5 billion) had been rehypothecated for RBS’s own transactions, in line with normal market practice.
Capital, liquidity and funding risk continued Loan:deposit ratios and funding surplus/(gap) The table below shows loans and advances to customers, customer deposits, loan:deposit ratios (LDR) and funding surplus/(gap).
Central items & other 77 190 nm 113 256 266 nm 10 * Re-presented to reflect the segmental reorganisation.
Capital, liquidity and funding risk continued Notes issued - residual maturity profile by note type The table below shows RBS's debt securities in issue and subordinated liabilities by residual contractual maturity.
The contractual maturity of balance sheet assets and liabilities reflects the maturity transformation role banks perform, lending long-term but mainly obtaining funding through short-term liabilities such as customer deposits. In practice, the behavioural profiles of many liabilities show greater stability and longer maturity than the contractual maturity. This is particularly true of many types of retail and corporate deposits which, despite being repayable on demand or at short notice, have demonstrated very stable characteristics even in periods of acute stress.
Less than 1-5Greater than Less than 1-5Greater than Less than 1-5 Greater than Less than 1-5 Greater than 1 year years 5 years Total 1 year years 5 years Total 1 year years 5 years Total 1 year years 5 years Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn * Re-presented to reflect the segmental reorganisation.
Key points (unaudited)  The net funding surplus has increased by £13 billion during 2017 to £44 billion, largely driven by deposit growth (mainly in UK PBB and RBSI International). NatWest Markets lending reduction exceeded deposit reduction, resulting in a lower funding gap in 2017.
Capital, liquidity and funding risk continued Encumbrance RBS evaluates the extent to which assets can be financed in a secured form (encumbrance), but certain asset types lend themselves more readily to encumbrance. The typical characteristics that support encumbrance are an ability to pledge those assets to another counterparty or entity through operation of law without necessarily requiring prior notification, homogeneity, predictable and measurable cash flows, and a consistent and uniform underwriting and collection process. Retail assets including residential mortgages, credit card receivables and personal loans display many of these features.
 Not currently encumbered. In this category, RBS has in place an enablement programme which seeks to identify assets capable of being encumbered and to identify the actions to facilitate such encumbrance whilst not affecting customer relationships or servicing.
Encumbered as a result of transactions with Pre-positioned Unencumbered assets not pre-positioned counterparties other than central banks & encumbered with central banks
Credit risk: management basis The following disclosures in this section are audited:  Forbearance.  Impairment provisioning and write-offs.  Portfolio overview by geographical area.  LTV distribution for mortgage lending.  Commercial real estate LTV distribution.
Definition Credit risk is the risk of financial loss due to the failure of a customer or counterparty to meet its obligation to settle outstanding amounts.
Risk governance The credit risk management function is led by the Chief Credit Officer (CCO). The function’s activities include:  Approving credit limits for customers.  Defining concentration risk and implementing the credit risk control framework.  Oversight of the first line of defence to ensure that credit risk remains within the risk appetite set by the Board.  Developing and monitoring compliance with credit risk policies.  Conducting RBS-wide assessments of provision adequacy.
The CCO has overall responsibility for the credit risk function and chairs the Wholesale Credit Risk Committee as well as the Retail Credit Risk Committee. These committees have authority for risk appetite (within the appetite set by the Board), strategy, frameworks and policy as well as oversight of RBS’s credit profile. The RBS Provisions Committee has authority over provisions adequacy and approves proposals from business provisions committees in accordance with approval thresholds. The RBS Provisions Committee is chaired either by the CCO or the Head of Provisions & Restructuring Credit.
Risk appetite (unaudited) RBS’s approach to lending is governed by comprehensive credit risk appetite frameworks. The frameworks are closely monitored and actions are taken to adapt lending criteria as appropriate. Credit risk appetite aligns to the strategic risk appetite set by the Board, which includes capital adequacy, earnings volatility, funding and liquidity, and stakeholder confidence. The credit risk appetite frameworks have been designed to reflect factors (e.g. strategic and emerging risks) that influence the ability to operate within risk appetite. Tools such as stress testing and economic capital are used to measure credit risk volatility and develop links between the credit risk appetite frameworks and risk appetite limits. The frameworks are supported by a suite of policies and transaction acceptance standards that set out the risk parameters within which franchises must operate.
Net exposure or loss given default for a given probability of default
The Personal credit risk framework sets limits that measure and control the quality of both existing and new business for each relevant franchise or business segment. The actual performance of each portfolio is tracked relative to these limits and management action is taken where necessary. The limits apply to a range of credit risk-related measures including expected loss at a portfolio level, expected loss in a given stress scenario, projected credit default rates and the LTV ratio of the Personal mortgage portfolios.
 Net of provisions – credit valuation adjustments for derivative and securities financing products; individual, collective and latent provisions across all other product types.
Exposures backed by guarantees are allocated to the guarantor rather than the direct obligor. This does not affect the current or potential exposure amount, but does affect allocations to obligors, sectors, country and product and asset classes.
Credit risk: management basis continued The following table summarises the differences between current exposure and potential exposure across product types: Product Current exposure Potential exposure(1,2) Lending Drawn balances Legally-committed limits
Contingent obligations Issued amount of the guarantee or letter of credit Legally-committed amount Leases Net present value plus residual value Banking book debt securities Purchase value less subsequent amortisation Trading book bonds Equity securities Settlement risk Suretyships Intra-group credit exposures
Notes: (1) Potential exposure includes all drawn exposure and all legally-committed undrawn exposure. (2) Potential exposure cannot be less than current exposure. (3) Current exposure and potential exposure for exchange-traded derivatives are defined as exposure at default.
Risk models (unaudited) The output of credit risk models is used in the credit approval process – as well as for ongoing assessment, monitoring and reporting – to inform risk appetite decisions. These models are divided into different categories. Where the calculation method is on an individual counterparty or account level, the models used will be probability of default (PD), loss given default (LGD), or exposure at default (EAD). The economic capital model is used for credit risk appetite setting.
All credit grades map to both an internal asset quality scale, used for external financial reporting, and a master grading scale for Wholesale exposures, which is used for internal management reporting across portfolios. Accordingly, measures of risk exposure may be aggregated and reported at differing levels of detail depending on stakeholder or business requirements. Performing loans are defined as AQ1-AQ9 (where the PD is less than 100%) and non-performing loans as AQ10 (where the PD is 100%).
The key sectors where RBS provides asset-backed lending are commercial real estate, shipping and residential mortgages. Valuation methodologies are detailed below.
Shipping valuations – Vessel valuations are obtained using several different independent sources. Valuations are usually undertaken on a desktop basis, assuming a willing buyer and willing seller. Most vessels are valued on a charter-free basis, but in certain circumstances the valuations take account of longer term committed charter income. Valuations are normally performed on a quarterly basis. From time to time, particularly for facilities showing increased signs of financial stress, a more formal valuation or specialist advice will be obtained.
Credit risk: management basis continued Counterparty credit risk RBS mitigates counterparty credit risk arising from both derivatives transactions and repurchase agreements through the use of market standard documentation, enabling netting, and through collateralisation.
A credit assessment is carried out before credit facilities are made available to customers. The assessment process is dependent on the complexity of the transaction.
For lower risk transactions below specific thresholds, credit decisions can be approved through self-sanctioning within the business. This is facilitated through an auto-decisioning system, which utilises scorecards, strategies and policy rules to provide a recommended credit decision. Such credit decisions must be within the approval authority of the relevant business sanctioner.
Transaction Acceptance Standards provide detailed transactional lending and risk acceptance metrics and structuring guidance. Transaction Acceptance Standards are one of the tools used to manage risk appetite at the customer/transaction level and are supplementary to the Credit Policy.
Personal customers are served through a lending approach that entails making a large number of small-value loans. To ensure that these lending decisions are made consistently, RBS analyses credit information, including the historical debt servicing behaviour of customers with respect to both RBS and their other lenders. RBS then sets its lending rules accordingly, developing different rules for different products.
The process is then largely automated, with customers receiving a credit score that reflects a comparison of their credit profile with the rule set. However, for relatively high-value, complex personal loans, including some residential mortgage lending, specialist credit managers make the final lending decisions.
Underwriting standards are monitored on an ongoing basis to ensure they remain adequate in the current market environment and are not weakened to sustain growth.
The framework focuses on Wholesale customers whose credit profiles have deteriorated since origination. Expert judgement is applied by experienced credit risk officers to classify cases into categories that reflect progressively deteriorating credit risk to the bank. There are two classifications which apply to non-defaulted customers within the framework – Heightened Monitoring and Risk of Credit Loss. The framework also applies to those customers that have met the bank’s default criteria (AQ10 exposures).
Credit risk: management basis continued Sector specific characteristics also exist. Heightened Monitoring customers require pre-emptive actions (outside the customer’s normal trading patterns) to return or maintain their facilities within the bank’s current risk appetite prior to maturity.
Risk of Credit Loss customers are performing customers who have met the criteria for Heightened Monitoring and also pose a risk of credit loss to the bank in the next 12 months, should mitigating action not be taken or not be successful.
Once classified as either Heightened Monitoring or Risk of Credit Loss, a number of mandatory actions are taken in accordance with policies. This includes a review of the customer’s credit grade, facility and security documentation and the valuation of security. 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 credit risk or relationship management units in the relevant business or by Restructuring.
Agreed customer management strategies are regularly monitored by both the business and credit teams. The largest Risk of Credit Loss exposures in RBS and in each business are regularly reviewed by a Risk of Credit Loss Committee. The committee members are experienced credit, business and Restructuring specialists. The purpose of the committee is to review and challenge the strategies undertaken for those customers who pose the largest risk of credit loss to the bank.
Appropriate corrective action is taken when circumstances emerge that may affect the customer’s ability to service its debt (see Heightened Monitoring characteristics). Corrective actions may include granting a customer various types of concessions. Any decision to approve a concession will be a function of specific country and sector appetite, the credit quality of the customer, the market environment and the loan structure and security. All customers granted forbearance are classified Heightened Monitoring as a minimum.
The Risk of Credit Loss framework does not apply to problem debt management for Business Banking customers in UK PBB. These customers are, where necessary, managed by specialised problem debt management teams, depending on the size of exposure or the Business Banking recoveries team where a loan has been impaired.
Restructuring For the Wholesale problem debt portfolio, customer relationships are managed by the Restructuring team (this excludes customers managed by PBB).
Collections The Collections function takes over management of a customer when the customer exceeds an agreed limit or misses a regular monthly payment. Once in Collections the customer will be supported by skilled debt management staff who will endeavour to provide the customer with solutions based on current circumstances and, where appropriate, any known future changes to their financial position. Solutions include short-term account restructuring, refinance loans and forbearance which can include interest suspension and breathing space. In the event that an affordable/sustainable agreement with a customer cannot be reached, the debt will transition into Recoveries.
The aim of forbearance is to support and restore the customer to financial health while minimising risk. To ensure that forbearance is appropriate for the needs and financial profile of the customer, RBS applies minimum standards when assessing, recording, monitoring and reporting forbearance.
Loans/debt 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.
Types of forbearance The type of forbearance offered is tailored to the customer’s individual circumstances.
In the Wholesale portfolio, forbearance may involve covenant waivers, amendment to margin, payment concessions and loan rescheduling (including extensions in contractual maturity), capitalisation of arrears, and debt forgiveness or debt for equity swap.
In the Personal portfolio forbearance may involve payment concessions and loan rescheduling (including extensions in contractual maturity), capitalisation of arrears and, in the Republic of Ireland only, temporary interest-only conversions. Forbearance is granted principally to customers with mortgages and less frequently to customers with unsecured loans. This includes instances where forbearance may be taken for customers with highly flexible mortgages.
For Personal portfolios, forborne loans are separated into a distinct population and reported on a regular basis until they exit the forborne population.
Provisioning for Wholesale forbearance Provisions for forborne loans are assessed in accordance with normal provisioning policies (refer to impairment loss provision methodology). The customer’s financial position and prospects as well as the likely effect of the forbearance, including any concessions granted, and revised PD or LGD gradings, are considered in order to establish whether an impairment provision is required.
Forbearance may result in the value of the outstanding debt exceeding the present value of the estimated future cash flows. This may result in the recognition of an impairment loss or a write-off.
Provisioning for personal forbearance The methodology used for provisioning in respect of Personal forborne loans will differ depending on whether the loans are performing or non-performing and which business is managing them due to local market conditions.
Granting forbearance will only change the arrears status of the loan in specific circumstances, which can include capitalisation of principal and interest in arrears, where the loan may be returned to the performing book if the customer has demonstrated an ability to meet regular payments and is deemed likely to continue to do so.
For the latent calculation, an extended emergence period is applied to account for the impact of forbearance within the portfolio. Additionally for portfolios with material forbearance, forborne loans form a separate risk pool and use a different PD model. The separate risk pool applies for the duration of the forbearance arrangement and with exit from forbearance segmentation dependent on meeting applicable probationary periods and performance criteria:  UK PBB (excluding NI): The separate risk pool comprises all forborne loans. The provisioning calculation uses the higher of the observed default rates or PD.
For non-performing loans, there is no difference in treatment with the exception of Ulster Bank RoI, where forborne loans which result in an economic loss to the group form a separate risk pool and are subjected to specific provisioning treatments.
Impairment, provisioning and write-offs In the overall assessment of credit risk, impairment, provisioning and write-offs are used as key indicators of credit quality.
Days-past-due measures are typically used to identify evidence of impairment. In both the Wholesale and Personal portfolios, a period of 90 days past due is used. In sovereign portfolios, the period used is 180 days past due. Indicators of impairment include the borrower’s financial condition; a forbearance event; a loan restructuring; the probability of bankruptcy; or evidence of diminished cash flows.
Provisioning The amount of an impairment 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. This includes cash flows from foreclosure (less costs of obtaining and selling the collateral), whether or not foreclosure is probable. Impairment provisions are not recognised where amounts due are expected to be settled in full on the realisation of collateral.
Available-for-sale portfolios Available-for-sale portfolios are also regularly reviewed for evidence of impairment, including: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and increased likelihood that the issuer will enter bankruptcy or other financial reorganisation.
The table below summarises current and potential exposure, by sector and asset quality. The table is unaudited except for forbearance, which is audited.
European Banking Authority requirements. (6) Completed during the year. (7) Provision (including latent).
 The increase in current exposure in the Personal portfolio mainly resulted from growth in UK mortgage lending and was within risk appetite. For further information, refer to page 185.
 The UK unsecured lending portfolio remained broadly stable in size.
 The level of Wholesale and Personal provisions decreased. This reflected progress in reducing defaulted facilities. The Personal portfolio also benefited from house price improvements.
 Exposure classified as Risk of Credit Loss decreased over 2017. This decrease was driven by the Shipping sector as a result of the reclassification of customers to Heightened Monitoring and portfolio disposals (refer to page 190 for further information).
 Wholesale forbearance decreased significantly over 2017. This was driven by lower levels of new forbearance in the Commercial Real Estate and Shipping sectors. Additionally a number of Shipping facilities which were previously forborne were exited during 2017. (Refer to page 190 for further information).
 £1.1 billion of wholesale forbearance related to payment concessions and £0.5 billion to non-payment concessions. Previously reported forbearance types are classified as non-payment (covenant concessions, release of security) and payment (payment concessions and loan rescheduling, forgiveness of all or part of the outstanding debt, variation in margin, standstill agreements).
Portfolio overview – geography The table below summarises both current and potential exposure, by geographic region.
 Exposure to the US and RoW decreased as RBS continued to focus on its core markets. The movement includes RBS exiting from the Shipping sector.
2017 2016* Ulster Private RBS Ulster Private RBS UK PBB Bank RoI Banking International Total UK PBB Bank RoI Banking International Total £m £m £m £m £m £m £m £m £m £m
 Most of the mortgage growth was in the owner-occupied portfolio. In line with market trends, new mortgages in the buy-to-let portfolio decreased as tax and regulatory changes in the UK affected borrower activity.
 Total provision and forbearance against mortgages continued to decrease. This reflected the relatively lowinterest -rate environment in the UK and house price growth as well as a focus on the ability of customers to repay in a sustainable manner over the term of the facility.
 Unsecured lending balances remained broadly stable despite an upward trend in the wider UK market. Growth in the unsecured loan portfolio was offset by declines in the cards and overdrafts portfolios. The reduction in the cards portfolio reflected RBS’s decision to abstain from the 0% credit card balance transfer market.
 The total provision for unsecured lending reduced, reflecting the exit from defaulted debt.
Credit risk: management basis continued Overview of new mortgage lending on a current exposure basis as at drawdown (unaudited) Ulster Private RBS UK PBB Bank RoI Banking International Total 2017 £m £m £m £m £m
Of which: Mixed (capital and interest only) 801 — — 3 804
Note: (1) For 2016, Private Banking includes additional lending of £1.5 billion. Following a change in methodology, this additional lending is excluded from 2017 data.
Notes: (1) Can include multiple arrangements. (2) Capitalisation term extensions, economic concessions. (3) Payment concessions, amortising payments of outstanding balances, payment holidays and temporary interest arrangements.
Credit risk: management basis continued Mortgage LTV distribution by segment on a current exposure basis
Note: (1) LTV is calculated on a current exposure basis, gross of provisions.
Credit risk: management basis continued UK PBB mortgage exposure by region and LTV on a current exposure basis
LTV ratio value <=50% <=80% <=100% <=150% >150% Total average LTV Other Total £m £m £m £m £m £m % £m £m 2016*
By geography and sub-sector (1) UK RoI Other Total UK RoI Other Total £m £m £m £m £m £m £m £m
Commercial & Private Banking. The reduction in exposure over the period is the result of the successful implementation of distribution and capital market activity, in line with business strategy.
Note: (1) Lending secured against property portfolios with multiple assets across the UK.
(2) Relates predominantly to business banking, rate risk management products and unsecured corporate lending.
Credit risk: management basis continued CRE asset quality on a current exposure basis (unaudited)
Cash and balances at central banks 98.3 — — — — (3.4) 94.9
Reverse repurchase agreements and stock borrowing (6) 41.8 — — (39.4) — — 2.4
Financial assets Exposure summary and credit mitigation The following table analyses financial asset exposures, both gross and net of offset arrangements, as well as credit mitigation and enhancement.
Government Securities Clearing Corporation. During 2016 and 2017, changes in the legal contracts with LCH and CME led to many derivatives cleared through that counterparty being settled to market each day rather than being collateralised as previously. This led to the derecognition of the associated assets and liabilities.
Note: (1) Includes loans made by consolidated conduits to asset owning companies.
Credit risk: balance sheet analysis continued Asset quality The asset quality analysis presented below is based on internal asset quality ratings which have ranges for the probability of default. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across RBS map to both an asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures used for internal management reporting across portfolios. Debt securities are analysed by external ratings and are therefore excluded from the following table and are set out on pages 201 to 202.
AQ1 0% - 0.034% AAA to AA AQ2 0.034% - 0.048% AA to AA- AQ3 0.048% - 0.095% A+ to A AQ4 0.095% - 0.381% BBB+ to BBB- AQ5 0.381% - 1.076% BB+ to BB AQ6 1.076% - 2.153% BB- to B+ AQ7 2.153% - 6.089% B+ to B AQ8 6.089% - 17.222% B- to CCC+ AQ9 17.222% - 100% CCC to C AQ10 100% D
Impairment AQ1-AQ4 AQ5-AQ8 AQ9 AQ10 Past due Impaired provision Total 2017 £bn £bn £bn £bn £bn £bn £bn £bn
Credit risk: balance sheet analysis continued Impairment AQ1-AQ4 AQ5-AQ8 AQ9 AQ10 Past due Impaired provision Total 2016 £bn £bn £bn £bn £bn £bn £bn £bn
Loans and related credit metrics The tables below analyse gross loans and advances (excluding reverse repos) and related credit metrics by reportable segment.
Banks Customers to customers of REIL to customers (releases) written-off 2016*
Key points  UK PBB: mortgage growth of £8.8 billion was the principal driver of the gross lending increase in 2017. Impairment losses and write-offs were higher as debt flow into default continues to increase, particularly for loans arising from business written between Q4 2015 and mid 2016.
 Private Banking: lending growth of £1.3 billion primarily on mortgages.
 NatWest Markets: customer lending decreased by £8.0 billion primarily due to disposal activity.
 Total provision fell by £0.6 billion to £3.8 billion principally in legacy NatWest Markets. Commercial Banking provisions increased by £236 million in Q4 2017 reflecting transfer of legacy assets, including Shipping.
For commentary on residential mortgages and commercial real estate see Credit risk management basis section
Europe of which: commercial real estate 947 78 78 8.2 100 8.2 (83) 878
Risk elements in lending The table below analyses REIL between UK and overseas, based on the location of the lending office.
2017 2016 Impaired loans Accruing past due Impaired loans Accruing past due £m £m £m £m
Notes: (1) REIL are stated without giving effect to any security held that could reduce the eventual loss should it occur or to any provisions marked. (2) For details on impairment methodology refer to Credit risk on page 182 and Accounting policy 15 Impairment of financial assets on pages 255 and 256.
2017 2016 Ulster Central UK Bank Commercial Private RBS NatWest items
PBB RoI Banking Banking International Markets & other Total Total £m £m £m £m £m £m £m £m £m
Inter segment transfers — — 293 — — (293) — — —
AFS reserves (gross of tax) 108 44 119 6 125 — 402 11
Of which: more than 12 months — — — — (2) — (2) —
UK US Other institutions ABS 2016 £m £m £m £m £m £m £m £m
Designated as at fair value (DFV) — — 25 — 2 — 27 —
(2) Comprises HFT £256 million (2016 - £282 million), AFS nil (2016 - £99 million) and LAR nil (2016 - nil). (3) Comprises HFT £14 million (2016 - £25 million), AFS nil (2016 - nil) and LAR £18 million (2016 - £48 million).
Notes: (1) Designated as at fair value through profit or loss balances are £134 million (2016 - £171 million), of which £47 million are other financial institutions (2016 - £142 million) and £87 million are corporate (2016 - £29 million). (2) Includes government sponsored entities. (3) HFT short positions of £1 million (2016 - £3 million) did not relate to non-periphery eurozone countries.
Key points  Interest rate derivative fair values decreased, reflecting the upward shift in yields of US dollar, sterling and euro during 2017, as well as trade compression and novations to clearing houses.
 Net asset and liability exposures both decreased in line with the overall reduction in fair values. The corporate sector reductions largely reflected disposal activity in legacy NatWest Markets. The other financial sector reduction was partially due to timing of collateral posting.
Key points  Both FVA and CVA were lower due to trade novations and market movements in 2017.  Reduced funding levels and an increase in the level of funding costs included within the discount rate applied to derivative cash flows also contributed to the FVA reduction.
Market risk RBS is exposed to non-traded market risk as a result of its banking activities and to traded market risk through its trading activities. It manages its non-traded and traded market risk exposures separately. Each type of market risk is discussed separately. The non-traded market risk section begins below. The traded market risk section begins on page 214.
Pension-related activities also give rise to market risk. Refer to page 220 for more information on risk related to pensions.
 Non-traded market risk VaR peaked at £83.1 million in H1 2017, mainly driven by an increase in bonds held within Treasury’s liquidity portfolio, which was aimed at investing surplus cash, rather than meeting increased liquidity requirements. The appreciation of foreign currency bonds within this portfolio, primarily US and German sovereign debt, also contributed. The target allocation between cash and bonds, which is determined by the cash requirement of the liquid asset buffer, was reached in H1 2017 and remained largely unchanged during H2 2017.
 RBS continued to invest in structural hedges in 2017, with an average notional of £129 billion, managed directly by Treasury. The disclosure now also shows the smaller structural hedging programmes in Private Banking, RBS International, UBI DAC and Ulster Bank Limited totalling an average of £20 billion in 2017.
Interest rate risk Non-traded interest rate risk (NTIRR) arises from the provision to customers of a range of banking products that have differing interest rate characteristics. When aggregated, these products form portfolios of assets and liabilities with varying degrees of sensitivity to changes in market interest rates. Mismatches in these characteristics can give rise to volatility in net interest income as interest rates vary.
Credit spread risk Credit spread risk arises from the potential adverse economic impact of a move in the spread between bond yields and swap rates, where the bond portfolios are accounted at fair value through equity.
Foreign exchange risk Non-traded foreign exchange risk exposures arise from two main sources:  Structural foreign exchange risk – arising from the capital deployed in foreign subsidiaries, branches and joint arrangements and related currency funding where it differs from sterling.
These limits are cascaded further down the organisation as required, as approved by the Technical Executive Risk Forum in the case of the Board risk measures and by the ALCo in the case of the key risk measures.
The limit framework at RBS level comprises value-at-risk (VaR), stressed value-at-risk (SVaR), sensitivity and stress limits, and earnings-at-risk limits.
 Option risk – which arises from option derivative positions or from optional elements embedded in assets, liabilities and/or off-balance sheet items, where RBS or its customer can alter the level and timing of their cash flows. Option risk can be further characterised into automatic option risk and behavioural option risk. One example of behavioural option risk is pipeline risk. This is the risk of loss arising from personal customers owning an option to draw down a loan (typically a mortgage loan) at a committed rate. Changes in interest rates can result in greater or fewer customers than anticipated taking up the committed offer. The risk depends on customer behaviour as the option will not automatically be exercised.
In order to manage exposures within these limits, RBS aggregates its interest rate positions and hedges them externally using cash and derivatives, primarily interest rate swaps.
Credit spread risk The bond portfolios primarily comprise high-quality securities that are maintained as a liquidity buffer to ensure RBS can continue to meet its obligations in the event that access to wholesale funding markets is restricted.
Additionally other high-quality bond portfolios are held for collateral purposes and to support payment systems.
Credit spread risk is monitored daily through sensitivities and VaR measures. The dealing authorities in place for the bond portfolios further mitigate the risk by imposing constraints by duration, asset class and credit rating. Exposures and limit utilisations are reported to senior management on a daily basis as well as to the ERF monthly and the Board Risk Committee quarterly.
The following table presents 1-day internal banking book VaR at a 99% confidence level, analysed by type of risk.
2017 2016 Average Maximum Minimum Period end Average Maximum Minimum Period end £m £m £m £m £m £m £m £m
Key points  On an average basis, total non-traded VaR increased during 2017, chiefly due to the increase in bonds held within Treasury’s liquidity portfolio, which was aimed at investing surplus cash, whilst the duration and quality of the assets remained largely unchanged. The increased investment in bonds increased the valuation sensitivity to movements between bond and swap rates as the bond portfolios are hedged with interest rate swaps.
 On a period-end basis, total non-traded VaR decreased, driven by credit spread VaR, which fell due to refinements in the source of the market data used for the VaR model. One of the largest loss dates dropped out of the historical time series for VaR during Q3 2017, which also contributed to the decline.
After hedging the net interest rate exposure of the bank externally, RBS Treasury allocates income to products or equity in structural hedges by reference to the relevant interest rate swap curve. Over time, the hedging programme has built up a portfolio of interest rate swaps that provide a basis for stable income attribution. The programme aims to track a time series of medium-term swap rates, but the yield will be affected by changes in product volumes and RBS’s capital composition.
The table below presents the incremental income associated with product structural hedges at segment level. These relate to the main banking businesses except Private Banking, RBS International, UBI DAC and Ulster Bank Limited.
UK Personal & Business Banking 440 390 * Re-presented to reflect the segmental reorganisation.
 The overall yield (including 3-month LIBOR) fell compared to 31 December 2016, reflecting the lower volume of equity hedges, new product hedges and maturing hedges reinvested at lower market rates.
 The increase in the average notional of the product hedge reflected growth in current account and deposit balances and increased hedging to reduce earnings sensitivity.
RBS uses both approaches to quantify its interest rate risk: VaR as its value-based approach and sensitivity of net interest income (NII) as its earnings-based approach.
These two approaches provide different yet complementary views of the impact of interest rate risk on the balance sheet at a point in time. The scenarios employed in the NII sensitivity approach incorporate business assumptions and simulated modifications in customer behaviour as interest rates change. In contrast, the VaR approach assumes static underlying positions and therefore does not provide a dynamic measurement of interest rate risk. In addition, while the NII sensitivity calculations are measured to a 12-month horizon and thus provide a shorterterm view of the risks on the balance sheet, the VaR approach can identify risks not captured in the sensitivity analysis, in particular the impact of duration and repricing risk on earnings beyond 12 months.
VaR is a statistical estimate of the potential change in the market value of a portfolio (and, thus, the impact on the income statement) over a specified time horizon at a given confidence level.
The non-traded interest rate risk VaR metrics for RBS’s retail and commercial banking activities are included within the banking book VaR table above. The VaR captures the risk resulting from mismatches in the repricing dates of assets and liabilities.
It includes any mismatch between structural hedges and stable non and low interest-bearing liabilities such as equity and money transmission accounts as regards their interest rate repricing behavioural profile.
The main driver of earnings sensitivity relates to interest rate pass-through assumptions on customer products. The scenario also captures the impact of the reinvestment of maturing structural hedges at higher or lower rates than the base-case earnings sensitivity and mismatches in the repricing dates of loans and deposits.
Non-traded market risk continued Euro Sterling US dollar Other Total 2017 £m £m £m £m £m
− 25 basis point shift in yield curves (8) (218) (13) (4) (243)
− 100 basis point shift in yield curves (11) (504) (49) (7) (571)
− 25 basis point shift in yield curves (1) (222) (11) (2) (236)
The table above focused solely on the projected sensitivity of net interest income over the next 12 months. In the case of multi-year forward projections, the negative impact of a downward change in rates or, conversely, the benefit of an immediate upward change in interest rates to current market rates would be greater. This is because, over time a greater proportion of maturing structural hedges will be reinvested at prevailing rates which may be higher or lower. Also, in the absence of dynamic assumptions relating to further management actions, the variance to the base-case income forecast arising from margin compression or expansion on managed rate products will continue to accrue.
The tables below show the net interest earnings sensitivity on a one-year, two-year and three-year forward-looking basis to a parallel upward or downward shift in interest rates of 25 basis points. The projection is a simplified sensitivity in which the balance sheet is assumed to be constant, with no change in customer behaviour or margin management strategy as a result of changes to the rates on offer.
The benefit of structural hedges increases (or decreases) as greater volumes of maturing hedges are reinvested at higher (or lower) rates over the three-year period.
Notes: (1) Primarily current accounts and savings accounts. (2) The projections for Years 2 and 3 consider only the main drivers of earnings sensitivity, namely structural hedging and margin management.
 Earnings sensitivity to 25 and 100 basis-point upward shifts in yield curves increased year on year, partly due to higher deposit volumes. Additionally, more benefit from higher rates was assumed to result from margin management in 2017 than in 2016.
 Sensitivity to a 100 basis-point downward shift in yield curves rose year on year, partly affected by the higher level of future interest rates in the central forecast. Interest rates fall further in a 100 basis-point downward shift in yield curves before they hit an assumed zero per cent floor; as customer deposit rates are less affected by the scenario, profit margins compress.
Non-traded market risk continued Sensitivity of available-for-sale and cash flow hedging reserves to interest rate movements (unaudited)
 The sensitivity of the available-for-sale reserve and the cash flow hedge reserve to upward and downward shifts in yield curves remain relatively stable year on year. The increase in sensitivity of the available-for-sale reserve reflected the increase in bonds held within Treasury’s liquidity portfolios.
Net investments in Net Structural foreign Residual structural Net investments in Non-controlling foreign operations investment currency exposures Economic foreign currency foreign operations interests (NCI) excluding NCI (1) hedges pre-economic hedges hedges (2) exposures 2017 £m £m £m £m £m £m £m
Notes: (1) Non-controlling interests (NCI) represents the structural foreign exchange exposure not attributable to owners’ equity. (2) Economic hedges mainly represent US dollar and euro preference shares in issue that are treated as equity under IFRS and do not qualify as hedges for accounting purposes.
 The reduction in net investment hedges mainly reflected the reduction in hedges of other non-sterling investments in foreign operations. Hedges are reduced as a result of the reduction in net investments in other non-sterling foreign operations due to disposals, dividends or other capital repatriations.
Unrealised gains included in Tier 1 or Tier 2 capital 60 53
Key point  The reduction in equity shareholdings mainly reflected disposals of equity stakes in private equity and other equity investments.
 During H1 2017, revised traded market risk appetite metrics were approved by the Board and cascaded to the franchises. In Q4 2017, the limits for NatWest Markets were revised to accommodate trading book positions from the legacy portfolio which has now been re-integrated into NatWest Markets.
Following the reintegration of legacy portfolios, traded market risk now almost entirely resides in the NatWest Markets franchise. The key categories of traded market risk are:  Interest rate risk – which is the risk that a position’s fair value will change due to a change in the absolute level of interest rates, in the spread between two rates, in the shape of the yield curve or in any other interest rate relationship.
 Foreign currency price risk – which is the risk that the fair value of a position will change due to the change in foreign currency rates, including gold.
 Equity price risk – which is the risk that the fair value of a position will change due to the change in equity prices.
Trading activities may also give rise to counterparty credit risk. For information on the management of this risk, refer to the Credit risk section on page 179.
Traded market risk positions are reported monthly to the Executive Risk Forum (ERF) and quarterly to the Board Risk Committee.
Market risk policy statements set out the governance and risk management framework through effective identification, measurement, reporting, mitigation, monitoring and control.
These limits are cascaded further down the organisation as required, as approved by the Technical Executive Risk Forum.
To ensure approved limits are not breached and that RBS remains within its risk appetite, triggers at RBS and lower levels have been set such that if exposures exceed a specified level, action plans are developed by the front office and Traded Market Risk.
Businesses’ profit and loss performance is monitored automatically through loss triggers which, if breached, require a remedial action plan to be agreed between the Market Risk function and the front office. The loss triggers are set using both a fall-from-peak approach and an absolute loss level.
Risk measurement RBS uses a comprehensive set of methodologies and techniques to measure traded market risk, namely VaR, SVaR and the incremental risk charge. Risks that are not adequately captured by VaR or SVaR are captured by the Risks not in VaR (RNIV) framework to ensure that RBS 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.
These methods have been designed to capture correlation effects and allow RBS to form an aggregated view of its traded market risk across risk types, markets and business lines while also taking into account the characteristics of each risk type.
For internal risk management purposes, VaR assumes a time horizon of one trading day and a confidence level of 99%.
When simulating potential movements in risk factors, a combination of absolute, relative and rescaled returns is used, depending on the risk factor.
The table below analyses 1-day 99% internal VaR for RBS’s trading portfolios, segregated by type of market risk exposure. 2017 2016
The Hypo P&L reflects the firm’s Actual P&L excluding any intraday activities.
The table below shows internal back-testing exceptions for a period of 250 days for 1-day 99% traded internal VaR vs. Actual and Hypo P&L for major NatWest Markets businesses.
As with VaR, the SVaR methodology produces estimates of the potential change in the market value of a portfolio, over a specified time horizon, at a given confidence level. SVaR is a VaR-based measure using historical data from a one-year period of stressed market conditions.
The RNIV framework is used to identify and quantify market risks that are inadequately captured by the internal VaR and SVaR models.
RBS uses a variety of models to manage and measure market risk. These include pricing models (used for valuation of positions) and risk models (for risk measurement and capital calculation purposes). They are developed and signed off in NatWest Markets, with material models subject to independent review by Model Risk Management.
Model Risk Management’s independent oversight provides additional assurance that RBS holds appropriate capital for the market risk to which it is exposed.
The table below analyses RBS’s balance sheet by non-trading and trading business. 2017 2016 Non-trading Trading Non-trading Trading Total business (1) business (2) Total business (1) business (2) £bn £bn £bn £bn £bn £bn Primary risk factor
Net loans and advances to customers 323.2 307.9 15.3 323.0 304.9 18.1 Interest rate
Derivatives 160.8 1.6 159.2 247.2 3.0 244.2 Interest rate, credit spreads
Deposits by banks 39.5 27.0 12.5 33.3 12.6 20.7 Interest rate
Short positions 28.5 — 28.5 22.1 — 22.1 Interest rate, credit spreads
Notes: (1) Non-trading businesses are entities that primarily have exposures that are not classified as trading book. For these exposures, with the exception of pension-related activities, the main measurement methods are sensitivity analysis of net interest income, internal non-traded VaR and fair value calculations. For more information refer to pages 206 to 213.
(2) Trading businesses are entities that primarily have exposures that are classified as trading book under regulatory rules. For these exposures, the main methods used by RBS to measure market risk are detailed under traded market risk measurement on pages 214 to 219.
Definition Pension obligation risk is the risk to RBS caused by its contractual or other liabilities to, or with respect to, a pension scheme (whether established for its employees or those of a related company or otherwise). It is also the risk that RBS will make payments or other contributions to, or with respect to, a pension scheme because of a moral obligation or because RBS considers that it needs to do so for some other reason.
Throughout 2017, various pension risk stress-testing initiatives were undertaken, focused both on internally-defined scenarios and on scenarios to meet integrated Bank of England stresstesting requirements. For more information on stress testing, refer to the following page.
The Pension Committee, which is chaired by the RBS Chief Financial Officer, acts as a sub-committee of the Executive Committee and formulates RBS’s view of pension risk. The Pension Committee considers mechanisms that could potentially be used for managing risk within the funds as well as financial strategy. The Pension Committee is a key component of RBS’s approach to managing pension risk and it reviews and monitors risk management, asset strategy and financing issues on behalf of RBS. The Pension Committee also serves as a formal link between RBS, RIEL and the trustee.
RBS maintains an independent view of the risk inherent in pension funds, with an associated risk appetite, and has defined metrics against which risk is measured. In addition to the scrutiny provided by the Pension Committee, RBS undertakes regular pension risk monitoring and reporting to the Board and the Board Risk Committee on the material pension schemes that RBS has an obligation to support.
Risk identification and measurement Pension risk reports are submitted to the Executive Risk Forum and the Board Risk Committee four times a year in the Risk & Conduct Management Quarterly Report. This includes an assessment of the overall deficit or surplus position, estimated capital requirements, and an assessment of the associated assets and liabilities.
P ro p or tio n o f l ia b ili ty c a sh fl ow s
Pension risk (unaudited) continued RBS also undertakes stress tests and scenario analyses on its material defined benefit pension schemes each year as part of its risk measurement framework. These stress tests are also used to satisfy the requests of regulatory bodies such as the Bank of England. The stress testing framework includes pension risk capital calculations for the purposes of the Internal Capital Adequacy Assessment Process as well as additional stress tests for a number of internal management purposes.
Pension stress tests take the form of both stochastic and deterministic stresses over time horizons ranging from instantaneous to seven years in duration. They are designed to examine the behaviour of the pension schemes’ assets and liabilities under a range of financial and demographic shocks. The results of the stress tests and their consequential impact on RBS’s balance sheet, income statement and capital position are incorporated into the overall RBS-wide stress test results.
Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields 1,199 750 449 Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields 1,289 1,329 (40)
Fall in AA credit spreads of 0.25% at all durations with no change in nominal or real swap yields or other credit spreads 9 2,074 (2,065) Fall in equity values of 10% (1) (905) — (905)
The chart below shows the pension liability cash flow profile, allowing for expected indexation of future payments. The majority of expected cash flows (84%) are anticipated within the next 40 years. The profile will vary depending on the assumptions made regarding inflation expectations and mortality.
The assets of the Main scheme, which represented around 90% of RBS’s pension plan assets at 31 December 2017, are invested in a diversified portfolio. This includes quoted and private equity, government and corporate fixed interest and index-linked bonds, property and other alternative assets.
Future developments The UK ring-fencing regime will require significant changes to the structure of RBS’s existing defined benefit pension schemes. From 2026 it will not be possible for any of the entities inside the ring-fence (or their wholly-owned subsidiaries) to participate in the same defined benefit pension scheme as entities outside the ring-fence.
The last triennial valuation of the Main scheme had an effective date of 31 December 2015. This valuation was concluded with the acceleration of the nominal value of all committed contributions in respect of past service (£4.2 billion), which was paid in the first quarter of 2016.
The trustee estimates that, as at 30 June 2017, the Main scheme had a surplus of £1.7 billion on the technical provisions assumptions agreed for the 31 December 2015 triennial valuation (the methodology for deriving these assumptions is shown in Note 4 on the consolidated accounts). A 25 basis point (0.25%) reduction in the technical provisions discount rate reduces the surplus position by around £2.4 billion.
This sensitivity to the discount rate assumption is greater than the sensitivity of the IAS 19 obligation of £2.0 billion to a 25 basis point change in the discount rate, shown in Note 4 on the consolidated accounts, as a result of two factors:  The technical provisions liability is greater than the IAS 19 obligation, meaning a proportionate change would have a larger absolute impact.
Key developments in 2017 Parts of the Conduct & Regulatory Affairs function were merged with the Risk function with effect from 1 January 2017. Regulatory Affairs moved to Corporate Governance & Secretariat while Remediation and Complaints moved to Services’ Chief Operating Office. The change was designed to take advantage of synergies across the risk, conduct and regulatory agendas.
 Following an enforcement notice from the Central Bank of Ireland in respect of tracker mortgages, a significant remediation programme was established.
 Work progressed to meet the requirements of the revised Markets in Financial Instruments Directive and Regulation (MiFID II/MiFIR) in advance of their introduction in early 2018.
 RBS updated its policies to reflect changes required in relation to the 4th Money Laundering directive, which came into force in H1 2017 to combat terrorist and criminal financing.
 The Criminal Finances Act 2017 came into force in H2 2017, introducing a new corporate offence of failure to prevent the facilitation of tax evasion. Policies and procedures in place to prevent such activity were reviewed and enhanced.
 The Financial Crime Risk Executive Committee (accountable to the Executive Risk Forum) ensures that the customer-facing businesses and the Services function fulfil strategic objectives by identifying and managing their financial crime risks effectively.
Controls Under the policy framework, there are 18 conduct policies. These are designed to provide both high-level direction and stipulate RBS-wide requirements. The policies provide the necessary clarity to staff on their conduct obligations and ensure RBS meets its regulatory obligations.
RBS can clearly demonstrate that its products and services are designed to meet customer needs, their level of complexity is appropriate for the target market and they work in the way they are expected to
RBS’s customers are sold products and services appropriate for their needs. Any information or advice provided is suitable, relevant and communicated in a clear, fair way. Delivery of after-sales support meets customer expectations
RBS has robust systems and controls in place to prevent financial crime
RBS has no appetite for actions that result in inappropriate outcomes for its customers or breach legal or regulatory requirements leading to censure or financial penalty
Risk appetite statements articulate the level of risk which functions and franchises must not exceed i.e. the RBSwide cascaded risk appetite
Risk appetite The conduct risk appetite framework was established in 2015 and has been embedded across RBS.
The conduct risk appetite framework and the Conduct Performance Assessment, which forms part of it, facilitate a consistent approach across RBS for assessing conduct risk.
The Group Audit Committee is provided with a whistleblowing report twice a year. The report comments on the operational effectiveness of our whistleblowing framework, internally branded as ‘Speak Up’, and any trends emerging from completed investigations. It details cases by internal reporting categories based on the RBS definition of whistleblowing included in the Speak Up policy.
Each business in RBS has enhanced its use of management information by linking it to the relevant Conduct risk appetite statements. This is required to help ensure appropriate customer outcomes are delivered and that the management information is compliant with the Basel Committee on Banking Supervision’s principles for effective risk data aggregation and risk reporting.
Risk mitigation Information is communicated to each customer-facing business and function about regulatory developments and discussions with regulators. This helps identify and execute any required changes to strategy or to business models.
Early identification and effective management of changes in legislation and regulation are critical to the successful mitigation of conduct risk. The effects of all changes are managed to ensure timely compliance readiness. Changes assessed as having a high or medium-high impact are managed closely.
Mandatory learning, across RBS, helps to ensure colleagues have the information necessary to carry out their duties in a way that complies with expected standards.
Key developments in 2017 RBS continued to work to embed its enhanced operational risk framework, improving links between risk appetite and risk exposure and building a more robust control environment.
The year also saw a continued focus on the risks arising from the execution of major projects, including: the Transformation portfolio; the restructuring of NatWest Markets; preparations for the implementation of the corporate structural reform agenda – for example the Independent Commission on Banking’s ringfencing proposals, recovery and resolution planning, as well as Brexit; the planned activities to meet the European Commission state aid obligations; and, the effect on RBS’s control environment due to cost reduction measures. These projects are essential in order for RBS to achieve its strategic objectives. Risk, Conduct & Restructuring ensured the associated risks to these projects were assessed and understood with mitigating activity in place wherever possible.
The external fraud threat remained high with data used by organised crime gangs to deceive customers through social engineering, and the continued evolution of financial malware. In 2017, there was an increase in fraud perpetrated by scams. RBS has a bank-wide response plan to address the increased threat, which focuses on profiling capabilities and educating customers about fraud protection as well as continued work to drive and support industry best practice. This aligned with fraud prevention programmes across RBS, with the objective of mitigating the effects of external fraud on customers and RBS itself. The plan was successfully implemented and key strategic initiatives enhanced RBS’s fraud prevention and detection capabilities, enabling it to limit the effects of fraudulent activity on its customers. As a result, RBS recorded a year-on-year decrease in the number of its customers falling victim to fraud in 2017.
The Operational Risk Executive Committee (OREC), which is a sub-committee of the Executive Risk Forum (ERF), acts on all operational risk matters. OREC’s duties include reviewing operational risk exposure against risk appetite; identifying and assessing both current and emerging material operational risks; reviewing and monitoring the operational risk profile; and reviewing and approving material operational risk policy management framework changes.
Risk appetite The operational risk appetite framework supports effective management of key operational risks. It expresses the level and types of operational risk RBS is willing to accept in order to achieve its strategic objectives and business plans.
RBS’s operational risk appetite is expressed through a set of qualitative risk appetite statements and quantitative measures which are defined at an aggregate, RBS-wide and individual business level. Appetite covers RBS’s most material operational risks, defined by a materiality assessment, which in turn considers past, current and future risk exposures. Appetite exposures for all material risks are regularly reported to business risk committees, the OREC, ERF and Board Risk Committee.
The aggregation of operational risk appetite allows RBS to monitor and report on its material risk exposures against predetermined limits. This drives management intervention and action at defined points, such as the breach of an early warning trigger.
The CEC process helps to ensure compliance with the RBS Policy Framework, Sarbanes-Oxley 404 requirements concerning internal control over financial reporting (as referenced in the Compliance report on page 106), and certain requirements of the UK Corporate Governance Code.
Risk identification and measurement Across all business areas, risk and control assessments are used to identify and assess material operational and conduct risks and key controls. To support identification of risk concentrations, all risks and controls are mapped to the risk directory. Risk assessments are refreshed at least annually to ensure they remain relevant and capture any emerging risks.
During 2017, work continued to increase the coverage of the enhanced end-to-end risk and control assessment methodology. This approach, which strengthens understanding of the risk profile of key products and services, is used to identify and quantify the most material operational risks. Subject matter experts and key stakeholders are engaged from across RBS to underpin management action in line with RBS’s financial and non-financial appetite statement. The results of the risk and control assessments support RBS’s on-going journey to build on, and enhance, its control environment.
Scenario analysis is used to assess how extreme but plausible operational risks will affect RBS. It provides a forward-looking basis for evaluating and managing operational risk exposures.
Percentage and value of events At 31 December 2017, events aligned to the ‘clients, products and business practices’ event category accounted for 84% of RBS’s operational risk losses (compared to 98% in 2016). The reduction reflects that the level of losses attributable to conductrelated events has significantly reduced compared to prior years. The reduction in conduct-related events also explains the increase in the proportion of events in the ‘execution, delivery and process management’ category.
Notes: (1) The calculation in the above table is based on the volume and value of events where the associated loss is more than or equal to £10,000. (2) 2016 has been restated from £6,282 million as a loss captured in 2016 has now been determined as a non-qualifying operational risk event.
Risk mitigation Risks are mitigated through the application of key preventative and detective controls. This is an integral step in the risk assessment methodology, which determines residual risk exposure. Control owners are accountable for the design, execution, performance and maintenance of key controls.
Business risk (unaudited) Definition Business risk is the risk that RBS makes inappropriate business or strategic choices or that RBS is not able to execute its chosen strategy in line with its budget.
In September 2017, RBS received final approval from the European Commission for its alternative remedies package, designed to promote competition for banking services to the SME marketplace. This approval allows RBS to resolve its final State Aid divestment obligation and brings clarity for customers and staff.
Risk identification Business risk is identified and managed at the product and transaction level. Estimated revenue, costs and capital are key considerations in the design of any new product or in any new investment decision.
Governance Reputational risk has Board-level oversight reinforced by a Reputational Risk Policy. The Board Risk Committee and Sustainable Banking Committee are responsible for overseeing how RBS manages its reputation. The Board’s oversight of reputational issues is supported by the senior RBS-wide Reputational Risk Forum (RRF) which opines on cases and issues that represent a material reputational risk to the whole organisation. The RRF, which has delegated authority from the Executive Risk Forum (ERF), also acts as a central forum to review sector or theme-specific reputational risk acceptance positions, including environmental, social and ethical risk positions, for example, in the Defence and Gambling sectors.
Risk mitigation Reputational risk is mitigated through the policy and governance framework, with ongoing staff training to ensure early identification, assessment and escalation of material issues. Lessons learned from committee meetings have also improved the way cases and issues are debated and decisions made.
Notes on the consolidated accounts 1 Net interest income 264 2 Non-interest income 264 7 Earnings per ordinary share 276 10 Financial instruments - maturity analysis 289 16 Property, plant and equipment 296 17 Prepayments, accrued income and other assets 297 18 Discontinued operations and assets and liabilities of disposal groups 20 Provisions for liabilities and charges 299 21 Accruals and other liabilities 300 24 Non-controlling interests 305 32 Net cash flow from operating activities 326 33 Analysis of the net investment in business interests and intangible assets 34 Interest received and paid 327 35 Analysis of changes in financing during the year 327 36 Analysis of cash and cash equivalents 327 38 Directors’ and key management remuneration 332 39 Transactions with directors and key management 332 41 Post balance sheet events 333
Opinion We have audited the financial statements (see table below) of The Royal Bank of Scotland Group plc (the Parent Company) and its subsidiaries (together, the ‘Group’) for the year ended 31 December 2017. In our opinion:  the financial statements give a true and fair view of the state of the Group’s and of the Parent Company’s affairs as at 31
December 2017 and of the Group’s profit for the year then ended;  the financial statements have been properly prepared in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union;  the Parent Company financial statements have been properly prepared in accordance with IFRSs as adopted by the European
Union and as applied in accordance with the provisions of the Companies Act 2006; and  the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the
We have audited the financial statements of The Royal Bank of Scotland Group plc which comprise: Group Parent Company
• the viability statement (set out on page 49) in the annual report as to how they have assessed the prospects of the entity, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the entity will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions.
Audit scope  The significant components of our audit cover the reportable segments identified in the financial statements together with the central functions of the Group based in the UK and overseas and include Finance, the Services function and Treasury.
 We performed an audit of the complete financial information of four components and audit procedures on specific balances for a further three components.
Management judgement is needed to determine whether an obligation exists and a provision should be recorded at 31 December 2017 in accordance with the accounting criteria set under IAS 37. This includes determining if:  It is probable that an economic outflow such as a payment will occur; and  The amount of the payment (or other economic outflow) can be estimated reliably. The measurement of the provision is based on the best estimate of the expenditure required to settle the present obligation.
The most significant areas of judgement are:  Completeness of provisions recognised: judgement is in the determination of whether an outflow in respect of identified material conduct matters are probable or can be estimated reliably;  Measurement of provisions recognised: appropriateness of assumptions and judgements used in the estimation of material provisions; and
We examined the relevant regulatory correspondence to assess developments in key cases, the Group’s complaint handling reports and litigation reports to identify potentially material cases. For cases where a provision was not recognised, we considered whether the outcome was probable and reliably estimable in accordance with the accounting criteria.
For the significant provisions made, we understood, assessed and challenged the provisioning methodology. We tested the underlying data and assumptions used in the determination of the provisions recorded, including expected claim rates, legal costs, and the timing of settlement. We also considered peer bank settlements in similar cases.
Where appropriate, we involved our conduct risk specialists. For key cases, we considered the regulatory developments and management’s interaction with the Regulators and concluded on the reasonableness of the assumptions used by management also by comparing the results of our independently performed benchmarking and sensitivity analysis. We also verified historical data and whether they supported current estimates.
We tested the disclosure provided on conduct, litigation and regulatory provisions to determine whether it complied with accounting standards. Given the inherent estimation uncertainty and the judgmental nature of these provisions, we evaluated the appropriateness of the disclosure made in the financial statements.
 The provision related to the FCA review of the Group’s treatment of SMEs is sensitive to a number of assumptions. Management’s estimate is within an acceptable range based on the current information available to us.
Report of the Group Audit Committee (page 65) Accounting policies (page 251) Note 20 of the financial statements (page 299)
The recognition and carrying value of deferred tax assets, goodwill and, in the parent company accounts, investments in subsidiaries are based on estimates of future profitability which require significant management judgement. At year end the Group had reported Goodwill of £5.6 billion (2016: £5.6 billion) and deferred tax assets of £1.7 billion (2016: £1.8 billion). The parent company has reported investments in subsidiaries of £47.6 billion (2016: £44.6 billion).
In testing for impairment, the Group estimates the value in use of its cash generating units based on the business forecasts:  Revenue and cost forecasts impacted by the Group’s transformation programme and reorganisation, business and strategic changes underway and the changing competitive environment;  Key assumptions used in the recoverability and valuation assessments (discount rates, growth rates, macroeconomic assumptions, etc.); and
We tested the design and operating effectiveness of the Group’s key controls around the preparation and review of the forecasts. We tested the controls over the value in use model including the significant assumptions, inputs, calculations, methodologies and judgements.
With the support of our valuation specialists, we tested whether key macroeconomic assumptions used in the Group’s forecasting process were reasonable. We evaluated how the discount rates and long term growth rates used by management compared to peer practice, external market data and corroborative calculations. We considered the Group’s cost reduction programme and the extent to which annual cost reductions had been met. We assessed the achievability of future cost reduction plans including considering how these compared to peer banks and the external commentary. We also considered the results of the independent review of the forecasts undertaken by the Risk function and management’s challenge of the carrying values and key assumptions in relevant executive committees of the Group.
We tested how previous management forecasts compared to actual results to evaluate the accuracy of the forecasting process. We also assessed how these forecasts impacted the carrying value of deferred tax, goodwill and investments.
We evaluated how management considered alternative assumptions and performed sensitivity analysis on the assumptions used. We considered how key events, such as Banking Structural Reform and Brexit impacted management’s estimates. We performed our own scenario analysis for certain assumptions we considered could have a significant impact on the results of the impairment tests.
In addition, we attended and observed management meetings where key judgements were discussed, including those used in the value in use model and the carrying value of deferred tax assets. We also reviewed Board and Executive Committee minutes to assess the effectiveness of management’s review process and the appropriateness of the conclusions reached.
 Inherent uncertainty of the five year forecasts and the difficulty predicting revenue and costs over this period, particularly with respect to the impact of Banking Structural Reform, the economic consequences of Brexit and other political developments, and disruptions in the business model over an extended period.
A significant degree of judgement is required to determine the timing and amount of impairment to recognise with respect to loans and advances. At year end the Group reported total gross loans and advances of £384.0 billion (2016: £386.5 billion) and impairment provisions of £3.8 billion (2016: £4.5 billion).
We have focused on the following significant judgements and estimates which could give rise to material misstatement or management bias:  Completeness and timing of recognition of loss events in accordance with criteria set out in IAS 39;  For individually assessed provisions, the measurement of the provision may be dependent on the valuation of collateral, estimates of exit values and the timing of cash flows;  For modelled provisions measurement is primarily dependent upon key assumptions relating to probability of default, ability to repossess collateral and recovery rates; and
We tested the design and operating effectiveness of key controls focusing on the following:  Identification of loss events, including early warning and default warning indicators;  Annual credit reviews;  Assessment and approval of individual impairment provisions;  Governance including model validation and the assessment of the suitability of models, appropriateness of assumptions, consideration of post model adjustments and approval of provisions; and
In addition, we periodically attended and observed risk committee and provision committee meetings.
For modelled provisions we tested data inputs and agreed a sample of data used in the models and calculators to source systems. We used our credit risk specialists to test the assumptions and calculations. We evaluated the methodology to establish model parameters and assessed the appropriateness of the models used. We performed code reviews for a sample of models and calculators.
To test the completeness of the identification of loans with loss events we selected a sample of performing loans and independently assessed whether any IAS 39 loss indicators were present.
We are satisfied that credit impairment provisions were reasonable and in compliance with IFRS. We highlighted the following:  Our testing of controls did not identify significant deficiencies.  Our testing of models and model assumptions did not highlight material differences. For individually assessed impairments, in a few instances we reported judgemental differences in respect of the extent of the impairment identified, however none of these differences were considered material.
 Overall, we were satisfied with the completeness of the identification of loss events.
The valuation of financial instruments with higher risk characteristics involves both significant judgment and risk of inappropriate revenue recognition through mis-marking. The judgement in estimating fair value of these instruments can involve complex valuation models and significant fair value adjustments both of which may be reliant on data inputs where there is limited market observability. At year end the Group reported level 3 assets £3.3 billion (2016: £4.5 billion) and level 3 liabilities £2.2 billion (2016: £3.0 billion).
The potential risk of inappropriate recognition of revenue is most likely to arise through the valuation of these instruments given the level of management judgement involved.
The key judgements and estimates are:  Complex model-dependent valuations, which are aligned with material pricing models as defined by the RBS Modelled Product Review Committee. These include interest-rate swaps linked to pre-payment behaviour and interest rate and foreign exchange options with exotic features such as those having multiple call dates or with a variable notional; We performed trade life-cycle product walkthroughs to confirm our understanding of RBS’s process and controls in the area of revenue recognition relating to financial instruments with higher risk characteristics.
We tested the design and operating effectiveness of the Group’s controls over financial instrument valuations, including independent price verification, model approval/review, collateral management, and income statement analysis and reporting.
We performed further procedures as set out below for each risk characteristic with involvement from our financial instrument valuation and modelling specialists. These procedures were performed at multiple points in the year to validate the appropriateness of revenue recognition.
Valuation of financial instruments with higher risk characteristics including related income from trading activities (continued)
 Pricing inputs and calibrations for illiquid instruments, which are largely aligned with material positions defined as level 3 within the Group’s IFRS 7 fair value hierarchy disclosure. These include rarely traded debt securities, and derivative instruments whose valuation is dependent upon the correlation between certain interest rates or uncertainty surrounding the discount rate associated with complex collateral arrangements;  Fair value adjustments made to uncollateralised derivatives to reflect funding risk, counterparty credit risk and other product and deal specific considerations. These include RBS’s Funding Valuation Adjustments (FVA),Credit Valuation Adjustments (CVA) relating to derivative counterparties whose credit spread is less readily able to be determined, and material product and deal specific adjustments on long dated uncollateralised derivative portfolios; and
Our re-pricing of instruments valued using illiquid pricing inputs covered material products associated with this risk and the results were compared to the valuations recorded by management. For a sample of derivatives, our valuation testing used independent models and data. For cash positions analytical procedures were performed to validate the population of identified illiquid positions and, prices of comparable positions and other data points were used to independently value these.
Where differences between our independent valuation and management’s valuation were outside our thresholds, we performed additional testing over each variance to support our assessment of the appropriateness of the fair value. This work included our own analysis of: (i) recent trade activity, involving trade exits to back-test key valuation judgements, (ii) collateral disputes and material differences with counterparty valuations, (iii) income statement attribution, particularly unexplained income statement in the year for the relevant instruments and (iv) associated valuation adjustments e.g. model fair value adjustments to reflect the associated uncertainty given lack of market data.
We are satisfied that the fair value of financial instruments with higher risk characteristics and the recognition of related income is reasonable and in accordance with IFRS. We highlighted the following to the Group Audit Committee:  Our independent valuation of a sample of derivatives were either within our threshold or, where initially outside, were corroborated by other data, for example, trade exit activity, valuation adjustments for model or data limitations, or benchmarking to peer practice. Valuations of hard-to-price cash positions were within our thresholds; and
 The Group’s recognition of fair value adjustments on uncollateralised derivatives is within a reasonable range of outcomes based upon our testing procedures which included revaluation exercises, benchmarking to peer practice and experience from recent trade activity.
The Group undertakes fair value and cash flow hedge accounting programs to mitigate income statement volatility arising from the Group’s activities.
We challenged the assumptions applied in testing hedge effectiveness in accordance with IAS 39.
We are satisfied that the Group has appropriately applied hedge accounting in accordance with IFRS. We highlighted that hedge ineffectiveness is correctly recorded in the income statement and we concurred with management’s assessment that there are no hedge relationships that should have been discontinued. We concluded on the effectiveness of controls in place over hedge accounting as at year end.
We tested the design and operating effectiveness of the Group’s key controls around the recognition and measurement of these restructuring costs. This included the review and approval of provisions recorded by finance and the estimate of the costs to record. We enquired of management involved in transactions to verify a proper understanding of the transactions and its impacts, both on accounting and disclosures.
We obtained a breakdown of the direct and indirect restructuring costs recorded during the year. We selected a sample of provisions and restructuring costs and assessed them for compliance with IAS 37 by considering the criteria which outline when a constructive obligation has been met in order to recognise a provision. For staff costs, this included determining whether the plans had been communicated with employees. For premises and equipment, this included determining whether the unavoidable costs to execute the planned exit exceed the benefit.
We assessed the measurement of the provision by testing the underlying data and assumptions used in estimating the amount recorded. We also assessed any impact to goodwill and intangibles.
We are satisfied that the restructuring costs are appropriately recorded and in compliance with IFRS. We highlighted the following:  Timing of the recognition of certain restructuring provisions and the control in place to estimate the amount of the provision and consider the relevant accounting judgements.
We are satisfied that the valuation and disclosure of the retirement benefit obligations recorded at 31 December 2017 is reasonable and in accordance with requirements of the relevant accounting standards.
In determining the accounting for the pension schemes, we understood management’s assessment of the impact of IFRIC 14 on the amount of the surplus recognised in the financial statements and verified its compliance with the applicable accounting standards.
Report of the Group Audit Committee (page 65) Accounting policies (page 251) Note 4 of the financial statements (page 269)
Our audit procedures have a focus on IT systems and controls due to the pervasive nature and complexity of the IT environment, the large volume of transactions processed in numerous locations daily and the reliance on automated and IT dependent manual controls. Our areas of audit focus included user access management, developer access to the production environment and changes to the IT environment. These are key to ensuring IT dependent and application based controls are operating effectively.
Where deficiencies were identified, we tested compensating controls or performed alternate procedures. In addition, we understood where relevant, changes were made to the IT landscape during the audit period and tested those changes that had a significant impact on financial reporting.
Central items and other (including Global Financial Services, Services and Treasury)
litigation costs, was integrated into NatWest Markets (NWM).  Capital Resolution RMBS litigation related costs was included, at a reportable operating segment level, within Central items & other.
Involvement with component teams In establishing our overall approach to the Group audit, we determined the type of work that needed to be undertaken in each of the components by us, as the primary audit engagement team, or by component auditors in the United Kingdom or from other EY global network firms operating under our instruction. Of the four full scope components, audit procedures were performed on one of these directly by the primary audit engagement team. Of the three specific scope components, where work was performed by component auditors, we determined the appropriate level of involvement to enable us to determine that sufficient audit evidence had been obtained as a basis for our opinion on the Group as a whole.
The primary audit engagement team interacted regularly with the component audit teams where appropriate throughout the course of the audit, which included holding planning meetings, maintaining regular communications on the status of the audits, reviewing key working papers and taking responsibility for the scope and direction of the audit process. The primary audit engagement team also participated in meetings with key management personnel in the components and, for certain overseas locations, implemented a programme of planned visits. These visits involved discussing the audit approach with the component team and any issues arising from their work, as well as meeting with local management. This, together with the additional procedures performed at Group level, gave us appropriate evidence for our opinion on the Group financial statements.
Materiality The magnitude of omission or misstatement that, individually or in the aggregate, could reasonably be expected to influence the economic decisions of the users of the financial statements. Materiality provides a basis for determining the nature and extent of our audit procedures.
We determined materiality for the Group and parent company to be £300 million (2016 materiality: £270 million), which is 0.6% of the total equity of the Group and 0.6% of the parent company. We considered that equity represented a relevant measure used by investors, regulators and other stakeholders when assessing the performance of the Group and parent company. Our materiality was based on the equity of the Group given the significant losses and volatility of results in recent years. During the course of our audit, we reassessed initial materiality and increased it from our initial level of £270 million in light of the fact that many legacy items are now reflected in equity.
On the basis of our risk assessments, together with our assessment of the Group’s overall control environment, our judgement was that performance materiality was 50% of our planning materiality, namely £150 million (2016: £135 million). We have set performance materiality at this percentage (which is at the lowest end of the range of our audit methodology) based on various considerations including the past history of misstatements, our ability to assess the likelihood of misstatements, the effectiveness of the control environment and other factors affecting the entity and its financial reporting.
We agreed with the Group Audit Committee that we would report to them all corrected and uncorrected audit misstatements in excess of £15 million, which is set at 5% of planning materiality, as well as misstatements below that threshold that, in our view, warranted reporting on qualitative grounds.
We also tested the design and operating effectiveness of key controls over the completeness and accuracy of the transition disclosure included in the financial statements.
In this context, we also have nothing to report in regard to our responsibility to specifically address the following items in the other information and to report as uncorrected material misstatements of the other information where we conclude that those items meet the following conditions:  Fair, balanced and understandable (set out on page 116) – the statement given by the directors that they consider the annual report and financial statements taken as a whole are fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy, is materially inconsistent with our knowledge obtained in the audit; or
Opinions on other matters prescribed by the Companies Act 2006 In our opinion, based on the work undertaken in the course of the audit:  the part of the directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006.  the information given in the strategic report and the directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements; and  the strategic report and the directors’ report have been prepared in accordance with applicable legal requirements.
Responsibilities of directors As explained more fully in the directors’ responsibilities statement (set out on page 116), the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view, and for the implementation of such internal control as the directors determine is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error.
In preparing the financial statements, the directors are responsible for assessing the Group and parent company’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the Group or the parent company or to cease operations, or have no realistic alternative but to do so.
Our approach was as follows:  We obtained an understanding of the legal and regulatory frameworks that are applicable to the Group and have a direct impact on the preparation of the financial statements. We determined that the most significant are: o Companies Act 2006 o Financial Reporting Council (FRC) and the UK Corporate Governance Code o Sarbanes Oxley Act (SOX) o Tax Legislation (governed by HM Revenue and Customs) o Financial Conduct Authority (FCA) rules o CRDIV (Basel III) and Prudential Regulatory Authority (PRA) rules
 We understood how the Group is complying with those frameworks by reviewing the RBS Policy Framework, holding discussions with the Group’s general counsel, external counsel compliance group, regulatory group, internal audit, amongst others. We inquired as to any known instances of non-compliance or suspected non-compliance with laws and regulations. We also reviewed the Group’s Complaints Management Policy and Whistleblowing Policy.
 We assessed the susceptibility of the group’s financial statements to material misstatement, including how fraud might occur by holding discussions with senior management, including the Chief Executive Officer, Chief Financial Officer, Chief Risk Officer, Head of Internal Audit and Group Audit Committee Chairman. We also reviewed the Group’s fraud-related policies and mandates of different governance forums assessing fraud.
 As part of our audit procedures, we were aware of the risk of fraud, especially in the areas of estimation and those we assessed as having the risk of management override.
 Based on this understanding we designed our audit procedures to identify non-compliance with such laws and regulations. Our procedures involved inquiring of key management, reviewing the key policies and reports on the aforementioned regulatory frameworks as well as reviewing the correspondence exchanged with the Regulators.
 We communicated with the component teams to assess if there were any specific considerations for these areas which were then incorporated in the Group-wide approach.
Other matters we are required to address  Following the recommendation of the Group Audit Committee we were appointed by the Group at its annual general meeting on 4
Profit from discontinued operations, net of tax 18 — — 1,541
Basic and diluted earnings/(loss) from continuing and discontinued operations 7 6.3p (59.5p) (27.7p)
Basic and diluted earnings/(loss) from continuing operations 7 6.3p (59.5p) (17.2p)
The accompanying notes on pages 264 to 333, the accounting policies on pages 251 to 263 and the audited sections of the Business review: Capital and risk management on pages 149 to 228 form an integral part of these financial statements.
Loss on fair value of credit in financial liabilities designated at fair value through profit or loss due to own credit risk (126) — —
Recycled to profit or loss on ceding control of Citizens (7) — — (36)
Recycled to profit or loss on disposal of businesses (8) (22) (40) 4
Recycled to profit or loss on ceding control of Citizens (8) — — (962)
(3) Paid-in equity reclassified to liabilities as a result of the call of US$564 million and CAD321 million EMTN notes in August 2017 (redeemed in October 2017), the call of RBS Capital Trust D in March 2017 (redeemed in June 2017), the call of RBS Capital Trust C in May 2016 (redeemed in July 2016), the call of RBS Capital Trust IV in January 2015 (redeemed in March 2015).
(4) AT1 capital notes totalling £2.0 billion issued in August 2016 (2015 - £2.0 billion). (5) On 15 June 2017, the Court of Session approved a reduction of RBSG plc capital so that the amounts which stood to the credit of share premium, account and capital redemption reserve were transferred to retained earnings. (6) 2015 Net of tax - £6 million charge. (7) 2015 Net of tax - £16 million credit. (8) No tax impact. (9) Includes £2,491 million relating to the secondary offering of Citizens in March 2015.
Adjustments for non-cash items and other adjustments included within income statement (4,498) (3,024) (5,601)
Effects of exchange rate changes on cash and cash equivalents (16) 8,094 576
1. Presentation of accounts The accounts, set out on pages 244 to 356 including these accounting policies on pages 251 to 263 and the audited sections of the Financial review: Capital and risk management on pages 149 to 228, are prepared on a going concern basis (see the Report of the directors, page 109) and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (EU) (together IFRS). The EU has not adopted the complete text of IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the standard's hedging requirements. The Group has not taken advantage of this relaxation: its financial statements are prepared in accordance with IFRS as issued by the IASB.
The Group adopted two revisions to IFRSs effective 1 January 2017: In January 2016, the IASB amended IAS 7 ‘Cash Flow Statements’ to require disclosure of the movements in financing liabilities. This is shown in Note 35.
2. Basis of consolidation The consolidated accounts incorporate the financial statements of the company and entities (including certain structured entities) that are controlled by the Group. The Group controls another entity (a subsidiary) when it is exposed, or has rights, to variable returns from its involvement with that entity and has the ability to affect those returns through its power over the other entity; power generally arises from holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. A subsidiary is included in the consolidated financial statements from the date it is controlled by the Group until the date the Group ceases to control it through a sale or a significant change in circumstances. Changes in the Group’s interest in a subsidiary that do not result in the Group ceasing to control that subsidiary are accounted for as equity transactions.
Credit and debit card fees - fees from card business include:  Interchange received: as issuer, the Group receives a fee
 Periodic fees payable by a credit card or debit card holder are deferred and taken to profit or loss over the period of the service.
4. Assets held for sale and discontinued operations A non-current asset (or disposal group) is classified as held for sale if the Group will recover its carrying amount principally through a sale transaction rather than through continuing use. A non-current asset (or disposal group) classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell. If the asset (or disposal group) is acquired as part of a business combination it is initially measured at fair value less costs to sell. Assets and liabilities of disposal groups classified as held for sale and non-current assets classified as held for sale are shown separately on the face of the balance sheet.
A discontinued operation is a cash generating unit or a group of cash generating units that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.
5. Employee benefits Short-term employee benefits, such as salaries, paid absences, and other benefits are accounted for on an accruals basis over the period in which the employees provide the related services. Employees may receive variable compensation satisfied by cash, by debt instruments issued by the Group or by RBSG shares. The treatment of share-based compensation is set out in Accounting policy 25. Variable compensation that is settled in cash or debt instruments is charged to profit or loss over the period from the start of the year to which the variable compensation relates to the expected settlement date taking account of forfeiture and clawback criteria.
Expenditure on internally generated goodwill and brands is written-off as incurred. Direct costs relating to the development of internal-use computer software are capitalised once technical feasibility and economic viability have been established. These costs include payroll, the costs of materials and services, and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended.
Goodwill arises on the acquisition of a joint venture when the cost of investment exceeds the Group’s share of the net fair value of the joint venture’s identifiable assets and liabilities. Goodwill is measured at initial cost less any subsequent impairment losses. Goodwill arising on the acquisition of associates is included within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.
A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment can be recognised when an increase in service potential arises provided the increased carrying value is not greater than it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
9. Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated but is stated at fair value. Fair value is based on current prices for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease in Other operating income. Lease incentives granted are recognised as an integral part of the total rental income.
Group entities record transactions in foreign currencies in their functional currency, the currency of the primary economic environment in which they operate, at the foreign exchange rate ruling at the date of the transaction.
12. Provisions The Group recognises a provision for a present obligation resulting from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount of the obligation can be estimated reliably.
Held-to-maturity investments - a financial asset may be classified as a held-to-maturity investment only if it has fixed or determinable payments, a fixed maturity and the Group has the positive intention and ability to hold to maturity. Held-to-maturity investments are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see Accounting policy 3) less any impairment losses.
Designated as at fair value through profit or loss - financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both, that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract. Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses are recognised in profit or loss as they arise.
Available-for-sale financial assets - financial assets that are not classified as held-to-maturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Availablefor -sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see Accounting policy 3) as are gains and losses attributable to the hedged risk on available-for-sale financial assets that are hedged items in fair value hedges (see Accounting policy 23). Other changes in the fair value of available-for-sale financial assets and any related tax are reported in other comprehensive income until disposal, when the cumulative gain or loss is reclassified from equity to profit or loss.
15. Impairment of financial assets The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets classified as held-to-maturity, as available-for-sale or as loans and receivables is impaired.
Financial assets carried at amortised cost - if there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivables or as held-tomaturity investments has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition. For collateralised loans and receivables, estimated future cash flows include cash flows that may result from foreclosure less the costs of obtaining and selling the collateral, whether or not foreclosure is probable.
Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective impairment assessments, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of observable data, to reflect current conditions not affecting the period of historical experience. Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If, in a subsequent period, the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment.
 Business and commercial loans: write offs of commercial loans are determined in the light of individual circumstances; the period does not exceed five years. Business loans are generally written off within five years.
16. Financial liabilities Financial liabilities are recognised initially at fair value and classified into held-for-trading; designated as at fair value through profit or loss; or amortised cost. Issues of financial liabilities measured at amortised cost are recognised on settlement date; all other normal transactions in financial liabilities are recognised on trade date.
Fair value - the Group’s approach to determining the fair value of financial instruments measured at fair value is set out in the section of Critical accounting policies and key sources of estimation uncertainty entitled Fair value - financial instruments; further details are given in Note 9 on the accounts.
17. Financial guarantee contracts Under a financial guarantee contract, the Group, in return for a fee, undertakes to meet a customer’s obligations under the terms of a debt instrument if the customer fails to do so. A financial guarantee is recognised as a liability; initially at fair value and, if not designated as at fair value through profit or loss, subsequently at the higher of its initial value less cumulative amortisation and any provision under the contract measured in accordance with Accounting policy 12. Amortisation is calculated so as to recognise fees receivable in profit or loss over the period of the guarantee.
18. Loan commitments Provision is made for loan commitments, other than those classified as held-for-trading, if it is probable that the facility will be drawn and the resulting loan will be recognised at an amount less than the cash advanced. Syndicated loan commitments in excess of the level of lending under the commitment approved for retention by the Group are classified as held-for-trading and measured at fair value.
If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement; if the Group has not retained control of the asset, it is derecognised.
A financial liability is removed from the balance sheet when the obligation is discharged, or is cancelled, or expires. On the redemption or settlement of debt securities (including subordinated liabilities) issued by the Group, the Group derecognises the debt instrument and records a gain or loss being the difference between the debt's carrying amount and the cost of redemption or settlement. The same treatment applies where the debt is exchanged for a new debt issue that has terms substantially different from those of the existing debt. The assessment of whether the terms of the new debt instrument are substantially different takes into account qualitative and quantitative characteristics including a comparison of the present value of the cash flows under the new terms with the present value of the remaining cash flows of the original debt issue discounted at the effective interest rate of the original debt issue.
Securities borrowing and lending transactions are usually secured by cash or securities advanced by the borrower. Borrowed securities are not recognised on the balance sheet or lent securities derecognised.
22. Capital instruments The Group classifies a financial instrument that it issues as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms and as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.
Gains and losses arising from changes in the fair value of derivatives that are not the hedging instrument in a qualifying hedge are recognised as they arise in profit or loss. Gains and losses are recorded in Income from trading activities except for gains and losses on those derivatives that are managed together with financial instruments designated at fair value; these gains and losses are included in Other operating income. The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or unrecognised firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a highly probable forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.
Hedge accounting is also discontinued if the Group revokes the designation of a hedge relationship.
24. Associates and joint ventures An associate is an entity over which the Group has significant influence. A joint venture is one which it controls jointly with other parties. Investments in associates and interests in joint ventures are recognised using the equity method. They are stated initially at cost, including attributable goodwill, and subsequently adjusted for post-acquisition changes in the Group’s share of net assets.
If an award is modified, the original cost continues to be recognised as if there had been no modification. Where modification increases the fair value of the award, this increase is recognised as an expense over the modified vesting period. A new award of shares or share options is treated as the modification of a cancelled award if, on the date the new award is granted, the Group identifies them as replacing the cancelled award. The cancellation of an award through failure to meet nonvesting conditions triggers an immediate expense for any unrecognised element of the cost of an award.
26. Cash and cash equivalents In the cash flow statement, cash and cash equivalents comprises cash and deposits with banks with an original maturity of less than three months together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
Goodwill is the excess of the cost of an acquired business over the fair value of its net assets. Goodwill is not amortised but is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.
Impairment testing in accordance with Accounting policy 8 inherently involves a number of judgmental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of cash-generating units; and the valuation of their separable assets. The sensitivity of the assessment to changes in assumptions is discussed in Note 15 on the accounts.
Provisions are liabilities of uncertain timing or amount, and are recognised when there is a present obligation as a result of a past event, the outflow of economic benefit is probable and the outflow can be estimated reliably. Judgement is involved in determining whether an obligation exists, and in estimating the probability, timing and amount of any outflows. Where the Group can look to another party such as an insurer to pay some or all of the expenditure required to settle a provision, any reimbursement is recognised when, and only when, it is virtually certain that it will be received.
Payment Protection Insurance - the Group has established a provision for redress payable in respect of the mis-selling of Payment Protection Insurance policies. The provision is management’s best estimate of the anticipated costs of redress and related administration expenses. The determination of appropriate assumptions to underpin the provision requires significant judgement by management. The principal assumptions underlying the provision together with sensitivities to changes in those assumptions are given in Note 20 on the accounts.
Deferred tax assets of £6,356 million (2016 - £7,940 million) have not been recognised in respect of tax losses and other temporary differences where the availability of future taxable profits is uncertain. Further details about the Group’s deferred tax assets are given in Note 22 on the accounts.
(iv) Loan impairment provisions The Group's loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost in accordance with Accounting policy 16. At 31 December 2017, customer loan impairment provisions amounted to £3,814 million (2016 - £4,455 million).
A loan is impaired when there is objective evidence that events since the loan was granted have affected expected cash flows from the loan. Such objective evidence, indicative that a borrower’s financial condition has deteriorated, can include for loans that are individually assessed: the non-payment of interest or principal; debt renegotiation; probable bankruptcy or liquidation; significant reduction in the value of any security; breach of limits or covenants; and deteriorating trading performance and, for collectively assessed portfolios: the borrowers’ payment status and observable data about relevant macroeconomic measures.
The impairment loss is the difference between the carrying value of the loan and the present value of estimated future cash flows at the loan's original effective interest rate.
(v) Fair value - financial instruments In accordance with Accounting policies 14, 16 and 23, financial instruments classified as held-for-trading or designated as at fair value through profit or loss and financial assets classified as available-for-sale are recognised in the financial statements at fair value. All derivatives are measured at fair value.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A fair value measurement takes into account the characteristics of the asset or liability if market participants would take those characteristics into account when pricing the asset or liability at the measurement date.
The principle features of IFRS 9 are as follows: Recognition and derecognition The sections in IAS 39 setting out the criteria for the recognition and derecognition of financial instruments have been included unamended in IFRS 9.
Classification and measurement Financial assets - There are three classifications for financial assets in IFRS 9.  Amortised cost - Financial assets with terms that give rise to interest and principal cash flows only and which are held in a business model whose objective is to hold financial assets to collect their cash flow are measured at amortised cost.
 Fair value through other comprehensive income - Financial assets with terms that give rise to interest and principal cash flows only and which are held in a business model whose objective is achieved by holding financial assets to collect their cash flow and selling them are measured at fair value through other comprehensive income.
 Fair value through profit and loss - Other financial assets are measured at fair value through profit and loss.
At initial recognition, any financial asset may be irrevocably designated as measured at fair value through profit or loss if such designation eliminates a measurement or recognition inconsistency.
Financial liabilities – Since early adopting in 2017 the IFRS 9 accounting for fair value attributable to own credit risk there are no further material changes on accounting for financial liabilities on adoption of IFRS 9.
A Group-wide programme implemented the necessary changes in the modelling of credit loss parameters, and the underlying credit management and financial processes.
In summary, on 1 January 2018, the impact on shareholders’ equity was a £71 million post tax reduction in equity, comprising:  Reclassification of financial instruments – £561 million pre tax increase in equity
 Change in impairment methodology – £616 million pre tax reduction.
The Group has opted to early adopt the IFRS 9 amendment on negative compensation with effect from 1 January 2018; this is expected to be endorsed for use in the EU in early 2018.
Effective 1 January 2018 – other standards IFRS 15 ‘Revenue from Contracts with Customers’ was issued in May 2014. It will replace IAS 11 ‘Construction Contracts’, IAS 18 ‘Revenue’ and several Interpretations. Contracts are bundled or unbundled into distinct performance obligations with revenue recognised as the obligations are met. A restatement is not expected on initial application of this standard.
IAS 40 ‘Investment Property’ was amended in December 2016 to clarify that transfers into or out of the investment property classification may only occur on a change of use or the property ceasing to meet the definition of an investment property.
On adoption, none of these standards are expected to have a material effect on the Group’s results.
IFRIC Interpretation 23 ‘Uncertainty over income tax treatments’ was issued in June 2017 to clarify how to apply judgement in assessing the tax position of the reporting entity. The effective date is 1 January 2019.
In October 2017, the IASB amended IAS 28 ’Investments in associates and joint ventures’ to require long term, non-equity interests in these investments to be tested for impairment first in accordance with IFRS 9 and then in accordance with IAS 28. The effective date of the amendment is 1 January 2019.
The Group is assessing the effect of adopting these standards on its financial statements.
Payment services 829 856 923 Credit and debit card fees 665 645 738 Lending (credit facilities) 1,060 1,044 1,076 Brokerage 148 154 262 Investment management 249 250 305 Trade finance 173 196 242 Other 214 195 196
Income from trading activities Foreign exchange 525 989 809 Interest rate (50) (480) 35 Credit 197 336 (80) Changes in fair value of own debt and derivative liabilities attributable to own credit - debt securities in issue (81) 87 252 - derivative liabilities 12 67 2 Equities and other 31 (25) 42
Pension costs - defined benefit schemes (see Note 4) 309 267 523 - loss/(gain) on curtailments or settlements (see Note 4) 66 1 (65)
Restructuring and divestment costs Included in operating expenses are the following restructuring and divestment costs: Premises, equipment, depreciation and amortisation 471 164 746
3 Operating expenses continued The average number of persons employed, rounded to the nearest hundred, in continuing operations during the year, excluding temporary staff, was 73,400 (2016 - 82,400; 2015 - 88,800); on the same basis there were no people employed in discontinued operations (2016 - nil; 2015 - 10,100). The average number of temporary employees during 2017 was 5,000 (2016 - 6,700; 2015 - 7,800). The number of persons employed in continuing operations at 31 December, excluding temporary staff, by reportable segment, was as follows: 2017 2016* 2015*
All Awards of ordinary shares Continuing employment or leavers in certain circumstances
Continuing employment or leavers in certain circumstances and/or achievement of performance conditions
3 Operating expenses continued The fair value of options granted in 2017 was determined using a pricing model that included: expected volatility of shares determined at the grant date based on historical volatility over a period of up to five years; expected option lives that equal the vesting period; no dividends on equity shares; and risk-free interest rates determined from UK gilts with terms matching the expected lives of the options.
Options are exercisable within six months of vesting; 3.7 million options were exercisable at 31 December 2017 (2016 – 8.1 million; 2015 - 1.0 million). The weighted average share price at the date of exercise of options was £2.77 (2016 - £1.78; 2015 - £3.54). At 31 December 2017, exercise prices ranged from £1.68 to £4.34 (2016 - £1.68 to £4.34; 2015 - £2.33 to £18.93) and the remaining average contractual life was 2.9 years (2016 - 2.9 years; 2015 – 2.9 years). The fair value of options granted in 2017 was £21 million (2016 - £18 million; 2015 - £12 million).
The awards granted in 2017 vest in three equal tranches on their anniversaries.
Variable compensation as a % of adjusted operating profit (4) 7% 9%
Reconciliation of variable compensation awards to income statement charge 2017 2016 2015 £m £m £m
Less: forfeiture of amounts deferred from prior years (7) (106) (102)
Less: forfeiture of amounts deferred from prior years (102) (106) (7) — —
The schemes generally provide a pension of one-sixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years and are contributory for current members. These have been closed to new entrants some ten years ago, although current members continue to build up additional pension benefits, currently subject to 2% maximum annual salary inflation, while they remain employed by the Group.
Unquoted assets Corporate and other bonds 1.0 1.8 Hedge funds — 0.2 Real estate 5.2 5.2 Derivatives 8.1 10.2 Cash and other assets 4.2 3.4 Equity exposure of equity futures (3.6) (1.8) Cash exposure of equity futures 3.6 1.9
Equity and bond call options 2 428 — 2 799 1
Swaps are used to manage interest rate and inflation risk of the liabilities, as well as being used to manage other risks within the Main scheme. They have been executed at prevailing market rates and within standard market bid/offer spreads with a number of counterparty banks, including The Royal Bank of Scotland plc.
Amounts in the Financial statements The Group recognises the net pension scheme surplus or deficit as a net asset or liability. In doing so, the funded status is adjusted to reflect any schemes with a surplus that the Group may not be able to access, as well as any minimum funding requirement to pay in additional contributions. This is most relevant to the Main scheme, where the current surplus is not recognised.
Main scheme All schemes Present value Asset Net Present value Asset Net Fair of defined ceiling/ pension Fair of defined ceiling/ pension value of benefit minimum liability/ value of benefit minimum liability/
Changes in value of net pension liability/(asset) plan assets obligation funding (1) (asset) plan assets obligation funding (1) (asset)
Notes: (1) In recognising the net surplus or deficit of a pension scheme, the funded status of each scheme is adjusted to reflect any minimum funding requirement imposed on the sponsor and any ceiling on the amount that the sponsor has an unconditional right to recover from a scheme. (2) The Group expects to make contributions to the Main scheme of £190 million in 2018.
The most significant assumptions used for the Main scheme are shown below: Principal IAS 19 actuarial assumptions
Discount rate 2.6 2.7 Fixed interest swap yield curve plus 1.5% per annum at all durations
Proportion of pension converted to a cash lump sum at retirement
Longevity at age 60 for future pensioners currently aged 40 (years) Males 28.6 29.0 29.9 Females 30.4 31.2 32.4
The sterling yield curve (applied to 96% of the Group’s defined benefit obligations) is constructed by reference to yields on ‘AA’ corporate bonds from which a single discount rate is derived based on a cash flow profile similar in structure and duration to the pension obligations. The weighted average duration of the Main scheme’s defined benefit obligation at 31 December 2017 is 21 years (2016 – 20.9 years).
Significant judgement is required when setting the criteria for bonds to be included in the population from which the yield curve is derived.
Main scheme (decrease)/increase in obligation at 31 December 2017 2016 £m £m 0.25% increase in the discount rate (1,964) (1,978)
The defined benefit obligation is attributable to the different classes of scheme members in the following proportions (Main scheme): Pensioners and dependants 36.5 36.0
History of defined benefit schemes 2017 2016 2015 2014 2013 2017 2016 2015 2014 2013 £m £m £m £m £m £m £m £m £m £m
Fair value of plan assets 44,652 43,824 30,703 30,077 24,272 49,746 49,229 34,708 34,359 28,488
Present value of plan obligations 37,937 38,851 30,966 31,776 26,958 42,378 43,990 35,152 36,643 31,484
Experience (losses)/gains on plan liabilities (107) 658 233 3 102 (93) 794 258 18 176
Actual return on plan assets - % 6.2% 32.2% 2.3% 23.8% 8.9% 6.1% 30.9% 2.2% 22.8% 8.6%
5 Auditor’s remuneration Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit-related and other services are approved by the Group Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Group Audit Committee recognises that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.
Fees payable to the auditor and its associates for other services to the Group — — - the audit of the company’s subsidiaries — 0.2 - audit-related assurance services (5) — 0.5
Losses and temporary differences in year where no deferred tax asset recognised (303) (742) (1,086)
Items not allowed for tax: - losses on disposals and write-downs (69) (45) (23)
Reduction in carrying value of deferred tax asset in respect of: Adjustments in respect of prior years (2) 116 31 226
(2) Prior year tax adjustments incorporate refinements to tax computations made on submission and agreement with the tax authorities. Current taxation balances include provisions in respect of uncertain tax positions, in particular in relation to restructuring and other costs where the taxation treatment remains subject to agreement with the relevant tax authorities.
Profit/(loss) from continuing operations attributable to ordinary shareholders 752 (6,955) (3,186)
Weighted average number of ordinary shares outstanding during the year 11,867 11,692 11,516
Effect of dilutive share options and convertible securities 69 51 60
Diluted weighted average number of ordinary shares outstanding during the year 11,936 11,743 11,576
Note: (1) All periods include the effect of 51 billion B shares that were converted to 5.1 billion ordinary shares in October 2015 (see Note 25).
There were no basic earnings/(loss) per ordinary share from discontinued operations (2016 - nil; 2015 – 10.5p). There were no diluted earnings per ordinary share from discontinued operations (2016 – nil; 2015 – 10.4p).
Earnings per share for periods ended after 25 June 2014 and prior to the retirement of the DAS reflect DAS dividends recognised before the end of a reporting period; this amounted to nil (2016 – £1,193; 2015- nil).
Cash and balances at central banks — — — 98,337 — 98,337 Loans and advances to banks - reverse repos 11,845 — — 2,152 — 13,997 - other (1) 6,889 — — 9,365 — 16,254 Loans and advances to customers - reverse repos 24,427 — — 2,308 — 26,735 - other 15,320 56 — 307,808 — 323,184 Debt securities 27,481 — 43,681 3,643 4,128 78,933 Equity shares 29 134 287 — — 450 Settlement balances — — 2,517 2,517 Derivatives 157,876 2,967 160,843 Other assets — — — — — 16,806 16,806
Cash and balances at central banks — — — 74,250 — 74,250 Loans and advances to banks - reverse repos 11,120 — — 1,740 — 12,860 - other (1) 6,780 — — 10,498 — 17,278 Loans and advances to customers - reverse repos 26,586 — — 2,341 — 28,927 - other 17,504 82 — 305,437 — 323,023 Debt securities 24,504 27 39,254 3,968 4,769 72,522 Equity shares 166 172 365 — — 703 Settlement balances — — 5,526 5,526 Derivatives 242,192 4,789 246,981 Other assets — — — — — 16,586 16,586
(3) Comprises bonds and medium term notes of £25,922 million (2016 - £24,037 million) and certificates of deposit and other commercial paper of £4,637 million (2016 - £3,208 million).
Gross offset sheet agreements collateral collateral related collateral arrangements sheet total £m £m £m £m £m £m £m £m £m
These initial classifications are reviewed and challenged by the Pricing Unit and are also subject to senior management review. Particular attention is paid to instruments crossing from one level to another, new instrument classes or products, instruments that are generating significant profit and loss and instruments where valuation uncertainty is high.
Non-modelled products Non-modelled products are valued directly from a price input typically on a position by position basis and include cash, equities and most debt securities.
Modelled products Modelled products valued using a pricing model range in complexity from comparatively vanilla products such as interest rate swaps and options (e.g. interest rate caps and floors) through to more complex derivatives. The valuation of modelled products requires an appropriate model and inputs into this model. Sometimes models are also used to derive inputs (e.g. to construct volatility surfaces). RBS uses a number of modelling methodologies.
 Recovery rates/loss given default - these are used as an input to valuation models and reserves for asset-backed securities and other credit products as an indicator of severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.
Valuation reserves When valuing financial instruments in the trading book, adjustments are made to mid-market valuations to cover bid-offer spread, liquidity and credit risk. A breakdown of valuation adjustments is provided in Capital and risk management: Balance sheet analysis - derivatives on page 204.
Vanilla risk on exotic products is typically reserved as part of the overall portfolio based calculation e.g. delta and vega risk on exotic products are included within the delta and vega bid-offer calculations.
Product related risks such as correlation risk, attract specific bidoffer reserves. Additional reserves are provided for exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects (taking into account how changes in one risk factor may affect other inputs rather than treating all risk factors independently) that are unlikely to be adequately reflected in a static hedge based on vanilla instruments. Where there is limited bid-offer information for a product, the pricing approach and risk management strategy are taken into account when assessing the reserve.
Reserves are also held in relation to fair value funding costs that are not within the scope of FVA, potential losses arising from receivables where there is a counterparty dispute and certain uncollateralised derivatives after the pricing impact of a significant novation in 2017 was incorporated into transactions of a similar nature.
Amounts deferred on initial recognition On initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data becomes observable; or when the transaction matures or is closed out as appropriate. At 31 December 2017, net gains of £56 million (2016 - £72 million) were carried forward. During the year, net gains of £64 million (2016 - £27 million) were deferred and £80 million (2016 - £48 million) were recognised in the income statement.
Own credit RBS takes into account the effect of its own credit standing when valuing financial liabilities recorded at fair value in accordance with IFRS. Own credit spread adjustments are made when valuing issued debt held at fair value, including issued structured notes, and derivatives. An own credit adjustment is applied to positions where it is believed that counterparties would consider RBS's creditworthiness when pricing trades.
For issued debt this adjustment is based on debt issuance spreads above average inter-bank rates (at a range of tenors). Secondary senior debt issuance spreads are used in the calculation of the own credit adjustment applied to senior debt.
 RBS subordinated debt spreads at the five year level tightened to 169 basis points at 31 December 2017 (31 December 2016 – 281 basis points).
 DVA in respect of derivative liabilities has reduced to nil following the tightening in spreads in 2017, such that adjustments overlap with FVA and are thus eliminated from DVA.
Financial instruments: carried at fair value - valuation hierarchy The following tables show financial instruments carried at fair value on the Group’s balance sheet by valuation hierarchy – level 1, level 2 and level 3 and related level 3 sensitivities.
Level 1 Level 2 Level 3 Total Level 3 sensitivity (5)
Price-based Price 0.164 585,066 GBP Valuation Discount factor 9% 13% Valuation Fund NAV 80% 120%
Price-based Price 56.77 JPY 148.68 EUR Valuation Fund NAV 0.202 977.24 GBP
Notes: (1) The table above excludes unobservable inputs where the impact on valuation is not significant. Movements in the underlying input may have a favourable or unfavourable impact on the valuation depending on the particular terms of the contract and the exposure. For example, an increase in the credit spread of a bond would be favourable for the issuer but unfavourable for the note holder. Whilst RBS indicates where it considers that there are significant relationships between the inputs, there inter-relationships will be affected by macro economic factors including interest rates, foreign exchange rates or equity index levels.
Areas of judgment Whilst the business has simplified, the diverse range of products historically traded by RBS results in a wide range of instruments that are classified into Level 3 of the hierarchy. Whilst the majority of these instruments naturally fall into a particular level, for some products an element of judgment is required. The majority of RBS financial instruments carried at fair value are classified as Level 2: inputs are observable either directly (i.e. as a price) or indirectly (i.e. derived from prices).
Other considerations Whilst certain inputs used to calculate CVA, FVA and own credit adjustments are not based on observable market data, the uncertainty of the inputs is not considered to have a significant effect on the net valuation of the related derivative portfolios and issued debt. The classification of the derivative portfolios and issued debt is not determined by the observability of these inputs and any related sensitivity does not form part of the Level 3 sensitivities presented.
Foreign exchange and other adjustments (16) (2) (18) 5 49 9 58 57
(2) Fair value through profit or loss comprises held-for-trading predominantly and designated at fair value through profit and loss.
9 Financial instruments: fair value of financial instruments not carried at fair value
Items where fair value approximates Carrying Fair value of hierarchy level carrying value value Fair value Level 1 Level 2 Level 3 2017 £bn £bn £bn £bn £bn £bn
Loans and advances to banks 1.0 10.5 10.5 — 9.1 1.4
Total loans and advances to customers 310.1 306.8 — 1.3 305.5
Items where fair value approximates Carrying Fair value of hierarchy level carrying value value Fair value Level 1 Level 2 Level 3 2016* £bn £bn £bn £bn £bn £bn
Cash and balances at central banks 98,337 — 98,337 74,250 — 74,250
10 Financial instruments – maturity analysis continued Assets and liabilities by contractual cash flow maturity The tables below show the contractual undiscounted cash flows receivable and payable, up to a period of 20 years, including future receipts and payments of interest of financial assets and liabilities by contractual maturity. The balances in the following tables do not agree directly with the consolidated balance sheet, as the tables include all cash flows relating to principal and future coupon payments, presented on an undiscounted basis. The tables have been prepared on the following basis: Financial assets have been reflected in the time band of the latest date on which they could be repaid, unless earlier repayment can be demanded by RBS. Financial liabilities are included at the earliest date on which the counterparty can require repayment, regardless of whether or not such early repayment results in a penalty. If the repayment of a financial instrument is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the time band that contains the latest date on which it can be repaid, regardless of early repayment.
0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2017 £m £m £m £m £m £m
Loans and advances to customers 45,898 32,031 65,077 52,016 68,500 81,995
Cash and balances at central banks 73,822 428 — — — —
Notes: (1) RBS is only called upon to satisfy a guarantee when the guaranteed party fails to meet its obligations. RBS expects most guarantees it provides to expire unused. (2) RBS has given commitments to provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. RBS does not expect all facilities to be drawn, and some may lapse before drawdown.
The following table shows the movement in the provision for impairment losses on loans and advances.
Carrying Carrying Cost Provision value Cost Provision value £m £m £m £m £m £m
12 Derivatives Companies within RBS transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
RBS enters into fair value hedges, cash flow hedges and hedges of net investments in foreign operations. The majority of RBS’s interest rate hedges relate to the management of RBS’s nontrading interest rate risk. RBS manages this risk within approved limits. Residual risk positions are hedged with derivatives principally interest rate swaps. Suitable larger financial instruments are fair value hedged; the remaining exposure, where possible, is hedged by derivatives documented as cash flow hedges and qualifying for hedge accounting. The majority of RBS’s fair value hedges involve interest rate swaps hedging the interest rate risk in recognised financial assets and financial liabilities. Cash flow hedges relate to exposures to the variability in future interest payments and receipts on forecast transactions and on recognised financial assets and financial liabilities. RBS hedges its net investments in foreign operations with currency borrowings and forward foreign exchange contracts.
For cash flow hedge relationships of interest rate risk, the hedged items are actual and forecast variable interest rate cash flows arising from financial assets and financial liabilities with interest rates linked to LIBOR, EURIBOR or the Bank of England Official Bank Rate. The financial assets are customer loans and the financial liabilities are customer deposits and LIBOR linked medium-term notes and other issued securities. At 31 December 2017 variable rate financial assets of £91 billion (2016 - £81 billion) and variable rate financial liabilities of £69 billion (2016 - £55 billion) were hedged in such cash flow hedge relationships.
Included in the table above are derivatives held for hedging purposes as follows: 2017 2016 Assets Liabilities Assets Liabilities £m £m £m £m
Hedge ineffectiveness recognised in other operating income in continuing operations comprised: 2017 2016 2015 £m £m £m
(Losses)/gains on the hedged items attributable to the hedged risk (48) 1,146 110
Substantially all forecast receivable hedged cash flows occur within 5 years (2016 - 5 years) and substantially all forecast payable cash flows occur within 10 years (2016 – 10 years); the income statement is impacted over the same periods.
UK US Other institutions ABS (1) 2017 £m £m £m £m £m £m £m £m
Designated as at fair value through profit or loss — — — — — — — —
There were no gross gains or losses in discontinued operations in 2017 or 2016.
14 Equity shares 2017 2016 Listed Unlisted Total Listed Unlisted Total £m £m £m £m £m £m
Designated as at fair value through profit or loss 6 128 134 3 169 172
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. Unquoted equity shares generated no material gains or losses in 2017 or 2016.
15 Intangible assets 2017 2016 Goodwill Other (1) Total Goodwill Other (1) Total
Currency translation and other adjustments 283 (5) 278 1,273 70 1,343
Disposals and write-off of fully amortised assets — (145) (145) — (471) (471)
Write down of goodwill and other intangible assets — 29 29 — 159 159
The impact of sensitivity to the more significant variables in each assessment is presented in the tables on the following page.
The carrying value of goodwill and the amount by which it is exceeded by the recoverable amount are set out below by reportable segment, along with the key assumptions applied in calculating the recoverable amount and sensitivities to changes in those assumptions. The recoverable amount of UK Personal & Business Banking, Commercial Banking and RBS International were £21.6 billion (2016 - £23.9 billion), £13.7 billion (2016 - £14.1 billion) and £3.3 billion (2016 - £2.7 billion) respectively. Consequential impact of 1% Consequential impact of 5% Break Assumptions Recoverable adverse movement in adverse movement even Terminal Pre-tax amount exceeded Discount Terminal Forecast Forecast discount Goodwill growth rate discount rate carrying value rate growth rate Income cost rate 31 December 2017 £bn % % £bn £bn £bn £bn £bn %
16 Property, plant and equipment Long Short Computers Operating Investment Freehold leasehold leasehold and other lease properties premises premises premises equipment assets Total 2017 £m £m £m £m £m £m £m
At 1 January 1,095 2,736 152 1,247 2,467 1,313 9,010 Transfers to disposal groups — (405) (10) (1) (21) — (437) Currency translation and other adjustments 18 (36) — — (17) (1) (36) Reclassifications — 109 — (109) — — — Additions 8 691 5 66 148 199 1,117 Change in fair value of investment properties (14) — — — — — (14) Disposals and write-off of fully depreciated assets (14) (80) (14) (218) (208) (447) (981)
Currency translation and other adjustments — 70 3 53 97 9 232
Net book value at 31 December 1,095 1,559 80 448 683 725 4,590
Investment property valuations principally employ present value techniques that discount expected cash flows. Expected cash flows reflect rental income, occupancy and residual market values; valuations are sensitive to changes in these factors. The fair value measurement of non-specialised properties in locations where the market for such properties is active and transparent are categorised as level 2 - 2% (2016 - 2%); otherwise investment property fair value measurements are categorised as level 3 - 98% (2016 - 98%). A 5% change in the most sensitive assumption, residual values, is £40 million.
Valuations were carried out by qualified surveyors who are members of the Royal Institution of Chartered Surveyors, or an equivalent overseas body; property with a fair value of £201 million (2016 - £222 million) was valued by independent valuers.
Provision for loss on disposal of interest in associate — — (130)
Profit from other discontinued operations, net of tax — — 16
RBS sold the final tranche of its interest in Citizens Financial Group, Inc (Citizens) during October 2015. Consequently, Citizens was classified as a disposal group at 31 December 2014 and presented as a discontinued operation until October 2015. From 3 August 2015 until the final tranche was sold in October 2015, Citizens was an associated undertaking.
There was no profit from discontinued operations attributable to non-controlling interests (2016 - nil; 2015 - £334 million).
Notes: (1) To reflect the increased volume of complaints following the FCA’s introduction of an August 2019 PPI timebar as outlined in FCA
announcement CP17/3 and the introduction of new Plevin (unfair commission) complaint handling rules, RBS increased its provision for PPI by £175m in 2017 (2016 - £601 million, 2015 - £600 million, 2014 - £650 million) bringing the cumulative charge to £5.1 billion, of which £3.7 billion (74%) in redress and £0.4 billion in administrative expenses had been paid by 31 December 2017. Of the £5.1 billion cumulative charge, £4.6 billion relates to redress and £0.5 billion to administrative expenses.
Notes: (1) Claims received directly by RBS to date, including those received via CMCs and Plevin (commission) only. Excluding those for proactive mailings and where no PPI
Under the settlement, RBS paid FHFA US$5.5 billion (£4.2 billion), of which US$754 million (£581 million) was reimbursed to RBS under indemnification agreements with third parties. The cost to RBS (net of the indemnity mentioned above) of US$4.75 billion (£3.65 billion) was largely covered by then-existing provisions but an incremental charge of US$196 million (£151 million) was recorded in Q2 2017 in relation to the settlement.
(3) RBS is party to certain legal proceedings and regulatory investigations and continues to co-operate with a number of regulators. All such matters are periodically reassessed with the assistance of external professional advisers, where appropriate, to determine the likelihood of RBS incurring a liability and to evaluate the extent to which a reliable estimate of any liability can be made. Details of these investigations and a discussion of the nature of the associated uncertainties are given in Note 31.
(5) The majority of property provisions relate to vacant leasehold property and comprise the present value of the shortfall between rentals payable and rentals receivable from sub-letting. In addition to the £800 million provision taken as an estimate of the cost of completing RBS's State Aid divestment commitments as referred to in (4), other provisions include restructuring provisions of £482 million principally in relation to termination benefits.
Net deferred tax asset comprised: Fair Tax Accelerated value of AFS Cash losses capital Deferred financial financial flow Share carried Pension allowances Provisions gains instruments assets Intangibles hedging schemes forward Other Total £m £m £m £m £m £m £m £m £m £m £m £m
(Credit)/charge to income statement (39) 149 25 (22) 1 (24) — (143) 13 317 (51) 226
Acquisitions and disposals of subsidiaries — (29) — — — — — — — — — (29)
UK tax losses carried forward - The Royal Bank of Scotland plc 125 182 - National Westminster Bank Plc 541 605
22 Deferred tax continued UK tax losses Under UK tax rules, tax losses can be carried forward indefinitely. In periods from 1 April 2015, the Finance Act 2015 limits the offset of losses carried forward by UK banks to 50% of profits. In periods from 1 April 2016, the Finance Act 2016 further limits the offset of losses carried forward by UK banks to 25% of profits. The main rate of UK Corporation Tax reduced from 20% to 19% from 1 April 2017 and will reduce to 17% from 1 April 2020. Under the Finance (No 2) Act 2015, tax losses arising prior to 1 January 2016 are given credit in future periods at the main rate of UK corporation tax, excluding the Banking Surcharge rate (8%) introduced by the Act. Deferred tax assets and liabilities at 31 December 2017 take into account the reduced rates in respect of tax losses and non-banking temporary differences and where appropriate, the banking surcharge inclusive rate in respect of other banking temporary differences.
The Royal Bank of Scotland plc – The Royal Bank of Scotland plc expects that the balance of recognised deferred tax asset at 31 December 2017 of £125 million in respect of tax losses amounting to c. £700 million will be substantially recovered by the end of 2022. Since 2012 RBS has reported mixed levels of taxable profits and losses because core banking profitability was offset by a series of restructuring plans as the group reshaped to meet commercial and regulatory demands. In total, £10,247 million of losses have not been recognised in the deferred tax balance at 31 December 2017; such losses will be available to offset 25% of future taxable profits in excess of those forecast in the closing deferred tax asset.
The following tables analyse the remaining contractual maturity of subordinated liabilities by the final redemption date and by the next call date.
US$ 25 million floating rate notes (partial redemption) Tier 2 — 6
CAD420 million 10.50% subordinated notes March 2022 Tier 2 255 —
£564 million 10.50% subordinated notes March 2022 Tier 2 489 —
AU$880 million 13.125% subordinated notes March 2022 Tier 2 548 —
£51 million 2.35% + 5 year UK Gilts yield undated subordinated notes (callable December 2012) Ineligible 51 —
CAD474 million 5.37% undated notes Ineligible — 283 €1 billion 4.625% dated notes Ineligible — 866
€250 million 4.70% notes 2019 (partial redemption) Tier 2 80 —
US$ 500 million 4.65% notes 2018 (partial redemption) Tier 2 244 —
NatWest Holdings Limited £20 million 11.75% perpetual tier two capital (partial redemption) Tier 2 9 —
April 33.4m 239.688p £80 million June 29.0m 259.046p £75 million September 56.6m 256.027p £145 million
In addition, the company issued 22 million ordinary shares of £1 each in connection with employee share plans. In October 2015, the company allotted and issued 5.1 billion new ordinary shares of £1 each to HM Treasury on conversion of 51 billion B shares.
The company did not pay an ordinary dividend in 2017 or 2016.
B shares and dividend access share From December 2009, HM Treasury owned 51 billion B shares with a nominal value of £0.01 each and a dividend access share (DAS) with a nominal value of £0.01.
In March 2016, a final payment of £1,193 million was made to HM Treasury to retire the DAS. The terms for the removal of the DAS were provided by the ‘DAS Retirement Agreement’ between RBS and HM Treasury. In line with the terms of the DAS Retirement Agreement, upon the final payment, the DAS lost its preferential rights and become a single B share, which was subsequently cancelled.
Preference shares Under IFRS certain of RBS's preference shares are classified as debt and are included in subordinated liabilities on the balance sheet.
25 Share capital continued These securities entitle the holders to interest which may be deferred at the sole discretion of the company. Repayment of the securities is at the sole discretion of the company on giving between 30 and 60 days notice.
In the context of macro-prudential policy discussions, the Board decided to partially neutralise any impact on CET1 capital of coupon and dividend payments from 2013 onwards. £300 million of new equity was issued during the course of 2017 and the Board has decided a further £300 million of new equity will be issued during the course of 2018 to again partially neutralise the CET1 impact of coupon and dividend payments.
Class of preference share Number of shares Redemption Redemption in issue Interest rate date on or after price per share Debt/equity (1)
Holders of the non-cumulative preference shares are not entitled to receive notice of or attend general meetings of the company except if any resolution is proposed for adoption by the shareholders of the company to vary or abrogate any of the rights attaching to the non-cumulative preference shares or proposing the winding-up or liquidation of the company. In any such case, they are entitled to receive notice of and to attend the general meeting of shareholders at which such resolution is to be proposed and are entitled to speak and vote on such resolution (but not on any other resolution). In addition, in the event that, prior to any general meeting of shareholders, the company has failed to pay in full the three most recent quarterly dividend payments due on the non-cumulative dollar preference shares (other than Series U), the two most recent semi-annual dividend payments due on the non-cumulative convertible dollar preference shares and the most recent dividend payments due on the non-cumulative euro preference shares, the noncumulative sterling preference shares, the Series U noncumulative dollar preference shares and the non-cumulative convertible sterling preference shares, the holders shall be entitled to receive notice of, attend, speak and vote at such meeting on all matters together with the holders of the ordinary shares. In these circumstances only, the rights of the holders of the non-cumulative preference shares so to vote shall continue until the company shall have resumed the payment in full of the dividends in arrears.
26 Other equity Paid-in equity - comprises equity instruments issued by the company other than those legally constituted as shares.
Trust preferred issues: subordinated notes (4) £93 million 5.6457% 2047 (redeemed June 2017) (5)
After 1 year but within 5 years 5,002 (518) (113) (68) 4,303 296
There were no amounts recognised as income and expense in discontinued operations (2016 - nil; 2015 - £75 million) in relation to operating leases - minimum rentals payable.
Residual value exposures The table below gives details of the unguaranteed residual values included in the carrying value of finance lease receivables and operating lease assets (refer to pages 296 and 297).
28 Structured entities A structured entity (SE) is an entity that has been designed such that voting or similar rights are not the dominant factor in deciding who controls the entity, for example, when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. SEs are usually established for a specific, limited purpose. They do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SEs are also used in fund management activities in order to segregate custodial duties from the provision of fund management advice.
Commercial paper conduits RBS consolidates a number of asset-backed commercial paper (ABCP) conduits. A conduit is an SE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is typically short-dated, usually up to three months. At 31 December 2017 assets held by the conduits were nil (2016 - £0.1 billion). At 31 December 2016 the conduits were funded entirely by RBS.
Covered bond programme Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of debt securities by RBS. RBS retains all of the risks and rewards of these loans. The partnerships are consolidated, the loans retained on RBS’s balance sheet and the related covered bonds included within debt securities in issue. At 31 December 2017, £8,915 million of mortgages provided security for debt securities in issue of £6,307 million (2016: mortgages - £8,621 million, bonds - £3,935 million).
Other than held-for-trading Loans and advances to customers 1,243 120 1,363 1,339 871 2,210
Notes: (1) Income from interests in unconsolidated structured entities includes interest receivable, changes in fair value and other income less impairments. (2) A sponsored entity is a structured entity established by RBS where RBS provides liquidity and/or credit enhancements or provides ongoing services to the entity. RBS can act as sponsor for its own or for customers’ transactions. (3) In 2017, no assets were transferred into sponsored structured entities (2016 - nil) which are not consolidated by RBS and for which RBS held no interest at 31 December 2017.
29 Asset transfers Transfers that do not qualify for derecognition Securities repurchase agreements and lending transactions RBS enters into securities repurchase agreements and securities lending transactions under which it transfers securities in accordance with normal market practice.
Assets subject to securities repurchase agreements or security lending transactions 2017(1) 2016 £m £m
Assets pledged against liabilities Liabilities secured by assets Loans and Loans and advances advances Deposits to banks to customers Securities Total by banks Derivatives Total £m £m £m £m £m £m £m
Qualifying instruments and related share premium subject to phase out 3,416 5,416
Qualifying instruments issued by subsidiaries and held by third parties 1,876 4,818
Guarantees and assets pledged as collateral security 1,354 493 481 5,390 7,718 7,867
Standby facilities and credit lines - under a loan commitment, RBS agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term, may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.
31 Memorandum items continued Trustee and other fiduciary activities In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group's financial statements. The Group earned fee income of £244 million (2016 - £251 million; 2015 - £321 million) from these activities.
The Financial Services Compensation Scheme The Financial Services Compensation Scheme (FSCS), the UK's statutory fund of last resort for customers of authorised financial services firms, pays compensation if a firm is unable to meet its obligations. The FSCS funds compensation for customers by raising management expenses levies and compensation levies on the industry. In relation to protected deposits, each deposittaking institution contributes towards these levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year (which runs from 1 April to 31 March), subject to annual maxima set by the Prudential Regulation Authority. In addition, the FSCS has the power to raise levies on a firm that has ceased to participate in the scheme and is in the process of ceasing to be authorised for the costs that it would have been liable to pay had the FSCS made a levy in the financial year it ceased to be a participant in the scheme.
The FSCS has borrowed from HM Treasury to fund compensation costs associated with the failure of Bradford & Bingley, Heritable Bank, Kaupthing Singer & Friedlander, Landsbanki ‘Icesave’ and London Scottish Bank plc. The industry repaid the remaining balance on the non-Bradford and Bingley loans during the period. The Bradford and Bingley loan is interest bearing with the reference rate being the higher of 12 month LIBOR plus 111 basis points or the relevant gilt rate for the equivalent cost of borrowing from HMT. The FSCS and HM Treasury have agreed that the period of these loans will reflect the expected timetable for recoveries from the estate of Bradford & Bingley. The total interest element levied on the industry in the 2017/18 scheme year was £202 million (£337 million in the 2016/17 scheme year).
RBS recognises a provision for a liability in relation to these Matters when it is probable that an outflow of economic benefits will be required to settle an obligation resulting from past events, and a reliable estimate can be made of the amount of the obligation.
While the outcome of these Matters is inherently uncertain, the directors believe that, based on the information available to them, appropriate provisions have been made in respect of the Matters as at 31 December 2017 (refer to Note 20).
Other than those discussed below, no member of the Group is or has been involved in governmental, legal or regulatory proceedings (including those which are pending or threatened) that are expected to be material, individually or in aggregate. RBS expects that in future periods additional provisions, settlement amounts, and customer redress payments will be necessary, in amounts that are expected to be substantial in some instances.
Litigation UK 2008 rights issue shareholder litigation Between March and July 2013, claims were issued in the High Court of Justice of England and Wales by sets of current and former shareholders, against RBSG (and in one of those claims, also against certain former individual officers and directors) alleging that untrue and misleading statements and/or improper omissions, in breach of the Financial Services and Markets Act 2000, were made in connection with the rights issue announced by RBS on 22 April 2008. These and other similar threatened claims were consolidated by the Court via a Group Litigation Order. Since then, further High Court claims have been issued against RBS under the Group Litigation Order. Prior to the settlement described below, the aggregate value of the shares subscribed for at 200 pence per share by all of the then claimant shareholders was approximately £4 billion.
The Court directed that any claimant choosing not to enter the settlement should, by 28 July 2017, issue an application to restore the proceedings. No such application was made.
Residential mortgage-backed securities (RMBS) litigation in the US RBS companies have been named as defendants in their various roles as issuer, depositor and/or underwriter in a number of claims in the US that relate to the securitisation and securities underwriting businesses. These cases include actions by individual purchasers of securities and a purported class action suit.
In general, plaintiffs in these actions claim that certain disclosures made in connection with the relevant offerings of RMBS contained materially false or misleading statements and/or omissions regarding the underwriting standards pursuant to which the mortgage loans underlying the securities were issued.
RBS Securities Inc. remains a defendant in a lawsuit relating to RMBS issued by Nomura Holding America Inc. (Nomura) and subsidiaries, filed by the US Federal Housing Finance Agency (FHFA) as conservator for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac).
In May 2015, following a trial, the United States District Court for the Southern District of New York issued a written decision in favour of FHFA, finding, as relevant to RBS, that the offering documents for four Nomura-issued RMBS for which RBS Securities Inc. served as an underwriter contained materially misleading statements about the mortgage loans that backed the securitisations. Nomura and RBS appealed. On 28 September 2017, the court’s judgment against Nomura and RBS Securities Inc. was affirmed by the United States Court of Appeals for the Second Circuit.
RBS Securities Inc. estimates that its net exposure under the court’s judgment is approximately US$318 million, which consists of the difference between the amount of the judgment against RBS Securities Inc. (US$636 million) and the estimated market value of the four RMBS that FHFA would return to RBS Securities Inc. pursuant to the judgment, plus the costs and attorney’s fees that will be due to FHFA if the judgment is upheld. The estimated net exposure in this matter is covered by an existing provision. The judgment is stayed pending defendants’ request for review by the United States Supreme Court, though post-judgment interest on the judgment amount will accrue while that request and any further review is pending. RBS Securities Inc. intends to pursue a contractual claim for indemnification against Nomura with respect to any losses it suffers as a result of this matter.
RBS companies are also defendants in a purported RMBS class action entitled New Jersey Carpenters Health Fund v. Novastar Mortgage Inc. et al., which remains pending in the United States District Court for the Southern District of New York. RBS has settled this matter for US$55.3 million, which has been paid into escrow pending court approval of the settlement.
In addition to the above, the remaining RMBS lawsuits against RBS companies consist of cases filed by the Federal Home Loan Banks of Boston and Seattle and the Federal Deposit Insurance Corporation that together involve the issuance of less than US$1 billion of RMBS issued primarily from 2005 to 2007.
As at 31 December 2017, the total aggregate of provisions in relation to certain of the RMBS litigation matters (described immediately above) and RMBS and other securitised products investigations (set out under ‘Investigations and reviews’ on page 319) was £3.2 billion (US$4.4 billion). The duration and outcome of these investigations and litigation matters remain uncertain, including in respect of whether settlements for all or any of such matters may be reached.
RBS continues to caution that, in connection with RMBS litigation matters and RMBS investigations taken as a whole, further substantial provisions and costs may be recognised and, depending on the final outcomes, other adverse consequences may occur.
Litigation, investigations and reviews continued London Interbank Offered Rate (LIBOR) and other rates litigation Certain members of the Group have been named as defendants in a number of class actions and individual claims filed in the US with respect to the setting of LIBOR and certain other benchmark interest rates. The complaints are substantially similar and allege that certain members of the Group and other panel banks individually and collectively violated various federal laws, including the US commodities and antitrust laws, and state statutory and common law, as well as contracts, by manipulating LIBOR and prices of LIBOR-based derivatives in various markets through various means.
In the coordinated proceeding, consolidated class action complaints were filed on behalf of (1) exchange-based purchaser plaintiffs, (2) over-the-counter purchaser plaintiffs, and (3) corporate debt purchaser plaintiffs. Over 35 other USD LIBORrelated actions naming RBS as a defendant, including purported class actions on behalf of lenders and mortgage borrowers, were also made part of the coordinated proceeding.
In a series of orders issued in 2013 and 2014, the district court overseeing the coordinated USD proceeding dismissed class plaintiffs' antitrust claims and claims under RICO (Racketeer Influenced and Corrupt Organizations Act), but declined to dismiss (a) certain Commodity Exchange Act claims on behalf of persons who transacted in Eurodollar futures contracts and options on futures contracts on the Chicago Mercantile Exchange (on the theory that defendants' alleged persistent suppression of USD LIBOR caused loss to plaintiffs), and (b) certain contract and unjust enrichment claims on behalf of over-the-counter purchaser plaintiffs who transacted directly with a defendant. On 23 May 2016, the district court’s dismissal of plaintiffs’ antitrust claims was vacated by the United States Court of Appeals for the Second Circuit, which held that plaintiffs have adequately pled antitrust injury and an antitrust conspiracy, but remanded to the lower court for further consideration on the question of whether plaintiffs possess the requisite antitrust standing to proceed with antitrust claims.
On 10 July 2017, the US Federal Deposit Insurance Corporation (FDIC), on behalf of 39 failed US banks, served a claim in the High Court of Justice of England and Wales against RBS, other LIBOR panel banks and the British Bankers’ Association, alleging collusion with respect to the setting of USD LIBOR.
On 12 July 2017, Alpari (US) LLC (Alpari) filed a class action complaint against RBS companies in the United States District Court for the Southern District of New York. The complaint alleges that RBS breached contracts with Alpari and other counterparties by rejecting FX orders placed over electronic trading platforms through the application of a function referred to as ‘Last Look’, and that the rejected orders were later filled at prices less favourable to putative class members. The complaint contains claims for breach of contract and unjust enrichment. RBS has filed a motion to compel arbitration of Alpari’s claims or, in the alternative, to dismiss those claims for improper venue.
In September 2015, certain members of the Group, as well as a number of other financial institutions, were named as defendants in two class actions filed in Ontario and Quebec on behalf of persons in Canada who entered into foreign exchange transactions or who invested in funds that entered into foreign exchange transactions, alleging that the defendants violated the Canadian Competition Act by conspiring to manipulate the prices of currency trades. RBS settled the matters for approximately CAD 13 million. The settlement amount has been paid and the settlement has received final court approval.
The complaint asserts claims under the US antitrust laws on behalf of persons who transacted in US Treasury securities or derivatives based on such instruments, including futures and options. The defendants anticipate filing a motion to dismiss the operative complaint in this matter.