Certain subsidiary undertakings are required to maintain balances with the Bank of England which, at 31 December 2005, amounted to £303 million (2004 – £260 million). Certain subsidiary undertakings are required by law to maintain reserve balances with the Federal Reserve Bank in the US. Such reserve balances amounted to US$156 million at 31 December 2005 (2004 – US$132 million).
External segment Total External segment Total expenses amortisation Provisions before tax 2005 £m £m £m £m £m £m £m £m £m £m
Operating profit before amortisation of purchased intangibles, integration costs and net gain on sale of
External segment Total External segment Total expenses amortisation Provisions before tax 2004 £m £m £m £m £m £m £m £m £m £m
Cost to Cost to acquire fixed acquire fixed assets and assets and intangible intangible
The geographical analyses in the tables below have been compiled on the basis of location of office where the transactions are recorded
Rest of UK USA Europe the world Total 2005 £m £m £m £m £m
Cost to acquire property, plant and equipment and intangible assets 3,353 337 1,581 17 5,288
Net assets attributable to equity shareholders and minority interests 20,326 14,299 2,716 56 37,397
Non-executive directors – emoluments 924 874 Chairman and executive directors – emoluments 8,994 8,421 Chairman and executive directors – contributions and allowances in respect of defined contribution pension schemes 220 178
Chairman and executive directors – amounts receivable under long-term incentive plans 4,778 2,189 Chairman and executive directors – gains on exercise of share options 11 5
(b) For the purposes of IAS 24 ‘Related Party Disclosures’, key management comprise directors of the company and members of the Group Executive Management Committee. The captions in the Group’s primary financial statements include the following amounts attributable, in aggregate, to key management: 43 Transactions with directors, officers and others
(a) Group companies provide development and other types of capital support to businesses in their roles as providers of finance. These investments are made in the normal course of business and on arm’s-length terms. In some instances, the investment may extend to ownership or control over 20% or more of the voting rights of the investee company. However, these investments are not considered to give rise to transactions of a materiality requiring disclosure under IAS 24.
(a) Goodwill Goodwill arising on acquisitions after 1 October 1998 is capitalised and amortised over its estimated useful economic life. Goodwill arising on acquisitions before 1 October 1998 was deducted from equity. Goodwill is reviewed for impairment at the end of the first full year following an acquisition and subsequently if events or changes in circumstances indicated that its carrying value might not be recoverable,
Assets held under operating leases are depreciated on a straight-line or reverse-annuity basis.
(f) Life assurance To reflect the distinct nature of long-term assurance assets and liabilities attributable to policyholders, they are shown separately on the consolidated balance sheet; the results of life assurance business are presented as a single contribution to profit before tax.
Changes in embedded value determined on a post-tax basis are grossed up for inclusion in the income statement.
Goodwill is recorded at cost less any accumulated impairment losses. Goodwill is tested annually for impairment or more frequently if events or changes in circumstances indicate that it might be impaired.
The carrying amount of goodwill in the Group’s opening IFRS balance sheet (as at 1 January 2004) was £13,131 million, its carrying value under UK GAAP as at 31 December 2003.
Computer software development costs are capitalised if they create an identifiable intangible asset. They are amortised over their estimated useful life of three years. Net computer software development costs of £818 million were recognised on transition to IFRS.
IFRS requires a level rate of return on the net investment in the lease. Tax cash flows are not reflected in the pattern of income recognition.
Assets held on operating leases are depreciated on a straightline basis.
(h) Property, plant and equipment The Group’s freehold and long leasehold property occupied for its own use is recorded at valuation on the basis of existing use value.
(j) Share-based payments No expense is recognised for options over The Royal Bank of Scotland Group plc shares granted to employees.
(l) Income tax Deferred tax is not accounted for in relation to revaluations of fixed assets where there is no commitment to dispose of the asset or in relation to taxable gains or losses on sales of fixed assets that are rolled over into the tax cost of replacement fixed assets.
Under UK GAAP, cash flows are classified under the following headings: • operating activities • dividends from joint ventures and associates • returns on investments and servicing of finance • taxation • capital expenditure and financial investment • acquisitions and disposals • ordinary equity dividends paid • financing
The definitions of associate and joint venture are similar to those in UK GAAP. However, significant influence is defined as the power to participate in the financial and operating policies of the associate. A joint venture is an entity where the strategic financial and operating decisions require the unanimous consent of the parties sharing control. Associates are accounted for using the equity method. The Group proportionately consolidates its joint ventures.
Under IFRS cash flows are classified into operating, investing and financing activities.
(n) Financial instruments: financial assets Loans are measured at cost less provisions for bad and doubtful debts, derivatives held-for-trading are carried at fair value and hedging derivatives are accounted for in accordance with the treatment of the item being hedged (see Derivatives and hedging below).
(o) Financial instruments: financial liabilities Under UK GAAP, short positions in securities and trading derivatives are carried at fair value; all other financial liabilities are recorded at amortised cost.
(p) Liabilities and equity Under UK GAAP, all shares are classified as shareholders' funds. An analysis of shareholders’ funds between equity and non-equity interests is given.
(r) Derivatives and hedging Under UK GAAP non-trading derivatives are accounted for on an accruals basis in accordance with the accounting treatment of the underlying transaction or transactions being hedged. If a non-trading derivative transaction is terminated or ceases to be an effective hedge, it is re-measured at fair value and any gain or loss amortised over the remaining life of the underlying transaction or transactions being hedged. If a hedged item is derecognised the related non-trading derivative is remeasured at fair value and any gain or loss taken to the income statement.
(t) Offset Under UK GAAP an intention to settle net is not a requirement for set off; the entity must have the ability to insist on net settlement and that ability is assured beyond doubt.
(v) Linked presentation FRS 5 ‘Reporting the Substance of Transactions’ allows qualifying transactions to be presented using the linked presentation.
(2) Analysis of IFRS adjustments, excluding IAS 32, IAS 39 and IFRS 4
UK GAAP Dividends Income tax Leases Consolidation costs property payment benefits Insurance adjustments IFRS £m £m £m £m £m £m £m £m £m £m £m £m
Settlement balances 2,857 — — — — — — — — — — 2,857 Derivatives at fair value 14,087 — — — — — — — — (40) (40) 14,047 Prepayments, accrued income
Long-term assurance assets 3,557 — — — — — — — — (3,557) (3,557) —
Liabilities Deposits by banks 68,281 — — — — — — — — — — 68,281
Opening balance sheet at 1 January 2004 – Company Valuation of Total
UK GAAP Dividends subsidiaries adjustments IFRS £m £m £m £m £m
Assets Loans and advances to banks 4,257 — — — 4,257 Loans and advances to customers 382 — — — 382 Investments in Group undertakings 32,354 — (16,857) (16,857) 15,497 Prepayments, accrued income and other assets 355 — — — 355
Liabilities Deposits by banks 156 — — — 156 Debt securities in issue 1,877 — — — 1,877 Accruals, deferred income and other liabilities 1,377 (1,059) — (1,059) 318 Subordinated liabilities 5,393 — — — 5,393
£m £m £m £m £m £m £m £m £m £m £m £m £m £m
Subordinated liabilities 20,366 — — — — — — — — — — — — 20,366
Property, including Software Share investment development based Employee Total UK GAAP property Leases Consolidation costs payments benefits Insurance Goodwill Other adjustments IFRS
Profit for the year 2,878 (4) (4) 2,874 45 Transition to IFRS (continued)
Balance sheet at 1 January 2005 – Group IFRS prospective adjustments
IFRS Provisioning Fair IFRS 31 December Other Debt Classification/ Embedded and Hedging/ Revenue Insurance value Total 1 January 2004 Offset IAS 39 equity measurement derivatives impairment measurement Derecognition recognition contracts option Other adjustments 2005 £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Treasury bills and other eligible bills 6,110 — — — (1) — — — — — — — — (1) 6,109
Loans and advances to banks 61,073 4,425 165 — — — — 4 — — 23 — 1 4,618 65,691
Intangible assets 19,242 — — — — — — — — — — — — — 19,242
Settlement balances 5,682 — — — — — — — — — — — — — 5,682
Retirement benefit liablities 2,940 — — — — — — — — — — — — — 2,940
UK GAAP shareholders’ funds at 31 December 2004 31,865 32,277 Standards applicable to all periods: Valuation of subsidiaries — (14,970) Proposed dividend 1,308 1,308 Goodwill and other intangibles 865 — Software development costs 551 — Leasing (319) — Share-based payments (20) —
Tax effect on adjustments (77) — Deferred tax (109) — Shareholders’ funds under IFRS at 31 December 2004 33,905 18,611 Standards applicable from 1 January 2005: Non-equity shares reclassified to debt (3,192) (3,192) Revenue recognition (932) — Derecognition (170) — Securities 229 — Investments in Group undertakings adjusted to historic cost — 108
Annual Report and Accounts 2005 46 Significant differences between IFRS and US GAAP The consolidated accounts of the Group have been prepared in accordance with IFRS issued and extant at 31 December 2005 which differ in certain significant respects from US GAAP. The significant differences which affect the Group are summarised below in three separate sections: Section (1) covers significant differences between US GAAP and IFRS for the income statement for the year ended 31 December 2005 and the balance sheet at 31 December 2005. These differences include those between US GAAP and IAS 32, IAS 39 and IFRS 4. As permitted by IFRS 1, the Group implemented IAS 32, IAS 39 and IFRS 4 from 1 January 2005 without restating comparatives.
Section (2) sets out the significant differences between US GAAP and IFRS for 2004.
Investment properties are carried at fair value; changes in fair value are included in the income statement.
(d) Loan origination Only costs that are incremental and directly attributable to the origination of a loan are deferred over the period of the related loan or facility.
N ot es o n th e ac co un ts Notes on the accounts continued
(f) Long-term assurance business IFRS requires bancassurance contracts to be analysed between insurance and investment contracts. Investment contracts are accounted for as financial instruments. Insurance contracts are accounted for using an embedded value methodology: the shareholders’ interest in the long-term assurance fund is valued as the discounted value of the cash flows expected to be generated from in-force policies together with net assets in excess of the statutory liabilities.
Financial liabilities All financial liabilities held-for-trading are classified as such and carried at fair value with changes in fair value recognised in net income. A financial liability may be designated as at fair value through profit or loss.
US GAAP also requires bancassurance contracts to be classified either as insurance or investment contracts; however US GAAP does not permit embedded value reporting.
(i) Liabilities and equity The Group classifies a financial instrument that it issues as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if there is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms. An instrument is classified as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities.
Under US GAAP, preference shares issued by the Group are classified as equity as they are perpetual and redeemable only at the option of the Group.
(d) Loan origination fees Certain loan fees, together with related costs, are recognised in the income statement as received or incurred.
(e) Pension costs Pension scheme assets are measured at their fair value. Scheme liabilities are measured on an actuarial basis using the projected unit method and discounted at the current rate of return on a high quality corporate bond of equivalent term and currency. Any surplus or deficit of scheme assets compared with liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). An asset is only recognised to the extent that the surplus can be recovered through reduced contributions in the future or through refunds from the scheme.
US GAAP does not permit embedded value reporting. US GAAP requires bancassurance contracts to be classified either as insurance or investment contracts.
US GAAP requires deferred acquisition cost and income accounting for all contracts. Where investment contract policy charges benefit future periods, they are deferred and amortised.
(2) For 2004 As indicated above, as permitted by IFRS 1, in the preparation of the Group's 2004 consolidated income statements and balance sheets, all IFRS have been applied except those relating to financial instruments and insurance contracts where UK GAAP principles then current have been applied.
(h) Securities The Group’s debt and equity securities are classified as being held as investment securities or for trading purposes. Investment securities are stated at cost less provision for any permanent diminution in value. Premiums and discounts on dated debt securities are amortised to interest income over the period to maturity. Securities held for trading purposes are carried at fair value with changes in fair value recognised in profit or loss.
(i) Derivatives and hedging activities Non-trading derivatives are entered into by the Group to hedge exposures arising from transactions entered into in the normal course of banking activities. They are recognised in the accounts in accordance with the accounting treatment of the underlying transaction or transactions being hedged. To be classified as nontrading, a derivative must match or eliminate the risk inherent in the hedged item from potential movements in interest rates, exchange rates and market values. In addition, there must be a demonstrable link to an underlying transaction, pool of transactions or specified future transaction or transactions. Specified future transactions must be reasonably certain to arise for the derivative to be accounted for as a hedge. In the event that a non-trading derivative transaction is terminated or ceases to be an effective hedge, the derivative is remeasured at fair value and any resulting profit or loss amortised over the remaining life of the underlying transaction or transactions being hedged. If a hedged item is derecognised, or a specified future transaction is no longer likely to occur, the related non-trading derivative is remeasured at fair value and the resulting profit or loss taken to the income statement.
(j) Consolidation All entities controlled by the Group are consolidated together with special purpose entities (SPEs) where the substance of the relationship between the reporting entity and the SPE indicates that it is controlled by the reporting entity.
Investment securities held by the Group’s private equity business are considered to be held by investment companies and carried at fair value, with changes in fair value being reflected in net income. The Group’s other investment debt securities and marketable investment equity shares are classified as availablefor -sale securities and measured at fair value with unrealised gains and losses reported in a separate component of equity, except when the unrealised loss is considered other-thantemporary in which case the loss is included in net income.
The Group recognises an other-than-temporary impairment on an available-for-sale equity share when its carrying value has exceeded its market value for a period of more than twelve months.
Goodwill arising on acquisitions after 1 October 1998 was capitalised and amortised over its estimated useful economic life. Goodwill arising on acquisitions before 1 October 1998 was deducted from equity. The carrying amount of goodwill in the Group's opening IFRS balance sheet was its carrying value under UK GAAP as at 31 December 2003.
US GAAP requires the same treatment of purchased goodwill. This was adopted by the Group from 1 July 2001. Prior to this goodwill was recognised as an asset and amortised over periods of up to 25 years. No amortisation was written back on this change of policy. During 2005, the Group changed the date for performing its annual goodwill impairment test from 1 January to 30 September for certain of its reporting units in order to conform to the date selected by the Group upon adoption of IFRS.
Other adjustments in the reconciliation of net income for the year ended 31 December 2005 from IFRS to US GAAP include refinements to estimates arising from the implementation of IFRS.
Recent developments in US GAAP In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards 154 ‘Accounting Changes and Error Corrections’. The standard replaces APB 20 and SFAS 3 and amends the treatment of changes of accounting principle and the correction of errors. It is effective for accounting changes and corrections of errors made in fiscal years beginning after 15 December 2005.
In February 2006, the FASB published SFAS 155 ‘Accounting for Certain Hybrid Financial Instruments – an amendment of FASB Statements No 133 and 140’ (SFAS 155) which is effective for all financial instruments acquired or issued by the Group after 1 January 2007. The statement allows any hybrid financial instrument that contains an embedded derivative that would otherwise require bifurcation to be measured at fair value. The statement also eliminates the exemption from applying SFAS 133 to interests in securitised financial assets.
Selected figures in accordance with US GAAP The following tables summarise the significant adjustments to consolidated net income available for ordinary shareholders and shareholders’ equity which would result from the application of US GAAP instead of IFRS. Where applicable, the adjustments are stated gross of tax with the tax effect shown separately in total.
Profit attributable to ordinary shareholders – IFRS 5,392 4,856 Adjustments in respect of: Acquisition accounting — 66 Property revaluation and depreciation (90) (65) Leasehold property provisions (26) (19) Loan origination 55 (85) Pension costs (363) (283) Long-term assurance business 10 (17) Extinguishment of liabilities — (94) Financial instruments (556) (628) Derivatives and hedging (119) 73 Liabilities and equity 74 — Intangible assets – timing difference (66) (95)
Shareholders’ equity – IFRS 35,435 33,905 Adjustments in respect of: Acquisition accounting 517 517 Property revaluation and depreciation (403) (313) Leasehold property provisions 38 64 Loan origination 614 (373) Pension costs 145 215 Long-term assurance business (47) (163) Extinguishment of liabilities — (178) Financial instruments (259) 76 Derivatives and hedging 260 238 Liabilities and equity 2,298 — Intangible assets – timing difference 1,919 1,985 Other — 140
Total assets under US GAAP of £700.4 billion (2004 – £631.1 billion) primarily reflects the effect of certain arrangements that can be netted under US GAAP, together with the effect of adjustments made to shareholders’ equity.
Earnings per share Basic and diluted earnings per share (“EPS”) under US GAAP differ from IFRS only to the extent that the income calculated under US GAAP differs from that under IFRS.
No. of Per share No. of Per share Income* shares amount Income* shares amount £m million pence £m million pence
Dilutive effect of share options and convertible preference shares 65 60 (0.6) 66 73 (0.8)
* US GAAP net income available to ordinary shareholders, see page 227.
Pensions On 1 April 2002, the Group’s main pension schemes, The Royal Bank of Scotland Staff Pension Scheme and the National Westminster Bank Pension Fund, were merged to form The Royal Bank of Scotland Group Pension Fund (“the plan”). The provisions of SFAS 87 ‘Employers’ Accounting for Pensions’ have been applied to the plan, which covers most of the Group’s UK employees; the impact of US GAAP on the other Group schemes is considered to be immaterial.
The Group has convertible preference shares totalling £200 million (2004 – £200 million), €nil million (2004 – €750 million) and $1,000 million (2004 – $1,900 million). All of the convertible preference shares have a dilutive effect in the current year and as such have been included in the computation of diluted earnings per share.
Fair value of plan assets at beginning of year 13,598 11,822 Actual return on plan assets 2,477 1,234 Employer’s contribution 380 1,069 Benefits and expenses paid (521) (527) Market value of plan assets at year end 15,934 13,598
Funded status (3,359) (2,594) Unrecognised net actuarial loss 6,383 5,990 Unrecognised prior service cost 11 12 Unrecognised transition amount — (6) Prepaid pension cost at year end 3,035 3,402
The Group expects to contribute £392 million to its main UK pension plan in 2006.
250 Exchange rates 251 Off balance sheet arrangements 253 Economic and monetary environment 253 Supervision and regulation 257 Description of property and equipment 257 Major shareholders
Notes: (1) Includes gain on sale of strategic investment of £333 million for the year ended 31 December 2005 (2004 – nil).
(4) Includes purchased intangibles amortisation of £97 million for the year ended 31 December 2005 (2004 – £45 million).
Notes: (1) All the convertible preference shares have a dilutive effect in the current year and as such have been included in the computation of diluted earnings per share. In 2004 their effect was anti-dilutive.
Analysis of loans and advances to customers – IFRS The following table analyses loans and advances to customers before provisions by remaining maturity, geographical area and type of customer. Overdrafts are included in the ‘Within 1 year’ category.
After 1 Within but within After 2005 1 year 5 years 5 years Total 2004 £m £m £m £m £m
Loans and advances to customers – gross 233,057 66,147 121,906 421,110 351,419 Loan impairment provisions (3,884) (4,168) Loans and advances to customers – net 417,226 347,251
Cross border exposures Cross border exposures are defined as loans to banks and customers (including finance lease and instalment credit receivables) and other monetary assets, including non-local currency claims of overseas offices on local residents.
The table below sets out the Group’s cross border outstandings in excess of 0.75% of Group total assets (including acceptances), which totalled £776.8 billion (2004 – £588.5 billion). None of these countries has experienced repayment difficulties that have required refinancing of outstanding debt.
Loan impairment provisions at end of year: – customers 3,884 – banks 3
As a % of average loans and advances to customers during the year: Total customer provisions charged to income statement 0.42% 0.47%
Finance leases and instalment credit 88 3.3 122 3.7 Accrued interest — 0.3
Total write-offs* 2,038 1,449 * Excludes amounts written-off in respect of banks of £2 million (2004 – nil).
Finance — 2 Service industries and business activities 2 1 Property 2 — Individuals – home mortgages — 1 Individuals – others 84 78 Finance leases and instalment credit 7 2 Total domestic 97 85
IAS 39 requires interest to be recognised on a financial asset (or a group of financial assets) after impairment at the rate of interest used to discount recoveries when measuring the impairment loss. Thus, interest on impaired financial assets is credited to profit or loss as the discount on expected recoveries unwinds. Despite this, such assets are not considered performing. All loans that have an impairment provision are classified as non-accrual. This is a change from past practice where certain loans with provisions were classified as past due 90 days or potential problem loans (and interest accrued on them).
Closing provisions for impairment as a % of total risk elements in lending 65% 76%
Closing provisions for impairment as a % of total risk elements in lending and potential problem loans 65% 72%
Analysis of deposits – product analysis The following table shows the distribution of the Group’s deposits by type and geographical area: IFRS
Commercial paper Outstanding at year end 14,110 8,391 Maximum outstanding at any month end during the year 16,853 8,391 Approximate average amount during the year 15,329 7,450 Approximate weighted average interest rate during the year 3.7% 1.9% Approximate weighted average interest rate at year end 4.2% 2.6%
Other short term borrowings Outstanding at year end 105,483 95,381 Maximum outstanding at any month end during the year 117,913 96,356 Approximate average amount during the year 100,681 85,496 Approximate weighted average interest rate during the year 3.4% 2.9% Approximate weighted average interest rate at year end 3.5% 3.1%
(2) All convertible preference shares have a dilutive effect in the current year and as such have been included in the computation of diluted earnings per share. In prior years their effect was anti-dilutive.
2004 2003 2002 2001 Summary consolidated balance sheet – UK GAAP £m £m £m £m
Loans and advances to banks (net of provisions) 58,260 51,891 44,296 38,513 Loans and advances to customers (net of provisions) 345,469 252,531 223,324 190,492 Debt securities and equity shares 94,171 82,249 68,928 65,597
Share price per ordinary share at period end – £ 17.52 16.46 14.88 16.72 Market capitalisation at period end – £bn 55.6 48.8 43.2 47.8 Net asset value per ordinary share – £ 8.62 7.82 7.43 7.79 Return on average total assets (2) 0.82% 0.51% 0.52% 0.53% Return on average equity shareholders’ funds (3) 16.0% 9.8% 8.8% 8.9% Adjusted return on average equity shareholders’ funds (4) 20.1% 20.1% 18.3% 16.8% Average shareholders’ equity as a percentage of average total assets 5.7% 5.9% 6.8% 7.2% Risk asset ratio – Tier 1 7.0% 7.4% 7.3% 7.1% Risk asset ratio – Total 11.7% 11.8% 11.7% 11.5% Ratio of earnings to combined fixed charges and preference share dividends (5)
– including interest on deposits 1.90 2.04 1.83 1.55 – excluding interest on deposits 9.26 9.73 7.24 6.52
(4) Adjusted return on average equity shareholders’ funds represents profit attributable to ordinary shareholders before integration costs, goodwill amortisation and the AVS dividend, in 2003, 2002 and 2001 expressed as a percentage of average equity shareholders’ funds.
Service industries and business activities 30,850 29,290 26,022 25,033 Agriculture, forestry and fishing 2,480 2,562 2,463 2,391
Loans and advances to customers – gross 349,691 256,453 227,244 194,137 Provisions for bad and doubtful debts (4,222) (3,922) (3,920) (3,645) Loans and advances to customers – net 345,469 252,531 223,324 190,492
Loans and advances to customers – gross 349,691 256,453 227,244 194,137
The following table shows the elements of provisions for bad and doubtful debts under UK GAAP. UK GAAP
Customer charge against profit as a % of gross loans and advances to customers Domestic 0.50% 0.56% 0.56% 0.47%
Notes: (1) Includes closing provisions against loans and advances to banks of £6 million in 2004 (2003 – £7 million; 2002 – £7 million; 2001 – £8 million).
As a % of average loans and advances to customers during the year: Total customer provisions charged to profit and loss 0.48% 0.59% 0.61% 0.54%
% of loans % of loans % of loans % of loans Closing to total Closing to total Closing to total Closing to total provision loans provision loans provision loans provision loans £m % £m % £m % £m %
Domestic Central and local government — 0.5 — 0.5 — 0.6 — 0.4
Finance leases and instalment credit 122 3.7 136 4.6 208 5.2 164 5.8
Risk elements in lending and potential problem loans The Group’s loan control and review procedures do not include the classification of loans as non-accrual, accruing past due, restructured and potential problem loans, as defined by the SEC in the US. The following table shows the estimated amount of loans that would be reported using the SEC’s classifications. The figures incorporate estimates and are stated before deducting the value of security held or related provisions.
Closing provisions for bad and doubtful debts as a % of total risk elements in lending and potential problem loans 73% 68% 65% 65%
Notes: (1) For the analysis above, ‘Domestic’ consists of the UK domestic transactions of the Group. ‘Foreign’ comprises the Group’s transactions conducted through offices outside the UK and through those offices in the UK specifically organised to service international banking transactions.
Other short term borrowings Outstanding at year end 95,381 84,795 Maximum outstanding at any month end during the year 96,356 94,570 Approximate average amount during the year 85,496 78,004 Approximate weighted average interest rate during the year 2.9% 2.2% Approximate weighted average interest rate at year end 3.1% 2.0%
Commercial paper conduits – the Group has established a number of SPEs that act as multi-seller commercial paper conduits. These allow customers to access liquidity in the commercial paper market by selling assets to the conduit which it finances by issuing commercial paper to third parties. The Group supplies certain services and contingent liquidity support to these vehicles on an arm’s length basis as well as programme credit enhancement. These vehicles with total assets of £6,688 million at 31 December 2005 are consolidated under IFRS and US GAAP.
Residential mortgages and credit card securitisations – in the UK and Ireland, the Group has securitised portfolios of residential mortgages and credit card receivables totalling £5,279 million as at 31 December 2005. These assets have been transferred to SPEs funded by the issue of notes to thirdparty investors. These SPEs are consolidated under IFRS and US GAAP and the securitised assets remain on the Group’s balance sheet.
Guarantees and assets pledged as collateral security 3,974 1,729 1,893 2,842 10,438
Undrawn formal standby facilities, credit lines and other commitments to lend 118,367 23,045 21,216 16,602 179,230
Unconditional obligations to purchase goods or services 733 421 148 152 1,454
The tables above do not include undated loan capital. Commitments for the purchase of software at 31 December 2005 were £139 million (2004 – £256 million).
On 31 December 1998, the European Currency Unit (the “ECU”) was replaced by the euro on the international currency markets, on a one-for-one basis. The rates for the euro against other international currencies were based upon the official closing rates for the ECU. The bilateral rates for the legacy currencies of the participating states were derived from their rates within the Exchange Rate Mechanism and the closing value of the ECU. These rates, between the legacy currencies and between these currencies and the euro, were fixed as of 1 January 1999. The euro became the formal currency for all eleven then-participating states.
1.2 Authorised firms in the Group As at 31 December 2005, 35 companies in the Group, spanning a range of financial services sectors (banking, insurance and investment business), are authorised and regulated to conduct regulated activities by the FSA. These companies are referred to as ‘authorised firms.’
General insurance business is principally undertaken by companies in the RBS Insurance division, whilst life assurance business is undertaken by Royal Scottish Assurance plc and National Westminster Life Assurance Limited (with the Group’s partner, the AVIVA Group) and Direct Line Life Insurance Company Limited. Investment management business is principally undertaken by companies in the Wealth Management division, including Adam & Co Investment Management Limited and Coutts & Co Investment Management Limited, and in the Corporate Markets division, RBS Asset Management Ltd.
1.3 The FSA’s regulatory approach and supervisory standards The regulatory regime focuses on the risks to the FSA of not meeting its statutory objectives and uses the full range of regulatory tools (including the authorisation of firms, rule-making, supervision, investigation and enforcement) available to the FSA. It is founded on a risk based, integrated approach to regulation.
Setting standards for firms The FSA carries out the prudential supervision and conduct of business regulation of all authorised firms and also regulates the conduct of their business in the UK. Currently, the application of its conduct of business rules to banking business is limited but detailed conduct of business requirements apply to general insurance intermediary activities, mortgage businesses and investment business activities.
Prudential supervision includes monitoring the adequacy of a firm's management, its financial resources and internal systems and controls. Firms are required to submit regular returns to the FSA which provide material for supervisory assessment. Different prudential requirements have applied to different sectors of the financial services industry. However, the FSA has prepared an Integrated Prudential Sourcebook (“IPSB”) aimed at applying a more harmonised and consistent approach to prudential regulation across the whole industry. From 1 January 2005, insurers were the first industry segment to comply with the FSA's new IPSB requirements. Implementation for the remainder of the industry is expected in stages, from 1 January 2005 until 1 January 2008.
As regards the insurance industry, the FSA’s primary objective is to regulate and supervise the industry so that policyholders have confidence that they have bought appropriate products, and so that UK insurers are able to meet their liabilities and treat customers fairly. The FSA sets requirements relating to “margins of solvency” (i.e. the excess of the value of assets over the amount of liabilities). Companies carrying out insurance business are required to submit regular returns covering reserves and solvency to the FSA.
1.5 Fraud Towards the end of October 2004, the FSA launched its new policy on combating fraud in the financial services industry – Fighting Fraud in Partnership. The FSA is working on a programme of activities focusing on (i) actions that the FSA will take, (ii) FSA support for work by trade associations and the industry, (iii) creating closer relationships with law enforcement agencies and, (iv) the Government making fraud a higher law enforcement priority and leading the development of a fraud strategy. On 26 October 2005, the Attorney General announced that the Government will carry out a wide ranging review of fraud to consider the scale and costs to the country of fraud. The final report is to be produced by late spring 2006.
1.7 Extension of the FSA’s responsibilities From 31 October 2004, the scope of the FSA’s responsibilities was widened to cover the regulation and supervision of mortgage lending and administration and the provision of mortgage advice. Arrangements relating to the sale and administration of general insurance (and certain other insurance) contracts became regulated from 1.8 Other relevant UK agencies and Government departments Consumer credit issues are covered by the Department of Trade and Industry (“DTI”) and the Office of Fair Trading (“OFT”) and competition issues are dealt with by the OFT.
A dd iti on al in fo rm a tio n 2 United States As the ultimate parent of Citizens’ subsidiary US banks, the company is a bank holding company within the meaning of, and subject to regulation and supervision under, the US Bank Holding Company Act of 1956, as amended (the ‘BHCA’), by the Board of Governors of the Federal Reserve System (the ‘Federal Reserve Board’). Under current Federal Reserve Board policy, the company is expected to act as a source of financial strength to its US bank subsidiaries.
In the EU, the framework became law through the Capital Requirements Directive (EU CRD) and associated changes to national laws or regulatory guidelines (for example the FSA’s Integrated Prudential Sourcebook). Within the US, regulators have the flexibility to implement Basel 2 directly, after a Final Notice of Prudential Rulemaking expected later in 2006. Full adoption of these new rules comes into force across the EU on 1 January 2008 and the US on 1 January 2009.
Application of Basel 2 differs between jurisdictions. The EU is applying Basel 2 to all banks and investment firms. The US is taking a different approach, mandating that their largest internationally active banks use the ‘Advanced’ approaches for credit and operational risk calculations; other banks can either remain on Basel 1 (or a modified version thereof, called Basel 1a) or ‘opt-into’ Basel 2. Our US subsidiary, Citizens, currently falls outside the group of mandated Basel 2 banks for the purposes of US regulation.
Major shareholders Details of major shareholders of the company’s ordinary and preference shares are given on page 111.
At 27 February 2006, the directors of the company had options to purchase a total of 1,583,566 ordinary shares of the company.
Financial calendar Annual General Meeting 28 April 2006 at 2.00 pm,
Dividends Payment dates: Ordinary shares (2005 Final) 9 June 2006 Ordinary shares (2006 Interim) October 2006 Cumulative preference shares 31 May and 29 December 2006 Non-cumulative dollar preference shares 31 March, 30 June, 29 September and 29 December 2006
Record dates: Ordinary shares (2005 Final) 10 March 2006 Cumulative preference shares 5 May 2006
For shareholders who held NatWest ordinary shares at 31 March 1982, the market value of one ordinary share held was 85.16p for shareholders who accepted the basic terms of the RBS offer. This takes account of the August 1984 and June 1986 rights issues and the June 1989 bonus issue of NatWest ordinary shares as well as the subsequent issue of Additional Value Shares.
Analyses of ordinary shareholders at 31 December 2005 % shareholdings millions of total
Banks and nominee companies 19,832 2,882.5 90.2 Investment trusts 162 0.7 —
At 31 December 2005, there were 216 registered shareholders of Series D ADSs, 114 registered shareholders of Series E ADSs, 133 registered shareholders of Series F ADSs, 83 registered shareholders of Series G ADSs, 82 registered shareholders of Series H ADSs, 112 registered shareholders of Series I ADSs, 62 registered shareholders of Series K ADSs, 28 registered shareholders of Series L ADSs, 1 registered shareholder of Series M ADSs, 43 registered shareholders of series N ADSs and 55 registered shareholders of Series P ADSs.
Non-cumulative convertible preference shares of US$0.01 – Series 1 91.18 50.33 49.05 54.89 59.15 62.70
Non-cumulative convertible preference shares of €0.01 – Series 1 (3) 19.83 11.54 44.19 49.58 44.45 41.34
Non-cumulative preference shares of €0.01 – Series 1 70.72 41.14 3.45 –– –– –– – Series 2 — — –– –– –– ––
Non-cumulative convertible preference shares of £0.01 – Series 1 126.97 73.87 73.87 73.87 73.87 73.87
The statements and practices set forth below regarding US and UK tax laws, including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “Treaty”), and the US/UK double taxation convention relating to estate and gift taxes (the “Estate Tax Treaty”), are based on those laws and practices as in force and as applied in practice on the date of this Report. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, and possible changes in taxation law, of the acquisition, ownership and disposition of non-cumulative dollar preference shares, ADSs, X-CAPs or PROs by consulting their own tax advisers.
A US Holder will, upon the sale, exchange or redemption of a non-cumulative dollar preference share or ADS, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption, such US Holder does not own, and is not deemed to own, any ordinary shares of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holder’s tax basis in the non-cumulative dollar preference share or ADS.
ha re ho ld er in fo rm at io n
Annual Report and Accounts 2005 business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the non-cumulative dollar preference share or ADS is subject to both UK inheritance tax and US federal estate or gift tax.
A US Holder will, upon the sale, exchange or redemption of X-CAPs, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption, such US Holder does not own, and is not deemed to own, any ordinary shares of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holders tax basis in the X-CAPs.
EU Directive on taxation of savings income The European Union has adopted a directive regarding the taxation of savings income. The Directive requires Member States of the European Union to provide to the tax authorities of other Member States details of payments of interest or other similar income paid by a person to an individual in another Member State, except that Belgium, Luxembourg and Austria are instead imposing a withholding system for a transitional period unless during such period they elect otherwise.
Stamp duty and SDRT No UK stamp duty is payable on the transfer by delivery or redemption of bearer X-CAPs, whether in definitive form or in the form of one or more global X-CAPs. No SDRT is payable on any agreement to transfer bearer X-CAPs, provided that the agreement is not made in contemplation of, or as part of an arrangement for, a takeover of the company.
EU Directive on taxation of savings income The European Union has adopted a directive regarding the taxation of savings income. The Directive requires Member States of the European Union to provide to the tax authorities of other Member States details of payments of interest and other similar income paid by a person to an individual resident in another Member State, except that Belgium, Luxembourg and Austria are instead imposing a withholding system for a transitional period unless during such period they elect otherwise.
Inheritance tax In relation to PROs held through DTC (or any other clearing system), the UK inheritance tax position is not free from doubt in respect of a lifetime transfer, or death of, a US Holder who is not domiciled nor deemed to be domiciled in the UK for inheritance tax purposes; HM Revenue & Customs is known to consider that the situs of securities held in this manner is not necessarily determined by the place where the securities are registered. In appropriate circumstances, there may be a charge to UK inheritance tax as a result of a lifetime transfer at less than fair market value by, or on the death of, such US Holder. However, exemption from, or a reduction of, any such UK tax liability may be available under the Estate Tax Treaty. US Holders should consult their professional advisers in relation to such potential liability.