Notes: (1) Based on end-point CRR Tier 1 leverage exposure under the CRR Delegated Act. (2) The UK leverage ratio excludes central bank claims from the leverage exposure where deposits held are denominated in the same currency and of contractual maturity that is equal or longer than that of the central bank claims.
Weighted undrawn commitments The table below provides a breakdown of weighted undrawn commitments.
Unconditionally cancellable credit cards 2.0 2.1 Other unconditionally cancellable items 7.1 4.7
As at and for year ended Senior debt roll-off profile (1) 31 December Roll-off profile RBSG 2018 H1 2019 H2 2019 2020 2021 2022 & 2023 2024 & later - amount (£m) 16,830 535 781 2 — 7,037 8,474 - weighted average rate spread (bps) 205 129 283 162 — 224 187
NWM Plc - amount (£m) 16,523 3,186 3,239 4,704 2,066 2,022 1,306 - weighted average rate spread (bps) 102 13 177 123 91 80 117
NatWest Plc - amount (£m) 329 253 77 — — — — - weighted average rate spread (bps) 7 4 15 — — — —
Securitisation - amount (£m) 1,375 — — — — — 1,375 - weighted average rate spread (bps) 418 — — — — — 418
Total notes issued (£m) 40,424 3,974 4,097 7,852 2,066 9,059 13,377 Weighted average spread 158 27 194 113 91 192 200
Credit risk credit risk Market risk Operational risk Total RWAs £bn £bn £bn £bn £bn
 RWAs decreased by £12.2 billion (excluding the day one impact of the adoption of IFRS 9) in 2018 primarily driven by the legacy business in NatWest Markets, the impact of capital initiatives in Commercial Banking and Ulster Bank RoI asset sale. These reductions were partially offset by increases in UK PBB and RBSI.
 The reduction within Commercial Banking was due to active capital management, partially offset by the impact of model updates and underlying business growth.
Capital, liquidity and funding risk continued Liquidity portfolio (audited) The table below shows the liquidity portfolio by product, liquidity value and carrying value. Liquidity value is lower than carrying value as it is stated after discounts (or haircuts) applied to instruments by the Bank of England and other central banks. Secondary liquidity comprises assets eligible for discount at central Banks but these do not form part of the liquid asset portfolio reported for regulatory LCR purposes or internal stressed outflow coverage purposes.
Capital, liquidity and funding risk continued Funding sources (audited) The table below shows the carrying values of the principal funding sources based on contractual maturity. Balance sheet captions include balances held at all classifications under IFRS 9/IAS 39 but excludes derivative cash collateral.
Repos (5) Sovereign 405 — 405 5,243 — 5,243 Financial institutions 29,664 — 29,664 31,891 — 31,891 Corporate 291 — 291 1,287 — 1,287 30,360 — 30,360 38,421 — 38,421
Of which: available in resolution (6) — 22,909 22,909 — 15,840 15,840
Capital, liquidity and funding risk continued Funding gap: maturity and segment analysis 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 1-5 Greater than Less than 1-5 Greater 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
Note: (1) Loans to customers and customer accounts include trading assets and trading liabilities respectively and excludes reverse repos and repos.
 The net customer funding surplus has increased by £5billion during 2018 to £49billion driven by £1billion deposit growth and £4billion lending reduction
Programmes to manage the use of assets to support funding actively are established within UK DoLSub, UBI DAC and NatWest Markets Plc.
The table shows the retained encumbered assets of the Group. Derivatives and Reverse Repos are disclosed within the credit risk section on pages 147 and 148.
Cash and balances at central banks — 6.7 6.7 — 82.2 — — 82.2 88.9 Trading assets — 49.1 49.1 — — 1.3 24.7 26.0 75.1 Derivatives — — — — — — 133.3 133.3 133.3 Settlement balances — — — — — — 2.9 2.9 2.9 Loans to banks - amortised cost 0.4 1.0 1.4 — 6.6 0.4 4.5 11.5 12.9 Loans to customers - amortised cost - residential mortgages - UK 7.1 — 7.1 110.1 20.9 11.5 — 32.4 149.6 - RoI 2.8 — 2.8 2.1 8.9 — — 8.9 13.8 - credit cards — — — — 3.7 0.3 — 4.0 4.0 - personal loans — — — — 5.8 2.6 1.8 10.2 10.2 - other 2.4 2.4 4.8 4.9 2.3 91.0 24.5 117.8 127.5 Other financial assets — 10.4 10.4 — 46.0 0.8 2.3 49.1 59.5 Intangible assets — — — — — — 6.6 6.6 6.6 Other assets — — — — — 2.3 7.6 9.9 9.9
(7) Cannot be used includes: (a) Derivatives, reverse repurchase agreements and trading related settlement balances. (b) Non-financial assets such as intangibles, prepayments and deferred tax. (c) Loans that cannot be pre-positioned with central banks based on criteria set by the central banks, including those relating to date of origination and level of documentation. (d) Non-recourse invoice financing balances and certain shipping loans whose terms and structure prohibit their use as collateral. (8) In accordance with market practice, RBS employs securities recognised on the balance sheet, and securities received under reverse repo transactions as collateral for repos.
The following disclosures in this section are audited:  Forbearance.  Impairment, provisioning and write-offs.  Transition from IAS 39 to IFRS 9.  Key elements of IFRS 9 impairment provisions: o Economic loss drivers (excluding economic parameters). o IFRS 9 credit risk modelling. o Significant increase in credit risk. o Asset lifetimes.
 Measurement uncertainty and ECL sensitivity analysis.  Banking activities (except PDs and additional Stage 2 and Stage 3 analysis).  Trading activities.
Sources of risk The principal sources of credit risk for RBS are lending, off-balance sheet products, derivatives and securities financing, and debt securities. RBS is also exposed to settlement risk through foreign exchange, trade finance and payments activities.
 New mortgage lending declined in 2018 (£32.8 billion compared to £33.9 billion in 2017). The overall personal portfolio increased by £1.7 billion (principally driven by growth of the mortgage portfolio).
 IFRS 9 Financial Instruments, which covers credit provisions, was implemented with effect from 1 January 2018. In line with expectations, the new accounting standard resulted in an overall increase in provisions compared with the previous accounting standard IAS 39. Further detail is provided later in the report.
 Impairment provisions totalled £3.4 billion at the year end representing coverage on amortised cost loans excluding balances at central banks of 1.1%.
The Chief Credit Officer, Ring-Fenced Bank, chairs the Wholesale and Retail Credit Risk Committees. These committees provide oversight of the aggregated RBS credit risk profile and review, recommend or approve risk appetite limits (depending on their materiality) within the appetite set by the RBS Board.
Risk appetite 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 (for example, 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 transaction acceptance standards that set out the risk parameters within which franchises should operate.
The Personal credit risk appetite 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 both portfolio and product level, projected credit default rates across products and the loan-to-value (LTV) ratio of the Personal mortgage portfolios.
Country Probability of default of a sovereign and average loss given default
Risk controls Credit policy standards are in place for both the Wholesale and Personal portfolios. They are expressed as a set of mandatory controls.
Credit risk continued Risk models 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.
Amounts owed by RBS to a counterparty are netted against amounts the counterparty owes RBS, in accordance with relevant regulatory and internal policies. Netting is only applied if a netting agreement is in place.
Risk assessment and monitoring Practices for credit stewardship – including credit assessment, approval and monitoring as well as the identification and management of problem debts – differ between the Personal and Wholesale portfolios.
The process is then largely automated, with each customer receiving an individual credit score that reflects both internal and external behaviours and this score is compared with the lending rules set. For relatively high-value, complex personal loans, including some residential mortgage lending, specialist credit managers make the final lending decisions. These decisions are made within specified delegated authority limits that are issued dependent on the experience of the individual.
Underwriting standards and portfolio performance are monitored on an ongoing basis to ensure they remain adequate in the current market environment and are not weakened materially to sustain growth.
Wholesale Wholesale customers – including corporates, banks and other financial institutions – are grouped by industry sectors and geography as well as by product/asset class and are managed on an individual basis. Consideration is given to identifying groups of individual customers with sufficient inter-connectedness to merit assessment as a single risk.
For lower risk transactions below specific thresholds, credit decisions can be approved through self-sanctioning within the business. This process is facilitated through an auto-decision making 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.
A key aspect of credit risk stewardship is ensuring that, when signs of customer stress are identified, appropriate debt management actions are applied.
Recoveries The Recoveries team will issue a notice of intention to default to the customer and, if appropriate, a formal demand, while also registering the account with credit reference agencies where appropriate. Following this, the customer’s debt may then be placed with a thirdparty debt collection agency, or alternatively a solicitor, in order to agree an affordable repayment plan with the customer. Exposures subject to formal debt recovery are defaulted and categorised as Stage 3 impaired.
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 RBS. There are two classifications which apply to non-defaulted customers within the framework – Heightened Monitoring and Risk of Credit Loss. For the purposes of provisioning, all exposures subject to the framework are categorised as Stage 2 and subject to a lifetime loss assessment. The framework also applies to those customers that have met RBS’s default criteria (AQ10 exposures). Defaulted exposures are categorised as Stage 3 impaired for provisioning purposes.
Other potential outcomes of the relationship review are to: remove the customer from the Risk of Credit Loss framework, offer additional lending and continue monitoring, transfer the relationship to Restructuring if appropriate, or exit the relationship.
Restructuring For the Wholesale problem debt portfolio, customer relationships are mainly managed by the Restructuring team (excluding customers managed by UK PBB). The purpose of Restructuring is to protect RBS’s capital. Where practicable, Restructuring does this by working with corporate and commercial customers to support their turnaround and recovery strategies and enable them to return to mainstream banking. Restructuring will always aim to recover capital in a fair and efficient manner.
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 of the customer, minimum standards are applied when assessing, recording, monitoring and reporting forbearance.
Monitoring of forbearance Personal For Personal portfolios, forborne loans are separated and regularly monitored and reported while the forbearance strategy is implemented, until they exit forbearance.
Additionally for some forbearance types a loan may be transferred to the performing book if a customer makes payments that reduce loan arrears below 90 days (UK PBB collections function).
For non-performing forborne loans, the Stage 3 loss assessment process is the same as for non-forborne loans with the exception of Ulster Bank RoI, where forborne loans which result in an economic loss form a separate risk pool and are subjected to specific provisioning treatments.
 Determination of significant increase in credit risk – this moves a subset of assets from a 12-month ECL (Stage 1) to lifetime ECL (Stage 2) when credit risk has significantly increased since origination – £356 million increase in provision.
Key points  Overall provisions – The overall provisioning requirement under
 Performing assets – Compared with the latent loss provision held under IAS 39 of £390 million, the ECL requirement on performing assets (Stage 1 and Stage 2) more than doubled, increasing by £479 million to £869 million.
 CPB and NatWest Markets – The assets are mainly Wholesale. The ECL provisioning requirement was £1.6 billion, an uplift of £222 million relative to IAS 39. The uplift in Stage 3 assets of £83 million was principally driven by assets defaulted but with expectation of full recovery under IAS 39.
Five key areas may materially influence the measurement of credit impairment under IFRS 9 – two of these relate to model build and three relate to their application:  Model build: o The determination of economic indicators that have most influence on credit loss for each portfolio and the severity of impact (this leverages existing stress testing mechanisms).
o The determination of a base case (or central) economic scenario which has the most material impact (of all forwardlooking scenarios) on the measurement of loss (RBS uses consensus forecasts to remove management bias).
Policy elections and simplifications relating to IFRS 9 In addition to the five key areas above, which are relevant from period to period, there was one further significant judgment that was made as a one-off exercise to support the Day One implementation: this was the application of the new IFRS 9 models to the determination of origination date metrics. Since it is not possible to determine the economic forecasts and alternative scenarios going backwards in time it is necessary to use a series of assumptions to enable this process. RBS assumed a flat economic forecast, for all dates historically. There were some other less significant judgments, elections and simplification assumptions that informed the ECL process; these were not seen as ‘critical’ in determining the appropriate level of impairment but represented choices taken by management across areas of estimation uncertainty. The main examples of these are:  Models – for example in the case of some low default portfolios,
capital requirement calculated under the standardised framework for regulatory purposes and do not have systematically modelled PDs, EADs and LGDs. Under IFRS 9, they have bespoke treatments for the identification of significant increase in credit risk and ECL provisions. With respect to the latter, benchmark PDs, EADs and LGDs are used with the benchmarks being reviewed annually for appropriateness. The main non-modelled portfolios are Private Banking, RBSI personal and Lombard.
 Multiple economic scenarios (MES) – it is the selection of the central (or base) scenario that is most critical to the ECL calculation, independent of the method used to generate a range of alternative outcomes and their probabilities. Different approaches to model MES around the central scenario have all been found of low significance for the overall ECL impact.
Economic loss drivers Introduction (audited) The portfolio segmentation and selection of economic loss drivers for IFRS 9 follow closely the approach already used in stress testing. To enable robust modelling the forecasting models for each portfolio segment (defined by asset class and where relevant – industry sector and region) are based on a selected, small number of economic factors, (typically two to four) that best explain the temporal variations in portfolio loss rates. The process to select economic loss drivers involves empirical analysis and expert judgment.
The most material primary economic loss drivers for Personal portfolios include national GDP, unemployment rate, House Price Index, and base rate for UK and Irish portfolios as relevant. In addition to some of these loss drivers, for Wholesale portfolios, world GDP is a primary loss driver.
Central base case economic scenario (audited) The internal base case scenario is the primary forward-looking economic information driving the calculation of ECL The same base case scenario is used for RBS’s financial planning. The key elements of the current economic base case, which includes forecasts over a five year forecast horizon, are summarised as follows:  United Kingdom – The central scenario projects modest growth in the UK economy, in line with the consensus outlook. Brexit related uncertainty results in subdued confidence in the near term, placing it in the lower quartile of advanced economies. Business investment is weak at the start of the forecast, improving only gradually. Consumer spending rises steadily as households benefit from falling inflation and rising wage growth, though it is a modest upturn. The central scenario assumes slower job growth than seen in recent years, meaning unemployment edges up from its current historic lows. House price growth slows, extending the current slowdown, before picking up to low single digit growth in later years. Monetary policy follows the market implied path for Bank of England base rate at the time the scenarios were set, therefore it is assumed only two further base rate increases over the next five years.
Use of the central base case in Wholesale As in Personal the primary input is the central base case scenario but a further adjustment is applied to explicitly enforce a gradual reversion to long run average credit cycle conditions from the first projected year onwards.
Credit risk continued Initially at transition, mean reversion was applied from year five onwards. Since H1 2018, mean reversion is applied from the first year onwards. The earlier application of the mean reversion adjustment was introduced to account for two empirical observations. Firstly historic credit loss rates in Wholesale portfolios show pronounced mean reversion behaviour and secondly, the accuracy of economic forecasts tends to drop significantly for horizons beyond one or two years.
Approach for MES (audited) The response of portfolio loss rates to changes in economic conditions is typically non-linear and asymmetric. Therefore in order to appropriately take account of the uncertainty in economic forecasts a range of MES are considered when calculating ECL.
 Personal – the approach to MES is based on using a set of discrete scenarios. In addition to the central base case a further four bespoke scenarios are taken into account – a base case upside and downside – and an additional upside and downside. The overall MES ECL is calculated as a probability weighted average across all five scenarios. (Refer to the Probability weightings of scenarios section below).
The simulation of alternative scenarios does not occur on the level of the individual economic loss drivers but operates on the aggregate CCI described earlier. Since the existing Wholesale credit models for PD and LGD were already built within the CCI framework the chosen Monte Carlo method provided a conceptually rigorous but still efficient approach to implement the MES requirement.
The Monte Carlo MES approach increases Wholesale ECL for Stage 1 and Stage 2 by approximately 5% above the single, central scenario outcomes. No additional MES overlay was applied for Wholesale.
For both Personal and Wholesale, the impact from MES is factored in to account level PDs through scalars. These MES-adjusted PDs are used to assess whether a significant increase in credit risk has occurred.
 Severity assessment – having selected the most appropriate scenarios their severity is then assessed based on the behaviour of UK GDP by calculating a variety of measures such as average GDP growth deviation from base and peak to trough falls in GDP. These measures are compared against a set of 1,000 model runs and it is established what percentile in the distribution most closely corresponds with each scenario.
 Probability assignment – having established the relevant percentile points, probability weights are assigned to ensure that the scenarios produce an unbiased result. If the severity assessment step shows the scenarios to be broadly symmetric, then this will result in a symmetric probability weighting (same probability weight above and below the base case, as was used in the first half of 2018). However if the downsides are not as extreme as the upsides, then more probability weight is allocated to the downsides to ensure the unbiasedness requirement is satisfied (as was the case in the second half of 2018). This adjustment is made purely to restore unbiasedness, not to address any relative skew in the distribution of risks in the economic outlook, which is dealt with through overlays and covered in the section on UK economic uncertainty.
Credit risk continued UK economic uncertainty (audited) RBS’s 2018 results were prepared during the run up to the UK leaving the European Union, a period of elevated uncertainty over the UK economic outlook. RBS’s approach to capturing that elevated uncertainty is to apply an overlay to ECL. Information is used from the earnings volatility scenario that is part of the 2018 planning process and credit risk appetite setting. Key elements include an alternative path the economy could take, being characterised as more severe than the Bank of England’s “Disruptive Brexit” scenario (ACS) but less severe than the “Disorderly Brexit” scenario and then applying management judgement as to its likelihood. The RBS-wide overlay of £101 million booked in the third quarter of 2018 remained in place at the year end.
IFRS 9 credit risk modelling (audited) IFRS 9 introduced lifetime ECL for the measurement of credit impairment. This required the development of new models or the enhancement of existing Basel models. IFRS 9 ECLs are calculated using a combination of:  Probability of default.  Loss given default.  Exposure at default.
In addition, lifetime PDs (as at reporting date and at date of initial recognition) are used in the assessment of a significant increase in credit risk (SICR) criteria.
For assets originated before IFRS 9 was introduced, comparable lifetime origination PDs did not exist. These have been retrospectively created using the relevant model inputs applicable at initial recognition. Due to data availability, two practical measures have been taken:  Where model inputs were not available at the point of initial recognition the earliest available robust metrics were used. For instance, since Basel II was introduced in 2008, the earliest available and reliable production Basel PDs range from between December 2007 and April 2008 depending on the portfolio.
 Economic conditions at the date of initial recognition have been assumed to remain constant from that point forward.
One year point-in-time PDs are then extrapolated to multi-year PDs using a conditional transition matrix approach. The conditional transition matrix approach allows the incorporation of forward-looking information, provided in the form of yearly CCI projections, by adjusting the credit state transition probabilities according to projected, forward-looking changes of credit conditions in each region/industry segment.
This results in forward-looking point-in-time PD term structures for each obligor from which the lifetime PD for a specific exposure can be calculated according to the exposure’s residual contractual maturity.
LGD estimates The general approach for the IFRS 9 LGD models was to leverage the Basel LGD models with bespoke IFRS 9 adjustments to ensure unbiased estimates, that is, the use of effective interest rate as the discount rate and the removal of downturn calibration, indirect costs, other conservatism and regulatory floors.
Personal Forward-looking information has only been incorporated for the secured portfolios, where changes in property prices can be readily accommodated. Analysis has indicated minimal impact for the other Personal portfolios. For UBIDAC, a bespoke IFRS 9 LGD model is used, reflecting its specific regional market.
Wholesale For Wholesale, EAD values are estimated on the basis of credit conversion factor (CCF) models. RBS have observed historic, realised CCF values to vary over time but there is no clear relationship between the temporal changes in CCF and economic conditions. RBS attribute changes in CCFs to changes in exposure management practices.
Therefore RBS does not include forward-looking economic information into projected CCF/EAD. To ensure CCF values reflect most recent exposure management practices, RBS update CCF coefficients in the model frequently (typically annually) using the last five years of observed data.
Asset lifetimes (audited) The choice of initial recognition and asset duration is another critical judgement in determining the quantum of lifetime losses that apply.  The date of initial recognition reflects the date that a transaction (or account) was first recognised on the balance sheet; the PD recorded at that time provides the baseline used for subsequent determination of SICR.
 Economic uncertainty – simulating the impact arising from the Downside 2 scenario, which is one of the five discrete scenarios used in the methodology for Personal MES. In the simulation RBS have assumed that the economic macro variables associated with the Downside 2 scenario replace the existing base case economic assumptions, giving them a 100% probability weighting for Personal and using the Monte Carlo approach in Wholesale to simulate the impact of MES around the base case economic scenario.
 As reflected in the economic metrics in the following table, the Downside 2 scenario assumes a significant economic downturn in the UK in 2019 running in to 2020 with recovery in the later years. UK GDP turns negative in 2019 compared to the base case assumption of continued growth, unemployment increases and peaks at the end of 2020. House prices fall in both 2019 and 2020 before starting to recover, and interest rates are assumed to be lower for longer. An economic slowdown is also assumed in the Republic of Ireland in 2019 and 2020.
GDP (year-on-year) 1.7 1.5 1.9 1.8 1.8 (1.2) 1.2 2.7 2.0 2.1 Unemployment rate 4.8 5.0 5.1 5.1 5.1 6.7 7.4 7.3 6.9 6.4 House Price Inflation (year-on-year) 1.1 0.7 1.5 2.3 3.4 (7.0) (4.5) 1.0 4.1 6.3 Bank of England rate 1.0 1.0 1.3 1.3 1.3 — — — — —
Republic of Ireland GDP (year-on-year) 4.2 2.9 2.8 2.8 2.5 0.7 3.5 4.4 4.5 4.0 Unemployment rate 5.2 5.1 5.1 5.2 5.3 7.6 7.7 6.5 5.9 5.7 House Price Inflation (year-on-year) 5.8 2.7 3.0 3.4 3.5 (6.7) (5.4) 2.2 7.2 8.8 European Central Bank rate — — 0.3 0.5 0.8 — — — — —
World GDP (year-on-year) 2.7 2.4 2.9 2.7 2.5 (0.8) 3.1 4.4 3.2 2.8
These common scenarios were complemented with two specific portfolio simulations:  Wholesale portfolios – simulating the impact of PDs moving upwards to the through-the-cycle (TTC) average from their current point-in-time (PIT) estimate. This simulation looks solely at PD movements, potential movements in LGD rates have not been considered. With the current benign economic conditions wholesale IFRS 9 PIT PDs are significantly lower than TTC PD. This scenario shows the increase to ECL by immediately switching to TTC PDs providing an indication of long run average expectations. IFRS 9 PDs have been used so there remains some differences to Basel TTC PDs where conservative assumptions are required, such as caps or floors, not permitted under the IFRS 9 best estimate approach.
 Mortgages – House Price Inflation (HPI) is a key economic driver and RBS have simulated a univariate scenario of a 5% decrease in HPI across the main mortgage portfolios. A univariate analysis using only HPI does not allow for the interdependence across the other key primary loss drivers to be reflected in any ECL estimate. The simulated impact is based on 100% probability weighting to demonstrate the sensitivity of HPI on the central base case. The Downside 2 scenario above has house prices falling by a more material amount, and also includes the impact of PD increases which are not captured under the HPI univariate simulation.
Credit risk continued Economic sensitivity analysis Actual position at 31 December 2018 Common scenarios (3)
Stage 1 and Stage 2 (1) Downside 2 25% PD increase Discrete scenarios (3) of which in ECL Exposure in Exposure in HPI (4)/TTC PD (5) Exposure in Exposure Stage 2 provision(2) Potential ECL uplift Stage 2 Potential ECL uplift Stage 2 potential ECL uplift Stage 2 £bn % £m £m % % £m % % £m % %
(2) The ECL provision includes the ECL overlay taken in quarter 3 to recognise the elevated economic uncertainty in the UK in the period running up to the UK leaving the European Union.
(4) HPI is applied to the most material mortgage portfolios only, UK PBB and Ulster Bank RoI. (5) TTC or long-run average PDs are applied to Wholesale portfolios only, excluding business banking exposures in PBB, the impact on which is included within the PBB portfolio for this analysis.
Key points  In the downside 2 scenario, the ECL requirement overall was simulated to increase by £326 million on stage 1 and 2 exposures from the current level of £1,023 million. The simulation estimates the balance sheet ECL requirement as at 31 December 2018 and assumes that the economic variables associated with the Downside 2 scenario had been RBS’s base case economic assumption at that time.
 On the univariate HPI scenario, the impact of a 5% fall in house prices was relatively modest, the simulated impact was similar in both UK PBB and Ulster Bank RoI. The relationship between the required ECL and house price movements is expected to be nonlinear should the level of house prices reduce by more material amounts, with the rate of loss accelerating when prices fall by more than 10%. Ulster Bank RoI also observed a modest increase in the percentage of exposures in Stage 2 reflecting small PD movements, whereas the UK PBB simulation was restricted to the LGD effect alone hence the percentage of assets in Stage 2 remained unchanged.
 The TTC PD and 25% PD increase scenarios see a significant ECL uplift in the property portfolio which is not observed under the Downside 2 scenario as under the Downside 2 scenario the Wholesale PDs begin to revert to long run averages (mean reversion) after 12 months so do not fully capture the further deterioration expected in the property portfolio in years 2 and 3.
 Downside 2 scenario results in more corporate exposure moving to Stage 2 than either the TTC PD or 25% PD increase scenarios. The impact is more concentrated on shorter dated exposure, reflecting the year 1 downturn, which has less of an impact on total ECL.
Refer to Accounting policy 14 and Note 14 on the consolidated accounts for revisions to policies and critical judgements relating to impairment loss determination.
Of the total third party £471 billion AC and FVOCI balance (gross of ECL), £463.9 billion or 98% was within the scope of the IFRS 9 ECL framework and comprised by stage: Stage 1 £430.1 billion; Stage 2 £26.1 billion and Stage 3 £7.7 billion (1 January 2018 – £468.8 billion of which Stage 1 £430.5 billion; Stage 2 £27.0 billion and Stage 3 £11.3 billion). Total assets within IFRS 9 ECL scope comprised the following by balance sheet caption and stage:  Loans: £319.8 billion of which Stage 1 £286.0 billion; Stage 2 £26.1 billion and Stage 3 £7.7 billion (1 January 2018 – £321.3 billion of which Stage 1 £283.3 billion; Stage 2 £26.8 billion and Stage 3 £11.2 billion).
 Other financial assets: £144.1 billion of which Stage 1 £144.1 billion; Stage 2 nil and Stage 3 nil (1 January 2018 – £147.4 billion of which Stage 1 £147.2 billion; Stage 2 £0.2 billion and Stage 3 nil).
 Equity shares of £0.5 billion as not within the IFRS 9 ECL framework by definition.
 Fair value adjustments on loans hedged by interest rate swaps, where the underlying loan was within the IFRS 9 ECL scope – £0.9 billion.
 Group-originated securitisations, where ECL was captured on the underlying loans of £0.4 billion.
Contingent liabilities and commitments In addition to contingent liabilities and commitments disclosed in Note 27 on the consolidated accounts – reputationally-committed limits, are also included in the scope of the IFRS 9 ECL framework. These are offset by £3.6 billion out of scope balances primarily related to facilities that, if drawn, would not be classified as AC or FVOCI, or undrawn limits relating to financial assets exclusions. Total contingent liabilities (including financial guarantees) and commitments within IFRS 9 ECL scope of £168.9 billion comprised Stage 1 £161.4 billion; Stage 2 £6.9 billion and Stage 3 £0.6 billion.
Credit risk – Banking activities continued Portfolio summary – segment analysis (audited) The table below summarises gross loans and ECL, by segment and stage, within the scope of the IFRS 9 ECL framework. Ulster Commercial Private Central items UK PBB Bank RoI Banking Banking RBSI NWM & other Total
Loans - amortised cost Stage 1 146,764 17,822 79,106 13,750 13,383 8,196 6,964 285,985 Stage 2 14,954 2,080 7,809 531 289 407 27 26,097 Stage 3 2,220 2,308 2,136 225 101 728 — 7,718 163,938 22,210 89,051 14,506 13,773 9,331 6,991 319,800 ECL provisions (2) Stage 1 131 35 94 13 6 6 — 285 Stage 2 488 114 136 10 3 12 — 763 Stage 3 796 638 743 20 17 106 — 2,320 1,415 787 973 43 26 124 — 3,368 ECL provisions coverage (3) Stage 1 (%) 0.09 0.20 0.12 0.09 0.04 0.07 — 0.10 Stage 2 (%) 3.26 5.48 1.74 1.88 1.04 2.95 — 2.92 Stage 3 (%) 35.86 27.64 34.78 8.89 16.83 14.56 — 30.06 0.86 3.54 1.09 0.30 0.19 1.33 — 1.05 Impairment losses ECL charge (4) 342 15 144 (6) (2) (92) (3) 398 ECL loss rate - annualised (basis points) 20.86 6.75 16.17 (4.14) (1.45) (98.60) (4.29) 12.45 Amounts written-off 557 372 460 7 9 89 — 1,494
Ulster Commercial Private Central items Balances at UK PBB Bank RoI Banking Banking RBSI NWM & other Total central banks Total
(2) ECL provisions are provisions on loan assets only. Other ECL provisions not included, relate to cash, debt securities and contingent liabilities, and amount to £28 million, of which £5 million was FVOCI.
The table below shows gross loans (excluding reverse repos) and related credit metrics by segment on an IAS 39 basis. Ulster Commercial Private Central items UK PBB Bank RoI Banking Banking RBSI NWM & other Total 2017 £m £m £m £m £m £m £m £m
Credit risk – Banking activities continued Portfolio summary – segment analysis (audited)
Key points  Total ECL provisions have reduced since transition as a result of reduced provisioning requirements on Stage 3 impaired assets, which reflected ongoing write-offs and debt sales, partially offset by increases in Stage 1 and Stage 2.
 Stage 3 ECL provisions – The reductions in the UK PBB business reflected a combination of business-as-usual write-offs and debt sale activity. For Ulster Bank RoI the significant reduction since transition was due to the sale of legacy impaired mortgage portfolio debt. In Commercial Banking and NatWest Markets the reductions were mainly attributable to write-offs.
 Stage 1 and Stage 2 – The increase in Stage 1 and Stage 2 ECL was driven by a number of factors. These included an ECL uplift for economic uncertainty, which affected all businesses, model refinements, asset migrations from Stage 3 impaired and portfolio growth.
Stage 1 <30 DPD >30 DPD Total Stage 3 Total Stage 1 <30 DPD >30 DPD Total Stage 3 Total
UK PBB 145,650 14,490 3,202 163,342 144 352 1,110 1,606 Ulster Bank RoI 19,055 2,347 3,669 25,071 29 106 1,054 1,189 Commercial Banking 84,393 8,490 3,468 96,351 58 106 1,156 1,320 Private Banking 12,755 333 324 13,412 18 9 27 54 RBS International 7,791 307 119 8,217 5 5 28 38 NatWest Markets 11,762 995 501 13,258 2 42 190 234 Central items & other 52,523 10 — 52,533 5 1 — 6 Total financial assets excluding balances at central banks 333,929 26,972 11,283 372,184 261 621 3,565 4,447 Balances at central banks 96,566 5 — 96,571 1 — — 1 Total financial assets 430,495 26,977 11,283 468,755 262 621 3,565 4,448
UK PBB 0.09 3.06 6.83 3.26 35.86 0.86 342 20.9 557 Personal 0.07 3.05 6.62 3.25 31.29 0.75 338 22.5 420 Wholesale 0.25 3.16 9.09 3.39 63.78 2.06 4 2.9 137 Ulster Bank RoI 0.20 5.23 9.82 5.48 27.64 3.54 15 6.8 372 Personal (4) 0.12 5.40 10.48 5.76 24.62 4.27 20 13.6 343 Wholesale 0.33 4.88 — 4.82 69.68 2.12 (5) (6.6) 29 Commercial Banking 0.12 1.80 0.55 1.74 34.78 1.09 144 16.2 460 Private Banking 0.09 1.32 3.31 1.88 8.89 0.30 (6) (4.1) 7 Personal 0.05 1.64 — 1.44 8.37 0.22 (6) (5.4) 5 Wholesale 0.27 1.02 3.97 2.17 13.64 0.55 — — 2 RBS International 0.04 1.09 — 1.04 16.83 0.19 (2) (1.5) 9 NatWest Markets 0.07 2.95 — 2.95 14.56 1.33 (92) (98.6) 89 Central items and other — — — — — — (3) (4.3) — Total loans excluding balances at central banks 0.10 2.80 5.02 2.92 30.06 1.05 398 12.5 1,494 Personal 0.08 3.25 6.82 3.45 26.61 1.00 354 19.8 776 Wholesale 0.13 2.21 2.29 2.21 34.51 1.11 44 3.1 718 Total loans 0.08 2.80 5.02 2.92 30.06 0.83 398 9.8 1,494
 The Commercial Banking business accounted for the majority of Wholesale exposures. Wholesale provisions in UK PBB reflected exposures to business banking customers and also the commercial businesses in RBS England & Wales/NatWest Scotland.
 On performing exposures (Stage 1 and Stage 2), materially higher ECL provision was held in credit deteriorated Stage 2 exposures than in Stage 1, in line with expectations. This was also reflected in provision coverage levels.
 Also in line with expectations, the majority of Stage 2 exposures were less than 30 days past due, since PD deterioration is the primary driver of credit deterioration.
 The differing cover rates between the Personal and Wholesale portfolios – and across the business – largely reflected differences in asset mix, including security cover, and the differing impacts of external environment events.
Credit risk – Banking activities continued Portfolio summary – sector analysis (audited) The table below summarises financial assets and off-balance sheet exposures gross of ECL and related ECL provisions, impairment and past due by sector, asset quality and geographical region based on the country of operation of the customer.
Credit risk – Banking activities continued Portfolio summary – sector analysis (audited) Personal Wholesale Credit Other Mortgages cards personal Total Property Corporate FI Sovereign Total Total Fixed Variable
Credit risk – Banking activities continued Portfolio summary – sector analysis (audited) Wholesale forbearance The table below summarises Wholesale forbearance, Heightened Monitoring and Risk of Credit Loss by sector. Personal forbearance is disclosed on page 132.
FI Property Sovereigns Other corporate Total 2018 £m £m £m £m £m
At 1 January 2017 2,372 3,513 1,946 105 109 2,264 1 10,310 Inter segment transfers — — 1,384 — — (1,384) — — Currency translation and other adjustments — 123 — — 5 (86) 1 43 Additions 1,227 550 1,590 28 62 98 14 3,569 Transfers between REIL and potential problem loans (152) — 10 (2) 7 8 — (129)
At 1 January 2017 1,537 1,200 845 31 38 803 1 4,455 Inter segment transfers — — 293 — — (293) — — Currency translation and other adjustments — 8 (7) — — (27) — (26) Repayments and disposals — — — — — (5) — (5)
Recoveries of amounts previously written-off 117 12 16 — 1 10 — 156 Charges/(releases) to income statement 235 60 362 6 3 (137) 1 530 Unwind of discount (37) (25) (12) (1) (1) (10) — (86)
Wholesale portfolios were in the UK and the Republic of Ireland. Other exposures in Europe and the Rest of the World were mainly Wholesale. Mortgages, the vast majority of which are in the UK, accounted for more than half of the total exposure.
 Weighted average 12 months PDs – In Wholesale, Basel PDs, which are based on a through-the-cycle approach, tend to be higher than point-in-time best estimate IFRS 9 PDs, reflecting the current state in the economic cycle, and also an element of conservatism in the regulatory capital framework. In Personal, the Basel PDs, which are point-in-time estimates, tend to be higher also reflecting conservatism, higher in mortgages than other products, and an element of default rate under-prediction in the IFRS 9 PD models. This has been mitigated by ECL overlays of approximately £60 million at the year end, pending model calibrations being implemented. The IFRS 9 PD for credit cards was higher than the Basel equivalent and reflected the relative sensitivity of the IFRS 9 model to forward-looking economic drivers.
 ECL provision by geography – In line with exposures by geography, the weight of ECL related to exposures in the UK and the Republic of Ireland. The ECL in RoI was mainly Stage 3 provisions in the legacy Ulster Bank RoI mortgage portfolio.
 Forbearance – Completed forbearance flow in 2018 for Wholesale was £2.6 billion compared to £1.9 billion in 2017. Forbearance granted in the transport sector increased to £493 million from £54 million, mainly driven by a customer which has been restructured and moved to Stage 2 from Stage 3 during the year. Forbearance across the diverse services sector increased from £347 million to £763 million. Of the forbearance that completed during the year, £1.1 billion related to payment concessions (2017 – £1.4 billion) and £1.4 billion related to non-payment concessions (2017 – £0.5 billion). Forbearance stock reduced by £0.6 billion, from £3.8 billion to £3.2 billion, driven by a decrease in forborne exposure in the energy and resources, property and retail and leisure sectors.
 Heightened Monitoring and Risk of Credit Loss – Exposure decreased from £5.1 billion at 31 December 2017, to £4.8 billion at 31 December 2018. There was also a decrease in the number of customers classified as Heightened Monitoring and Risk of Credit Loss during the year. Despite the current economic uncertainty in the UK, the portfolio has remained stable.
Wholesale (1) Wholesale (1) Banks and Current Banks and Total Personal other FI's Sovereigns (2) Other exposure Personal other FI's Sovereigns (2) Other Total exposure
UK 158,965 17,992 91,161 94,896 363,014 33 4 19 20 76 413,378 RoI 15,319 751 2,416 4,612 23,098 3 — 1 1 5 24,502 Other Western Europe 514 7,504 43,414 8,559 59,991 — 2 9 2 13 86,866 US 377 6,987 8,430 2,580 18,374 — 1 2 1 4 31,497 RoW (3) 1,461 4,575 2,155 3,144 11,335 — 1 — 1 2 14,602 176,636 37,809 147,576 113,791 475,812 36 8 31 25 100 570,845
REIL Provisions Provisions Impairment Gross as a % of as a % as a % of losses/ Amounts 2017 loans REIL Provisions gross loans of REIL gross loans (releases) written-off
Of which: commercial real estate 24,784 1,189 293 4.8 25 1.2 (76) 139 Manufacturing 8,862 147 64 1.7 44 0.7 4 25 Finance leases and instalment credit 12,019 170 88 1.4 52 0.7 23 14 Retail, wholesale and repairs 12,300 446 193 3.6 43 1.6 93 81 Transport and storage 4,241 700 195 16.5 28 4.6 (32) 165 Health, education and leisure 11,337 330 145 2.9 44 1.3 65 48 Hotels and restaurants 6,049 193 80 3.2 41 1.3 17 46 Utilities 4,172 35 21 0.8 60 0.5 (18) 13 Other 17,726 471 256 2.7 54 1.4 (10) 131 Latent — — 390 — — — (14) —
Credit risk – Banking activities continued Credit risk enhancement and mitigation (audited) The table below summarises exposures of modelled portfolios within the scope of the ECL framework and related credit risk enhancement and mitigation (CREM). Excluded from this analysis are the non modelled portfolios, primarily Private Banking and RBSI mortgage portfolios, which are discussed in the Personal – portfolio section, including loan-to-value ratios. Refer to Policy elections and simplifications relating to IFRS 9 section for details on non-modelled portfolios.
CREM exposure ECL Total Stage 3 Financial (1) Property Other (2) Total Stage 3 Total Stage 3 2018 £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Notes: (1) Financial collateral includes cash and securities collateral. (2) Other collateral includes guarantees, charges over trade debtors as well as the amount by which credit risk exposure is reduced through netting arrangements, mainly cash management pooling, which give RBS a legal right to set off the financial asset against a financial liability due to the same counterparty. (3) RBS holds collateral in respect of individual loans – amortised cost to banks and customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant and equipment, inventories and trade debtors; and guarantees of lending from parties other than the borrower. RBS obtains collateral in the form of securities in reverse repurchase agreements. Collateral values are capped at the value of the loan.
(6) At 31 December 2018, £0.3 billion personal Stage 3 balances primarily relate to loan commitments, the draw down of which is effectively prohibited.
Notes: (1) RBS holds collateral in respect of individual loans. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. RBS obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
Clearing House (LCH) and US Government Securities Clearing Corporation. During 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.
(6) The carrying value on the balance sheet represents the maximum exposure to credit risk by class of financial instrument. (7) The amount by which credit risk exposure is reduced through arrangements, such as master netting agreements and cash management pooling, which give
RBS a legal right to set off the financial asset against a financial liability due to the same counterparty. (8) Comprises credit derivatives (bought protection) and guarantees against exposures.
 Overall – The overall credit risk profile of the Personal portfolio, and its performance against credit risk appetite, remained stable during 2018.
 Total lending – Total mortgage lending grew by £1.2 billion with new lending partly offset by redemptions and repayments.
 New mortgage lending was lower than 2017. Existing mortgage stock and new business were closely monitored against agreed risk appetite parameters. These included loan-to-value ratios, buy-to-let concentrations, new-build concentrations and credit quality. Underwriting standards were maintained during the period.
 LTVs – The mortgage portfolio loan-to-value ratio remained stable. The improvement in Ulster Bank RoI reflected house price recovery and the disposal of a portfolio of mortgages during the year, which also contributed to the reduction in the level of exposures in Stage 3.
 Interest only – By value, the proportion of mortgages on interest only and mixed terms (capital and interest only) reduced, driven by fewer buy-to-let mortgages.
 Regional mortgage analysis – For UK PBB, 42% of mortgage lending was in Greater London and the South East (31 December 2017 – 43%). The level of exposure in this region remained broadly unchanged, reflecting lower demand for buy-to-let properties as well as mortgage redemptions. The weighted average loan-to-value for these regions was 52% (31 December 2017 – 51%) compared to an average of 56%.
 Provisions – As expected, total ECL – including ECL for unsecured lending – generally increased under the IFRS 9 methodology compared to provisions calculated under IAS 39. The reduction in Ulster Bank RoI mortgage provisions was driven by a sale of legacy impaired debt.
 Other lending – Total unsecured lending grew modestly in 2018, driven by growth in the PBB personal loan portfolio. Overdraft balances have shown a modest decline year-on-year.
Personal portfolio (audited) Mortgage LTV distribution by stage The table below summarises gross mortgage lending and related ECL by LTV band. Mortgage lending not within the scope of IFRS 9 ECL reflected portfolios carried at fair value. Mortgages ECL ECL provisions coverage (2) Not within Of which: UK PBB IFRS 9 ECL gross new Stage 1 Stage 2 Stage 3 scope Total lending Stage 1 Stage 2 Stage 3 Total (1) Stage 1 Stage 2 Stage 3 Total
Credit risk – Banking activities continued Personal portfolio (audited) Mortgage LTV distribution by stage Mortgages ECL provisions ECL provisions coverage (2)
Ulster Bank RoI Not within Stage 1 Stage 2 Stage 3 IFRS 9 ECL Total Stage 1 Stage 2 Stage 3 Total Stage 1 Stage 2 Stage 3 Total
Notes: (1) Excludes a non-material amount of provisions held on relatively small legacy portfolios. (2) ECL provisions coverage is ECL provisions divided by drawn exposure.
Credit risk – Banking activities continued Personal portfolio (audited) UK PBB Mortgage LTV distribution by region 50% 80% 100% Weighted ≤50% ≤80% ≤100% ≤150% >150% Total average LTV Other Total Total
Commercial real estate (CRE) The CRE portfolio comprises exposures to entities involved in the development of, or investment in, commercial and residential properties (including house builders but excluding housing associations, construction and building materials). The sector is reviewed regularly at senior executive committees. Reviews include portfolio credit quality, capital consumption and control frameworks. All disclosures in the CRE section are based on current exposure (gross of provisions and risk transfer). Current exposure is defined as: loans; the amount drawn under a credit facility plus accrued interest; contingent obligations; the issued amount of the guarantee or letter of credit; derivatives - the mark to market value, netted where netting agreements exist and net of legally enforceable collateral.
Credit risk – Banking activities continued Commercial real estate (CRE) CRE LTV distribution by stage (audited) The table below summarises CRE current exposure and related ECL by LTV band.
2018 2017 Current exposure (gross of provisions) (1,2) ECL provisions ECL provisions coverage (4)
≤50% 8,229 245 52 795 9,321 7 4 14 25 0.1 1.7 26.4 0.3 9,622 66 9,688 >50% and ≤70% 4,769 297 78 703 5,847 6 6 14 26 0.1 2.0 17.8 0.5 6,621 119 6,740 >70% and ≤80% 394 43 33 6 476 1 1 8 10 0.3 2.6 23.4 2.1 405 52 457 >80% and ≤90% 55 11 24 2 92 — — 5 5 0.3 3.4 20.9 6.1 158 42 200 >90% and ≤100% 31 7 20 1 59 — — 7 7 0.6 5.1 34.9 12.9 89 31 120 >100% and ≤110% 53 4 15 — 72 — — 5 5 0.3 4.2 34.6 7.6 34 21 55 >110% and ≤130% 22 3 111 4 140 — — 22 22 0.4 5.4 19.4 16.0 60 421 481 >130% and ≤150% 6 10 10 — 26 — 1 4 5 0.9 6.3 40.6 18.1 44 29 73 >150% 30 6 42 — 78 — 1 29 30 0.5 9.8 69.6 38.1 149 72 221
 2018 trends – Growth in the commercial property market slowed during 2018.
 Credit quality – The CRE retail portfolio had a low default rate, with a limited number of new defaults. The sub-sector was monitored on a regular basis and credit quality was in line with the wider CRE portfolio.
 Economics – Fundamentals such as rental incomes, property values and investor/occupier demand for other commercial subsectors appeared more robust, however, all are exposed to some degree to the risk of a disorderly exit from the EU. Conditions for the mainstream residential sector remained resilient, supported by mortgage availability and high levels of employment. However, the higher value end of the market was characterised by low transaction volumes.
 Risk appetite – Lending criteria for commercial real estate were at conservative levels, contributing to materially reduced leverage for new origination in London offices and parts of the retail sector.
 Financial assets presented in the flow statements include treasury liquidity portfolios, comprising balances at central banks and debt securities, as well as loans. Both modelled and non-modelled portfolios are included.
 Inter-Group transfers were a feature of the ECL flows during 2018 as a result of ring-fencing related changes. These transfers had no impact at a RBS Group-wide level.
At 31 December 2018 422,541 297 27,360 772 7,796 2,327 457,697 3,396 Net carrying amount 422,244 26,588 5,469 454,301
At 31 December 2018 127,671 10 10,241 74 1,216 132 139,128 216 Net carrying amount 127,661 10,167 1,084 138,912
 Overall ECL reduction was primarily driven by business-as-usual write-offs in Stage 3.
 Stage 1 ECL levels remained steady despite portfolio growth during 2018 as a result of modest PD reduction, with Stage 2 ECL showing an increase as a result of some additional forward-looking provisions being taken during the year.
 Transfers from Stage 3 back to the performing book were higher than those in Personal unsecured lending, due to the higher cure activity typically seen in mortgages.
Credit risk – Banking activities continued Flow statements (audited) Stage 1 Stage 2 Stage 3 Total Financial Financial Financial Financial
UK PBB - credit cards assets ECL assets ECL assets ECL assets ECL
At 1 January 2018 2,841 52 997 94 105 75 3,943 221 Transfers from Stage 1 to Stage 2 (739) (15) 739 15 — — — — Transfers from Stage 2 to Stage 1 763 50 (763) (50) — — — — Transfers to Stage 3 (42) (1) (88) (20) 130 21 — — Transfers from Stage 3 1 1 2 1 (3) (2) — — Net re-measurement of ECL on stage transfer (38) 66 68 96 Changes in risk parameters (model inputs) (15) — (4) (19) Other changes in net exposure (192) 2 343 17 (45) — 106 19 Other (P&L only items) 3 (1) (11) (9)
Income statement (releases)/charges (48) 82 53 87 Amounts written-off — — (4) (4) (81) (81) (85) (85)
 Overall ECL increased primarily due to increased levels of Stage 2 inflows in the first half of the year. This was the result of activity to calibrate and refine the criteria used to identify significant increase in credit risk, with underlying performance stable.
 ECL transfers from Stage 3 back to the performing book were relatively small as expected.
Net re-measurement of ECL on stage transfer (34) 110 114 190 Changes in risk parameters (model inputs) 2 58 (1) 59 Other changes in net exposure 1,325 19 (363) (11) (104) (7) 858 1 Other (P&L only items - primarily fortuitous recoveries) — — (42) (42)
Income statement (releases)/charges (13) 157 64 208 Amounts written-off (2) (2) (9) (9) (322) (322) (333) (333)
 Increases in Stage 2 reflected the underlying performance of recent new business growth maturing. Additionally, the ECL overlay for economic uncertainty contributed to the uplift captured in changes in risk parameters.
 The portfolio continued to experience cash recoveries after writeoff, reported in other (P&L only items – primarily fortuitous recoveries). This benefited the income statement without affecting ECL.
Credit risk – Banking activities continued Flow statements (audited) Stage 1 Stage 2 Stage 3 Total Financial Financial Financial Financial assets ECL assets ECL assets ECL assets ECL
At 1 January 2018 6,505 29 684 29 268 224 7,457 282 Transfers from Stage 1 to Stage 2 (691) (4) 691 4 — — — — Transfers from Stage 2 to Stage 1 366 12 (366) (12) — — — — Transfers to Stage 3 (35) (1) (63) (8) 98 9 — — Transfers from Stage 3 2 2 9 2 (11) (4) — —
Net re-measurement of ECL on stage transfer (12) 24 43 55 Changes in risk parameters (model inputs) (6) 2 (11) (15) Other changes in net exposure 156 3 (57) 3 (36) (23) 63 (17) Other (P&L only items) — — (31) (31)
 Stage 2 ECL did increase during the year as a result of net Stage 2 inflows from Stage 1, partly driven by PD model refinements throughout the year.
 The portfolio continued to experience cash recoveries after writeoff, reported in other (P&L only items). This benefited the income statement without affecting ECL.
UK PBB - commercial At 1 January 2018 6,771 6 595 11 126 57 7,492 74 Currency translation and other adjustments 1 — — — — — 1 — Inter-Group transfers (71) — (1) — (5) — (77) — Transfers from Stage 1 to Stage 2 (781) (2) 781 2 — — — — Transfers from Stage 2 to Stage 1 389 6 (389) (6) — — — — Transfers to Stage 3 (16) — (70) (1) 86 1 — — Transfers from Stage 3 1 — 25 — (26) — — —
Net re-measurement of ECL on stage transfer (4) 10 19 25 Changes in risk parameters (model inputs) 4 — — 4 Other changes in net exposure (886) (1) (123) (1) (62) (6) (1,071) (8)
Income statement (releases)/charges (3) 10 14 21 Amounts written-off — — — — (27) (27) (27) (27) Other movements — — (1) (1)
Ulster Bank RoI - mortgages assets ECL assets ECL assets ECL assets ECL
At 1 January 2018 10,650 8 1,532 72 3,167 881 15,349 961 Currency translation and other adjustments 94 — 12 1 15 3 121 4 Transfers from Stage 1 to Stage 2 (344) (1) 344 1 — — — — Transfers from Stage 2 to Stage 1 414 7 (414) (7) — — — — Transfers to Stage 3 (32) — (124) (8) 156 8 — — Transfers from Stage 3 4 — 245 36 (249) (36) — —
Net re-measurement of ECL on stage transfer (6) (4) 11 1 Changes in risk parameters (model inputs) 3 (1) (23) (21) Other changes in net exposure (4) — (188) (2) (630) 14 (822) 12 Other (P&L only items) (2) 2 28 28
Income statement (releases)/charges (5) (5) 30 20 Amounts written-off — — (13) (13) (322) (322) (335) (335) Other movements — — (20) (20)
 In addition to the debt sale activity, the reduction in ECL in Stage 3 reflected ongoing improvements in underlying portfolio performance.
ECL charges.  Stage 3 charges were mainly driven by a charge on new to default exposures where the ECL can increase significantly following an individual assessment.
 Inter-Group transfers reflected the impact of transfers completed in preparation of ring-fencing. The reductions in net exposure were also related to ring-fencing changes, where short-term borrowing was renewed in other franchises.
At 1 January 2018 9,089 2 1,276 42 456 190 10,821 234 Currency translation and other adjustments 252 — 22 (2) 3 3 277 1 Inter-Group transfers 3,590 — (4) 1 374 14 3,960 15 Transfers from Stage 1 to Stage 2 (393) — 393 — — — — — Transfers from Stage 2 to Stage 1 318 28 (318) (28) — — — — Transfers to Stage 3 — — (3) — 3 — — — Transfers from Stage 3 — — 35 — (35) — — —
 Stage 1 and Stage 2 changes to risk parameters largely reflected the increase in ECL for economic uncertainty, and a change to the forward-looking modelling approach for point-in-time PDs, where PDs now revert to long run average after one year rather than five years.
Key points  ECL reduced due to a combination of write-offs and impairment releases.  The majority of the release was in Stage 1, due to a reduction in loss rates for Retail exposures.
 Exposure increased in Stage 1 reflecting growth in the portfolio
Net re-measurement of ECL on stage transfer (4) 2 — (2) Changes in risk parameters (model inputs) 2 — — 2 Other changes in net exposure 15,948 — (156) — 155 (1) 15,947 (1)
Personal Currently in arrears (>30 DPD) 658 10 90 10 3 — 17 6 88 22 856 48 Currently up-to-date 9,612 64 1,292 66 — — 1,226 114 1,985 225 14,115 469 - PD deterioration 3,855 54 680 44 — — 778 85 1,255 176 6,568 359 - Up-to-date, PD persistence 1,448 5 54 1 — — 337 17 440 26 2,279 49 - Other driver (adverse credit, forbearance etc) 4,309 5 558 21 — — 111 12 290 23 5,268 61 Total Stage 2 10,270 74 1,382 76 3 — 1,243 120 2,073 247 14,971 517
 In Wholesale exposures, the ECL coverage was broadly consistent in total. Coverage can vary across categories or sectors reflecting the individual characteristics of the customer and exposure type.
Stage 2 decomposition by SICR trigger UK mortgages RoI mortgages Other mortgages Credit cards Other Total 31 December 2018 £m % £m % £m % £m % £m % £m %
PD movement 4,273 41.6 767 55.6 — — 793 63.8 1,307 63.0 7,140 47.7 PD persistence 1,450 14.1 54 3.9 — — 338 27.2 440 21.2 2,282 15.2 Adverse credit bureau recorded with credit reference agency 2,996 29.2 — — — — 61 4.9 101 4.9 3,158 21.1 Forbearance support provided 206 2.0 2 0.1 — — — — 13 0.6 221 1.5 Customers in collections 144 1.4 57 4.1 — — 5 0.4 36 1.7 242 1.6 Other reasons (2) 982 9.6 502 36.3 — — 46 3.7 151 7.3 1,681 11.2 Days past due >30 219 2.1 — — 3 100.0 — — 25 1.2 247 1.6 10,270 100 1,382 100 3 100 1,243 100 2,073 100 14,971 100 Key point
(3) Includes customers where a PD assessment cannot be undertaken due to missing PDs.
Credit risk – Banking activities continued Stage 3 vintage analysis The table below provides estimated vintage analysis of the material Stage 3 portfolios totalling 87% of the Stage 3 loans of £7.7 billion.
 Mortgages – The proportion of the Stage 3 defaulted population who have been in default for over five years reflected RBS’s support for customers in financial difficulty. When customers continue to engage constructively with RBS making regular payments, RBS continues to support them. RBS’s provisioning approach retains customers in Stage 3 for a life-time loss provisioning calculation even when their arrears status reverts to below 90 days past due.
 Wholesale – The value of Stage 3 loans that have been impaired for 5-10 years was mainly due to customers being in a protracted formal insolvency process or subject to litigation or a complaints process.
The mapping to the S&P ratings is used by RBS as one of several benchmarks for its wholesale portfolios, depending on customer type and the purpose of the benchmark. The mapping is based on all issuer types rated by S&P. It should therefore be considered illustrative and does not, for instance, indicate that exposures reported against S&P ratings either have been or would be assigned those ratings if assessed by S&P. In addition, the relationship is not relevant for retail portfolios, smaller corporate exposures or specialist corporate segments given that S&P does not typically assign ratings to such entities.
Internal asset quality band Probability of default range Indicative S&P rating
Credit risk – Banking activities continued Asset quality (audited) The table below summarises asset quality bands of gross loans and ECL by stage for the Personal portfolio.
AQ1-AQ4 5,164 226 5,390 4 5 9 0.08 2.21 0.17 AQ5-AQ8 5,668 717 6,385 7 32 39 0.12 4.46 0.61 AQ9 12 439 451 — 39 39 — 8.88 8.65 AQ10 (1) 2,124 2,124 515 515 24.25 24.25
AQ1-AQ4 102,172 3,892 106,064 14 21 35 0.01 0.54 0.03 AQ5-AQ8 57,274 9,591 66,865 106 367 473 0.19 3.83 0.71 AQ9 107 1,488 1,595 2 129 131 1.87 8.67 8.21 AQ10 4,351 4,351 1,158 1,158 26.61 26.61
 The majority of exposures were in AQ1-AQ4, with a significant proportion in AQ5-AQ8. As expected, mortgage exposures have a higher proportion in AQ1-AQ4 than unsecured borrowing.
Property AQ1-AQ4 15,740 393 16,133 8 9 17 0.05 2.29 0.11 AQ5-AQ8 17,397 1,418 18,815 35 26 61 0.20 1.83 0.32 AQ9 8 66 74 — 4 4 — 6.06 5.41 AQ10 1,685 1,685 506 506 30.03 30.03 33,145 1,877 1,685 36,707 43 39 506 588 0.13 2.08 30.03 1.60 Corporate AQ1-AQ4 21,814 773 22,587 13 14 27 0.06 1.81 0.12 AQ5-AQ8 40,004 7,647 47,651 93 171 264 0.23 2.24 0.55 AQ9 26 333 359 1 15 16 3.85 4.50 4.46 AQ10 1,643 1,643 634 634 38.59 38.59 61,844 8,753 1,643 72,240 107 200 634 941 0.17 2.28 38.59 1.30 Financial institutions AQ1-AQ4 22,150 247 22,397 5 5 10 0.02 2.02 0.04 AQ5-AQ8 2,352 222 2,574 7 2 9 0.30 0.90 0.35 AQ9 — 5 5 — — — — — — AQ10 35 35 22 22 62.86 62.86 24,502 474 35 25,011 12 7 22 41 0.05 1.48 62.86 0.16 Sovereign AQ1-AQ4 6,780 22 6,802 1 — 1 0.01 — 0.01 AQ5-AQ8 161 — 161 — — — — — — AQ10 4 4 — — — — 6,941 22 4 6,967 1 — — 1 0.01 — — 0.01 Total AQ1-AQ4 66,484 1,435 67,919 27 28 55 0.04 1.95 0.08 AQ5-AQ8 59,914 9,287 69,201 135 199 334 0.23 2.14 0.48 AQ9 34 404 438 1 19 20 2.94 4.70 4.57 AQ10 3,367 3,367 1,162 1,162 34.51 34.51 126,432 11,126 3,367 140,925 163 246 1,162 1,571 0.13 2.21 34.51 1.11
The table below summarises derivatives by type of contract. The master netting agreements and collateral shown below do not result in a net presentation on the balance sheet under IFRS 9. A significant proportion (more than 90%) of the derivatives relate to trading activities in NatWest Markets, the table below also includes hedging derivatives in Treasury.
Of which: Interest rate (1) Interest rate swaps 81,855 74,004 99,065 91,025 Options purchased 14,481 — 21,733 — Options written — 16,371 — 21,021 Futures and forwards 74 69 147 114
Notes: (1) The notional amount of interest rate derivatives include £5,952 billion (2017 – £7,400 billion) in respect of contracts cleared through central clearing counterparties. (2) Transactions with certain counterparties with whom RBS has netting arrangements but collateral is not posted on a daily basis; certain transactions with specific terms that may not fall within netting and collateral arrangements; derivative positions in certain jurisdictions for example China where the collateral agreements are not deemed to be legally enforceable.
Traded on Settled Not settled Traded on Traded Traded on Traded recognised by central by central recognised over the recognised over the 2018 exchanges counterparties counterparties Total exchanges counter exchanges counter £bn £bn £bn £bn £m £m £m £m
Debt securities (audited) The table below summarises debt securities held at mandatory fair value through profit or loss by issuer as well as ratings based on the lowest of Standard & Poor’s, Moody’s and Fitch. A significant proportion (more than 95%) of these positions are trading securities in NatWest Markets.
AAA — — 2,093 1,459 7 3,559 AA to AA+ 6,834 4,689 3,161 773 120 15,577 A to AA- — — 4,571 482 51 5,104 BBB- to A- — — 3,592 802 285 4,679 Non-investment grade — — 81 832 237 1,150 Unrated — — — 572 8 580 Total 6,834 4,689 13,498 4,920 708 30,649
Credit risk – Cross border exposure Cross border exposures comprise both banking and trading activities, including reverse repurchase agreements. Exposures comprise loans and advances, including finance leases and instalment credit receivables, and other monetary assets, such as debt securities. The geographical breakdown is based on the country of domicile of the borrower or guarantor of ultimate risk. Cross border exposures include non-local currency claims of overseas offices on local residents but exclude exposures to local residents in local currencies. The table below sets out cross border exposures greater than 0.5% of RBS’s total assets.
Government Banks Other Total Short positions Net of short positions 2018 £m £m £m £m £m £m
Western Europe 21,121 19,003 16,741 56,865 14,103 42,762 Of which: France 3,396 10,209 1,579 15,184 1,626 13,558 Of which: Germany 8,023 3,086 1,145 12,254 5,397 6,857 Of which: Netherlands 1,142 675 3,739 5,556 985 4,571 United States 13,558 5,458 8,379 27,395 2,103 25,292 Japan 4,857 2,327 405 7,589 11 7,578 2017
Assets that are defaulted are shown as credit impaired. RBS uses 90 days past due as a consistent measure for default across all product classes. The population of credit impaired assets is broadly consistent with IAS 39, though measurement differs because of the application of MES. Assets that were categorised as potential problems with no impairment provision are now categorised as Stage 3.
Default aligned to loss events, all financial assets where an impairment event had taken place – 100% probability of default and an internal asset quality grade of AQ10 – were classed as non-performing.
A default shall be considered to have occurred with regard to a particular financial asset when either or both of the following have taken place: – RBS considers that the customer is unlikely to pay its credit obligations without recourse by the institution to actions such as realising security; – The customer is past due more than 90 days.
For Personal exposures, the definition of default may be applied at the level of an individual credit facility rather than in relation to the total obligations of a borrower.
For Personal, the prevailing economic conditions at the reporting date (pointin -time) are used.
The staging assessment requires a definition of when a SICR has occurred; this moves the loss calculation for financial assets from a 12 month horizon to a lifetime horizon. Management has established an approach that is primarily informed by the increase in lifetime probability of default, with additional qualitative measures to account for assets where PD does not move, but a high risk factor is determined.
Expected balance sheet exposure at default. It differs from the regulatory method as follows: – It includes the effect of amortisation; and
Modification A modification occurs when the contractual cash flows of a financial asset are renegotiated or otherwise modified and the renegotiation or modification does not result in derecognition. A modification requires immediate recognition in the income statement of any impact on the carrying value and effective interest rate (EIR) or examples of modification events include forbearance and distressed restructuring. The financial impact is recognised in the income statement as an impairment release/(loss).
Modification was not separately defined but accounting impact arose as an EIR adjustment on changes that were not derecognition or impairment events.
Market risk RBS is exposed to non-traded market risk through its banking activities and to traded market risk through its trading activities. Non-traded and traded market risk exposures are managed separately. As a result, each type of market risk is discussed separately. The non-traded market risk section begins below. The traded market risk section begins on page 157.
 Non-trading book foreign exchange risk – arises from customer transactions and profits and losses that are in a currency other than the functional currency of the transacting operation.
Key developments in 2018  Interest rates rose in 2018 but remained low by historical standards.
The UK base rate rose from 0.5% to 0.75% in August 2018. The five-year swap rate was 1.22% at 31 December 2018 compared to 0.98% at 31 December 2017.
 Sterling weakened against the US dollar and slightly against the euro over the year.
 Changes in accounting treatment under IFRS 9, which took effect from 1 January 2018, had an impact on the way certain non-traded market risk exposures are calculated. Some structured loans were recognised at fair value through the profit and loss on transition to IFRS 9. However, this exposure had declined by the end of the year, mainly due to asset disposals.
Market risk policy statements set out the governance and risk management framework.
Risk appetite RBS’s qualitative appetite is set out in the non-traded market risk appetite statement.
To ensure approved limits are not breached and that RBS remains within its risk appetite, triggers at RBS and lower levels have been set and are actively managed.
 Option risk – 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 also includes pipeline risk.
Non-traded market risk continued from portfolios originated in prior periods, depending on the extent to which exposure has been hedged. To manage exposures within appetite, RBS aggregates its interest rate positions and hedges these externally using cash and derivatives (primarily interest rate swaps).
Foreign exchange risk The only material non-traded open currency positions are the structural foreign exchange exposures arising from investments in foreign subsidiaries, branches and associates and their related currency funding. These exposures are assessed and managed to predefined risk appetite levels under delegated authority from the Asset & Liability Management Committee. RBS seeks to limit the potential volatility impact on its CET1 ratio from exchange rate movements by maintaining a structural open currency position. Gains or losses arising from the retranslation of net investments in overseas operations are recognised in equity reserves and reduce the sensitivity of capital ratios to foreign exchange rate movements primarily arising from the retranslation of non-sterling-denominated RWAs. Sensitivity is minimised where, for a given currency, the ratio of the structural open position to RWAs equals the CET1 ratio.
Investments, acquisitions or disposals of a strategic nature are referred to the Acquisitions & Disposals Committee. Once approved by the Acquisitions & Disposals Committee for execution, such transactions are referred for approval to the Board, the Executive Committee, the Chief Executive, the Chief Financial Officer or as otherwise required. Decisions to acquire or hold equity positions in the non-trading book that are not of a strategic nature, such as customer restructurings, are taken by authorised persons with delegated authority under the credit approval framework.
Accounting volatility risk Accounting volatility can be mitigated through hedge accounting. The profit and loss impact of the derivatives can be mitigated by marking the exposure to market. However, volatility will remain in cases where accounting rules mean that hedge accounting is not an option. Accounting volatility risk is reported to the Asset & Liability Management Committee monthly and capitalised as part of the Internal Capital Adequacy Assessment Process.
2018 2017 Average Maximum Minimum Period end Average Maximum Minimum Period end £m £m £m £m £m £m £m £m
Euro 2.1 3.9 1.0 1.0 3.3 4.3 2.3 3.3 Sterling 14.5 26.0 7.9 13.3 6.3 13.8 1.8 2.8 US dollar 4.7 8.7 1.4 8.7 5.5 8.8 2.1 7.7 Other 0.5 0.7 0.3 0.7 1.0 1.1 0.8 0.8
Credit spread 59.7 77.8 49.4 77.8 60.6 82.4 47.4 49.7 Structural foreign exchange rate 13.4 32.7 5.9 13.0 12.4 17.2 9.3 15.4 Pipeline risk (1) 0.6 1.3 0.3 0.4 0.9 1.7 0.2 1.0 Diversification (2) (24.9) (20.5) (19.2) (17.3)
Notes: (1) Pipeline risk is the risk of loss arising from personal customers owning an option to draw down a loan – typically a mortgage – at a committed rate, where interest rate changes may result in greater or fewer customers than anticipated taking up the committed offer. (2) RBS benefits from diversification across various financial instrument types, currencies and markets. The extent of the diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR.
 Interest rate VaR peaked in January driven by the impact of transition to IFRS 9 on interest rate exposure in the structured loan portfolio. It subsequently declined, driven by additional hedging put in place during H1 2018 and asset disposals during H2 2018.
Non-traded market risk continued Structural hedging RBS has the benefit of a significant pool of stable, non and low interest-bearing liabilities, principally comprising equity and money transmission accounts. These balances are usually hedged, either by investing directly in longer-term fixed-rate assets (such as fixed-rate mortgages or UK government Gilts) or by using interest rate swaps, which are generally booked as cash flow hedges of floating-rate assets, in order to provide a consistent and predictable revenue stream.
The table below presents the incremental income allocation (above three-month LIBOR), total income allocation (including three-month LIBOR), the period end and average notional balances and the total yield (including three-month LIBOR) associated with the structural hedges managed by RBS.
2018 2017 Incremental Total Period end Average Total Incremental Total Period end Average Total income income notional notional yield income income notional notional yield £m £m £bn £bn % £m £m £bn £bn %
UK Personal & Business Banking 242 440 Commercial Banking 124 235 Other 2 5
Key points  The incremental income from the structural hedge was lower than that in 2017 primarily due to the increase in three-month LIBOR during 2018. The overall yield of the hedge was relatively stable.
 Five-year and ten-year sterling swap rates at 31 December 2018 were 1.22% and 1.35%, respectively. Equity structural hedges amortise over ten years whilst product hedges amortise over five years. Other structural hedges also amortise over five years except a small proportion of RBSI’s hedge which amortises over ten years.
 Compliance with ring-fencing regulations during H2 2018 resulted in a split of the equity structural hedge between NatWest Holdings and NatWest Markets. Approximately £6 billion of the equity hedge was allocated to NWM Plc in 2018.
Non-traded market risk continued Interest rate risk NTIRR can be measured from either an economic value-based or earnings-based perspective, or a combination of the two. Value-based approaches measure the change in value of the balance sheet assets and liabilities over a longer timeframe, including all cash flows. Earnings-based approaches measure the potential short-term (generally one-year) impact on the income statement of changes in interest rates.
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 NII sensitivity calculations are measured to a 12-month horizon and thus provide a shorter-term 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.
Earnings sensitivity to rate movements is derived from a central forecast over a 12-month period. A simplified scenario is shown below based on the period-end balance sheet (assuming that non-interest rate variables remain constant). Market-implied forward rates are used to generate the base case earnings forecast, which is then subject to interest rate shocks. The variance between the central forecast and the shock gives an indication of underlying sensitivity to interest rate movements.
The main driver of earnings sensitivity relates to interest rate passthrough 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.
 Net interest earnings sensitivity to a 100-basis-point downward shift in yield curves rose in 2018 compared to 2017. In the shock scenarios, rates fell further at 31 December 2018 than at 31 December 2017 before hitting an assumed zero per cent floor on interest rates. This was mainly due to rises in short-term cash rates since December 2017, which increased the impact of the rate shock. This effect was not seen in the 25-basis-point downward shift as most rates remain above zero per cent after the interest rate shock.
Sensitivity of fair value through other comprehensive income (FVOCI) and cash flow hedging reserves to interest rate movements. RBS holds most of the bonds in its liquidity portfolio at fair value. Valuation changes that are not hedged (or not in effective hedge accounting relationships) are recognised in FVOCI reserves. This is a component of credit spread risk.
The table below shows the sensitivity of FVOCI reserves and cash flow hedge reserves to a parallel shift in all rates. In this analysis, interest rates have not been floored at zero. Hedges are assumed to be fully effective. Hedge ineffectiveness would be expected to result in a portion of the reserve gains or losses shown below being recognised in P&L instead of reserves. Hedge ineffectiveness P&L is monitored and the effectiveness of cash flow and fair value hedge relationships are regularly tested in accordance with IFRS requirements. Note that a movement in the FVOCI reserve would have an impact on CET1 capital but a movement in the cash flow hedge reserve would not be expected to do so. Volatility in both reserves affects tangible net asset value.
+25 basis points -25 basis points +100 basis points -100 basis points 2018 £m £m £m £m
FVOCI reserves (55) 55 (220) 216 Cash flow hedge reserves (318) 323 (1,250) 1,315 2017 FVOCI reserves (41) 42 (164) 167 Cash flow hedge reserves (443) 448 (1,744) 1,819
 The sensitivity of the cash flow hedge reserve to interest rate movements fell in 2018. In part this reflected an increase in customer demand for longer fixed rates on mortgage products. Customers increasingly opted to fix mortgage rates for five years. This reduced the requirement for five-year interest rate swaps.
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) (1) excluding NCI hedges pre-economic hedges hedges (2) exposures 2018 £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 of US dollar net investments in foreign operations represent US dollar equity securities that do not qualify as net investment hedges for accounting purposes. They provide an offset to structural foreign exchange exposures to the extent that there are net assets in overseas operations available. Economic hedges of other currency net investments in foreign operations represent monetary liabilities that are not booked as net investment hedges.
Exchange-traded equity 41 41 Private equity 303 243 Other 87 136
Net realised gains arising from disposals 23 82 Unrealised gains included in Tier 1 or Tier 2 capital 153 60
The following disclosures in this section are audited:  Traded VaR (1-day 99%)
Trading activities may also give rise to counterparty credit risk. For further detail refer to the Credit risk section on page 111.
Key developments in 2018  Geopolitical risk resulted in periods of market volatility during the year. This mainly related to threats of a trade war between China and the US, elections in Italy and negotiations on a Brexit deal. European interest rates remained at low levels, although the Bank of England and US Federal Reserve continued raising rates.
The limits are reviewed to reflect changes in risk appetite, business plans, portfolio composition and the market and economic environments. 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 relevant business and the Market Risk function and implemented.
Traded market risk exposures are monitored against limits and analysed daily by market risk reporting and control functions. A daily report summarising the position of exposures against limits at RBS, franchise, business and desk levels is provided to senior management and market risk managers across the function. Limit reporting is supplemented with regulatory capital and stress testing information as well as ad hoc reporting.
 Model Risk Management review – As part of the model lifecycle, all risk models (including the VaR model) are independently reviewed to ensure the model is still fit for purpose given current market conditions and portfolio profile.
Note: (1) RBS benefits from diversification since it reduces risk by allocating positions across various financial instrument types, currencies and markets. The extent of the diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR.
Key points  Although traded VaR fluctuated throughout 2018 as explained earlier, it remained broadly unchanged year-on-year on both an average and period-end basis.
Traded market risk continued VaR back-testing The main approach employed to assess the VaR model’s ongoing performance is back-testing, which counts the number of days when a loss exceeds the corresponding daily VaR estimate, measured at a 99% confidence level.
The Actual P&L for a particular business day is the firm’s actual P&L in respect of trading activities, including intraday activities, adjusted by stripping out fees and commissions, brokerage, and additions to and releases from reserves not directly related to market risk.
A portfolio is said to produce a back-testing exception when the Actual or Hypo P&L exceeds the VaR level on a given day. Such an event may be caused by a large market movement or may highlight issues such as missing risk factors or inappropriate time series. Any such issues identified are analysed and addressed through appropriate remediation or development action. Both Actual and Hypo back-testing exceptions are monitored.
The table below shows internal back-testing exceptions for the 250-business-day period to 31 December 2018 for one-day 99% traded internal VaR compared with Actual and Hypo P&L for the major NatWest Markets businesses.
A simulation of 99% VaR is run on the current portfolio for each 250day period from 2005 to the current VaR date, moving forward one day at a time. The SVaR is the worst VaR outcome of the simulated results.
Incremental risk charge (IRC) The IRC model quantifies the impact of rating migration and default events on the market value of instruments with embedded credit risk (in particular, bonds and credit default swaps) held in the trading book. It further captures basis risk between different instruments, maturities and reference entities.
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 approved in NatWest Markets, with material models subject to independent review by Model Risk Management. For further detail on the independent model validation carried out by Model Risk Management refer to page 93. Information relating to pricing and market risk models is presented below.
Pricing models Pricing models are developed by a dedicated first line team, in conjunction with the trading desk. The models are used to value positions for which prices are not directly observable as well as for the risk management of the portfolio. Any pricing models that are used as the basis for valuing portfolios and records are subject to approval and oversight by asset-level modelled product review committees. These committees comprise representatives of the trading, finance, market risk, model development and model review functions. Approval requires review and approval by these stakeholders as well as Model Risk Management.
Management, considering the materiality of the risk booked against the model and an assessment of the degree of model risk, which is the valuation uncertainty arising from the choice of modelling assumptions.
 The sensitivities derived from the pricing models are validated.  The conclusions of the review are used to inform risk limits and by the Finance function to inform model reserves.
Pension risk 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.
Pension scheme liabilities vary with changes in long-term interest rates and inflation as well as with pensionable salaries, the longevity of scheme members and legislation. Pension scheme assets vary with changes in interest rates, inflation expectations, credit spreads, exchange rates, and equity and property prices. RBS is exposed to the risk that the schemes’ assets, together with future returns and additional future contributions, are insufficient to meet liabilities as they fall due. In such circumstances, RBS could be obliged (or might choose) to make additional contributions to the schemes, or be required to hold additional capital to mitigate this risk.
 RBS made a £2 billion contribution to the Main section in H2 2018 and it was agreed this could be followed by up to a further £1.5 billion of dividend linked contributions to be paid from 2020, capped at £500 million per year.
 The contribution to the scheme facilitated a reduction in the risk profile of the fund, principally the sale of approximately £6 billion of quoted equity exposure and the purchase of further interest rate and inflation hedging.
Risk appetite RBS maintains an independent view of the risk inherent in its pension funds. RBS has an annually reviewed pension risk appetite statement incorporating defined metrics against which risk is measured. RBS undertakes regular pension risk monitoring and reporting to the Board, the Board Risk Committee and the Pension Committee on the material pension schemes that RBS has an obligation to support.
Risk controls A pension risk management framework is in place to provide formal controls for pension risk reporting, modelling, governance and stress testing. A pension risk policy, which sits within the RBS policy framework, is also in place and is subject to associated framework controls.
Risk monitoring and measurement Pension risk reports are submitted to the Executive Risk Committee and the Board Risk Committee four times a year in the Risk Management Quarterly Report.
Risk mitigation The trustee has taken measures to mitigate inflation and interest rate risks, both by investing in suitable financial assets and by entering into inflation and interest rate swaps. The Main section also uses derivatives to manage the allocation of the portfolio to different asset classes and to manage risk within asset classes. The contribution made to the Main section also facilitated a £6 billion reduction in quoted equity exposure and an increase in interest rates and inflation hedging in 2018.
Risk governance RBS defines appropriate standards of compliance and conduct and ensures adherence to those standards through its risk management framework.
Compliance & conduct risk continued Risk appetite Risk appetite for compliance and conduct risks is set at Board level. RBS Risk appetite statements articulate the levels of risk that legal entities, franchises and functions work within when pursuing their strategic objectives and business plans.
Risk controls RBS operates a range of controls to ensure its business is conducted in accordance with legal and regulatory requirements, as well as delivering good customer outcomes. A suite of policies addressing compliance and conduct risks set appropriate standards across RBS. Examples of these include the Complaints Management Policy, Client Assets & Money Policy, and Product Lifecycle Policy as well as policies relating to customers in vulnerable situations, cross-border activities and market abuse. Continuous monitoring and targeted assurance is undertaken, as appropriate.
Risk monitoring and measurement Compliance and conduct risks are measured and managed through continuous assessment and reporting to RBS’s senior risk committees and at Board level.
Risk mitigation Activity to mitigate the most-material compliance and conduct risks is carried out across RBS with specific areas of focus in the customerfacing franchises and legal entities. Examples of mitigation include consideration of customer needs in business and product planning, targeted training, complaints management, as well as independent assurance activity. Internal policies help support a strong customer focus across RBS. Independent assessments of compliance with applicable regulations are also carried out at a legal entity level.
Desist Order originally imposed in July 2011 for financial crime compliance weaknesses identified across RBS’s US businesses and concerns about the level of oversight that the RBS Board of Directors had over large and complex US operations. The termination of the Order followed a multi-year programme of work to establish an enhanced governance and oversight framework, risk management programme and compliance programme.
Risk governance Financial crime risk is principally governed through the Financial Crime Risk Executive Committee, which is chaired by the Chief Financial Crime Officer. The committee reviews and, where appropriate, escalates material risks and issues to the Group Executive Risk Committee and the Group Board Risk Committee.
Risk controls RBS operates a framework of preventative and detective controls designed to ensure RBS mitigates the risk that it could facilitate financial crime. These controls are supported by a suite of policies, procedures and detailed instructions to ensure they operate effectively.
Risk monitoring and measurement Financial crime risks are identified and reported through continuous risk management and regular monthly reporting to RBS’s senior risk committees and the Board. Quantitative and qualitative data is reviewed and assessed to measure whether financial crime risk is within the Group’s risk appetite.
Risk mitigation Through the financial crime framework, RBS employs relevant policies, systems, processes and controls to mitigate financial crime risk. This would include the use of dedicated screening and monitoring controls to identify people, organisations, transactions and behaviours which might require further investigation or other actions. RBS ensures that centralised expertise is available to detect and disrupt threats to the Group and its customers. Intelligence is shared with law enforcement, regulators and government bodies to strengthen national and international defences against those who would misuse the financial system for criminal motives.
Operational risk continued Key developments in 2018  Risk provided oversight of several bank-wide programmes including the Transformation portfolio, structural reform, European Commission (EC) State Aid obligations and Brexit preparations.
 Key corporate structural reform milestones were delivered, including the implementation of the Financial Services Markets Act Part VII and migration activities to separate the ring-fence bank from the non ring-fenced bank.
 RBS is well positioned to deliver the activities required to support the Business Banking Switch Scheme that is due to commence in 2019, as part of the Group’s final EC State Aid obligation.
 Internal security improvement programmes and controls were developed and strengthened to protect RBS and its customers. RBS uses proactive threat management and intelligence processes to identify, manage and mitigate credible threats.
 Internal training programmes ensure all employees are aware of the threats facing RBS and remain vigilant to unauthorised attempts to access systems and data.
The Operational Risk function is responsible for the execution and continuous improvement of the operational risk management framework.
The Operational Risk Executive Committee (OREC) is responsible for reviewing operational risk exposure; 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 changes.
Risk appetite Operational risk appetite supports effective management of material operational risks. It expresses the level and types of operational risk RBS is willing to accept to achieve its strategic objectives and business plans.
Risk controls The Control Environment Certification (CEC) process is a half yearly self-assessment by the CEOs of RBS’s franchises and business units, as well as the heads of the support and control functions, providing a view on the adequacy and effectiveness of the internal control environment in a consistent and comparable manner. In line with ringfencing requirements, from H2 2018 certificates were also produced for the following legal entities: NatWest Holdings Limited; NatWest Markets Plc; The Royal Bank of Scotland International Limited; Ulster Bank Ireland DAC; and Coutts and Co.
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 84), and certain requirements of the UK Corporate Governance Code.
RBS uses the standardised approach to calculate its Pillar 1 operational risk capital requirement. This is based on multiplying three years’ average historical gross income by coefficients set by the regulator based on business line. As part of the wider Internal Capital Adequacy Assessment Process an operational risk economic capital model is used to assess Pillar 2A, which is a risk-sensitive add-on to Pillar 1.The model uses historical loss data (internal and external) and forward-looking scenario analysis that is provided by Operational Risk to provide a risk-sensitive view of RBS’s P2A capital requirement.
Business risk Definition Business risk is the risk that RBS does not have a strategy that is sufficiently well defined to provide clarity on its long-term ambitions to key internal and external stakeholders, or that it is not able to execute upon its chosen strategy as communicated to the market, regulators and other key stakeholders. The risk is that RBS does not deliver its expected business performance which could give rise to a deterioration in stakeholder trust and confidence and/or a breach of regulatory thresholds. RBS may not be able to execute its chosen strategy if there are material changes to RBS’s internal or external operating environment.
Sources of risk Business risk arises as a result of RBS’s exposure to the macroeconomy (including economic and political factors), the competitive environment, regulatory and technological changes. In addition, internal factors such as the ability to deliver complex change, volatility in sales volumes, input costs, and other operational risks affect RBS’s ability to execute its chosen strategic business plan as intended and thus contribute to business risk.
capital structure. The shares in NatWest Holdings Limited, which owns the ring-fenced sub-group, were distributed to RBS. This separated the ring-fenced sub-group from the non-ring-fenced entities, as required by ring-fencing legislation. RBS also transferred the customer interest rate and foreign exchange derivatives business of National Westminster Bank Plc to NatWest Markets Plc.
 UK Government Investments Limited announced the successful completion of the disposal of part of HM Treasury's shareholding in The Royal Bank of Scotland Group plc, representing approximately 7.7% of the ordinary share capital of the Group. HM Treasury’s shareholding in RBS now represents 62.3% of the Group’s ordinary share capital.
Risk appetite Risk Appetite defines the level and types of risk it is willing to accept in order to achieve its strategic objectives and business plans. RBS articulates its appetite for business risk through the implementation of qualitative risk appetite statements and quantitative risk measures at franchise and function level. These statements and measures help determine the level and types of business risk RBS is willing to accept.
Risk monitoring and measurement 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. Business risk is reported, assessed and challenged at every governance level within the organisation. Each franchise monitors its financial performance relative to plans and reports this on a regular basis to the finance directors of each franchise.
 Metrics were reviewed and enhanced to help measure reputational risk across the Group.
 Risk appetite positions for countries and sectors identified as presenting heightened reputational risk continued to be reviewed and strengthened.
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 2018. 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 2018 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 Group financial statements, Article 4 of the IAS Regulation.
The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, as regards the Parent Company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
Basis for opinion We conducted our audit in accordance with International Standards on Auditing (UK) (ISAs (UK)) and applicable law. Our responsibilities under those standards are further described in the Auditor’s responsibilities for the audit of the financial statements section of our report below. We are independent of the Group and Parent Company in accordance with the ethical requirements that are relevant to our audit of the financial statements in the UK, including the Financial Reporting Council’s Ethical Standard as applied to listed public interest entities, and we have fulfilled our other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.
Conclusions relating to principal risks, going concern and viability statement We have nothing to report in respect of the following information in the annual report, in relation to which the ISAs(UK) require us to report to you whether we have anything material to add or draw attention to,
 the directors’ viability statement 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.
Provisions for conduct, litigation and regulatory matters, customer remediation and claims The continued litigious environment and heightened regulatory scrutiny gives rise to a high level of judgement in determining appropriate provisions and disclosures. At 31 December 2018, the Group has reported £3.0 billion (2017: £7.8 billion) of provisions for liabilities and charges, including £2.0 billion (2017: £5.8 billion) for conduct and litigation claims, including Residential Mortgage Backed Securities (RMBS), Payment Protection Insurance (PPI) and the Financial Conduct Authority (FCA) review of RBS’s treatment of Small and Medium-sized Enterprises (SMEs) as detailed in Note 20 of the financial statements.
Management judgement is needed to determine whether an obligation exists and a provision should be recorded at 31 December 2018 in accordance with the accounting criteria set under IAS 37.
The most significant areas of judgement are:  Adequacy of provisions: judgement is involved in the determination of whether an outflow in respect of identified material conduct or legal matters are probable and can be estimated reliably and the appropriateness of assumptions and judgements used in the estimation of material provisions; and
For the significant provisions made, such as PPI and the FCA review of RBS’s treatment of SMEs, 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 considered the accuracy of management’s historical estimates and peer bank settlement in similar cases. We also developed our own range of reasonable alternative estimates and compared them to management’s provision.
We received confirmations from the Group’s external counsel for significant matters to confirm the existence of the obligation and management’s estimate of the outflow at year-end. We corroborated management’s conclusion by challenging the underlying information used in estimating the provisions including consideration of alternate sources.
We considered regulatory developments and, for key cases, assessed the reasonableness of the assumptions used by management by comparing to the results of our independently performed benchmarking and sensitivity analysis. Where appropriate, we involved our conduct risk specialists. We also verified historical data and whether it supported current estimates.
Key observations communicated to the Group Audit Committee We are satisfied that the Group’s provisions for conduct, litigation and regulatory matters, customer remediation and claims are within a reasonable range and recognised in accordance with IFRS. We did not identify any material unrecorded provisions. We highlighted the following matters to the Group Audit Committee:  The PPI provision remains sensitive to key assumptions, the most significant of which is future complaint volumes. Management’s estimate was within our range of outcomes based on reasonable alternative assumptions;  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; and
We tested the design and operating effectiveness of key controls across the processes relevant to the ECL. This included the allocation of assets into stages, model governance, data accuracy and completeness, credit monitoring, multiple economic scenarios, post model adjustments, individual provisions and production of journal entries and disclosures.
We challenged the criteria used to allocate an asset to stage 1, 2 or 3 in accordance with IFRS 9; this included peer benchmarking to assess staging levels. We tested assets in stage 1, 2 and 3 to verify that they were allocated to the appropriate stage.
With the support of our internal modelling specialists, we tested the assumptions, inputs and formulas used in a sample of ECL models. This included assessing the appropriateness of model design and formulas used, considering alternative modelling techniques and recalculating the Probability of Default, Loss Given Default and Exposure at Default for a sample of models.
With the support of our internal economic specialists, we assessed the base case and alternative economic scenarios, including challenging probability weights and comparing to other scenarios from a variety of external sources, as well as EY internally developed forecasts. We assessed whether forecasted macroeconomic variables were appropriate, such as GDP, unemployment, interest rates and House Price Index. With the support of our modelling specialists we challenged the correlation and impact of the macroeconomic factors to the ECL including how non-linearity was captured.
Future profitability estimates impacting the recognition of deferred tax and the impairment of goodwill and, in the parent company accounts, investments in subsidiaries. At 31 December 2018 the Group had reported Goodwill of £5.6 billion (2017: £5.6 billion) and deferred tax assets of £1.4 billion (2017: £1.7 billion). The parent company has reported investments in subsidiaries of £57.7 billion (2017: £47.6 billion).
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. The recognition of deferred tax assets considers the future profit forecasts of the legal entities as well as interpretation of recent changes to tax rates and laws.
We tested the design and operating effectiveness of key controls over the preparation and review of the forecasts, the significant assumptions, inputs, calculations, methodologies and judgements.
We assessed the reasonableness of revenue forecasts by challenging the underlying business strategies, comparing to expected market trends and considering anticipated balance sheet growth.
We evaluated how the discount rates and long-term growth rates used by management compared to our reasonable ranges which were informed by peer practice, external market data and calculations performed by our valuation specialists.
With the support of our taxation specialists, we assessed the estimate of future taxable profits used to calculate the level of deferred tax assets recognised, including an assessment of the time horizon used for the recoverability of losses and other temporary differences.
 We noted the inherent uncertainty predicting revenue and costs over the five-year forecasts period, particularly with respect to the impact of Brexit, and other political developments, and disruptions in the business model over an extended period.
Relevant references in the Annual Report and Accounts Report of the Group Audit Committee Accounting policies Note 7 and Note 16 on the financial statements, and Note 6 on the Parent company financial statements.
Valuation of financial instruments with higher risk characteristics including related income from trading activities The valuation of financial instruments with higher risk characteristics involves both significant judgement and the risk of inappropriate revenue recognition through incorrect pricing. 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 31 December 2018 the Group reported level 3 assets of £3.3 billion (2017: £3.2 billion) and level 3 liabilities of £1.95 billion (2016: £2.2 billion).
We performed walkthroughs of transactions from inception to financial reporting to confirm our understanding of process and controls in the area of revenue recognition.
Key observations communicated to the Group Audit Committee 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 matters to the Audit Committee:  Complex-model dependent valuations were appropriate based on the output of our independent re-valuation, analysis of trade activity and peer benchmarking;  The fair value estimates of hard-to-price portfolios appropriately reflected the Group’s planned exit route and latest available pricing information; and
Accounting and reporting risks arising include:  Appropriate application of accounting standards in recording the value of assets and liabilities transferred between legal entities, specifically with respect to fair value and hedge accounting in the financial statements of the relevant entities;  Future profitability estimates at a legal entity level, given the transfer of activities and services, and the impact on the impairment assessment of the carrying value of goodwill and investments in subsidiaries;  Accuracy of costs recorded in each legal entity given changes to the Group’s approach to cost recharging and cost allocation;  Impact of the restructuring of the Group and movement of legal entities including the carrying value of investments and reserves including foreign exchange reserves; and
 Accuracy of financial reporting given changes to the legal entity financial reporting closing processes to reflect changes in the Group.
We challenged management’s assessment of the accounting impacts of ICB, including the accounting treatment for transfers of businesses and legal entities and the appropriateness of the interpretations used on areas of judgement, including hedge accounting and pensions, as well as the valuation of the assets moved. We analysed significant changes to financial information arising from legal entity changes and assessed if they were in line with our expectations.
We tested the design and operating effectiveness of key controls and performed substantive procedures over the transfer of balances between legal entities.
We tested the design and operating effectiveness of the Group’s key controls over legal entity recharges, including the governance and implementation of changes to legal entity recharges due to ICB. We tested adherence to internally agreed policies at a legal entity level, including assessments on the appropriateness of transfer pricing mark-ups applied.
Pension valuation and retirement benefit obligations The Group operates a number of defined benefit schemes which in total are significant in the context of the overall balance sheet. At 31 December 2018 the Group reported a net pension asset of £355 million (2017: £263 million) comprising £520 million of schemes in surplus and £165 million of schemes in deficit (2017: £392 million and £129 million, respectively). The net pension asset is sensitive to changes in the key judgements and estimates, which include:  Actuarial assumptions and inputs including the discount rate, inflation, pension payment and longevity to determine the valuation of retirement benefit liabilities;  Pricing inputs and calibrations for illiquid or complex model-dependent valuations of certain investments held by the schemes;  Quantification of trustee’s rights to unilaterally augment benefits (Augmentation cap) to determine the recognition of surplus; and
We tested the design and operating effectiveness of key controls over the actuarial assumptions setting process, the data inputs used in the actuarial calculation and the measurement of the fair value of the schemes’ assets.
In readiness for compliance with the requirements of the UK ring-fencing legislation, a Memorandum of Understanding (MoU) was entered into with the Trustees of RBS Group Pension Fund. We read the MoU, assessed the implications and challenged the appropriateness of the accounting treatment in accordance with relevant accounting standards.
We assessed the adequacy of the disclosures made in the financial statements, including the appropriateness of the key assumptions and sensitivities disclosed.
 Management’s estimate of the impact of the GMP liability was materially consistent with our independent estimate using our own model. Relevant references in the Annual Report and Accounts Report of the Group Audit Committee Accounting policies Note 5 on the financial statements Risk Our response to the risk IT systems and controls impacting financial reporting The IT environment is complex and pervasive to the operations of the Group due to the large volume of transactions processed in numerous locations daily and the reliance on automated and IT dependent manual controls. Appropriate IT controls are required to ensure that applications process data as expected and that changes are made in an appropriate manner. Such controls contribute to mitigating the risk of potential fraud or errors as a result of changes to applications and data.
We assessed automated controls within business processes and the reliability of relevant reports used as part of a manual control. This included challenging the integrity of system interfaces, the completeness and accuracy of data feeds, automated calculations and specific input controls.
Where control deficiencies were identified, we tested remediation activities performed by management and compensating controls in place and assessed where necessary to mitigate any residual risk.
We are satisfied that IT controls relevant to financial reporting operated effectively at year-end. We highlighted the following matters to the Group Audit Committee:  Instances of user access related deficiencies were identified. Compensating controls were tested or alternate procedures were performed; and
 Exceptions were reported in some Service Organisation Controls Reports provided by third parties including Cloud providers.We tested compensating controls with no issues noted.
UK Personal & Business Banking Full United Kingdom Ulster Bank RoI Specific Republic of Ireland Commercial Banking Full United Kingdom Private Banking Specific United Kingdom RBS International Specific Channel Islands NatWest Markets Full United Kingdom, United States, and Singapore Central items, Treasury and Services Full United Kingdom, India, Poland
Notes 1) Full scope: audit procedures on all significant accounts 2) Specific scope: audit procedures on selected accounts 3) Other procedures: considered in analytical procedures
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 £100 million (2017: £150 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, the effectiveness of the control environment and other factors affecting the entity and its financial reporting.
Reporting threshold An amount below which identified misstatements are considered to be clearly trivial. We agreed with the Group Audit Committee that we would report to them all corrected and uncorrected audit misstatements in excess of £10 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.
 Directors’ statement of compliance with the UK Corporate Governance Code – the parts of the directors’ statement required under the Listing Rules relating to the company’s compliance with the UK Corporate Governance Code containing provisions specified for review by the auditor in accordance with Listing Rule 9.8.10R(2) do not properly disclose a departure from a relevant provision of the UK Corporate Governance Code.
 certain disclosures of directors’ remuneration specified by law are not made; or
 we have not received all the information and explanations we require for our audit
Explanation as to what extent the audit was considered capable of detecting irregularities, including fraud The objectives of our audit, in respect to fraud, are; to identify and assess the risks of material misstatement of the financial statements due to fraud; to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to fraud, through designing and implementing appropriate responses; and to respond appropriately to fraud or suspected fraud identified during the audit. However, the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and management. 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:  The regulations, licence conditions and supervisory requirements of the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA).
 Following the recommendation of the Group Audit Committee we were appointed by the Group at its annual general meeting on 4 May 2016 to audit the financial statements of the Group for the period ending 31 December 2016 and subsequent financial periods. The period of total uninterrupted engagement including previous renewals and reappointments is 3 years, covering periods from our appointment through 31 December 2018.
 The audit opinion is consistent with the additional report to the Group Audit Committee
Remeasurement of retirement benefit schemes 5 - contributions in preparation for ring-fencing (1) (2,053) — — - other movements 86 90 (1,049) Profit/(loss) on fair value of credit in financial liabilities designated at fair value through profit or loss due to own credit risk 200 (126) — Fair value through other comprehensive income (FVOCI) financial assets (2) 48 — — Tax 502 (10) 288
Items that do qualify for reclassification Fair value through other comprehensive income (FVOCI) financial assets (2) 7 26 (94) Cash flow hedges (581) (1,069) 765 Currency translation 310 100 1,263 Tax 189 256 (106)
(2) Refer to Note 33 for further information on the impact of IFRS 9 on classification and basis of preparation, year ended 31 December 2018 prepared under IFRS 9 and prior years under IAS 39.
Cash and balances at central banks 11 88,897 98,337 Trading assets 9 75,119 85,991 Derivatives 10 133,349 160,843 Settlement balances 2,928 2,517 Loans to banks - amortised cost 11 12,947 11,517 Loans to customers - amortised cost 11 305,089 310,116
Securities subject to repurchase agreements 9,890 13,717 Other financial assets excluding securities subject to repurchase agreements 49,595 38,212
Called-up share capital - at 1 January 11,965 11,823 11,625 Ordinary shares issued 84 142 198 At 31 December 12,049 11,965 11,823
FVOCI reserve - at 1 January (5) 255 238 307 Implementation of IFRS 9 on 1 January 2018 34 — — Unrealised gains 97 202 282 Realised gains (42) (176) (376)
Cash flow hedging reserve - at 1 January 227 1,030 458 Amount recognised in equity (6) (63) (277) 1,867 Amount transferred from equity to earnings (7) (518) (792) (1,102)
Own shares held - at 1 January (43) (132) (107) Shares issued under employee share schemes 87 161 41 Own shares acquired (65) (72) (66)
Non-controlling interests (see Note 21) - at 1 January 763 795 716 Currency translation adjustments and other movements 25 17 111 (Loss)/profit attributable to non-controlling interests (8) 35 10 Dividends paid (5) (25) — Equity withdrawn and disposals (21) (59) (42)
Total equity is attributable to: Ordinary shareholders 41,182 41,707 41,462 Preference shareholders 496 2,565 2,565 Paid-in equity holders 4,058 4,058 4,582 Non-controlling interests 754 763 795
The accompanying notes on pages 187 to 238, the accounting policies on pages 182 to 186 and the audited sections of the Business review: Capital and risk management on pages 89 to 164 form an integral part of these financial statements.
Sale and maturity of securities 9,062 11,656 8,599 Purchase of securities (16,181) (17,212) (11,607) Sale of property, plant and equipment 264 405 447 Purchase of property, plant and equipment (619) (1,132) (912) Net investment in business interests and intangible assets 28 (481) (199) (886) Net cash flows from investing activities (7,955) (6,482) (4,359)
Issue of ordinary shares 144 306 300 Issue of other equity instruments: Additional Tier 1 capital notes — — 2,046 Redemption of other equity instruments (2,826) (779) (1,312) Redemption of debt preference shares — (748) — Own shares disposed/(acquired) 22 89 (25) Redemption of subordinated liabilities (2,258) (5,747) (3,606) Service cost of other equity instruments (803) (612) (1,697) Interest on subordinated liabilities (566) (717) (813) Net cash flows from financing activities (6,287) (8,208) (5,107) Effects of exchange rate changes on cash and cash equivalents 676 (16) 8,094
Note: (1) Includes interest received of £10,927 million (2017 - £10,946 million, 2016 - £11,321 million) and interest paid of £2,511 million (2017 - £2,300 million,
Accounting policies 1. Presentation of accounts The accounts, set out on pages 176 to 181 including these accounting policies on pages 182 to 186 and the audited sections of the Financial review: Capital and risk management on pages 89 to 164, are prepared on a going concern basis (see the Report of the directors, page 85) and in accordance with International Financial Reporting Standards as issued by the International Accounting Standards Board (IASB) and interpretations as issued by the IFRS Interpretations Committee of the IASB and adopted by the European Union (EU) (together IFRS). ).
Other amendments to IFRS IFRS 15 ‘Revenue from Contracts with Customers’ has been adopted with effect from 1 January 2018. The Accounting policy is updated to reflect the terminology in the new standard but it has had no effect on financial information reported in the current or comparative periods. Interest income and expense continues to be recognised using the effective interest rate method for financial instruments measured at historical cost. There has been no restatement of profit or loss for comparative periods.
Net interest income in the income statement only relates to financial instruments measured at amortised cost; the interest on debt instruments classified as fair value through OCI; and the effective part of any related accounting hedging instruments. Other interest relating to financial instruments measured at fair value is recognised as part of the movement in fair value.
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.
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 23. 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.
For defined benefit schemes, the defined benefit obligation is measured on an actuarial basis using the projected unit credit method and discounted at a rate determined by reference to market yields at the end of the reporting period on high quality corporate bonds of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. The difference between scheme assets and scheme liabilities, the net defined benefit asset or liability, is recognised in the balance sheet. A defined benefit asset is limited to the present value of any economic benefits available to the Group in the form of refunds from the plan or reduced contributions to it.
 past service cost resulting from a scheme amendment or curtailment
Actuarial gains and losses (i.e. gains or and losses on re-measuring the net defined benefit asset or liability) are recognised in other comprehensive income in full in the period in which they arise.
economic viability are expensed as incurred as are all training costs and general overheads. The costs of licences to use computer software that are expected to generate economic benefits beyond one year are also capitalised.
7. Impairment of intangible assets and property, plant and equipment At each balance sheet date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.
If an asset does not generate cash flows that are independent from those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s cash-generating units or groups of cash-generating units expected to benefit from the combination. The recoverable amount of an asset or cash-generating unit is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash-generating unit that have not been taken into account in estimating future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. 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. Foreign currencies The Group's consolidated financial statements are presented in sterling which is the functional currency of the company.
Transactions in foreign currencies are recorded in the functional currency at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations (see Accounting policy 21).
Non-monetary items denominated in foreign currencies that are stated at fair value are translated into the relevant functional currency at the foreign exchange rates ruling at the dates the values are determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on nonmonetary financial assets classified as available for sale, for example equity shares, which are recognised in other comprehensive income unless the asset is the hedged item in a fair value hedge.
10. Leases As lessor Contracts with customers to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer; all other contracts with customers to lease assets are classified as operating leases.
Finance lease receivables are included in the balance sheet, within net loans to customers, at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment and included in Interest receivable. Unguaranteed residual values are subject to regular review; if there is a reduction in their value, income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.
11. 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.
If the Group has a contract that is onerous, it recognises the present obligation under the contract as a provision. An onerous contract is one where the unavoidable costs of meeting the Group’s contractual obligations exceed the expected economic benefits. When the Group vacates a leasehold property, a provision is recognised for the costs under the lease less any expected economic benefits (such as rental income).
12. Tax Income tax expense or income, comprising current tax and deferred tax, is recorded in the income statement except income tax on items recognised outside profit or loss which is credited or charged to other comprehensive income or to equity as appropriate.
Deferred tax is the tax expected to be payable or recoverable in respect of temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that the asset will be recovered.
13. Financial instruments On initial recognition, financial instruments are measured at fair value. Subsequently they are classified as follows: designated at fair value through profit or loss; amortised cost, the default class for liabilities; fair value through profit or loss, the default class for assets; or financial assets may be designated as at fair value through other comprehensive income. Regular way purchases of financial assets classified as amortised cost are recognised on the settlement date; all other regular way transactions in financial assets are recognised on the trade date.
Designated as at fair value through profit or loss – a financial instrument 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 a financial liability 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.
Amortised cost assets – have to meet both the following criteria: (a) the asset is held within a business model whose objective is solely to hold assets to collect contractual cash flows; and
Fair value through profit or loss - a financial liability is measured at fair value if it arises from: a financial guarantee contract; a commitment to lend at below market rates; an obligation arising from the failed sale of an asset; or a contingent consideration for a business acquisition. Fair value through profit or loss is the default classification for a financial asset.
Fair value – the 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.
Business model assessment – business models are assessed at portfolio level, being the level at which they are managed. This is expected to result in the most consistent classification of assets because it aligns with the stated objectives of the portfolio, its risk management, manager’s remuneration and the ability to monitor sales of assets from a portfolio. The criteria for classifying cash flows as solely principal and interest are assessed against the contractual terms of a facility, with attention to leverage features; prepayment and extension terms; and triggers that might reset the effective rate of interest.
Expected credit losses are a probabilityweighted estimate of credit losses. The probability is determined by the risk of default which is applied to the cash flow estimates. In the absence of a change in credit rating, allowances are recognised when there is reduction in the net present value of expected cash flows. On a significant increase in credit risk, allowances are recognised without a change in the expected cash flows, although typically expected cash flows do also change; and expected credit losses are rebased from 12 month to lifetime expectations.
On restructuring a financial asset without causing derecognition of the original asset the revised cash flows are used in re-estimating the credit loss. Where restructuring causes derecognition of the original financial asset, the fair value of the replacement asset is used as the closing cash flow of the original asset.
Impaired loans and receivables are written off, when the Group concludes that there is no longer any realistic prospect of recovery of part or all of the loan. For loans that are individually assessed for impairment, the timing of write off is determined on a case-bycase basis. Such loans are reviewed regularly and write off will be prompted by bankruptcy, insolvency, renegotiation and similar events.
The typical time frames from initial impairment to write off for the Group’s collectivelyassessed portfolios are:  Retail mortgages: write off usually occurs within five years, or when an account is closed if earlier.
16. Loan commitments Provision is made for expected credit loss on loan commitments, other than those classified as held-for-trading. 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.
20. 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. Incremental costs and related tax that are directly attributable to an equity transaction are deducted from equity.
21. Derivatives and hedging In accordance with IAS 39 ‘hedge relationships’, derivative financial instruments are initially recognised, and subsequently measured, at fair value.
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 ordinary 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.
23. Share-based compensation The Group operates a number of share-based compensation schemes under which it awards RBSG shares and share options to its employees. Such awards are generally subject to vesting conditions: conditions that vary the amount of cash or shares to which an employee is entitled. Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the employee to complete a specified period of service and specified performance targets to be met). Other conditions to which an award is subject are non-vesting conditions (such as a requirement to save throughout the vesting period).
The cost of employee services received in exchange for an award of shares or share options is measured by reference to the fair value of the shares or share options on the date the award is and takes into account nonvesting conditions and market performance conditions (conditions related to the market price of RBSG shares): an award is treated as vesting irrespective of whether any market performance condition or non-vesting condition is met. The fair value of options is estimated using valuation techniques which incorporate exercise price, term, risk-free interest rates, the current share price and its expected volatility. The cost is expensed on a straight-line basis over the vesting period (the period during which all the specified vesting conditions must be satisfied) with a corresponding increase in equity in an equitysettled award, or a corresponding liability in a cash-settled award. The cost is adjusted for vesting conditions (other than market performance conditions) so as to reflect the number of shares or share options that actually vest.
24. 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.
Critical accounting policies and key sources of estimation uncertainty The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. UK company law and IFRS require the directors, in preparing the Group's financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB's ’Conceptual Framework for Financial Reporting’. The judgements and assumptions involved in the Group's accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results
Accounting Developments International Financial Reporting Standards A number of IFRS’s and amendments to IFRS were in issue at 31 December 2018 that would affect the Group from 1 January 2019 or later
Effective 1 January 2019 IFRS 16 ‘Leases’ was issued in January 2016 to replace IAS 17 ‘Leases’. The Group will apply the standard with effect from 1 January 2019. Lessees will capitalise operating leases through the recognition of assets representing the contractual rights of use. The present value of contractual payments will be recognised as lease liabilities.
Premises and equipment 1,383 1,565 1,388 UK bank levy 179 215 190 Depreciation and amortisation 731 808 778 Other administrative expenses (1) 3,193 3,108 8,555
RBS International 1,600 1,600 800 NatWest Markets 4,500 5,300 1,500 Central items & other 20,900 32,300 39,300
During 2018 the reporting lines of central and support staff directly supporting a reportable Group segment were realigned to that segment.
Share-based payments As described in the Remuneration report, the Group grants share-based awards to employees principally on the following bases: Award plan Eligible employees Nature of award Vesting conditions (1) Settlement
3 Operating expenses continued The fair value of options granted in 2018 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.
The strike price of options and the fair value on granting awards of fully paid shares is the average market price over the five trading days (three trading days for Sharesave) preceding grant date.
At 1 January 2.38 60 2.46 56 2.87 56 Granted 1.89 28 2.27 21 1.68 17 Exercised 2.44 (4) 2.46 (3) 2.37 — Cancelled 2.46 (9) 2.49 (14) 3.02 (17)
Options are exercisable within six months of vesting; 4.9 million options were exercisable at 31 December 2018 (2017 – 3.7 million; 2016 – 8.1 million). The weighted average share price at the date of exercise of options was £2.13 (2017 - £2.77; 2016 - £1.78). At 31 December 2018, exercise prices ranged from £1.68 to £3.43 (2017 - £1.68 to £4.34; 2016 - £1.68 to £4.34) and the remaining average contractual life was 2.9 years (2017 - 2.9 years; 2016 – 2.9 years). The fair value of options granted in 2018 was £21 million (2017 - £21 million; 2016 - £18 million).
At 1 January 102 37 2 119 38 4 153 44 5 Granted 12 5 — 35 15 — 37 16 — Vested/exercised (5) (2) — (22) (7) — (39) (12) — Lapsed (24) (8) — (30) (9) (2) (32) (10) (1)
Variable compensation awards The following tables analyse the Group's variable compensation awards for 2018.
Total non-deferred variable compensation 37 51 (27) Deferred bond awards 191 134 43 Deferred share awards 107 157 (32)
Variable compensation as a % of operating profit before tax (3) 9% 13% Proportion of variable compensation that is deferred 89% 85% of which - deferred bond awards 64% 46% - deferred share awards 36% 54%
Add: current year charge for amounts deferred from prior years 86 96 147
Variable compensation deferred from 2016 and earlier 147 96 5 9 4 Variable compensation deferred from 2017 — — 81 22 15 Less: forfeiture of amounts deferred from prior years (106) (7) (66) — — Variable compensation for 2018 deferred — — — 89 41
Reportable operating segments The reportable operating segments are as follows: Personal & Business Banking (PBB) comprises two reportable segments: UK Personal & Business Banking (UK PBB) and Ulster Bank RoI. UK PBB serves individuals and mass affluent customers in the UK, together with small businesses (generally up to £2 million turnover). UK PBB includes Ulster Bank customers in Northern Ireland. Ulster Bank RoI serves individuals and businesses in the Republic of Ireland (RoI).
Allocation of central balance sheet items RBS allocates all central costs relating to Services and Functions to the business using appropriate drivers, these are reported as indirect costs in the segmental income statements. Assets (and risk-weighted assets) held centrally, mainly relating to RBS Treasury, are allocated to the business using appropriate drivers.
UK Personal & Business Banking 7,153 68 7,221 7,348 44 7,392 7,197 52 7,249 Ulster Bank RoI 668 — 668 676 (4) 672 660 1 661
RBS International 506 148 654 309 119 428 313 156 469 NatWest Markets 1,882 916 2,798 1,408 809 2,217 1,708 1,539 3,247 Central items & other 2,155 (1,411) 744 2,147 (1,185) 962 1,862 (1,988) (126)
UK Personal & Business Banking 6,260 22 6,282 6,465 12 6,477 6,115 12 6,127 Ulster Bank RoI 613 (3) 610 609 (5) 604 584 (8) 576
Fees and commissions receivable - Credit and debit card fees 527 27 99 12 — — — 665 - Investment management, trustee and fiduciary services 72 4 35 133 4 1 — 249
PBB Bank RoI Banking Banking International Markets & other Total 2016 £m £m £m £m £m £m £m £m
UK Personal & Business Banking 194,247 187,678 190,636 183,410 181,357 173,040 Ulster Bank RoI 25,193 21,189 24,564 19,853 24,111 19,299
Operating profit/(loss) before tax 3,230 (580) (485) 74 2,239 Total assets 662,314 38,485 34,280 2,977 738,056 Total liabilities 626,103 36,564 25,171 1,125 688,963 Net assets attributable to equity owners and non-controlling interests 36,211 1,921 9,109 1,852 49,093 Contingent liabilities and commitments 128,127 78 7,823 22 136,050
Investment strategy The assets of the Main section, which is typical of other group schemes, represent 90% of plan assets at 31 December 2018 (2017 - 90%) and are invested in a diversified portfolio as shown below.
The Main section employs derivative instruments to achieve a desired asset class exposure and to reduce the section’s interest rate, inflation and currency risk. This means that the net funding position is considerably less sensitive to changes in market conditions than the value of the assets or liabilities in isolation.
Inflation rate swaps 13 347 502 11 310 555 Interest rate swaps 55 8,132 5,362 44 8,161 4,779 Currency forwards 10 22 164 12 160 34 Equity and bond call options 1 277 — 2 428 — Equity and bond put options 4 3 1 3 3 1 Other 4 1,027 1,092 4 327 444
The schemes do not invest directly in the Group but can have exposure to the Group. The trustees of the respective UK schemes are responsible for ensuring that indirect investments in the Group do not exceed the 5% regulatory limit.
Currency translation and other adjustments — — — — 20 17 (1) (4) Income statement
Current service cost — 190 — 190 — 240 — 240 Past service cost — 14 — 14 — 14 — 14 Loss on curtailments or settlements — — — — — 74 — 74
Return on plan assets excluding recognised interest income (1,891) — — 1,891 (2,090) — — 2,090 Experience gains and losses — 122 — 122 — 81 — 81 Effect of changes in actuarial financial assumptions — (2,338) — (2,338) — (2,537) — (2,537) Effect of changes in actuarial demographic assumptions — 820 — 820 — 826 — 826 Asset ceiling adjustments: Attributable to contributions required by ring fencing — — 2,000 2,000 — — 2,053 2,053 Other movements in the year — — (468) (468) — — (546) (546)
Contributions by plan participants and other scheme members 7 7 — — 12 12 — — Liabilities extinguished upon settlement — — — — (259) (259) — — Transfer of pension assets and liabilities from Main section (2) (276) (198) (78) — — — — — Benefits paid (2,027) (2,027) — — (2,282) (2,282) — —
Notes: (1) 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 section, where the surplus is not recognised.
Assumptions Placing a value on the Group’s defined benefit pension schemes’ liabilities requires the Group’s management to make a number of assumptions, with the support of independent actuaries. The ultimate cost of the defined benefit obligations depends upon actual future events and the assumptions made are unlikely to be exactly borne out in practice, meaning the final cost may be higher or lower than expected.
Discount rate The IAS 19 valuation uses a single discount rate by reference to the yield on a basket of ‘high quality’ sterling corporate bonds. For the triennial valuation discounting is by reference to a yield curve.
Significant judgement is required when setting the criteria for bonds to be included in IAS 19’s basket of bonds that is used to determine the discount rate used in the valuations. The criteria include issue size, quality of pricing and the exclusion of outliers. Judgement is also required in determining the shape of the yield curve at long durations: a constant credit spread relative to gilts is assumed. Sensitivity to the main assumptions is presented below.
The table below shows how the present value of the defined benefit obligation of the Main section would change if the key assumptions used were changed independently. In practice the variables are somewhat correlated and do not move completely in isolation.
Increase in equity values of 10% (1) 419 — 419 0.25% increase in interest rates/discount rate (2,218) (1,964) (254)
The experience history of Group schemes is shown below: Main section All schemes
History of defined benefit schemes 2018 2017 2016 2015 2014 2018 2017 2016 2015 2014 £m £m £m £m £m £m £m £m £m £m
Experience (losses)/gains on plan liabilities (122) (107) 658 233 3 (81) (93) 794 258 18 Experience (losses)/gains on plan assets (1,891) 1,580 8,562 (415) 4,629 (2,090) 1,728 9,254 (458) 5,171 Actual return on plan assets (768) 2,735 9,872 703 5,766 (848) 3,013 10,708 749 6,485 Actual return on plan assets - % (1.7%) 6.2% 32.2% 2.3% 23.8% (1.7%) 6.1% 30.9% 2.2% 22.8%
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.
Deferred tax: (Charge)/credit for the year (280) 108 246 Increase/(reduction) in the carrying value of deferred tax assets 7 (30) (317) Under provision in respect of prior years (35) (111) (155)
The actual tax charge differs from the expected tax (charge)/credit computed by applying the standard rate of UK corporation tax of 19% (2017 – 19.25%; 2016 – 20.00%) as follows: Expected tax (charge)/credit (638) (431) 816 Losses and temporary differences in year where no deferred tax asset recognised (55) (303) (742) Foreign profits taxed at other rates (8) 104 340 UK tax rate change impact (1) — (7) 6 Items not allowed for tax: - losses on disposals and write-downs (44) (69) (45)
Notes: (1) In recent years, the UK government has steadily reduced the rate of UK corporation tax, with the latest enacted rates standing at 19% from 1 April 2017 and 17% from 1 April 2020. (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.
Judgment: Tax contingencies The Group’s income tax charge and its provisions for income taxes necessarily involve a degree of estimation and judgement. The tax treatment of some transactions is uncertain and tax computations are yet to be agreed with the tax authorities in a number of jurisdictions. The Group recognises anticipated tax liabilities based on all available evidence and, where appropriate, in the light of external advice. Any difference between the final outcome and the amounts provided will affect current and deferred income tax charges in the period when the matter is resolved.
Net deferred tax asset comprised: Tax Accelerated losses capital Expense Financial carried Pension allowances provisions instruments forward Other Total £m £m £m £m £m £m £m
Acquisitions and disposals of subsidiaries — (29) — — — — (29) Charge/(credit) to income statement 3 (126) 55 46 121 (66) 33 Charge/(credit) to other comprehensive income 266 — — (243) — (19) 4 Currency translation and other adjustments — (14) 1 — (10) (1) (24)
Implementation of IFRS9 on 1 January 2018 — — — 16 — — 16 (Credit)/charge to income statement (40) 22 121 154 5 46 308 (Credit)/charge to other comprehensive income (95) 1 — (23) — 33 (84) Currency translation and other adjustments — 5 (14) 4 (2) (34) (41)
Judgment - The Group has considered the carrying value of deferred tax assets and concluded that, based on management’s estimates, sufficient taxable profits will be generated in future years to recover recognised deferred tax assets.
Estimate -These estimates are partly based on forecast performance beyond the horizon for management’s detailed plans. They have regard to inherent uncertainties, such as Brexit and climate change.
UK tax losses - Under UK tax rules, tax losses can be carried forward indefinitely. As the recognised tax losses in the Group arose prior to 1 April 2015, credit in future periods is given against 25% of profits at the main rate of UK corporation tax, excluding the Banking Surcharge 8% rate introduced by The Finance (No. 2) Act 2015. Deferred tax assets and liabilities at 31 December 2018 take into account the reduced rates in respect of tax losses and temporary differences and where appropriate, the banking surcharge inclusive rate in respect of other banking temporary differences.
NatWest Markets Plc – NatWest Markets Plc expects that the balance of recognised deferred tax asset at 31 December 2018 of £151 million in respect of tax losses amounting to approximately £800 million will be recovered by the end of 2024. Since 2012 NatWest Markets Plc 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, £10.2 billion of losses have not been recognised in the deferred tax balance at 31 December 2018; such losses will be available to offset 25% of future taxable profits in excess of those forecast in the closing deferred tax asset.
National Westminster Bank Plc – A deferred tax asset of £505 million has been recognised in respect of total losses of £2,936 million. The losses arose principally as a result of significant impairment and conduct charges between 2009 and 2012 during challenging economic conditions in the UK banking sector. National Westminster Bank plc returned to tax profitability during 2015 and expects the deferred tax asset to be consumed by future taxable profits by the end of 2023.
Ulster Bank Ireland DAC – A deferred tax asset of £261 million has been recognised in respect of losses of £2,089 million of total losses of £8,855 million carried forward at 31 December 2018. The losses arose principally as a result of significant impairment charges between 2008 and 2013 during challenging economic conditions in the Republic of Ireland. Subsequent movements reflect the £:€ exchange differences. As UBIDAC continues to operate in a small open economy subject to short term volatility and extended non-performing loan realisation periods the company expects, in assessing its deferred tax asset on tax losses, that they will be consumed by future taxable profits by the end of 2027.
Unrecognised deferred tax Deferred tax assets of £5,118 million (2017 - £6,356 million; 2016 - £7,940, million) have not been recognised in respect of tax losses and other temporary differences carried forward of £25,597 million (2017 - £30,049 million; 2016 - £33,376 million) in jurisdictions where doubt exists over the availability of future taxable profits. Of these losses and other temporary differences, £939 million expire within five years and £5,992 million thereafter. The balance of tax losses and other temporary differences carried forward has no expiry date.
Diluted weighted average number of ordinary shares outstanding during the year 12,061 11,936 11,743 9 Trading assets and liabilities
Reverse repos 24,759 36,272 Collateral given 19,036 21,558 Other loans 1,308 651 Total loans 45,103 58,481 Securities Central and local government - UK 6,834 3,514 - US 4,689 3,667 - other 13,498 14,736 Other securities 4,995 5,593 Total securities 30,016 27,510 Total 75,119 85,991
10 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.
2018 2017 Notional Notional amount Assets Liabilities amount Assets Liabilities £bn £m £m £bn £m £m
The majority of RBS’s fair value hedges involve interest rate swaps hedging the fixed 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 due to the movement of benchmark interest rates or foreign exchange rates on forecast transactions and on recognised financial assets and financial liabilities. This variability in cash flows is hedged by interest rate swaps and forward foreign exchange contracts. RBS hedges its net investments in foreign operations with currency borrowings and forward foreign exchange contracts.
The Group hedges currency risk in respect of its net investment in foreign currency denominated operations with currency borrowings and forward foreign exchange contracts. The Group reviews the value of the investments net assets, executing hedges where appropriate, to reduce the sensitivity of capital ratios to foreign exchange movements.
Included in the table above are derivatives held for hedging purposes as follows: 2018 2017 Notional Assets Liabilities Assets Liabilities £bn £m £m £m £m
Fair value hedging Interest rate contracts 60.0 965 2,061 904 2,211
The following table shows the period in which the hedging contract ends: 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 20+ years Total
Fair value hedging Hedging assets - Interest rate risk (£bn) 1.0 1.8 11.0 4.9 7.8 3.7 3.8 34.0 Hedging liabilities - Interest rate risk (£bn) — 2.0 7.5 10.0 4.6 1.9 — 26.0
The table below analyses assets and liabilities subject to hedging derivatives. Impact on hedged Carrying value Impact on items ceased to be (CV) of hedged hedged items adjusted for hedging assets and liabilities included in CV gains or losses 2018 £m £m £m
Cash flow hedging - exchange rate Other financial liabilities - debt securities in issue 5,590 Subordinates liabilities 6,902
Hedge ineffectiveness recognised in other operating income comprised: 2018 2017 2016 £m £m £m
Gains/(losses) on the hedged items attributable to the hedged risk 54 (48) 1,146 (Losses)/gains on the hedging instruments (7) 78 (1,117)
Fair value hedging ineffectiveness 47 30 29 Cash flow hedging ineffectiveness (112) 9 (29)
 Upfront present values on the hedging derivatives where hedge accounting relationships have been designated after the trade date (cash flow hedge and fair value hedge).
11 Financial instruments – classification The following tables analyse financial assets and liabilities in accordance with the categories of financial instruments on an IFRS 9 basis at 31 December 2018 and on an IAS39 basis at 31 December 2017. Assets and liabilities outside the scope of IFRS 9/IAS 39 are shown within other assets and other liabilities.
Loans to customers - amortised cost 305,089 305,089 Other financial assets 1,638 — 46,077 11,770 59,485 Intangible assets — — — — 6,616 6,616
Notes: (1) Mandatory fair value through profit or loss. (2) Designated as at fair value through profit or loss. (3) Includes items in the course of collection from other banks of £484 million (2017 - £1,017 million).
Liabilities trading DFV (1) derivatives Amortised cost liabilities £m £m £m £m £m £m
Bank deposits (2) — — 23,297 23,297 Customer deposits (3) — — 360,914 360,914 Settlement balances — — 3,066 3,066 Trading liabilities 72,350 — 72,350 Derivatives 125,954 — 2,943 128,897 Other financial liabilities — 2,840 36,892 39,732 Subordinated liabilities — 867 9,668 10,535 Other liabilities — — 2,218 6,736 8,954 31 December 2018 198,304 3,707 2,943 436,055 6,736 647,745 Bank deposits (2) — — 30,396 30,396 Customer deposits (3) — — 361,316 361,316 Settlement balances — — 2,844 2,844 Trading liabilities 81,982 — 81,982 Derivatives 150,935 — 3,571 154,506 Other financial liabilities — 4,277 26,049 30,326 Subordinated liabilities — 939 11,783 12,722 Other liabilities — — 2,181 12,690 14,871
Notes: (1) Designated as at fair value through profit or loss. (2) Includes items in the course of transmission to other banks of £125 million (2017 - £214 million). (3) The carrying amount of other customer accounts designated as at fair value through profit or loss is £26 million (2017 - £114 million) higher than the principal amount.
The Group's financial assets and liabilities include: 2018 2017 £m £m
Loans to banks - amortised cost 3,539 2,152 Loans to customers - amortised cost 9 2,308 Trading assets 24,759 36,272
Repos Bank deposits 941 3,839 Customer deposits 3,774 6,669 Trading liabilities 25,645 28,363
Trading reverse repos 65,508 (32,639) 32,869 (329) — (32,498) 42 3,403 36,272 Trading repos 58,695 (32,639) 26,056 (329) — (25,727) — 2,307 28,363
Note: (1) The net IFRS offset balance of £1,735 million (2017 - £469 million) relates to variation margin netting reflected on other balance sheet lines.
12 Financial instruments - valuation continued Fair value hierarchy Financial Instruments carried at fair value have been classified under the IFRS fair value hierarchy as follows.
Level 1 – Instruments valued using unadjusted quoted prices in active and liquid markets, for identical financial instruments. Examples include government bonds, listed equity shares and certain exchangetraded derivatives.
Equity and equity index prices - quoted prices are generally readily available for equity shares listed on the world's major stock exchanges and for major indices on such shares.
Commodity prices - many commodities are actively traded in spot and forward contracts and futures on exchanges in London, New York and other commercial centres. Price volatilities and correlations - volatility is a measure of the tendency of a price to change with time.
Prepayment rates - the fair value of a financial instrument that can be prepaid by the issuer or borrower differs from that of an instrument that cannot be prepaid. In valuing prepayable instruments that are not quoted in active markets, RBS considers the value of the prepayment option.
Valuation control RBS's control environment for the determination of the fair value of financial instruments includes formalised protocols for the review and validation of fair values independent of the businesses entering into the transactions.
12 Financial instruments - valuation continued RBS contributes to consensus pricing services where there is a significant interest either from a positional point of view or to test models for future business use. Data sourced from consensus pricing services are used for a combination of control processes including direct price testing, evidence of observability and model testing. In practice this means that RBS submits prices for all material positions for which a service is available. Data from consensus services are subject to the same level of quality review as other inputs used for IPV process.
Funding – FVA 250 440 Credit – CVA 419 346 Bid – Offer 238 285 Product and deal specific 327 1,033 1,234 2,104
The reduction in valuation reserves was primarily driven by a combination of trade close-out activity and a reallocation of product and deal specific reserves that are now included within the discount rate applied to the derivative cash flows. There was a net increase in CVA due to the extension of the CVA reserve to include margin period of risk on collateralised counterparties and a reclassification of product and deal specific reserves to CVA.
Credit valuation adjustments (CVA) CVA represents an estimate of the adjustment to fair value that a market participant would make to incorporate the counterparty credit risk inherent in derivative exposures. CVA is actively managed by a credit and market risk hedging process, and therefore movements in CVA are partially offset by trading revenue on the hedges.
Collateral held under a credit support agreement is factored into the CVA calculation. In such cases where RBS holds collateral against counterparty exposures, CVA is held to the extent that residual risk remains.
Trading assets and Other financial assets Loans Price-based Price % 0 132 0 101
Debt securities in issue Price-based Price CCY 21 JPY 136 EUR 56 JPY 149 EUR Valuation Fund NAV GBP 0 622 0 977
Interest rate & FX Option pricing Correlation % (45) 99 (75) 100 derivatives Volatility % 1 76 0 292
(4) Recovery rate: reflects market expectations about the return of principal for a debt instrument or other obligations after a credit event or on liquidation. Recovery rates tend to move conversely to credit spreads.
Upfront points will compensate for the difference between the standard premium and the actual premium at the start of the contract. (10) RBS does not have any material liabilities measured at fair value that are issued with an inseparable third party credit enhancement.
12 Financial instruments – valuation: 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. IFRS requires extra disclosures in respect of level 3 instruments.
The decision to classify a modelled instrument as Level 2 or 3 will be dependent upon the product/model combination, the currency, the maturity, the observability and quality of input parameters and other factors. All these must be assessed to classify the asset. If an input fails the observability or quality tests then the instrument is considered to be in Level 3 unless the input can be shown to have an insignificant effect on the overall valuation of the product.
Debt securities in issue 112 10 (10) 50 — — Short positions — — — 16 — — Derivatives Interest rate 808 70 (70) 1,104 120 (120)
12 Financial instruments – valuation: level 3 sensitivities The Level 3 sensitivities presented above are calculated at a trade or low level portfolio basis. They are not calculated on an overall portfolio basis and therefore do not reflect the likely potential uncertainty on the portfolio as a whole. The figures are aggregated and do not reflect the correlated nature of some of the sensitivities. In particular, for some of the portfolios the sensitivities may be negatively correlated where a downwards movement in one asset would produce an upwards movement in another, but due to the additive presentation of the above figures this correlation cannot be displayed. The actual potential downside sensitivity of the total portfolio may be less than the noncorrelated sum of the additive figures as shown in the above table.
At 1 January (1) 2,692 530 3,222 2,187 3,933 604 4,537 2,997 Amounts recorded in the income statement (2) (147) 178 31 (344) (593) 21 (572) (341) Amounts recorded in the statement of comprehensive income — 23 23 — — 2 2 — Level 3 transfers in 1,307 19 1,326 419 679 315 994 530 Level 3 transfers out (624) (1) (625) (231) (1,015) (3) (1,018) (672)
Amounts recorded in the income statement in respect of balances held at year end - unrealised (134) 158 24 (330) (59) (21) (80) 595 - realised (2) 6 4 — 271 5 276 (100)
Notes: (1) Refer to Note 33 for further information on the impact of IFRS9 on classification and basis of preparation, year ended 31 December 2018 prepared under IFRS9 and prior years under IAS39. (2) There were £185 million net losses on trading assets and liabilities (2017 - £240 million HFT) recorded in income from trading activities. Net losses on other instruments of £190 million (2017 - £9 million gains) were recorded in other operating income and interest income as appropriate. (3) Trading assets comprise assets held at fair value in trading portfolios. (4) Other financial assets comprise fair value through other comprehensive income (2017 - available-for-sale), designated at fair value through profit or loss and other fair value through profit or loss.
The following table shows the carrying value and fair value of financial instruments carried at amortised cost on the balance sheet. Items where fair value approximates Carrying Fair value hierarchy level carrying value value Fair value Level 1 Level 2 Level 3 2018 £bn £bn £bn £bn £bn £bn
Cash and balances at central banks 98.3 Settlement balances 2.5 Loans to banks 1.0 10.5 10.5 — 9.1 1.4 Loans to customers 310.1 306.8 — 1.3 305.5 Other financial assets
Financial liabilities Bank deposits 4.5 25.9 26.0 — 22.4 3.6 Customer deposits 321.5 39.8 39.9 — 12.9 27.0 Settlement balances 2.8 Other financial liabilities Debt securities in issue 26.0 27.3 — 22.2 5.1 Subordinated liabilities 11.8 12.6 — 12.5 0.1 Other liabilities - notes in circulation 2.2
For certain portfolios where there are very few or no recent transactions, a bespoke approach is used.
Cash and balances at central banks 88,897 — 88,897 98,337 — 98,337 Trading assets 49,094 26,025 75,119 66,315 19,676 85,991 Derivatives 28,503 104,846 133,349 32,372 128,471 160,843 Settlement balances 2,928 — 2,928 2,517 — 2,517 Loans to banks - amortised cost 12,833 114 12,947 11,424 93 11,517 Loans to customers - amortised cost 67,354 237,735 305,089 69,832 240,284 310,116 Other financial assets 11,681 47,804 59,485 8,776 43,153 51,929
Liabilities Bank deposits 7,438 15,859 23,297 10,813 19,583 30,396 Customer deposits 359,148 1,766 360,914 358,857 2,459 361,316 Settlement balances 3,066 — 3,066 2,844 — 2,844 Trading liabilities 50,668 21,682 72,350 53,787 28,195 81,982 Derivatives 29,028 99,869 128,897 32,212 122,294 154,506 Other financial liabilities 8,240 31,492 39,732 8,467 21,859 30,326 Subordinated liabilities 299 10,236 10,535 2,383 10,339 12,722
0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2018 £m £m £m £m £m £m
Cash and balances at central banks 88,897 — — — — — Settlement balances 2,928 — — — — — Loans to banks - amortised cost 11,920 925 106 — — — Other financial assets (1) 4,451 7,397 14,138 11,279 11,826 2,744
Total maturing assets 108,196 8,322 14,244 11,279 11,826 2,744 Loans to customers - amortised cost 43,096 32,087 66,441 51,839 66,978 79,543 Derivatives held for hedging 224 529 995 345 152 130
Guarantees and commitments notional amount Guarantees (3) 3,952 — — — — — Commitments (4) 116,843 — — — — —
Cash and balances at central banks 98,337 — — — — — Settlement balances 2,517 — — — — — Loans to banks - amortised cost 10,792 633 94 — — — Other financial assets (1) 3,675 5,889 11,960 11,312 12,813 3,638
Total maturing assets 115,321 6,522 12,054 11,312 12,813 3,638 Loans to customers - amortised cost 45,898 32,031 65,077 52,016 68,500 81,995 Derivatives held for hedging 281 832 1,336 334 166 111
Total maturing liabilities 18,657 9,162 15,769 21,374 17,569 2,702 Customer deposits 356,340 3,843 1,052 77 20 28 Derivatives held for hedging 212 289 1,188 526 813 738
Notes: (1) Other financial assets excludes equity shares. (2) Other liabilities include notes in circulation. (3) 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. (4) 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.
ECL provision coverage (3) - Stage 1 % 0.10 0.1 - Stage 2 % 2.92 2.3 - Stage 3 % 30.06 31.6
Impairment losses ECL charge (4) 398 530 ECL loss rate - annualised (basis points) 12.45 16.48
IFRS 9 ECL model design principles To meet IFRS 9 requirements for ECL estimation, PD, LGD and EAD used in the calculations must be:  Unbiased - material regulatory conservatism has been removed to produce unbiased model estimates;  Point-in-time - recognise current economic conditions;  Forward-looking - incorporated into PD estimates and, where appropriate, EAD and LGD estimates; and
IFRS 9 requires that at each reporting date, an entity shall assess whether the credit risk on an account has increased significantly since initial recognition. Part of this assessment requires a comparison to be made between the current lifetime PD (i.e. the current probability of default over the remaining lifetime) with the equivalent lifetime PD as determined at the date of initial recognition.
The general approach for the IFRS 9 LGD models has been to leverage the Basel LGD models with bespoke IFRS 9 adjustments to ensure unbiased estimates, i.e. use of effective interest rate as the discount rate and the removal of: downturn calibration, indirect costs, other conservatism and regulatory floors.
For Wholesale, while conversion ratios in the historical data show temporal variations, these cannot (unlike in the case of PD and some LGD models) be sufficiently explained by the CCI measure and are presumed to be driven to a larger extent by exposure management practices. Therefore point-in-time best estimates measures for EAD are derived by estimating the regulatory model specification on a rolling five year window.
15 Other financial assets Debt securities Central and local government Other Equity Other
16 Intangible assets 2018 2017 Goodwill Other (1) Total Goodwill Other (1) Total
Accumulated amortisation and impairment At 1 January 12,481 1,274 13,755 12,198 1,173 13,371 Currency translation and other adjustments 77 5 82 283 (5) 278 Disposals and write-off of fully amortised assets — (573) (573) — (145) (145) Charge for the year — 271 271 — 222 222 Write down of goodwill and other intangible assets — 37 37 — 29 29
Net book value at 31 December 5,606 1,010 6,616 5,558 985 6,543
Impairment testing involves the comparison of the carrying value of each cash-generating unit (CGU) with its recoverable amount. The carrying values of the segments reflect the equity allocations made by management which are consistent with the Group’s capital targets. In 2018, the methodology was enhanced to reflect legal entity changes in the group. Consequently certain corporate assets, represented primarily by bonds and liquidity assets in Treasury are no longer considered to be directly attributable or directly available to the CGUs. These assets are, therefore, not included in the carrying value of the CGUs, resulting in an increase in the available headroom for some CGUs. Recoverable amount is the higher of fair value and value in use. Value in use is the present value of expected future cash flows from the CGU. Fair value is the price that would be received to sell an asset in an orderly transaction between market participants. The recoverable amounts for all CGUs at 31 December 2018 were based on value in use, using management's latest five-year revenue and cost forecasts. The long-term growth rates have been based on expected nominal growth of the CGUs. The pre-tax risk discount rates are based on those observed to be applied to businesses regarded as peers of the CGUs.
Critical accounting policy: Goodwill Critical estimates Impairment testing involves a number of judgemental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of discount rates appropriate to each business; estimation of the fair value of the CGUs; and the valuation of separable assets of each business whose goodwill is reviewed.
The sensitivity to the more significant variables in each assessment is presented below.
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 2018 £bn % % £bn £bn £bn £bn £bn %
UK Personal & Business Banking 3.4 2.0 13.1 9.7 (1.8) (1.2) (4.0) (1.7) 21.6 Commercial & Private Banking 1.9 2.0 12.9 1.3 (1.2) (0.8) (2.4) (1.0) 13.9 RBS International 0.3 2.0 11.0 0.6 (0.4) (0.3) (0.4) (0.1) 12.8
Property, plant and equipment 4,351 4,602 Deferred tax (Note 7) 1,412 1,740 Assets of disposal groups (1) 1,404 195 Prepayments 435 392 Accrued income 317 378 Interests in associates (2) 404 1,410 Pension schemes in net surplus (Note 5) 520 392 Tax recoverable 37 27 Other assets 925 1,127 9,805 10,263 Notes: (1) Includes interest in Alawwal Bank £1,179 million (2017 - nil). (2) Includes interest in Business Growth Fund £387 million (2017 - £316 million).
£200 million 7.387% Series 1 non-cumulative convertible £0.01 preference shares (partial redemption) Ineligible — 15
US$1,000 million 9.118% Series 1 non-cumulative convertible preference shares of US$0.01 (partial redemption) Ineligible — 48 $156 million 7.65% Series F non-cumulative preference shares (callable) Ineligible — 120 $242 million 7.25% Series H non-cumulative preference shares (callable) Ineligible — 186 $751 million 5.75% Series L non cumulative preference shares (callable) Ineligible — 577
NatWest Markets Plc £103 million 9.5% undated subordinated bonds 2018 (callable August 2018) Ineligible 103 —
US$300 million 8.6250% non-cumulative preference shares (callable) Tier 1 — 178
NWM N.V. and subsidiaries US$500 million 4.65% dated notes 2018 Tier 2 141 —
US$16 million floating rate notes 2019 (partial redemption) Tier 2 2 —
US$500 million 4.65% notes 2018 (partial redemption) Tier 2 — 244
Payment protection insurance 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 £200 million in 2018 (2017 - £175 million, 2016 - £601 million, 2015 - £600 million) bringing the cumulative charge to £5.3 billion, of which £4.2 billion (79%) in redress and £0.4 billion in administrative expenses had been paid by 31 December 2018. Of the £5.3 billion cumulative charge, £4.8 billion relates to redress and £0.5 billion to administrative expenses.
Plevin (commission), excluding those for which no PPI policy exists. (3) Average redress for PPI (mis-sale) and Plevin (commission) pay-outs. (4) Processing costs per claim on a valid complaints basis, includes direct staff costs and associated overhead - excluding FOS fees.
Background information for all material provisions is given in Note 27
Critical accounting policy: Provisions for liabilities Judgment 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.
Estimates - 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. Any difference between the final outcome and the amounts provided will affect the reported results in the period when the matter is resolved.
Ordinary shares of £1 12,049 11,965 12,048,605 11,964,565 Non-cumulative preference shares of US$0.01 (1) — — 10 26,459 Non-cumulative preference shares of €0.01 (2) — — — 2,044 Non-cumulative preference shares of £1 (3) — — — 54 Cumulative preference shares of £1 1 1 900 900
Notes: (1) 26 million shares with a total nominal value of £0.2 million were redeemed in December 2018. (2017 – 46 million shares with a total nominal value of £0.3 million were redeemed). (2) 2 million shares, with a nominal value of €20 thousand, were redeemed in December 2018. (3) 54,442 shares, with a nominal value of £54 thousand, were redeemed in December 2018.
During 2018, the company allotted and issued the following new ordinary shares of £1 each. The shares were allotted to UBS AG at the subscription prices determined by reference to the average market prices during the sale periods set out below: Month Number of shares Subscription price per share Sale period
Other securities Additional Tier 1 Notes issued by RBS having the legal form of debt are classified as equity under IFRS. Capital recognised for regulatory purposes cannot be redeemed without Prudential Regulation Authority consent. This includes ordinary shares, preference shares and additional Tier 1 Notes.
The company may redeem some or all of the non-cumulative preference shares from time to time at the rates detailed in the table below plus dividends otherwise payable for the then current dividend period to the date of redemption.
Non-cumulative preference shares classified as equity Number of shares Redemption Redemption in issue Interest rate date on or after price per share
Shares of US$0.01 - Series U 10,130 floating 29 September 2017 US$100,000
Note: (1) Those preference shares where distributions are discretionary are classified as equity.
US$2.0 billion 7.5% notes callable August 2020 (2) 1,278 1,278 1,278
EMTN notes US$564 million 6.99% capital securities (redeemed October 2017) - - 275
(2) Issued in August 2015. In the event of conversion, converted into ordinary shares at a price of $3.606 nominal per £1 share.
Own shares held - at 31 December 2018, 8 million ordinary shares of £1 each of the company (2017 - 16 million) were held by employee share trusts in respect of share awards and options granted to employees. During the year, the employee share trusts purchased 25 million ordinary shares and delivered 33 million ordinary shares in satisfaction of the exercise of options and the vesting of share awards under the employee share plans.
Within 1 year 3,164 (212) (125) (70) 2,757 129 After 1 year but within 5 years 4,686 (444) (94) — 4,148 257 After 5 years 2,062 (742) (27) — 1,293 21
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.
2018 2017 Year in which residual value will be recovered Year in which residual value will be recovered
Total Within 1 but within but within After 5 Within 1 but within but within After 5 year 2 years 5 years years year 2 years 5 years years £m £m £m £m £m £m £m £m £m £m
24 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.
The table below analyses the asset categories for those own-asset securitisations where the transferred assets continue to be recorded on RBS balance sheet.
Other credit risk transfer securitisations RBS also transfers credit risk on originated loans and mortgages without the transfer of assets to an SE. As part of this, RBS enters into credit derivative and financial guarantee contracts with consolidated SEs. At 31 December 2018, debt securities in issue by such SEs (and held by third parties) were £596 million (2017 - £398 million). The associated loans and mortgages at 31 December 2018 were £8,402 million (2017 - £6,092 million).
Covered debt programme Group companies have assigned loans to customers and debt investments to bankruptcy remote limited liability partnerships to provide security for issues of debt securities. RBS retains all of the risks and rewards of these assets and continues to recognise them. The partnerships are consolidated by RBS and the related covered bonds included within other financial liabilities. At 31 December 2018, £9,446 million (2017 - £8,915) of loans to customers and £478 million (2017 - £76 million) of debt investments provided security for debt securities in issue and other borrowing of £6,627 million (2017 - £6,307 million).
Trading assets and derivatives Trading assets 590 164 754 884 131 1,015 Derivative assets 495 325 820 660 117 777 Derivative liabilities (223) (332) (555) (561) (131) (692)
Trading assets 35,571 36,631 Loans to banks - amortised cost 1,050 738 Loans to customers - amortised cost 25,930 31,312 Other financial assets 713 3,397
The capital resources based on the PRA transitional basis for Bank are set out below.
Shareholders’ equity 45,736 48,330 Preference shares - equity (496) (2,565) Other equity instruments (4,058) (4,058)
Qualifying instruments and related share premium 6,386 6,501 Qualifying instruments issued by subsidiaries and held by third parties 1,565 1,876
It is RBS policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, RBS has regard to the supervisory requirements of the PRA. The PRA uses capital ratios as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the Pillar 1 capital ratios should be not less than 8% with a Common Equity Tier 1 component of not less than 4.5%. RBS has complied with the PRA’s capital requirements throughout the year.
27 Memorandum items Contingent liabilities and commitments The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December 2018. Although RBS is exposed to credit risk in the event of a customer’s failure to meet its obligations, the amounts shown do not, and are not intended to, provide any indication of RBS's expectation of future losses.
27 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 £257 million (2017 - £244 million; 2016 - £251 million) from these activities.
There are situations where RBS may pursue an approach that in some instances leads to a settlement agreement. This may occur in order to avoid the expense, management distraction or reputational implications of continuing to contest liability, or in order to take account of the risks inherent in defending claims or investigations, even for those Matters for which RBS believes it has credible defences and should prevail on the merits. The uncertainties inherent in all such
Matters affect the amount and timing of any potential outflows for both Matters with respect to which provisions have been established and other contingent liabilities.
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.
For a discussion of certain risks associated with the Group’s litigation, investigations and reviews, see the Risk Factor relating to legal, regulatory and governmental actions and investigations set out on page 261.
London Interbank Offered Rate (LIBOR) and other rates litigation NatWest Markets Plc and certain other members of the Group, including RBSG, are defendants in a number of class actions and individual claims pending in the US (primarily in the United States District Court for the Southern District of New York (SDNY)) with respect to the setting of LIBOR and certain other benchmark interest rates. The complaints allege that certain members of the Group and other panel banks 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 LIBORbased derivatives in various markets through various means.
Several class actions relating to USD LIBOR, as well as more than two dozen non-class actions concerning USD LIBOR, are part of a coordinated proceeding in the SDNY. In December 2016, the SDNY held that it lacks personal jurisdiction over NatWest Markets Plc with respect to certain claims. As a result of that decision, all Group companies have been dismissed from each of the USD LIBOR-related class actions (including class actions on behalf of over-the-counter plaintiffs, exchanged-based purchaser plaintiffs, bondholder plaintiffs, and lender plaintiffs), but six non-class cases in the coordinated proceeding remain pending against Group defendants. The dismissal of Group companies for lack of personal jurisdiction is the subject of a pending appeal to the United States Court of Appeals for the Second Circuit.
Notes on the consolidated accounts 27 Memorandum items continued Litigation, investigations and reviews English and European competition law as well as asserting common law claims of fraud under US law.
Four other class action complaints were filed against RBS companies in the SDNY, each relating to a different reference rate. In the case relating to Pound Sterling LIBOR, the court dismissed all claims against RBS companies, for various reasons, on 21 December 2018, and plaintiffs are seeking reconsideration of that decision. In the case relating to the Australian Bank Bill Swap Reference Rate, the court dismissed all claims against RBS companies for lack of personal jurisdiction on 26 November 2018, but plaintiffs have filed an amended complaint, which will be the subject of a further motion to dismiss. In the case relating to Euribor, the court dismissed all claims against RBS companies for lack of personal jurisdiction on 21 February 2017. In the case relating to Swiss Franc LIBOR, the court dismissed all claims against all defendants on various grounds on 25 September 2017, but held that it has personal jurisdiction over NatWest Markets Plc and allowed the plaintiffs to replead their complaint. Defendants’ renewed motion to dismiss the amended complaint relating to Swiss Franc LIBOR remains pending.
NatWest Markets Plc has also been named as a defendant in a motion to certify a class action relating to LIBOR in the Tel Aviv District Court in Israel.
On 4 February 2019, a claim was issued against NatWest Markets Plc by London Borough of Newham, in respect of certain lender option borrower option (LOBO) loans.
Details of UK litigation claims in relation to the alleged mis-sale of interest rate hedging products (IRHPs) involving LIBOR-related allegations are set out under ‘Interest rate hedging products litigation’ on page 232.
In 2015, RBS companies paid US$255 million to settle the consolidated antitrust class action on behalf of persons who entered into over-the-counter FX transactions with defendants or who traded FX instruments on exchanges. That settlement received final court approval in August 2018. On 7 November 2018, some members of the settlement class who opted out of the settlement filed their own nonclass complaint in the SDNY asserting antitrust claims against RBS companies and others. On 31 December 2018, some of the same claimants, as well as others, filed proceedings in the High Court in London, asserting competition claims against NatWest Markets Plc and several other banks.