The company did not pay an ordinary dividend in 2013, 2012 or 2011.
3 Financial instruments - classification The following table analyses the company's financial assets and liabilities in accordance with the categories of financial instruments in IAS 39 with assets and liabilities outside the scope of IAS 39 shown separately.
Financial assets Loans and advances to banks 24.6 24.9 24.1 24.8 18.4 18.4 Loans and advances to customers 0.2 0.2 1.3 1.3 4.1 4.1 Debt securities 1.5 2.5 1.5 2.0 1.6 1.5
2013 2012 2011 Less than More than Less than More than Less than More than 12 months 12 months Total 12 months 12 months Total 12 months 12 months Total £m £m £m £m £m £m £m £m £m
Deposits by banks 2 327 324 988 — — Customer accounts 18 1 742 — — — Debt securities in issue 736 1,056 3,649 1,230 1,145 — Subordinated liabilities 123 1,149 1,804 1,567 5,151 2,114 879 2,533 6,519 3,785 6,296 2,114 2012 Deposits by banks 6 338 325 958 — — Customer accounts 18 97 742 — — — Debt securities in issue 1,975 3,663 2,406 567 1,194 — Subordinated liabilities 85 826 1,796 680 3,158 2,314 2,084 4,924 5,269 2,205 4,352 2,314 2011 Deposits by banks 5 16 341 — 965 — Customer accounts — 993 — — — — Debt securities in issue 777 3,152 3,597 163 1,155 — Subordinated liabilities 94 340 1,860 1,020 1,527 2,525 876 4,501 5,798 1,183 3,647 2,525
6 Derivatives The following table shows the notional amounts and fair values of the company's derivatives.
Exchange rate contracts 1 43 12 3 214 2 7 1,182 26 Interest rate contracts 5 117 50 6 297 5 4 320 — Credit derivatives — — — — — — 10 — 53 Equity and commodity contracts 1 4 — — — — — — — 164 62 511 7 1,502 79
Fair value hedging £m £m £m £m £m £m 7 Debt securities Debt securities comprise the partial repurchase of preferred securities issued by the trusts referred to in Notes 24 and 26 on the consolidated accounts.
8 Investments in Group undertakings Investments in Group undertakings are carried at cost less impairment. Movements during the year were as follows: 2013 2012 2011 £m £m £m
The Royal Bank of Scotland plc and RFS Holdings B.V. are directly owned by the company, and all of the other subsidiary undertakings are owned directly, or indirectly through intermediate holding companies, by these companies. All of these subsidiaries are included in the Group's consolidated financial statements and have an accounting reference date of 31 December.
The Royal Bank of Scotland plc Banking Great Britain 100% National Westminster Bank Plc (1) Banking Great Britain 100%
In accordance with undertakings given to the EC, the company sold the following ordinary share interests in its former wholly-owned subsidiary Direct Line Insurance Group Plc: October 2012 - 34.7%, March 2013 - 16.8% and September 2013 - 20%. The remaining investment of 28.5% at 31 December 2013 is classified as held for disposal.
The above information is provided in relation to the principal related undertakings as permitted by Section 410(2) of the Companies Act 2006. Full information on all related undertakings is included in the Annual Return delivered to the Registrar of Companies for Scotland.
9 Accruals, deferred income and other liabilities 2013 2012 2011 £m £m £m
Share capital, share premium, paid-in equity and merger reserve Subordinated liabilities 2013 2012 2011 2013 2012 2011 £m £m £m £m £m £m
Issue of ordinary shares 264 120 2 — — — Issue of subordinated liabilities — — — 2,216 2,747 940 Repayment of subordinated liabilities — — — — — (193) Net cash inflow from financing 264 120 2 2,216 2,747 747 Transfer to retained earnings — — (50) — — — Share capital sub-division and consolidation — (8,933) — — — — Ordinary shares issued in respect of employee share schemes 174 437 270 — — — Other adjustments including foreign exchange — — — (1,095) (219) (18)
2013 2012* 2011* 2010* 2009* Summary consolidated income statement £m £m £m £m £m
Loss per ordinary and equivalent B share from continuing operations - pence (81.3) (54.5) (22.7) (3.9) (58.4) Diluted loss per ordinary and equivalent B share from continuing operations - pence (1) (81.3) (54.5) (22.7) (3.9) (58.4) Share price per ordinary share at year end - £ 3.38 3.25 2.02 3.91 2.92 Market capitalisation at year end - £bn 38.2 36.3 22.3 42.8 31.4 Net asset value per ordinary and equivalent B share - £ 5.24 6.31 6.90 7.02 8.81 Return on average total assets (2) (0.7%) (0.4%) (0.1%) (0.1%) (0.2%) Return on average owners equity (3) (12.6%) (7.8%) (2.8%) (1.5%) (4.9%) Return on average ordinary and B shareholders' equity (4) (14.5%) (8.9%) (3.1%) (0.9%) (7.4%) Average owners' equity as a percentage of average total assets 5.6% 5.2% 4.9% 4.6% 2.8%
After 1 year Within but within After 2013 1 year 5 years 5 years Total 2012 2011 2010 2009 £m £m £m £m £m £m £m £m
Service industries and business activities 22,357 19,691 10,205 52,253 56,435 59,190 70,006 78,806
Loans and advances to customers - gross 194,467 128,729 142,679 465,875 521,271 535,366 573,315 745,519
Loans and advances to customers - net 440,722 500,135 515,606 555,260 728,393
The Group provides credit facilities at variable rates to its corporate and retail customers. Variable rate credit extended to the Group’s corporate and commercial customers includes bullet and instalment loans, finance lease agreements and overdrafts; interest is generally charged at a margin over a benchmark rate such as LIBOR or base rate. Interest on variable rate retail loans may also be based on LIBOR or base rate; other variable rate retail lending is charged at variable interest rates set by the Group such as its mortgage standard variable rate in the UK.
Financial summary continued Loan impairment provisions For a discussion of the factors considered in determining the amount of provisions, refer to the provisions policy on page 381 and ‘Critical accounting policies and key sources of estimation uncertainty’ on pages 386 to 389. The following table shows the movements in loan impairment provisions.
Currency translation and other adjustments UK 323 635 5 (23) (244)
Recoveries of amounts previously written-off UK 78 164 158 151 176 Overseas 178 177 369 260 223 256 341 527 411 399 Charged to income statement - continuing operations (1) UK 3,593 2,351 2,937 3,916 5,593 Overseas 4,819 2,964 4,304 5,228 7,497 8,412 5,315 7,241 9,144 13,090 Charged to income statement - discontinued operations Overseas — 4 (8) 42 1,044
Provisions at the end of the year (2) UK 11,005 9,754 8,222 8,537 7,004 Overseas 14,211 11,496 11,661 9,645 10,279 25,216 21,250 19,883 18,182 17,283 Gross loans and advances to customers (3) UK 286,983 311,488 309,122 340,587 357,572 Overseas 128,995 139,736 164,750 180,216 346,907 415,978 451,224 473,872 520,803 704,479
Closing customer provisions as a % of gross loans and advances to customers (3, 4)
Customer charge to income statement as a % of gross loans and advances to customers (3, 4) UK 1.3% 0.8% 1.0% 1.1% 1.6%
The following table shows additional information in respect of loan impairment provisions. 2013 2012 2011 2010 2009 £m £m £m £m £m
2013 2012 2011 2010 2009 % of loans % of loans % of loans % of loans % of loans
Closing to total Closing to total Closing to total Closing to total Closing to total Provision Loans Provision Loans Provision Loans Provision Loans Provision Loans
Latent book provisions 2,003 1,960 1,986 2,650 3,076 Total provisions 25,153 21,136 19,760 18,055 17,126
The following table analyses amounts written-off by geographical area and type of UK customer.
Manufacturing 41 61 115 107 225 Construction 159 158 228 110 243 Finance 47 30 24 6 105 Service industries and business activities 422 542 383 410 706 Agriculture, forestry and fishing 6 11 4 5 3 Property 950 490 493 396 334 Residential mortgages 180 32 25 17 2 Personal lending 681 610 1,007 1,152 1,192 Finance leases and instalment credit 61 193 129 67 115 Total UK 2,547 2,127 2,408 2,270 2,925 Overseas 1,799 2,139 2,119 3,772 4,014 Total write-offs (1) 4,346 4,266 4,527 6,042 6,939
Accruing loans which are contractually overdue 90 days or more as to principal or interest UK 1,962 2,007 1,698 2,374 2,224
Closing provisions for impairment as a % of total risk elements in lending 64% 52% 49% 47% 45% Risk elements in lending as a % of gross lending to customers excluding reverse repos (3) 9.5% 9.1% 8.6% 7.4% 5.4%
Notes: (1) The write-off of impaired loans affects the closing provisions for impairment as a % of total risk elements in lending (the coverage ratio). The coverage ratio reduces if the loan written off carries a higher than average provision and increases if the loan written off carries a lower than average provision. (2) Impaired loans at 31 December 2013 include £7,687 million (2012 - £6,009 million) of loans subject to forbearance granted during the year. (3) Includes disposal groups.
Notes: (1) Wholesale loans subject to forbearance include only those arrangements above thresholds set individually by the divisions, ranging from nil to £3 million. (2) For 2013, wholesale loans subject to forbearance were £4,305 million (refer to page 244) and secured retail loans subject to forbearance were £3,596 million (refer to page 248). Unsecured retail loans subject to forbearance are not included. The balance of unsecured retail loans subject to forbearance amounts to £272 million.
The table below sets out the Group’s cross border exposures greater than 0.5% of the Group’s total assets. None of these countries have experienced repayment difficulties that have required restructuring of outstanding debt.
United States 18,936 1,736 30,983 51,655 12,080 39,575 Germany 14,678 4,289 6,812 25,779 1,956 23,823 France 6,563 13,285 6,224 26,072 2,157 23,915 Netherlands 5,350 2,227 11,200 18,777 1,124 17,653 Spain 893 4,789 6,328 12,010 515 11,495 Italy 3,767 373 1,165 5,305 2,301 3,004 Japan 4,338 6,822 1,410 12,570 2,326 10,244 Republic of Ireland 217 3,557 3,071 6,845 59 6,786 2011 United States 20,932 7,300 38,721 66,953 13,329 53,624 Germany 34,615 5,952 9,787 50,354 2,946 47,408 France 11,633 14,800 8,189 34,622 5,903 28,719 Netherlands 4,466 2,210 10,711 17,387 982 16,405 Spain 340 3,656 10,282 14,278 973 13,305 Italy 5,190 548 1,489 7,227 4,826 2,401 Japan 8,350 7,505 3,375 19,230 3,141 16,089 Republic of Ireland 665 3,287 2,759 6,711 68 6,643
Demand deposits - interest-free 85,268 73,439 66,840 - interest-bearing 169,580 173,384 132,047 Time deposits - savings 76,043 81,884 81,003 - other 8,357 34,859 63,930 Total UK 339,248 363,566 343,820 Overseas Demand deposits - interest-free 38,235 42,250 30,780 - interest-bearing 23,536 34,548 44,413 Time deposits - savings 23,920 26,891 25,296 - other 24,786 23,057 38,947 Total overseas 110,477 126,746 139,436 Total deposits 449,725 490,312 483,256
Held-for-trading 30,000 42,648 48,458 Designated as at fair value through profit or loss 5,862 6,323 5,627 Amortised cost 413,863 441,341 429,171 Total deposits 449,725 490,312 483,256
Repos UK 40,018 62,055 56,826 US 38,085 63,744 61,411 Rest of the World 7,031 6,573 10,266
Certificates of deposit 671 39 537 65 1,312 Other time deposits 21,575 1,776 2,579 3,505 29,435
Short-term borrowings Short-term borrowings comprise repurchase agreements, borrowings from financial institutions, commercial paper (CP) and certificates of deposit (CDs). Derivative collateral received from financial institutions is excluded from the table below, as are certain long-term borrowings.
During the year - maximum balance (£bn) 172 155 3 3 333 181 103 18 20 322 357 - average balance (£bn) 130 71 3 3 207 149 82 9 11 251 288 - weighted average interest rate 0.3% 0.6% 0.4% 0.9% 0.4% 0.5% 0.6% 0.6% 1.2% 0.5% 1.0%
Notes: (1) Excludes derivative cash collateral of £26 billion at 31 December 2013 (2012 - £37 billion; 2011 - £41 billion), 2013 average of £31 billion (2012 - £38 billion; 2011 - £35 billion). (2) Excludes Federal Home Loan Bank’s long-term borrowings of £2 billion at 31 December 2013 (2012 and 2011 - £1 billion), 2013 average of £1 billion (2012 and 2011 - £1 billion).
The table below summarises the Group's other contractual cash obligations by payment date. 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years
Operating leases 90 258 630 513 786 1,358 Contractual obligations to purchase goods or services 107 266 189 588 12 — 197 524 819 1,101 798 1,358 2012 Operating leases 214 185 694 559 910 1,376 Contractual obligations to purchase goods or services 110 334 500 15 — — 324 519 1,194 574 910 1,376
Period end rate 1.6574 1.6262 1.5537 1.5392 1.6167 Average rate for the year (1) 1.5673 1.5924 1.6105 1.5415 1.5707
Notes: (1) The average of the Noon Buying Rates on the last US business day of each month during the year. (2) The rates used by the Group for translating US dollars into sterling in the preparation of its financial statements. (3) On 25 February 2014, the Noon Buying Rate was £1.00 = US$1.6696.
Investment management business is principally undertaken by companies in the Wealth division, including Coutts & Co, Adam & Company Investment Management Limited, and in the Markets and International Banking divisions, through RBS Asset Management Limited and The Royal Bank of Scotland plc.
United States The Royal Bank of Scotland Group plc (RBSG) is both a bank holding company and a financial holding company within the meaning of the US Bank Holding Company Act of 1956. As such, it is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Among other things, the Group's direct and indirect activities and investments in the United States are limited to those that are 'financial in nature' or 'incidental' or 'complementary' to a financial activity, as determined by the Federal Reserve. The Group is also required to obtain the prior approval of the Federal Reserve before acquiring directly or indirectly, the ownership or control of more than 5% of any class of the voting shares of any US bank or holding company. Under current Federal Reserve policy, the Group is required to act as a source of financial strength for its US bank subsidiaries. Among other things, this source of strength obligation could require the Group to inject capital into any of its US bank subsidiaries if any of them became undercapitalised.
The Group's US bank and non-bank subsidiaries and the Royal Bank's US branches are also subject to supervision and regulation by a variety of other US regulatory agencies. RBS Citizens N.A. is supervised by the Office of the Comptroller of the Currency, which is charged with the regulation and supervision of nationally chartered banks. RBS Citizens N.A. owns CCO Investments Services Corp., a US broker dealer subject to regulation and supervision by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) with respect to its securities activities. Citizens Bank of Pennsylvania is subject to the regulation and supervision of the US Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking. Both banks are subject to supervision and regulation by the Consumer Financial Protection Bureau (CFPB).
Other jurisdictions The Group operates in over 45 countries through a network of branches, local banks and non-bank subsidiaries and these activities are subject to supervision in most cases by a local regulator or central bank.
Description of property and equipment The Group operates from a number of locations worldwide, principally in the UK. At 31 December 2013, the Royal Bank and NatWest had 608 and 1,392 retail branches, respectively, in the UK. Ulster Bank has a footprint of 214 branches and an extensive network of business banking offices across Northern Ireland and the Republic of Ireland. US Retail & Commercial had 1,366 retail banking offices (including in-store branches) covering Connecticut, Delaware, Illinois, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island and Vermont. A substantial majority of the UK branches are owned by the Royal Bank, NatWest and their subsidiaries or are held under leases with unexpired terms of over 50 years. The Group's principal properties include its headquarters at Gogarburn, Edinburgh, its principal offices in London at 135 and 280 Bishopsgate and the Drummond House administration centre located at South Gyle, Edinburgh.
In December 2009, HM Treasury acquired 51 billion B shares in the company representing the entire issued B share capital. As a result of the ordinary share sub-division and consolidation which took place in June 2012, HM Treasury’s holding in the company’s ordinary shares became 3,964 million ordinary shares of £1 each. At 31 December 2013, HM Treasury’s holding in the company’s ordinary shares was 63.9%.
As far as the company is aware, there have been no significant changes in the percentage ownership of major shareholders of the company's ordinary, B and preference shares during the three years ended 26 February 2014. All shareholders within a class of the company's shares have the same voting rights.
As at 31 December 2013, almost all of the company's US$ denominated preference shares and American Depository Shares representing ordinary shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.
Material contracts The company and its subsidiaries are party to various contracts in the ordinary course of business. Material contracts include the following: Consortium and Shareholders Agreement (CSA) On 28 May 2007, Fortis Bank Nederland, the company, Santander and RFS Holdings entered into the CSA. Fortis Bank Nederland acceded to the CSA on 26 July 2007. On 3 October 2008, the Dutch State acquired Fortis Bank Nederland. On 24 December 2008 the Dutch State acceded to the CSA following its acquisition of the shares held by Fortis Bank Nederland in RFS Holdings pursuant to a Deed of Accession entered into between RFS Holdings, the company, Fortis Bank Nederland, Santander and the Dutch State. On 1 April 2010 the CSA was restated. It was the subject of a further amendment on 18 July 2011. On 7 November 2012, Stichting Administratiekantoor Beheer Financiële Instellingen (the Foundation) acceded to the CSA (as amended and restated) as a shareholder following its acquisition of the shares held by the Dutch State in RFS Holdings pursuant to a Deed of Accession entered into between RFS Holdings, the company, Santander, the Dutch State and the Foundation. The Dutch State remains a party to the CSA. The CSA (as amended and restated) governs the relationships amongst the parties thereto in relation to the acquisition by RFS Holdings of ABN AMRO (now RBS Holdings N.V.). The CSA (as amended and restated) details, inter alia, the equity interests in RFS Holdings, the governance of RFS Holdings, the arrangements for the transfer of certain ABN AMRO businesses, assets and liabilities to the Dutch State (previously Fortis Bank Nederland), the company and Santander, further funding obligations of the Dutch State, the company and Santander where funding is required by regulatory authorities in connection with the ABN AMRO businesses, the allocation of taxes and conduct of tax affairs and the steps that the Dutch State, the company and Santander expect to take to enable the company to become the sole shareholder of RFS Holdings.
B Share Acquisition and Contingent Capital Agreement On 26 November 2009, the company and HM Treasury entered into the Acquisition and Contingent Capital Agreement pursuant to which HM Treasury subscribed for the initial B shares and the Dividend Access Share (the "Acquisitions") and agreed the terms of HM Treasury's subscription (the “Contingent Subscription”) for an additional £8 billion in aggregate in the form of further B shares (the "Contingent B shares"), which will be issued on the same terms as the initial B shares. The Acquisitions were subject to the satisfaction of various conditions, including the company having obtained the approval of its shareholders in relation to the Acquisitions.
The company and HM Treasury further agreed the terms of the £8 billion Contingent Subscription of the Contingent B shares in the Acquisition and Contingent Capital Agreement. For a period of five years from 22 December 2009 or, if earlier, until the occurrence of a termination event or until the company’s decision (with PRA (formerly FSA) consent) to terminate such Contingent Subscription (the "Contingent Period"), if the Core Tier 1 ratio of the company fell below five per cent (and if certain other conditions were met) HM Treasury would be committed to subscribe for the Contingent B shares in no fewer than two tranches of £6 billion and £2 billion (or such smaller amounts as the company and HM Treasury may agree). Any unused portion of the £8 billion could be subscribed in one or more further tranches.
The company gave certain representations and warranties to HM Treasury on the date of the Acquisition and Contingent Capital Agreement, on the date the circular was posted to shareholders, on the first date on which all of the conditions precedent were satisfied, or waived, and on the date of the Acquisitions.
Material contracts continued HM Treasury has agreed to waive its statutory pre-emption rights arising out of the B shares and the Dividend Access Share in respect of any future issue of equity securities by the company other than B shares and has agreed to vote its B shares and the Dividend Access Share, as applicable, in favour of each special resolution to disapply its pre- emption rights under the B shares and/or the Dividend Access Share then held by HM Treasury every time they arise in respect of any such future issue. The pre-emption rights arising out of the B shares and the Dividend Access Share have also been disapplied in the Articles of Association.
HM Treasury has agreed that it shall not be entitled to vote the B shares or the Dividend Access Share to the extent that votes cast on such B shares and the Dividend Access Share, together with any other votes which HM Treasury is entitled to cast in respect of any ordinary shares held by or on behalf of HM Treasury, would exceed 75 per cent of the total votes eligible to be cast on a resolution proposed at a general meeting of the company.
State Aid Commitment Deed As a result of the State Aid granted to the company, it was required to work with HM Treasury to submit a State Aid restructuring plan to the European Commission, which was then approved under the State Aid rules. The company agreed a series of measures which supplemented the measures in the company's strategic plan.
The Group is currently in discussions with HM Treasury and the European Commission in relation to certain amendments to the terms of the State Aid approval and therefore expects to enter into a new version of the State Aid Commitment Deed in the near future
Sale of RBS England & Wales and NatWest Scotland branch based business On 27 September 2013, the Group agreed a £600 million pre-IPO investment with a consortium of investors led by Corsair Capital and Centerbridge Partners, in relation to its RBS England and Wales and NatWest Scotland branch based business which centres around 314 branches in the UK. Following completion of the operational and legal separation of the business into a standalone bank to be branded Williams & Glyn, an exercise that is already well underway, the Group will pursue an Initial Public Offering (IPO). The pre-IPO investment took the form of a £600 million bond, which was issued by the Royal Bank on 21 October 2013, which will be exchangeable for a significant minority interest in Williams & Glyn at the time of IPO. The bond will convert into Williams & Glyn shares at the IPO price, subject to a minimum ownership level which will be linked to the tangible book value of Williams & Glyn prior to the IPO, and in any case no more than a stake of 49%. To the extent the maximum ownership level is reached, the bond will be partially redeemed in cash such that the investors will receive a total value of £600 million of cash and shares at the IPO price. At the IPO, subject to RBSG's consent, the investors will have the option to acquire up to 10% additionally at the IPO price, subject to their pro forma ownership being no more than 49% in aggregate. The Royal Bank Markets division provided a £270 million secured financing package to the investor-consortium in relation to the investment.
Risk factors Set out below are certain risk factors which could adversely affect the Group's future results, its financial condition and prospects and cause them to be materially different from what is expected. The factors discussed below and elsewhere in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties facing the Group.
During Q3 2013, the Group worked with HM Treasury as part of its assessment of the merits of creating an external “bad bank” to hold certain assets of the Group. Although the review concluded that the establishment of an external “bad bank” was not in the best interests of all stakeholders, the Group committed to take a series of actions to further de-risk its business and strengthen its capital position.
• Lifting the Group’s capital targets including by: ° accelerating the divestment of RBS Citizens, the Group’s US banking subsidiary, with a partial IPO now planned for 2014, and full divestment of the business intended by the end of 2016; and
Implementation of the Group’s new strategic plan will require significant restructuring of the Group at the same time that it will also be implementing structural changes to comply with the Financial Services (Banking Reform) Act 2013 (the “Banking Reform Act” 2013) and its ringfencing requirements. The level of structural change intended to be implemented within the Group over the medium term taken together with the overall scale of change to make the Group a smaller, more focused financial institution, are likely to be disruptive and increase operational risks for the Group. There can be no assurance that the Group will be able to successfully implement this new strategy together with other changes required of the Group in the time frames contemplated or at all.
Risk factors continued The Group is subject to political risks The Group and The Royal Bank of Scotland plc (“RBS” or the “Royal Bank”), its principal operating subsidiary, are both headquartered and incorporated in Scotland. The Scottish Government is holding a referendum in September 2014 on the question of Scottish independence from the UK. Although the outcome of such referendum is uncertain, subject to any mitigating factors, the uncertainties resulting from an affirmative vote in favour of independence would be likely to significantly impact the Group’s credit ratings and could also impact the fiscal, monetary, legal and regulatory landscape to which the Group is subject. Were Scotland to become independent, it may also affect Scotland’s status in the EU. The occurrence of any of the impacts above could significantly impact the Group’s costs and would have a material adverse effect on the Group’s business, financial condition, results of operations and prospects.
The Group is subject to a number of legal, regulatory and governmental actions and investigations. Unfavourable outcomes in such actions and investigations could have a material adverse effect on the Group’s operating results or reputation The Group’s operations are diverse and complex, and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory and governmental investigations and other regulatory risk. As a result, the Group has recently settled a number of legal and regulatory investigations and is, and may in the future be, involved in a number of legal and regulatory proceedings and investigations in the UK, the EU, the US and other jurisdictions.
The Group is involved in ongoing class action litigation, investigations into foreign exchange trading and rate setting activities, continuing LIBOR related litigation and investigations, securitisation and securities related litigation, and anti-money laundering, sanctions, mis-selling and compliance related investigations, in addition to a number of other matters. In respect of the LIBOR and other trading rate-related investigations, the Group reached settlements on 6 February 2013 with the Financial Services Authority, the Commodity Futures Trading Association and the United States Department of Justice and on 4 December 2013 with the EC. In addition, the Group and the Royal Bank reached a settlement with the Board of Governors of the Federal Reserve System, the New York State Department of Financial Services and the Office of Foreign Assets Control with respect to the Royal Bank’s historical compliance with US economic sanction regulations outside the United States. The Group continues to cooperate with these and other governmental and regulatory authorities in connection with ongoing investigations and the probable outcome is that it will incur additional financial penalties which may be material.
The Group, like many other financial institutions, has come under greater regulatory scrutiny in recent years and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with historical, new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and antiterrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Past or current failure to comply with any one or more of these laws or regulations could have a significant adverse effect on the Group’s reputation, financial condition and results of operations.
In addition to the effects of such measures on the Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place the Group at a significant competitive disadvantage and prevent the Group from successfully implementing its strategy, which could have a material adverse effect on the Group’s financial condition and results of operations.
During 2013 the Group replaced its Group Chief Executive, Group Finance Director and Chief Risk Officer and its newly appointed Group Finance Director (October 2013) resigned and a search for a new Group Finance Director is continuing. The Group’s changing strategy, particularly with respect to its Markets business and recently announced disposition of RBS Citizens, has led to the exodus of talented staff. The lack of continuity of senior management and the loss of important personnel within the Group could have an adverse impact on the implementation of the Group’s strategic objectives and regulatory commitments.
These and other changes to the competitive landscape could adversely affect the Group’s business, margins, profitability, financial condition and prospects.
Challenging economic and market conditions create a difficult operating environment for the Group’s businesses, which is characterised by: • reduced activity levels, additional write-downs and impairment charges and lower profitability, especially in combination with regulatory changes or action of market participants, which either alone or collectively may restrict the ability of the Group to access funding and liquidity; • central bank actions to engender economic growth which have resulted in a prolonged period of low interest rates constraining, through margin compression and low returns on assets, the interest income earned on the Group’s interest earning assets; and
The Group and its UK bank subsidiaries are subject to the provisions of the Banking Act 2009, as amended by the Banking Reform Act 2013, which includes special resolution powers including nationalisation and bail-in Under the Banking Act 2009, substantial powers have been granted to HM Treasury, the Bank of England and the Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA) (together, the “Authorities”) as part of a special resolution regime. These powers enable the Authorities to deal with and stabilise certain deposit-taking UK incorporated institutions that are failing, or are likely to fail, to satisfy the threshold conditions (within the meaning of section 41 of the Financial Services and Markets Act 2000 (FSMA), which are the conditions that a relevant entity must satisfy in order to obtain its authorisation to perform regulated activities). The special resolution regime consists of three stabilisation options: (i) transfer of all or part of the business of the relevant entity and/or the securities of the relevant entity to a private sector purchaser, (ii) transfer of all or part of the business of the relevant entity to a ‘bridge bank’ wholly owned by the Bank of England and (iii) temporary public ownership (nationalisation) of the relevant entity. If HM Treasury decides to take the Group into temporary public ownership pursuant to the powers granted under the Banking Act 2009, it may take various actions in relation to any securities without the consent of holders of the securities.
The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan The Group was required to obtain State Aid approval for the aid given to the Group by HM Treasury as part of the placing and open offer undertaken by the Group in December 2008, the issuance to HM Treasury of £25.5 billion of B shares in the capital of the Group which are, subject to certain terms and conditions, convertible into ordinary shares in the share capital of the Group and a contingent commitment by HM Treasury (which has now been terminated) to subscribe for up to an additional £8 billion of B Shares if certain conditions are met in addition to the Group’s participation in the Asset Protection Scheme (APS) (which has now been terminated). In that context, as part of the terms of the State Aid approval, the Group, together with HM Treasury, agreed the terms of a restructuring plan.
The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan, including required asset disposals. In particular, the Group agreed to undertake a series of measures including the disposal of a number of businesses now completed, the disposal of Direct Line Group (DLG) and the disposal of the Royal Bank branchbased business in England and Wales and the National Westminster Bank Plc (NatWest) branches in Scotland, along with the direct and other small and medium-size enterprise (SME) customers and certain midcorporate customers across the UK. The initial sale of 34.7% of DLG through an IPO was completed in October 2012, with further sales in March and September 2013 reducing the Group’s stake to 28.5% at yearend, marking the continuation of the Group’s disposal strategy as part of its on-going delivery against EU-mandated commitments. In respect of the Royal Bank and NatWest branch-based business, the divestment process continues to progress following the withdrawal of its original buyer in October 2012 and a pre-IPO investment by a consortium of investors was announced in September 2013. The Group is currently in discussions with HM Treasury and the EC in relation to certain matters, including the potential retirement of the Dividend Access Share.
There is no assurance that the price that the Group receives or has received for any assets sold pursuant to the State Aid restructuring plan will be or has been at a level the Group considers adequate or which it could obtain in circumstances in which the Group was not required to sell such assets in order to implement the State Aid restructuring plan or if such sale were not subject to the restrictions contained in the terms thereof. Further, if the Group fails to complete any of the required disposals within the agreed timeframes for such disposals, or fails to negotiate extensions in respect of such disposals, under the terms of the State Aid approval, a divestiture trustee may be empowered to conduct the disposals, with the mandate to complete the disposal at no minimum price.
In implementing the State Aid restructuring plan, the Group has lost, and will continue to lose, existing customers, deposits and other assets (both directly through sale and potentially through the impact on the rest of the Group’s business arising from implementing the State Aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals.
The disposal of Global Merchant Services and RBS Sempra Commodities reduced the Group’s assets by approximately £13.0 billion and £2.4 billion, respectively (based on total assets immediately prior to disposal). The quantum of assets and deposits that would be included in a divestment of the Royal Bank branch-based business in England and Wales and the NatWest branches in Scotland is not certain. However, at 31 December 2013, this business included approximately £19.4 billion of assets, £23.2 billion of deposits and two million customers.
Risk factors continued The Group is subject to other global risks By virtue of the Group’s global presence, the Group is exposed to risks arising out of geopolitical events, such as the existence of trade barriers, the implementation of exchange controls and other measures taken by sovereign governments that can hinder economic or financial activity levels. Furthermore, unfavourable political, military or diplomatic events, armed conflict, pandemics and terrorist acts and threats, and the response to them by governments could also adversely affect levels of economic activity and have an adverse effect upon the Group’s business, financial condition and results of operations.
The Group’s business performance could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements Effective management of the Group’s capital is critical to its ability to operate its businesses, and to pursue its strategy of returning to standalone strength. The Group is required by regulators in the UK, the US and other jurisdictions in which it undertakes regulated activities to maintain adequate capital resources. The maintenance of adequate capital is also necessary for the Group’s financial flexibility in the face of continuing turbulence and uncertainty in the global economy and specifically in its core UK, US and European markets.
The Basel Committee on Banking Supervision’s package of reforms to the regulatory capital framework raises the quantity and quality of capital required to be held by a financial institution with an emphasis on Common Equity Tier 1 (CET1) capital and introduces an additional requirement for both a capital conservation buffer and a countercyclical buffer to be met with CET1 capital. The Basel Committee also has proposed that global systemically important banks (GSIBs) be subject to an additional CET1 capital requirement, depending on a bank’s systemic importance. The Group has been identified by the Financial Stability Board (FSB) as a GSIB. The FSB list of GSIBs is updated annually, based on new data and changes to methodology. The November 2013 update placed the Group in the second from bottom bucket of GSIBs, subjecting it to more intensive oversight and supervision and requiring to have additional loss absorption capacity of 1.5% in CET1, to be phased in from the beginning of 2016.
Since 1 January 2014, the Group has been required to comply with the requirements of CRD IV, the EBA’s RTSs and ITSs and the PRA’s Policy Statement PS 7/13 (Strengthening capital standards: implementing CRD IV, feedback and final rules). The Group must also operate by reference to the capital and leverage requirements set out by the PRA in its supervisory statement SS3/13 issued in November 2013 which is applicable to the eight major UK banks and building societies.
The provisions of PS7/13 embody PRA requirements to accelerate the introduction and phasing in of certain transitional provisions of CRD IV. The policy statement also sets out the intent of the PRA in respect of capital buffers as well as the approach to so-called Pillar 2 risks. By their nature, Pillar 2A risks, which contribute to the scaling of the Group’s Individual Capital Guidance from the PRA, can include risks which the Group considers would only materialise at the point of non-viability, an example being pension obligation risk. PS7/13 does not recognise this distinction and requires that Pillar 2A risks are met by at least 56% of CET1 by 1 January 2015.
The Banking Reform Act 2013, implementing the ICB recommendations, will introduce mechanisms requiring systemically important UK banks and building societies to hold loss-absorbing capacity, in addition to the capital held to satisfy their capital requirements under CRD IV as implemented by the PRA. These requirements, as well as other recommendations of the ICB, are to be established through secondary legislation and are expected to be phased in between 2015 and 2019. The US Federal Reserve has also recently adopted new rules relating to how it will regulate the US operations of foreign banking operations such as the Group that may affect the capital requirements of the Group’s operations in the US. As the implementation of the ICB recommendations is the subject of secondary legislation not yet adopted and the Federal Reserve has only recently adopted its final rules, the Group cannot predict the impact such rules will have on the Group’s overall capital requirements or how they will affect the Group’s compliance with applicable capital and loss absorbency requirements.
To the extent the Group has estimated the indicative impact that CRD IV rules may have on its risk-weighted assets and capital ratios, such estimates are preliminary and subject to uncertainties and may change. In particular, the estimates assume mitigating actions will be taken by the Group (such as deleveraging of legacy positions and securitisations, including RCR as well as other actions being taken to de-risk market and counterparty exposures), which may not occur as anticipated, in a timely manner, or at all.
At 31 December 2013, the Group’s Tier 1 and Core Tier 1 capital ratios were 13.1% and 10.9%, respectively, calculated in accordance with PRA requirements. On a fully loaded Basel III basis, the Group’s equivalent CET1 ratio was 8.6%. The Group continues to target a fully loaded Basel III CET1 ratio of approximately 11% by the end of 2015 and to be at 12% or above by the end of 2016. The Group’s ability to achieve such targets will turn on a number of factors, including the implementation of the Group’s strategy which calls for a significant downsizing of the Group in part through the sale of RBS Citizens in the U.S. See “Forward looking Statements” and “The Group’s ability to implement its new strategic plan and achieve its capital goals depends on the success of the Group’s plans to refocus on its core strengths and the timely divestment of RBS Citizens”.
The Group’s borrowing costs, its access to the debt capital markets and its liquidity depend significantly on its and the UK Government’s credit ratings The credit ratings of RBSG, RBS and other Group members have been subject to change and may change in the future, which could impact their cost of, access to and sources of financing and liquidity. A number of UK and other European financial institutions, including RBSG, the Royal Bank and other Group members, have been downgraded multiple times during the last three years in connection with rating methodology changes, a review of systemic support assumptions incorporated into bank ratings and the likelihood, in the case of UK banks, that the UK Government is more likely in the future to make greater use of its resolution tools to allow burden sharing with debt holders. Most recently credit ratings of RBSG, the Royal Bank and other Group members were downgraded in connection with the Group’s creation of RCR, coupled with concerns about execution risk, litigation risk and the potential for conduct related fines. Furthermore, subject to any mitigating factors, uncertainties resulting from an affirmative vote in favour of Scottish independence would be likely to have a negative impact on the credit ratings of RBSG and the Royal Bank.
The Group’s liquidity and funding management focuses, among other things, on maintaining a diverse and appropriate funding strategy for its assets in line with the Group’s wider strategic plan. The Group has, at times, been required to rely on shorter-term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. Such schemes require the pledging of assets as collateral and changes to asset valuations or eligibility criteria can negatively impact the available assets and reduce available liquidity access particularly during periods of stress when such lines may be needed most. Although conditions have improved, there have been recent periods where corporate and financial institution counterparties have reduced their credit exposures to banks and other financial institutions, limiting the availability of these sources of funding. Under certain circumstances, the Group may need to seek funds from alternative sources potentially at higher costs than has previously been the case, and/or with higher collateral or may be required to consider disposals of other assets not previously identified for disposal to reduce its funding commitments.
The occurrence of any of the risks described above could have a material adverse impact on the Group’s financial condition and results of operations.
The regulatory capital treatment of certain deferred tax assets recognised by the Group depends on there being no adverse changes to regulatory requirements While there was no restriction on the recognition of deferred tax assets at 31 December 2013, the Capital Requirements Regulation, which took effect from 1 January 2014, requires the deduction in full from CET1 capital of deferred tax assets that rely on future profitability and do not arise from temporary differences (for example, deferred tax assets related to trading losses). Other deferred tax assets which rely on future profitability and arise from temporary differences are subject to a threshold test and only the amount in excess of the threshold is deducted from CET1 capital. The PRA has not adopted the transitional provisions in relation to the change in the treatment of deferred tax assets and therefore the threshold deduction has the potential to impact CET1 capital from 1 January 2014.
Each of the Group’s businesses is subject to substantial regulation and oversight. Significant regulatory developments and changes in the approach of the Group’s key regulators has had and is likely to continue to have a material adverse effect on how the Group conducts its business and on its results of operations and financial condition The Group is subject to extensive financial services laws, regulations, corporate governance requirements, administrative actions and policies in each jurisdiction in which it operates. Many of these have been changing and are subject to further change, particularly in the current regulatory and market environment, where there have been unprecedented levels of government intervention (including nationalisations and injections of government capital), changes to the regulations governing financial institutions and reviews of the industry, in the UK, in many other European countries, the US and at the EU level.
Although it is difficult to predict with certainty the effect that all of the recent regulatory changes, developments and heightened levels of public and regulatory scrutiny will have on the Group, the enactment of legislation and regulations in the UK and the EU, the other parts of Europe in which the Group operates and the US (such as the bank levy and Banking Reform Act 2013 in the UK, the RRD and CRD IV or the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US) has resulted in increased capital and liquidity requirements, changes in other regulatory requirements and increased operating costs and has impacted, and will continue to impact, products offerings and business models. The Group may not be able to meet increased capital requirements by reducing lending which could result in the Group being obliged to continue to deploy capital in less profitable areas than it might otherwise have chosen. Such changes may also result in an increased number of regulatory investigations and proceedings. Any of these developments could have an impact on how the Group conducts its business, applicable authorisations and licences, the products and services it offers, its reputation, the value of its assets, and a material adverse effect on its funding costs and its results of operations and financial condition.
The measures in relation to the promotion of competition are already largely in process, including the development of an industry mechanism to make it easier for customers to switch their personal current accounts to a different provider, which was introduced in September 2013.
Bail-in mechanisms, will, if used, affect the rights of creditors, including holders of senior and subordinated bonds, and shareholders in the event of the implementation of a resolution scheme or an insolvency and could thereby materially affect the price of such securities. Such mechanics are being implemented through the Banking Reform Act 2013 and will also be part of the RRD. The implementation of a ring-fence of retail banking operations is also included in the Banking Reform Act 2013. The Banking Reform Act 2013 provides primary enabling legislation in the short term with a view to completing the legislative framework for the ring-fence of retail banking operations by May 2015, requiring compliance as soon as practicable thereafter and setting a final deadline for full implementation by 2019.
Risk factors continued The impact of any final legislation on the Group is difficult to estimate with any precision at this stage. The Statutory Instruments setting out the scope of the ring-fence required by the Banking Reform Act 2013 are currently under discussion and final versions are expected to be published at some point in the summer of 2014. The PRA will have responsibility for drawing up the ring-fencing rules which will impact on the governance and operation of the ring-fenced bank. It is understood that the first consultation on the PRA rules will commence around the summer of 2014. It is also likely that ring-fencing certain of the Group’s operations would require significant restructuring with the possible transfer of large numbers of customers between legal entities. Ringfencing is also likely to entail changes to the structure of the Group’s existing pension arrangements, so as to ensure that any ring-fenced and non-ring-fenced banks that may eventually be established should not be liable for each other’s pension liabilities. Any such changes could result in additional costs and increased operational risks. It is possible that such ring-fencing, by itself, or taken together with the impact of other proposals contained in this legislation and other EU legislation that will apply to the Group could have a material adverse effect on the Group’s structure and on the viability of certain businesses, in addition to the Group’s results of operations, financial conditions and prospects.
On 29 January 2014, the EC published proposals on structural measures to improve the resilience of EU credit institutions which included potential separation of certain trading activities from retail banking operations. The proposal currently contemplates that member states having already implemented ring-fencing legislation, such as the UK, may apply for a derogation from the separation of trading activities provisions included in the proposals if they can satisfy the EC that such local legislation meets the objectives and requirements set out in the EU proposal. The timeline envisaged under the proposals would be the effective separation of other trading activities to apply as of 1 July 2018.
Under the US Federal Reserve’s new rules which change how it regulates the US operations of large foreign banking groups ( the “FBO Rules”), foreign banking organisations with total global consolidated assets of $50 billion or more (“Large FBOs”) and Large FBOs with total US assets of $50 billion or more (excluding assets of US branches and agencies of a Large FBO’s foreign banks and certain other US subsidiaries) will have to create a separately capitalised top-tier US intermediate holding company (IHC) that would hold all US bank and non-bank subsidiaries. The IHC would be subject to US capital, liquidity and other enhanced prudential standards on a consolidated basis. Among other things, an IHC will be subject to the same US risk based and leverage capital standards that apply to a US bank holding company.
The Group is subject to resolution procedures under current and proposed resolution and recovery schemes which may result in various actions being taken in relation to any securities of the Group, including the write off, write-down or conversion of the Group’s securities As a result of its status as a GSIFI and in accordance with current and proposed resolution and recovery schemes and the Prudential Standards issued by the PRA on 19 December 2013 on recovery and resolution planning, the Group was required to meet certain resolution planning requirements contemplating its possible failure by the end of 2012 and 2013 and will be required to meet others in 2014. The Group made the required submissions in 2012 to the Financial Services Authority (FSA) (now the PRA) and its US business made their required submissions to the Federal Reserve and the FDIC in H1 2013 and further submissions will be required to be made in 2014. Similar to other major financial institutions, both the Group and its key subsidiaries remain engaged in a constructive dialogue on resolution and recovery planning with key national regulators and other authorities. The Prudential Standards issued by the PRA may evolve over time to ensure continued consistency with the Financial Stability Board’s (FSB) recommendations and the technical standards and guidelines produced by the European Banking Authority to implement the RRD.
The potential impacts of these resolution and recovery powers may include the total loss of value of securities issued by the Group and, in addition for debt holders, the possible conversion into equity securities, and under certain circumstances the inability of the Group to perform its obligations under its securities. As these resolution and recovery measures remain subject to further implementation both at the European and UK level, changes may be made in the course of the legislative process, which may affect their impact on the Group and securities issued by the Group.
In addition, in June 2012 and more recently in November 2013, computer system failures prevented NatWest, RBS and Ulster Bank customers from accessing accounts in both the UK and Ireland. Ongoing issues relating to the failure continued for several months, requiring the Group to set aside a provision for compensation to customers who suffered losses as a result of the system failure, in addition to other related costs. See page 451. The vulnerabilities of the Group’s IT systems are due to the complexity of the Group’s IT infrastructure attributable in part to overlapping multiple legacy systems acquired through the Group’s acquisitions and resulting gaps in how the IT systems operate, and insufficient-investments in IT infrastructure in the past, creating challenges in recovering from system breakdowns.
In order to eliminate this deficit, the Group has been and will continue to pay additional contributions each year over the period 2011 until 2018. Contributions started at £375 million per annum in 2011, increased to £400 million per annum in 2013 and will further increase from 2016 onwards in line with price inflation. These contributions are in addition to the regular annual contributions of around £200 million for on-going accrual of benefits as well as contributions to meet the expenses of running the schemes.
The financial performance of the Group has been, and continues to be, materially affected by counterparty credit quality and deteriorations could arise due to prevailing economic and market conditions and legal and regulatory developments The Group has exposure to many different industries and counterparties, and risks arising from actual or perceived changes in credit quality and the recoverability of monies due from borrowers and counterparties are inherent in a wide range of the Group’s businesses. In particular, the Group has significant exposure to certain individual counterparties in weakened business sectors and geographic markets and also has concentrated country exposure in the UK, the US and across the rest of Europe (principally Germany, The Netherlands, Ireland and France) (at 31 December 2013 credit risk assets in the UK were £320.0 billion, in North America £96.1 billion and in Western Europe (excluding the UK) £104.3 billion); and within certain business sectors, namely personal finance, financial institutions, shipping and commercial real estate (at 31 December 2013 personal finance lending amounted to £177.1 billion, lending to financial institutions was £91.0 billion, lending against ocean going vessels was £8.6 billion and commercial real estate lending was £52.6 billion). The Group expects its exposure to the UK to increase proportionately as its business becomes more concentrated in the UK, with exposures generally being reduced in other parts of its business as it continues to implement its strategy.
In certain jurisdictions in which the Group does business, particularly Ireland, additional constraints have been imposed in recent years on the ability of certain financial institutions to complete foreclosure proceedings in a timely manner (or at all), including as a result of interventions by certain states and local and national governments.
The EU, the ECB, the International Monetary Fund and various national authorities have proposed and implemented certain measures intended to address systemic financial stresses in the Eurozone, including the creation of a European Banking Union which, through a Single Resolution Mechanism (SRM) will apply the substantive rules of bank recovery and resolution set out in the RRD. Current expectations are that the RRD, which is intended to provide supervisory authorities with common tools and powers to address banking crises pre-emptively in order to safeguard financial stability and minimise taxpayers’ exposure to losses, will be finalised early in 2014. The effectiveness of these and other actions proposed and implemented at both the EU and national level to address systemic stresses in the Eurozone is not assured.
The trends and risks affecting borrower and counterparty credit quality have caused, and in the future may cause, the Group to experience further and accelerated impairment charges, increased repurchase demands, higher costs, additional write-downs and losses for the Group and an inability to engage in routine funding transactions.
Risk factors continued In the UK and in other jurisdictions, the Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers In the UK, the Financial Services Compensation Scheme (FSCS) was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. The FSCS can pay compensation to customers if a firm is unable or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act 2009. The FSCS is funded by levies on firms authorised by the FCA, including the Group. In the event that the FSCS raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have an adverse impact on its results of operations and financial condition. In addition, the RRD will require the establishment of national resolution funds, which will require ex ante levies on banks and investment firms to ensure that the resolution tools contemplated by the RRD can be applied effectively.
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate Under International Financial Reporting Standards (IFRS), the Group recognises at fair value: (i) financial instruments classified as held-fortrading or designated as at fair value through profit or loss; (ii) financial assets classified as available-for-sale; and (iii) derivatives.
The Group’s results could be adversely affected in the event of goodwill impairment The Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the Group tests goodwill for impairment annually, or more frequently when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of the value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. At 31 December 2013, the Group carried goodwill of £10.1 billion on its balance sheet. The value in use and fair value of the Group’s cash generating units are affected by market conditions and the performance of the economies in which the Group operates. Where the Group is required to recognise a goodwill impairment, it is recorded in the Group’s income statement, although it has no effect on the Group’s regulatory capital position. Any significant write-down of goodwill could have a material adverse effect on the Group’s results of operations.
The recoverability of certain deferred tax assets recognised by the Group depends on the Group’s ability to generate sufficient future taxable profits In accordance with IFRS, the Group has recognised deferred tax assets on losses available to relieve future profits from tax only to the extent that it is probable that they will be recovered. The deferred tax assets are quantified on the basis of current tax legislation and accounting standards and are subject to change in respect of the future rates of tax or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax legislation or accounting standards may reduce the recoverable amount of the recognised deferred tax assets. In April 2011, the UK Government commenced a staged reduction in the rate of UK corporation tax from 28% to 23% over a four-year period and further rate reductions were announced in 2012 and 2013 which will lead to a corporation tax rate of 20% by April 2015. Such changes in the applicable tax rates will reduce the recoverable amount of the recognised deferred tax assets.
Financial calendar Annual General Meeting 25 June 2014 RBS Conference Centre
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Dividends Payment dates Cumulative preference shares 30 May and 31 December 2014 31 March, 30 June, 30 September and 31 December 2014
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Analyses of ordinary shareholders Number of shares At 31 December 2013 Shareholdings - millions %
Trading market Non-cumulative dollar preference shares On 26 March 1997, 8 February 1999, 30 September 2004, 26 August 2004, 19 May 2005, 9 November 2005, 25 May 2006, 27 December 2006, 28 June 2007, 27 September 2007 and 4 October 2007, the company issued the following series of American Depository Shares (ADSs) representing noncumulative dollar preference shares of the company, in the United States, of which the following were outstanding at 31 December 2013: 6,255,408 Series F ("Series F ADSs") representing 6,255,408 non-cumulative dollar preference shares, Series F; 9,687,654 Series H ("Series H ADSs") representing 9,687,654 non-cumulative dollar preference shares, Series H; 30,027,877 Series L ("Series L ADSs") representing 30,027,877 non-cumulative dollar preference shares, Series L; 23,125,869 Series M (“Series M ADSs”) representing 23,125,869 non-cumulative dollar preference shares, Series M; 22,113,160 Series N ("Series N ADSs") representing 22,113,160 non-cumulative dollar preference shares, Series N; 9,883,307 Series P ("Series P ADSs") representing 9,883,307 non-cumulative dollar preference shares, Series P; 20,646,938 Series Q ("Series Q ADSs") representing 20,646,938 non-cumulative dollar preference shares, Series Q; 10,163,932 Series R ("Series R ADSs") representing 10,163,932 non-cumulative dollar preference shares, Series R; 26,449,040 Series S ("Series S ADSs") representing 26,449,040 non-cumulative dollar preference shares, Series S; 51,245,839 Series T ("Series T ADSs") representing 51,245,839 non-cumulative dollar preference shares, Series T; and 10,130 Series U ("Series U ADSs") representing 10,130 non-cumulative dollar preference shares, Series U.
At 31 December 2013, there were 54 registered shareholders of Series F ADSs, 34 registered shareholders of Series H ADSs, 21 registered shareholders of Series L ADSs, 6 registered shareholders of Series M ADSs, 13 registered shareholders of Series N ADSs, 24 registered shareholders of Series P ADSs, 9 registered shareholders of Series Q ADSs, 3 registered shareholders of Series R ADSs, 1 registered shareholder of Series S ADSs, 18 registered shareholders of Series T ADSs and 1 registered shareholder of Series U ADSs.
ADSs representing ordinary shares In October 2007, the company listed ADSs, each representing one ordinary share nominal value 25p each (or a right to receive one ordinary share), and evidenced by an ADR or uncertificated securities, on the NYSE. The ADSs were issued in connection with the company's bid for the outstanding share capital of ABN AMRO Holding N.V.. With effect from 7 November 2008, the ratio of one ADS representing one ordinary share changed to one ADS representing 20 ordinary shares.
At the Annual General Meeting on 30 May 2012, shareholders approved a sub-division and consolidation of the Group’s ordinary shares which resulted in new ordinary shares of 100 pence each being admitted to trading in London and New York with effect from 6 June 2012. The ratio of one ADS representing 20 ordinary shares changed to one ADS representing two ordinary shares with effect from 6 June 2012. As at 31 December 2013, 30.6 million ADSs were outstanding.
The ADSs described above were issued pursuant to a Deposit Agreement, among the company, The Bank of New York Mellon, as depository, and all owners and holders from time to time of ADSs issued thereunder. The ordinary shares of the company are listed and traded on the London Stock Exchange. All ordinary shares are deposited with the principal London office of The Bank of New York Mellon, as custodian for the depository.
By quarter 2013: Q4 High 25.24 24.85 20.25 21.88 21.75 21.40 22.95 21.18 22.49 24.76 97.50 105.16 Low 24.32 23.83 19.13 20.23 20.07 19.88 21.16 19.70 20.72 23.05 92.50 102.20 2013: Q3 High 24.95 24.70 20.42 21.16 21.08 20.89 22.24 20.71 21.82 23.84 95.00 102.80 Low 24.16 23.64 18.46 19.58 19.46 19.29 20.57 19.26 20.23 22.28 89.00 91.38 2013: Q2 High 25.86 25.55 23.87 24.03 23.72 23.92 24.63 23.70 24.45 25.44 98.50 106.76 Low 24.07 23.52 18.99 20.21 20.16 20.00 21.05 19.79 20.49 21.83 84.00 90.27 2013: Q1 High 25.62 25.41 24.00 23.87 23.69 23.71 24.54 23.47 24.21 25.03 97.00 107.70 Low 24.77 24.70 22.39 22.24 22.20 21.92 23.32 21.77 23.03 24.19 89.00 100.24 2012: Q4 High 25.20 24.92 23.57 23.09 22.98 22.83 23.40 22.96 23.31 24.50 90.00 100.59 Low 24.33 23.99 21.32 20.73 20.71 21.15 21.16 21.26 20.89 22.78 82.50 97.92 2012: Q3 High 25.35 24.96 22.29 21.24 21.31 21.76 21.93 21.26 21.44 23.54 85.00 98.46 Low 23.23 21.92 18.02 17.53 17.28 17.52 18.20 17.50 17.85 19.76 66.00 79.51 2012: Q2 High 23.43 22.33 19.10 17.76 17.64 18.33 18.77 17.85 18.44 20.45 71.00 86.60 Low 20.39 19.34 17.00 15.85 15.70 15.85 16.39 15.58 16.23 18.11 62.00 73.78 2012: Q1 High 24.24 22.74 19.48 16.64 16.51 16.52 17.39 16.57 16.98 19.00 71.38 85.32 Low 17.60 16.76 15.46 11.63 11.53 11.41 12.24 11.41 11.83 13.08 53.63 66.58
January 2014 High 3.750 2013: Q4 High 3.849 2013 High 3.849 Low 3.322 Low 3.159 Low 2.661 December 2013 High 3.400 2013: Q3 High 3.727 2012 High 3.250 Low 3.159 Low 2.700 Low 1.966 November 2013 High 3.400 2013: Q2 High 3.519 2011 High 4.900 Low 3.218 Low 2.661 Low 1.734 October 2013 High 3.849 2013: Q1 High 3.678 2010 High 5.804 Low 3.521 Low 2.755 Low 3.125 September 2013 High 3.727 2012: Q4 High 3.250 2009 High 5.765 Low 3.286 Low 2.573 Low 1.030 August 2013 High 3.447 2012: Q3 High 2.790 Low 3.174 Low 1.966 2012: Q2 High 2.775 Low 1.998 2012: Q1 High 2.917 Low 2.007
On 25 February 2014, the closing price of the ordinary shares on the London Stock Exchange was £3.624, equivalent to $6.051 per share translated at the Noon Buying Rate of $1.6696 per £1.00 on 25 February 2014.
ADSs The following table shows, for the periods indicated, the high and low sales prices for the company's ordinary ADSs, as reported on the NYSE composite tape.
January 2014 High 12.40 2013: Q4 High 12.35 2013 High 12.35 Low 11.00 Low 10.25 Low 8.15 December 2013 High 11.33 2013: Q3 High 11.97 2012 High 10.79 Low 10.35 Low 8.23 Low 6.09 November 2013 High 10.85 2013: Q2 High 10.81 2011 High 15.83 Low 10.25 Low 8.15 Low 5.36 October 2013 High 12.35 2013: Q1 High 11.84 2010 High 17.30 Low 11.39 Low 8.37 Low 9.89 September 2013 High 11.97 2012: Q4 High 10.79 2009 High 18.95 Low 10.31 Low 8.20 Low 3.33 August 2013 High 10.84 2012: Q3 High 9.05 Low 9.77 Low 6.09 2012: Q2 High 8.87 Low 6.17 2012: Q1 High 9.29 Low 6.25
On 25 February 2014, the closing price of the ordinary ADSs on the New York Stock Exchange was $12.05.
On 4 May 2012, RBS determined that it was in a position to recommence payments on RBS Group instruments. In June 2013 RBS Holdings N.V. resumed payments on its hybrid capital instruments. Future coupons and dividends on hybrid capital instruments will only be paid subject to, and in accordance with, the terms of the relevant instruments.
Taxation of capital gains A US Holder that is not resident in the UK will not normally be liable for UK tax on capital gains realised on the disposition of an ordinary share, an ordinary ADS or a preference ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a branch or agency and, in each case, such ordinary share, ordinary ADS or preference ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), carried on through such permanent establishment, branch or agency. Special rules apply to individuals who are temporarily not resident in the UK.
A US Holder will, upon the sale or other disposition of an ordinary share, an ordinary ADS or a preference ADS, or upon the redemption of preference ADS, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption of a preference ADS, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holder’s tax basis in such share or ADS. This capital gain or loss will be long-term capital gain or loss if the US Holder held the share or ADS so sold, disposed or redeemed for more than one year. The deductibility of capital losses is subject to limitations.
An ordinary share, an ordinary ADS or a preference ADS beneficially owned by an individual, whose domicile is determined to be the United States for purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual’s death or on a lifetime transfer of such share or ADS, except in certain cases where the share or ADS (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the ordinary share, ordinary ADS or preference ADS is subject to both UK inheritance tax and US federal estate or gift tax.
Taxation for US Holders continued PROs United States Payments of interest on a PRO (including any UK withholding tax, as to which see below) will constitute foreign source dividend income for US federal income tax purposes to the extent paid out of the current or accumulated earnings and profits of the company, as determined for US federal income tax purposes. Because the company does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions will be reported to US Holders as dividends. Payments will not be eligible for the dividends-received deduction generally allowed to corporate US holders. A US Holder who is entitled under the Treaty to a refund of UK tax, if any, withheld on a payment will not be entitled to claim a foreign tax credit with respect to the refundable tax. Subject to applicable limitations that vary depending upon a US Holder’s particular circumstances and the discussion above regarding concerns expressed by the US Treasury, dividends paid to certain non-corporate US Holders may be taxable at the favourable rates applicable to long-term capital gain. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at these favourable rates.
However, a US Holder who is entitled under the Treaty to a refund of UK tax, if any, withheld on a payment will not be entitled to claim a foreign tax credit with respect to the refundable tax.
Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a branch or agency in each case in connection with which the interest is received or to which the PROs are attributable. There are also exemptions for interest received by certain categories of agents (such as some brokers and investment managers).
Disposal (including redemption) A disposal (including redemption) of PROs by a non-corporate US Holder will not give rise to any liability to UK tax on capital gains unless the US Holder carries on a trade (which for this purpose includes a profession or a vocation) in the UK through a branch or agency and the PROs are, or have been, held or acquired for the purposes of that trade, carried on through such branch or agency.
The company's possible status as a PFIC is determined annually, however, and may be subject to change if the company fails to qualify under this special rule for any year in which a US Holder owns ordinary shares, ordinary ADSs, preference ADSs or PROs. If the company were to be treated as a PFIC for any taxable year during which a US Holder owned ordinary shares, ordinary ADSs, preference ADSs or PROs, the US Holder would generally be subject to adverse US federal income tax consequences and certain reporting obligations. Holders should consult their own tax advisers as to the potential application of the PFIC rules to the ownership and disposition of the company's ordinary shares, ordinary ADSs, preference ADSs or PROs.
Foreign financial assets reporting Certain US Holders who are individuals (and under proposed regulations, certain entities) may be required to report information relating to the company’s securities, subject to certain exceptions (including an exception for securities held in accounts maintained by US financial institutions). US Holders are urged to consult their tax advisers regarding the application of these rules in the US Holders’ particular circumstances.
Exchange controls The company has been advised that there are currently no UK laws, decrees or regulations which would prevent the import or export of capital, including the availability of cash or cash equivalents for use by the Group, or the remittance of dividends, interest or other payments to non-UK resident holders of the company's securities.
Memorandum and Articles of Association The company's Memorandum and Articles of Association as in effect at the date of this annual report are registered with the Registrar of Companies of Scotland. The Articles of Association were last amended on 30 May 2012. Copies can be obtained from Companies House in the UK or from the Group’s website (rbs.com).
BIPRU - the prudential sourcebook for banks, building societies and investment firms. The part of the Financial Conduct Authority's (FCA) Handbook that sets out detailed prudential requirements for the banks that they regulate.
CRD IV - the European Union has implemented the Basel III capital proposals through the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD), collectively known as CRD IV. CRD IV was implemented on 1 January 2014. The European Banking Authority’s technical standards are still to be finalised through adoption by the European Commission and implemented within the UK.
Credit derivative product company (CDPC) - a structured entity that sells credit protection under credit default swaps or certain approved forms of insurance policies. Sometimes they can also buy credit protection. CDPCs are similar to monoline insurers. However, unlike monoline insurers, they are not regulated as insurers.
Effective interest rate method - the effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.
Expected loss (EL) - expected loss represents the anticipated loss on an exposure over one year. It is determined by multiplying probability of default, loss given default and exposure at default and can be calculated at individual, credit facility, customer or portfolio level.
Fully loaded Basel III basis - capital ratios based on the rules that will apply at the end of the Basel III transition period.
G10 - the Group of Ten comprises the eleven industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) that have agreed to participate in the International Monetary Fund’s (IMF’s) General Arrangements to Borrow.
Government Sponsored Enterprises (GSEs) - a group of financial services corporations created by the US Congress. Their function is to improve the efficiency of capital markets and to overcome statutory and other market imperfections which otherwise prevent funds from moving easily from suppliers of funds to areas of high loan demand. They include the Federal Home Loan Mortgage Corporation and the Federal National Mortgage Association.
Mortgage servicing rights - the rights of a mortgage servicer to collect mortgage payments and forward them, after deducting a fee, to the mortgage lender.
Non-performing loans - loans classified as Risk elements in lending and Potential problem loans. They have a 100% probability of default and have been assigned an AQ10 internal credit grade.
Pillar 3 - the part of Basel II that sets out the information banks must disclose about their risks, the amount of capital required to absorb them, and their approach to risk management. The aim is to strengthen market discipline.
Prudential Regulation Authority (PRA) - the statutory body responsible, from 1 April 2013, for the prudential supervision of banks, building societies, insurers and a small number of significant investment firms in the UK. The PRA is a subsidiary of the Bank of England.
Securitisation - a process by which assets or cash flows are transformed into transferable securities. The underlying assets or cash flows are transferred by the originator or an intermediary, typically an investment bank, to a structured entity which issues securities to investors. Asset securitisations involve issuing debt securities (asset-backed securities) that are backed by the cash flows of income-generating assets (ranging from credit card receivables to residential mortgage loans).
Standstill - is an agreement, usually for a specified period of time, not to enforce the Bank’s rights as a result of a customer breaching the terms and conditions of their facilities. This is a concession to the customer. A standstill is most commonly used in a complex restructuring of a company’s debts, where a group of creditors agree to delay enforcement action to give the company time to gather information and formulate a strategy with a view to establishing a formal restructuring.
Structured entity (SE) - 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.
Super senior CDO - the most senior class of instrument issued by a CDO vehicle. They benefit from the subordination of all other instruments, including AAA rated securities, issued by the CDO vehicle.
Supervisory slotting approach - a method of calculating regulatory capital, specifically for lending exposures in project finance and income producing real estate, where the PD estimates do not meet the minimum IRB standards. Under this approach, the bank classifies exposures from 1 to 5, where 1 is strong and 5 is default. Specific risk-weights are assigned to each classification.
Risk governance and risk management strategies/business model 8 Stress testing. 181-182 9 Pillar 1 minimal capital requirements. 193-194 10 Composition of capital and reconciliation between accounting and regulatory balance 11 Regulatory capital flow statement. 198-199 12 Capital planning and management. 193-194 13 Risk-weighted assets (RWAs) and business activities. 202-204 14 Capital requirements and RWAs. 195, 330 15 Credit risk in the banking book for major portfolios. 207-208 16 RWA flow statements. 202-204
Capital adequacy and riskweighted assets 17 Back-testing of models. 326-327 Liquidity 18 Liquid assets and their management. 210-214 Funding 19 Encumbered assets. 223-226 20 Contractual maturity of assets, liabilities and off-balance sheet commitments. 217, 220-222 21 Funding strategy including key sources. 216-220 Market risk 22 Linkages the balance sheet and market risk portfolios. 320 23 Significant trading and non-trading market risk factors. 323 24 Model limitations, assumptions and validation procedures 324-328 25 Stress testing and scenario analysis. 329 Credit risk 26 Credit risk exposures, including linkage to balance sheet. 269-278, 206 27 Policies for impaired loans and forbearance. 242-251 28 Flow statements for impaired loans and allowance for loan losses. 299-316 29 Counterparty credit risk that arises from derivatives transactions. 241, 296-299 30 Credit risk mitigation. 237-241, 269 Other risks 31 Other risk types. 189-191 32 Discussion of publicly known risk events. 4-5, 22
Accounting Accounting developments 389 Accounting policies 377 Critical accounting policies 386
Board Risk Committee report Letter from the Chairman of the Board Risk Committee 58 Report of the Board Risk Committee 60
Corporate governance Compliance report 91 Governance at a glance 20 Risk management 176 The Board and its committees 38
Derivatives Risk and balance sheet management 296 Notes on the consolidated accounts 438
Intangible assets Accounting policies 379 Segmental analysis of goodwill 492 Notes on the consolidated accounts 443
Non-interest income Business review 122 Notes on the consolidated accounts 392
Operating expenses Business review 124 Notes on the consolidated accounts 393
Parent company Balance sheet 497 Cash flow statement 500 Income statement 501 Statement of changes in equity 498 Statement of comprehensive income 501 Notes 501
Payment Protection Insurance Notes on the consolidated accounts 393 Critical accounting policies 387
Pensions Accounting policies 378 Critical accounting policies 386 Notes on the consolidated accounts 398 Pension risk 356
Provisions Accounting policies 381 Additional information 512 Notes on the consolidated accounts 436,451
Segmental reporting Business review 129 Description of business 104 Notes on the consolidated accounts 487
Shareholder information Analysis of ordinary shareholders 539 Annual General Meeting 538 Shareholder enquiries 538
Sustainability Letter from the Chairman of the Group Sustainability Committee 64 Report of the Group Sustainability Committee 65 Strategic report 31