Divisional review 07 Global Banking & Markets 09 Global Transaction Services 10 UK Retail & Commercial Banking 13 US Retail & Commercial Banking 14 Europe & Middle East Retail & Commercial Banking 15 Asia Retail & Commercial Banking 16 RBS Insurance
Report and accounts 23 Business review 145 Governance 171 Financial statements 267 Additional information 285 Shareholder information 2008 Key financials
The key pro forma financials above are based on the pro forma results for the year ended 31 December 2008 and include only those business units of ABN AMRO Holding N.V. which will be retained by the Group. The statutory results are presented on pages 177 to 266.
Notes: (1) Profit before tax, credit market write-downs and one-off items, impairment losses on reclassified assets, purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs and share of ABN AMRO shared assets.
(2) Before write-down of goodwill and other intangible assets, net of tax.
(3) Excluding credit market write-downs and one-off items and share of shared assets.
(7) Adjusted for the conversion of preference shares into ordinary shares.
(8) Loss per ordinary share is based on the assumption that the rights issue and capitalisation issue were completed on 1 January 2008.
Despite this, I believe strongly that RBS can be successful once again. I am privileged to have been given the opportunity to chair the Group. This remains a truly international company with many excellent businesses. Our roots may be in Scotland and our largest market in the UK, but we also employ 10,000 people in India, enjoy strong positions on the island of Ireland through Ulster Bank and in our United States markets through Citizens. The Global Markets businesses are precisely that: global. They will continue to operate in the leading financial centres, supporting our corporate, institutional and financial sector clients around the world. The international nature of the Group is reflected by the fact that during 2008 we were able to benefit from liquidity support provided by central banks in a number of jurisdictions.
The UK government wants RBS to operate on a commercial basis and intends to act as an arms length commercial shareholder, which will sell its interests in RBS and other banks at the earliest attractive time. Our interests coincide. We are working to restore the Group’s financial performance in order to allow us to repay the UK taxpayer as soon as is practicable.
It is not appropriate to pay any dividend on the ordinary shares in 2009. However, the Board is very mindful that dividends are an extremely important part of shareholder return and income. It is the Board’s intention over time to return to paying dividends, taking account of the Group’s capital position, retained earnings and prospects. To that end, we welcome the fact that the existing prohibition on the payment of dividends on the ordinary shares will be removed when the preference shares held by UKFI are redeemed.
My first statement to you as Chairman follows an exceptionally difficult period in the history of The Royal Bank of Scotland Group. The last 12 months or so have been painful for our shareholders and employees and sometimes testing for our customers.
Our people Last year was also a period of great anxiety and uncertainty for our employees. Despite this, the vast majority of them contributed to a profitable year for their own businesses and they demonstrated the commitment that will be needed to return the Group to good health. Unfortunately, however, the uncertainty is not over and many of our people will be affected by the steps we must take to restore RBS to strength. My experience of leading businesses through periods of significant change has taught me that people are resilient and work best when they have certainty over strategic direction, clarity about the role they are being asked to play and feel engaged in pursuing shared objectives. We have already begun to provide certainty and clarity over strategy and management structures. My further commitments to our people are that we will move as swiftly as possible where change is required and that we will work to ensure that those affected by change are the first to know about it.
Aligning remuneration with long-term shareholder value In recognition of the crisis in global financial services and the unprecedented losses incurred by the RBS Group in 2008 the Remuneration Committee of the Board has been working to bring about fundamental change to the way remuneration works throughout the Group. There is an obvious need for very significant change to compensation policies and practice across the industry and we intend that RBS will be fully engaged in the necessary process of change.
Our approach has sought to balance the reality of our current losses at Group level with a need to offer a competitive remuneration package for teams and individuals that are performing well and in a manner that is sustainable in the long-term.
Our customers and communities Most of our businesses were profitable in 2008. That was because they met their customers’ needs. A consistent hallmark of RBS has been the ability to work with our customers and to provide them with a high quality of service, whether they are personal or corporate customers, be they in the UK, Ireland, the USA or across continental Europe and Asia. RBS has frequently led our peers in service quality league tables.
In every country where RBS operates, we do so within a wider community. Our activities affect, and are affected by the customers, governments, suppliers and other stakeholders with which we interact. On joining the company, it was encouraging to learn that we provide banking services to more small firms than any other UK bank and that our flagship money advice and financial education programme, MoneySense, has been in place for many years. As an international company, we have extended MoneySense to Ireland and the US. We support the causes our staff care about and invest to improve the capacity of community to generate wealth. These programmes are more relevant than ever to the challenges that lie ahead.
In addition, the change in market outlook and our vulnerability thereto has required a £16.2 billion accounting write-down of goodwill and other intangibles relating to prior year acquisitions, most notably of ABN AMRO in 2007 and Charter One in the US in 2004. This non-cash item has minimal impact on capital but does highlight the risk of acquisitions if economic conditions change adversely.
RBS has strong businesses, and has taken steps to restore its capital base and benefits from clear Government support. It is our primary task to rebuild standalone strength in the coming years.
Our aspiration is that RBS should again become one of the world’s premier financial institutions, anchored in the UK but serving individual and institutional customers here and globally, and doing it well. We aim for AA category standalone credit status and to rebuild shareholder value, along the way enabling the UK Government to sell down its shareholding.
In management style we want to be purposeful, to “make it happen” for our customers and then for our shareholders. We will anchor our efforts in strategic understanding of the businesses, focusing on long-term, quality profitability. Our business mix should be more biased to stable customer businesses than before. We aim to rely less on volatile, unsecured wholesale funding.
As part of this effort our representation in approximately 36 of the 54 countries in which we operate will be significantly reduced or sold. We will remain strong in all our major existing global hubs, however.
Given the commercial and human sensitivity of these issues, detail on this will not be given until the interim results.
The income, expenses, impairments and write-downs associated with the Non-Core Division in 2008 were approximately £3.9 billion, £1.1 billion, £3.2 billion and £9.2 billion respectively.
• At all times we will responsibly compare the value to RBS of each of our businesses with realistic alternatives and take different actions if they prove compelling. The current state of markets for financial assets and businesses offers little immediate encouragement in that regard.
This will be underpinned by a full suite of risk and funding constraints, including concentration limits.
This major change programme has already begun. To carry it through while running our continuing business in difficult markets will test our management capacity. We expect to be successful overall, though we will inevitably have setbacks and make mistakes along the way. But there is no alternative. RBS must change in a far-reaching way. If we do that, the strength, quality and power that are already present in our business across the world will be what shines through once again.
To rebuild shareholder value, along the way enabling the UK Government to sell down its shareholding
Focusing our activities on serving enduring customer franchises, with top tier competitive positions where we choose to compete
Achieving primarily organic growth at rates consistent with the markets in which our businesses operate
Having businesses that reinforce each other with shared products, customers and expertise
“Making it happen” for our customers and then for our shareholders
Global Banking & Markets Global Banking & Markets is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers.
In 2008 the division was organised along four principal business lines: rates, currencies, and commodities, including RBS Sempra Commodities LLP, the commodities-marketing joint venture between RBS and Sempra Energy which was formed on 1 April 2008; equities; credit markets; and asset and portfolio management.
The poor results recorded by GBM in 2008 should not be allowed to disguise the fact that many businesses produced good performances, most notably rates and currencies, and that the activities which directly support our relationships with customers provide the platform for a return to sustainable profitability.
These losses occurred in relatively narrow parts of the business, focused on proprietary trading, structured credit and counterparty exposure. More than 50% of losses pertained to ABN AMRO-originated portfolios.
Equities saw reduced customer flow and write-downs on trading positions as markets deteriorated rapidly. Credit markets achieved some successes in arranging debt financing for its customers but remained severely affected by market dislocation.
None of this will be easy. The difficult economic environment around the world will make 2009 another challenging year. We are confident, however, that at the core of GBM lies an excellent franchise which can deliver enduring profitability to the Group.
Growth was driven by a strong performance in cash management, which provides clients with liquidity management, and international and domestic payment services. Income rose 9% in the year to £1,514 million with good growth in international cash management markets and steadier growth in UK and US domestic markets. The Division was successful throughout the year in winning new international cash management mandates from existing RBS Group clients due to the strength of the international payments platform and network.
Trade finance executes and advises on customers’ trade-related finance and risk requirements. It made significant progress, with income continuing to grow strongly throughout the year, up 57%
Merchant services and commercial cards offers customers a wide range of card issuing and acquiring solutions, products and services. It delivered a 6% increase in income to £694 million. Acquiring volumes were up 23% in the year driven by good growth in online volumes, although weaker consumer confidence in the latter part of the year meant that average transaction values decreased, slowing income growth. Commercial cards income grew by 16%.
On scope, GTS is an integral part of the offering of GBM, and our regional commercial and corporate businesses, which, in turn, introduce customers to GTS.
Although the year ahead will present challenges as slowing global growth affects trade flows and transaction volumes, GTS remains an attractive component of the Group’s portfolio for the future.
UK Retail & Commercial Banking UK Retail & Commercial Banking (‘RBS UK’) comprises retail, corporate and commercial banking and wealth management services. It operates through a range of channels including on-line and fixed and mobile telephony, and through two of the largest networks of branches and ATMs in the UK.
In the retail market, RBS UK serves over 15 million personal customers through the RBS and NatWest brands. It offers a full range of banking products and related financial services including mortgages, bancassurance products, deposit accounts, and credit and charge cards.
The results for the year reflect a weaker second half with rapidly deteriorating economic conditions in the UK. Total income grew modestly, up 2% on 2007 to £10,814 million. A consistent theme across the businesses was the weakness of non-interest income, which was down 5%, reflecting generally lower demand for a range of products. Direct expenses increased by 6% to £3,171 million and impairment losses by 44% to £1,964 million, with a marked deterioration in the second half of the year. Operating profit declined by 18% to £3,283 million. The indicative ROE of UK Retail & Commercial Banking was 18%.
In a testing environment, Retail Banking supported customers by maintaining the availability of lending, while managing risk.
• Business Banking continued to grow, maintaining market leadership with a share of 26%. Loans and advances to small business customers were up 7% despite a significant contraction in demand.
A number of specific initiatives were taken to help customers deal with the effects of market turbulence and the recession.
Steps were also taken to assist Business Banking customers through the downturn.
• Under our Price Promise to small business customers, we have undertaken not to increase: – margins on overdrafts for existing customers at facility review where there is no change to their risk profile; and – standard fees for arranging an overdraft.
• The Committed Overdraft facility provides customers with reassurance that their facility will remain in place for the agreed term, usually 12 months.
• Business Lifeline is a source of advice and information which complements the work of relationship managers. Open from ‘8 to 8’, Monday to Friday, the telephone help desk allows customers to speak directly to experienced bankers.
• Almost 700,000 Business Banking customers have received a guide to support them through the downturn, covering topics such as managing cash-flow, and spreading risk and a directory of sources of advice and information.
The Retail Banking franchise exhibits a number of strengths that position it well for the long-term. The RBS and NatWest brands enjoy a reputation for excellence in customer service. Last year, according to leading independent research, RBS retained top position and NatWest was again joint second for customer satisfaction amongst main high street banks. The Group ranks second in terms of market share in the critical current account market and regularly secures the largest share of current accounts opened by first year higher education students. Examples for 2008 which illustrate the strength of the franchise include: • personal savings grew by 9% and business deposits by 3% despite increased competition and a slowing market for deposits; and
UK Corporate & Commercial Banking Total income increased by 5% to £3,161 million, with growth slowing in the second half of the year as the economy deteriorated. Direct expenses increased by 13% to £1,015 million, principally as a result of a 26% rise in operating lease depreciation to £401 million reflecting both higher volumes and lower than expected residual values in the Lombard vehicle leasing business. Excluding this item, direct expenses increased by 6% to £614 million as additional relationship managers were recruited. Impairment losses increased from the historically low level of 2007, by 273% to £671 million. Operating profit fell by 30% to £1,116 million.
RBS enjoys leading positions in the corporate and commercial markets. Customer satisfaction in corporate is strong and increased in 2008 over 2007, both overall and in the key area of the quality of relationship managers. Almost 19 out of 20 customers surveyed said that they would advocate RBS to other businesses. These are strong foundations on which to build enduring profitability.
UK Wealth generates earnings from both private banking and investment services. This balanced income base allowed it to maintain robust organic growth, despite market conditions. Coutts & Co performed particularly well, with contribution up 15%.
Our UK wealth businesses have strong brands and are well positioned in their markets. Adam & Company is number one in Scotland, with RBS International also number one in the Channel Islands and the Isle of Man. Coutts & Co is number two across the UK. In addition to their profit contribution, they generate deposits for the Group. We believe that attractive opportunities exist for further sustainable, profitable development of our UK wealth businesses, building on these existing strengths.
Wealth management remains a strong growth opportunity and the business plans to pursue a more consolidated approach to the market through more co-ordination across the multiple brands with which it currently faces the market, whilst investing in additional Relationship Managers and platform functionality.
The Division will pursue above market growth in customer deposits to improve its funding contribution to the Group, and will diversify its customer lending, reducing its exposure to commercial property.
US Retail & Commercial Banking US Retail & Commercial Banking provides financial services primarily through the Citizens and Charter One brands.
Rising impairments were the main cause of the decline in operating profit and reflected an environment in which house prices continued to fall and unemployment to rise, credit spreads widened and household wealth contracted. Impairment losses increased by 184% to $1,929 million, compared with 2007. In the externally sourced home equity portfolio, impairments rose by 80% to $592 million, although the second half figure of $268 million was lower than the first half’s $324 million. In the core US Retail & Commercial portfolio, impairments were 281% higher than in 2007 at $1,337 million, with a marked deterioration in the second half of the year. Stress was evident in all sectors. Citizens’ loss rates were low relative to its peers.
Europe & Middle East Retail & Commercial Banking Europe & Middle East Retail & Commercial Banking comprises Ulster Bank and the Group’s combined retail and commercial businesses in Europe and the Middle East.
Steps to support customers through this difficult economic period have also been initiated in Ireland. Ulster Bank announced in February 2009 that it will be making available significant funds for the Northern Ireland (‘NI’) SME sector, with a similar support initiative soon to launch in RI. Ulster Bank has also adopted the Group’s pledge regarding certainty of overdraft limits for this segment.
Strategic review Ulster Bank remains a core part of the Group’s global banking operations. It has a strong franchise in Ireland and has the product and distribution capability to grow profitably and well in normal market conditions. The business plans to manage its balance sheet over the medium term, with particular focus on reducing risk concentrations as market conditions allow, whilst increasing and diversifying its customer deposit base.
Asia Retail & Commercial Banking Asia Retail & Commercial Banking is present in markets including India, Pakistan, China, Taiwan, Hong Kong, Indonesia, Malaysia and Singapore.
It provides financial services across four segments: affluent banking, cards and consumer finance, business banking and international wealth management, which offers private banking and investment services to clients in selected markets through the RBS Coutts brand.
Asia’s economies slowed sharply in 2008 and especially the second half, ending a decade of consistent, widespread and often rapid growth in the region. This was reflected in the performance of Asia Retail & Commercial Banking, although comparisons with the prior year are affected by the marked depreciation of sterling during the year. While income increased by 12% to £781 million, an operating loss after manufacturing costs of £113 million was incurred, compared with a loss of £20 million in 2007.
Direct expenses increased by 30% to £483 million. This reflected higher collection costs and continued investment in the Group’s infrastructure in the region, including the recruitment of additional experienced private bankers in RBS Coutts Asia. Impairment losses increased by 44% to £171 million, largely as a result of pressures on the Indian consumer finance book. The indicative ROE of Asia Retail & Commercial Banking was -16%.
Credit cards and consumer finance metrics have continually been reviewed over the period resulting in further tightening of consumer lending policies. This has led to lower levels of card and loan acquisition. There has also been a slowdown in the number of card transactions. Despite this, the cards and consumer finance business reported income growth of 20%. Business banking saw strong growth across most regions with revenue increasing by 28%, having performed particularly well in India, Pakistan and China.
RBS Coutts, our wealth management business, continued to deliver good income growth of 19% and strong levels of client acquisition, up 5% in the year. Despite adverse financial markets and significant levels of client de-leveraging, assets under management in the international wealth business grew by 8%. We continued to rebrand Coutts’ businesses outside the UK to RBS Coutts.
RBS Insurance RBS Insurance is the UK’s second largest general insurer and the largest personal lines insurer by gross written premiums. It sells and underwrites personal lines and SME insurance over the telephone and internet, as well as through brokers, RBS Group bank branches and partnerships.
RBS remains the UK’s largest motor insurer and its second largest home insurer. This is supported by the strength of the Direct Line and Churchill brands which maintained their positions as the two leading motor insurance brands. The total number of in-force policies was 7% higher in December 2008 than 12 months earlier.
In 2008, RBS Insurance continued to develop its synergies with the wider Group. Excellent sales growth was achieved through the RBS and NatWest brands, where home insurance new business sales increased by 289%, the equivalent of one policy every minute during branch opening hours.
The international businesses performed well, with income up 24% and contribution up 37%. These businesses now have more than 2.5 million customers. RBS Insurance, under the Direct Line brand, is the largest direct motor insurer in Spain, the second largest in Italy and the third largest in Germany.
Given the importance to stakeholders and to RBS of customer service, it was encouraging that, according to leading independent research RBS retained top position and NatWest was again joint second for customer satisfaction among main high street banks. Saturday opening was extended, so that 40% of the RBS/NatWest branch network now opens on Saturdays. We increased the number of Customer Advisers in NatWest branches by 200 in 2008.
Investing in financial education Understanding and confidently managing money are crucial life skills. RBS has a long-standing commitment to financial education, one which was expanded in 2008 to help people navigate difficult economic times.
The Group’s financial education activities are built around the MoneySense programme which has been running for more than 15 years. It provides free and impartial guidance about money and financial services, and is the largest financial education programme of its kind. MoneySense aims to ensure that an ever-increasing number of people – whether or not they choose to bank with the Group – are able to make informed decisions based on a solid understanding of their money and how financial products and services work.
MoneySense for Schools is accredited by the Personal Finance Education Group, an independent charity that helps schools to plan and teach personal finance education.
The core of MoneySense for Schools is lessons delivered to young people in their classrooms. Since 2004 alone, more than two million MoneySense lessons have been delivered to pupils, with the figure for 2008 exceeding 700,000. Some lessons are delivered by RBS and NatWest employees who visit schools in their local communities and others by teachers. Resources have been developed to support teachers and include: • online tutorials; • a free telephone helpline which gives teachers the opportunity to speak to MoneySense educational experts; and
• Teacher Zone, an area from which registered users can download support materials and resources for the modules.
In November, the Group made a series of promises to small business customers of RBS and NatWest. Under the Committed Overdraft promise, customers’ committed facilities remain in place for 12 months from the date they are agreed, rather than being repayable on demand. The Price Promise means that committed overdraft pricing is guaranteed usually for 12 months from the date it is agreed. At renewal, the price will not increase unless there has been a rise in the risk associated with lending to the customer.
As well as this financial support, RBS also extended the face-toface advice and support that is already available to customers through their relationship managers. A team of 500 highly experienced managers was selected to provide business customers with hands on support to manage their businesses through the downturn. This was followed in December 2008 by the launch of Business Lifeline, a specialist helpline which RBS has established to provide advice and support to small business customers.
An additional 1,000 MoneySense Advisers introduced to NatWest and RBS branches
Business review 24 Presentation of information 25 Forward-looking statements 26 Description of business 27 Risk factors 35 Key financials 36 Summary consolidated income statement 40 Analysis of results 50 Divisional performance 69 Consolidated balance sheet 72 Cash flow 73 Capital resources 74 Reconciliations of pro forma to statutory income statements and balance sheets 78 Risk, capital and liquidity management
International Financial Reporting Standards As required by the Companies Act 1985 and Article 4 of the European Union IAS Regulation, the consolidated financial statements of the Group are prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the International Financial Reporting Interpretations Committee of the IASB (together ‘IFRS’) as adopted by the European Union. It also complies with IFRS as issued by the IASB. On implementation of IFRS on 1 January 2005, the Group took advantage of the option in IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ to implement IAS 39 ‘Financial Instruments: Recognition and Measurement’, IAS 32 ‘Financial Instruments: Disclosure and Presentation’ and IFRS 4 ‘Insurance Contracts’ from 1 January 2005 without restating its 2004 income statement and balance sheet. The date of transition to IFRS for the Group and the company and the date of their opening IFRS balance sheets was 1 January 2004.
Certain other assets will continue to be shared by the consortium members.
Given the significant write-downs on the Group’s credit market exposures, and in order to provide a basis for comparison of underlying performance, these write-downs and other one-off items including writedown of goodwill and other intangible assets are shown separately in the pro forma income statement.
The forward-looking statements contained in this document speak only as of the date of this report, and the Group does not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Description of business Introduction The Royal Bank of Scotland Group plc is the holding company of a large global banking and financial services group. Headquartered in Edinburgh, the Group operates in the United Kingdom, the United States and internationally through its two principal subsidiaries, the Royal Bank and NatWest. Both the Royal Bank and NatWest are major UK clearing banks whose origins go back over 275 years. In the United States, the Group’s subsidiary Citizens is a large commercial banking organisation. The Group has a large and diversified customer base and provides a wide range of products and services to personal, commercial and large corporate and institutional customers in over 50 countries.
Following a placing and open offer in December 2008, HM Treasury currently own approximately 58% of the enlarged ordinary share capital of the company and £5 billion of preference shares. The company, subject to shareholder approval, intends to issue new ordinary shares by way of an open offer, the proceeds from which will be used to repay the £5 billion non-cumulative sterling preference shares issued to HM Treasury, together with the accrued dividend. The open offer will be underwritten by HM Treasury and this may result in their shareholding increasing to approximately 70% of the enlarged ordinary share capital of the company.
The Group had total assets of £2,401.7 billion and owners’ equity of £58.9 billion at 31 December 2008. The Group’s capital ratios, which include the equity minority interest of Fortis Bank Nederland and Santander in ABN AMRO, were a total capital ratio of 14.1 per cent., a core Tier 1 capital ratio of 6.8 per cent. and a Tier 1 capital ratio of 10.0 per cent., as at 31 December 2008.
Global Banking & Markets is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. In 2008 the division was organised along four principal business lines: rates, currencies, and commodities, including RBS Sempra Commodities LLP (the commodities-marketing joint venture between RBS and Sempra Energy which was formed on 1 April 2008); equities; credit markets; and asset and portfolio management.
UK Retail & Commercial Banking (RBS UK) comprises retail, corporate and commercial banking and wealth management services. It operates through a range of channels including on-line and fixed and mobile telephony, and through two of the largest networks of branches and ATMs in the UK.
RBS UK holds a leading market share across all of the Business & Commercial and Corporate sectors. Through its network of relationship managers it distributes a full range of banking, finance and risk management services, including market-leading Invoice Finance and Asset Finance offerings.
Citizens is engaged in retail and corporate banking activities through its branch network in 13 states in the United States and through nonbranch offices in other states. Citizens was ranked the tenth-largest commercial banking organisation in the United States based on deposits as at 30 September 2008.
In Ireland, Ulster Bank and First Active compete in retail and commercial banking with the major Irish banks and building societies, and with other UK and international banks and building societies active in the market.
Risk factors Set out below are certain risk factors which could affect the Group’s future results and cause them to be materially different from expected results. The Group’s results are also affected by competition and other factors. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.
The company may face the risk of full nationalisation and under such circumstances shareholders may lose the full value of their shares. Under the provisions of the Banking Act, substantial powers have been granted to HM Treasury, the Bank of England and the FSA as part of the Special Resolution Regime to stabilise banks that are in financial difficulties and may fail. The Special Resolution Regime gives the authorities three stabilisation options: private sector transfer; transfer to a ‘bridge bank’ established by the Bank of England; and temporary public ownership (nationalisation).
Shareholders may have a claim for compensation under one of the compensation schemes provided for in the Banking Act. For the purposes of determining an amount of compensation, an independent valuer must disregard actual or potential financial assistance provided by the Bank of England or HM Treasury.
The Group’s businesses, earnings and financial condition have been and will continue to be affected by the continued deterioration in the global economy, as well as ongoing instability in the global financial markets.
Liquidity risk is the risk that a bank will be unable to meet its obligations, including funding commitments, as they fall due. This risk is inherent in banking operations and can be heightened by a number of enterprise specific factors, including an over-reliance on a particular source of funding (including, for example, short term and overnight funding), changes in credit ratings or market-wide phenomena such as market dislocation and major disasters. Credit markets worldwide have experienced and continue to experience a severe reduction in liquidity and term-funding in the aftermath of events in the US sub-prime residential mortgage market and the current severe market dislocation. Perception of counterparty risk between banks has also increased significantly following the bankruptcy filing by Lehman Brothers. This increase in perceived counterparty risk has led to further reductions in inter-bank lending, and hence, in common with many other banks, the Group’s access to traditional sources of liquidity has been, and may continue to be, restricted.
The governments of some of the countries in which the Group operates have taken steps to guarantee the liabilities of the banks and branches operating in their respective jurisdiction. Whilst in some instances the operations of the Group are covered by government guarantees alongside other local banks, in other countries this may not necessarily always be the case. This may place subsidiaries operating in those countries, such as Ulster Bank Ireland Ltd, which did not participate in such government guarantee schemes, at a competitive disadvantage to the other local banks and therefore may require the Group to provide additional funding and liquidity support to these operations.
Governmental support schemes are subject to cancellation or change, which may have a negative impact on the availability of funding in the markets in which the Group operates.
Governmental support schemes are subject to cancellation or change, based on changing economic and political conditions in the jurisdiction of the relevant scheme. Furthermore, certain schemes which have been recently announced have in fact not been fully implemented, or their terms have not yet been finalised. To the extent government support schemes are cancelled or changed in a manner which diminishes their effectiveness, or to the extent such schemes fail to generate additional liquidity or other support in the relevant markets in which such schemes operate, the Group, in common with other banks, may continue to face limited access to, have insufficient access to, or incur higher costs associated with, funding alternatives, which could have a material adverse impact on the Group’s business, financial condition, results of operations, prospects and result in a loss of value in RBS shares.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of the Group’s businesses. The outlook for the global economy over the near to medium term has continued to deteriorate, particularly in the UK, the United States and other European economies. For example, there is an expectation of further reductions in residential and commercial property prices, higher unemployment rates and reduced profitability of corporate borrowers. As a result, the Group has seen and expects to continue to see adverse changes in the credit quality of its
Business review continued borrowers and counterparties, with increasing delinquencies, defaults and insolvencies across a range of sectors. This trend has led and may lead to further impairment charges, higher costs, additional write downs and losses for the Group or result in a loss of value in RBS shares.
The actual or perceived failure or worsening credit of the Group’s counterparties could adversely affect the Group.
The Group’s ability to engage in routine funding transactions has been and will continue to be adversely affected by the actual or perceived failure or worsening credit of its counterparties, including other financial institutions and corporate borrowers. The Group has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. As a result, defaults by, or even the perceived creditworthiness of or concerns about, one or more corporate borrowers, financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Group or by other institutions. Many of these transactions expose the Group to credit risk in the event of default of the Group’s counterparty or client. In addition, the Group’s credit risk is exacerbated when the collateral it holds cannot be realised or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due to the Group, which is most likely to occur during periods of illiquidity and depressed asset valuations, such as those currently experienced. Any such losses could have a material adverse effect on the Group’s results of operations and financial condition or result in a loss of value in RBS shares.
The value or effectiveness of any credit protection that the Group has purchased from monoline and other insurers and other market counterparties (including credit derivative product companies) depends on the value of the underlying assets and the financial condition of the insurers and such counterparties.
The Group has credit exposure arising from over-the-counter derivative contracts, mainly credit default swaps (CDSs), which are carried at fair value. The fair value of these CDSs, as well as the Group’s exposure to the risk of default by the underlying counterparties, depends on the valuation and the perceived credit risk of the instrument against which protection has been bought. Since 2007, monoline and other insurers and other market counterparties (including credit derivative product companies) have been adversely affected by their exposure to residential mortgage linked and corporate credit products. As a result, their actual and perceived creditworthiness deteriorated significantly in 2008 and may continue to be so impacted in 2009. If the financial condition of these counterparties or their actual and perceived creditworthiness deteriorates further, the Group may record further credit valuation adjustments on the CDSs bought from these counterparties in addition to those already recorded.
Some of the most significant market risks the Group faces are interest rate, foreign exchange, bond, equity and commodity price risks. Changes in interest rate levels, yield curves and spreads may affect the interest rate margin realised between lending and borrowing costs, the effect of which may be heightened during periods of liquidity stress, such as those experienced in recent months. Changes in currency rates, particularly in the sterling-US dollar and sterling-euro exchange rates, affect the value of assets, liabilities, income and expenses denominated in foreign currencies and the reported earnings of the Group’s non-UK subsidiaries (principally ABN AMRO, Citizens and RBS Greenwich Capital) and may affect income from foreign exchange dealing. The performance of financial markets may affect bond, equity and commodity prices and, therefore, cause changes in the value of the Group’s investment and trading portfolios. This has been the case during the period since August 2007, with market disruptions and volatility resulting in significant reductions in the value of such portfolios. While the Group has implemented risk management methods to mitigate and control these and other market risks to which it is exposed, it is difficult, particularly in the current environment, to predict with accuracy changes in economic or market conditions and to anticipate the effects that such changes could have on the Group’s financial performance and business operations or result in a loss of value in RBS shares.
The Group’s business performance could be adversely affected if its capital is not managed effectively.
The Group’s future earnings and financial condition in part depend on the success of the Group’s strategic refocus on core strengths and its disposal programme.
In addition to the effects of consolidation, increased government ownership of, and involvement in, banks generally may have an impact on the competitive landscape in the major markets in which the Group operates. Although, at present, it is difficult to predict what the effects of this increased government ownership and involvement will be or how it will differ from jurisdiction to jurisdiction, such involvement may cause the Group to experience stronger competition for corporate, institutional and retail clients and greater pressure on profit margins. Since the markets in which the Group operates are expected to remain highly competitive in all areas, these and other changes to the competitive landscape could adversely affect the Group’s business, margins, profitability and financial condition or result in a loss of value in RBS shares.
The Group has agreed to certain undertakings in relation to the operation of its business in the First Placing and Open Offer Agreement and the Second Placing and Open Offer Agreement.
Under the terms of the First Placing and Open Offer Agreement, the Group provided certain undertakings aimed at ensuring that the subscription by HM Treasury for the relevant Ordinary Shares and the Preference Shares and the Group’s potential participation in the guarantee scheme promoted by HM Treasury as part of its support for the UK banking industry is compatible with the common market under EU law. These undertakings include (i) supporting certain initiatives in relation to mortgage lending and lending to SMEs until 2011, (ii) regulating management remuneration and (iii) regulating the rate of growth of the Group’s balance sheet. These undertakings, while not having a material effect on the Group, may still serve to limit the Group’s operations. In addition, pursuant to the terms of the Second Placing and Open Offer Agreement, the Group is subject to further undertakings, which are (i) to extend the lending commitments made to HM Treasury in the First Placing and Open Offer Agreement and (ii) to increase the level at which competitively priced lending is made available and actively marketed by the Group in the United Kingdom by £6 billion.
The Group’s ability to implement its strategy depends on the ability and experience of its senior management and other key employees. The loss of the services of certain key employees, particularly to competitors, could have a negative impact on the Group’s business. The Group’s future success will also depend on its ability to attract, retain and remunerate competitively with its peers and retain highly skilled and qualified personnel, which cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management compensation arrangements, in particular those in receipt of Government funding (such as the Group). The Group recently announced changes to its compensation structure which included significant reductions in bonuses to be paid in respect of 2008, and limitations on pay rises in 2009. Details of these changes are outlined in the letter from the Chairman of the Remuneration Committee on page 159. In addition to the effects of such measures on the Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could prevent the Group from successfully implementing its strategy, which could have a material adverse effect on the Group’s financial condition and results of, operations or result in a loss of value in RBS shares.
The Group is subject to financial services laws, regulations, administrative actions and policies in each location in which it operates. All of these are subject to change, particularly in the current market environment, where there have been unprecedented levels of government intervention and changes to the regulations governing financial institutions, including recent nationalisations in the United Kingdom, the United States and other European countries. As a result of these and other ongoing and possible future changes in the financial services regulatory landscape (including requirements imposed by virtue of the Group’s participation in any government or regulator-led initiatives), the Group expects to face greater regulation in the United Kingdom, the United States, the Netherlands and other countries in which it operates, including throughout the rest of Europe. Compliance with such regulations may increase the Group’s capital requirements and costs and have an adverse impact on its business, the products and services it offers and the value of its assets or result in a loss of value in RBS shares.
The Group’s results have been and could be further adversely affected in the event of goodwill impairment.
The Group is and may be subject to litigation and regulatory investigations that may impact its business.
Operational risks are inherent in the Group’s operations. The Group’s operations are dependent on the ability to process a very large number of transactions efficiently and accurately while complying with applicable laws and regulations where it does business. The Group has complex and geographically diverse operations and operational risk and losses can result from internal or external fraud, errors by employees or third-parties, failure to document transactions properly or to obtain proper authorisation, failure to comply with applicable regulatory requirements and conduct of business rules (including those arising out of anti-money laundering and anti-terrorism legislation), equipment failures, natural disasters or the inadequacy or failure of systems and controls, including those of the Group’s suppliers or counterparties. Although the Group has implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures and identifying and rectifying weaknesses in existing procedures and to training staff, it is not possible to be certain that such actions have been or will be effective in controlling each of the operational risks faced by the Group. Any weakness in these systems or controls, or any breaches or alleged breaches of applicable laws or regulations could have a materially negative impact on the Group’s business, reputation, results of operations and share price. Notwithstanding anything contained in this risk factor, it should not be taken as implying that either the company or the Group will be unable to comply with its obligations as a company with securities admitted to the Official List or as a supervised firm regulated by the FSA.
The acquisition of a majority shareholding in the Group by HM Treasury could lead to certain adverse tax consequences for the Group. The acquisition by HM Treasury of a majority shareholding in the Group in consequence of the First Placing and Open Offer could, in certain circumstances, have adverse tax consequences which could affect the post-tax profitability of the Group.
In the United Kingdom, the Financial Services Compensation Scheme (the “Scheme”) was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. The Scheme can pay compensation to customers if a firm is unable, or likely to be unable, to pay claims against it and, if the Banking Bill is enacted in its current form, may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under that Bill. The Scheme is funded by levies on firms authorised by the FSA, including the Group. In the event that the Scheme raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have a material impact on its results of operations and financial condition. During the financial year ended 31 December 2008, the Group made a provision of £150 million related to a levy by the Scheme.
The performance of the Group is significantly influenced by the geopolitical and economic conditions prevailing at any given time in the countries in which it operates, particularly the United Kingdom, the United States and other countries in Europe and Asia. For example, the Group has a presence in countries where businesses could be exposed to the risk of business interruption and economic slowdown following the outbreak of a pandemic, or the risk of sovereign default following the assumption by governments of the obligations of private sector institutions. Similarly the Group faces the heightened risk of trade barriers, exchange controls and other measures taken by sovereign governments which may impact a borrower’s ability to repay. Terrorist acts and threats and the response to them of governments in any of these countries could also adversely affect levels of economic activity and have an adverse effect upon the Group's business.
The restructuring plan in place for the integration and separation of ABN AMRO into and among the businesses and operations of the consortium members is complex, involving substantial reorganisation of ABN AMRO’s operations and legal structure. In addition, the plan contemplates activities taking place simultaneously in a number of businesses and jurisdictions. Although integration efforts are well underway and are being advanced on a number of fronts, the implementation of the reorganisation and the realisation of the forecast benefits within the planned timescales, particularly given current market and economic conditions, remains challenging, although the Group remains confident that such goals will be achieved. Execution of the restructuring requires management resources previously devoted to the Group businesses and the retention of appropriately skilled ABN AMRO staff. The Group may not realise the benefits of the acquisition or the restructuring when expected or to the extent projected. It is not expected that the State of the Netherlands’ acquisition of Fortis Bank Nederland’s shares in RFS Holdings, which was effected in December 2008, will materially affect the integration benefits envisaged by the Group.
Notes: (1) Pro forma total income excludes credit market write-downs and one-off items and share of shared assets. In the statutory consolidated income statement on page 174, these items are included in total income.
(3) Pro forma excludes write-down of goodwill and other intangible assets.
(7) 2008 data are on a Basel II basis; data for 2007 are on a Basel I basis.
Overview of results As discussed on page 24, the results of ABN AMRO are fully consolidated in the Group’s financial statements. Consequently, the statutory results of RBS for the year ended 31 December 2007 and 2008 include the results of ABN AMRO for 76 days and the full year respectively. The interests of the State of the Netherlands and Santander in RFS Holdings are included in minority interests.
Summary consolidated income statement for the year ended 31 December 2008 In the pro forma income statement set out below credit market writedowns and one-off items, amortisation of purchased intangible assets, write-down of goodwill and other intangible assets, integration costs, restructuring costs and share of shared assets are shown separately. In the statutory consolidated income statement set out below and on page 174, these items are included in non-interest income, operating expenses and impairment, as appropriate.
Amortisation of purchased intangible assets 443 124 — — Integration costs 1,050 108 — — Restructuring costs 307 — — — Share of shared assets 300 94 — — (Loss)/profit before tax (8,127) 8,962 (40,667) 9,832
(Loss)/profit after tax from continuing operations (6,847) 7,253 (38,344) 7,788 Profit/(loss) from discontinued operations, net of tax — — 3,971 (76) (Loss)/profit for the year (6,847) 7,253 (34,373) 7,712
(Loss)/profit attributable to ordinary shareholders before write-down of goodwill and other intangible assets (7,855) 6,823 (24,137) 7,303 Write-down of goodwill and other intangible assets, net of tax (16,196) — — —
After tax, minority interests and preference share dividends, the loss attributable to ordinary shareholders was £24,051 million, compared with an attributable profit of £6,823 million in 2007.
Total income Total income, excluding credit market write-downs and one-off items, declined by 20% to £26,875 million, with a significant deterioration experienced during the second half of the year principally as a result of £5.8 billion of trading asset write-downs, counterparty failure and incremental reserving within GBM. While income increased in 2008 in Global Transaction Services, and held steady in Regional Markets and Insurance, a significant reduction occurred in Global Banking & Markets, where a strong performance in rates, currencies and commodities was offset by marked deterioration in credit markets and equities.
Net interest income Net interest income increased by 29% to £15,939 million, with average loans and advances to customers up 17% and average customer deposits up 6%. Group net interest margin rose from 2.00% to 2.10% largely reflecting the success of the rates business in a declining interest rate environment. However, margins tightened within Regional Markets as market interest rates fell, with deposit markets remaining competitive and price adjustments on lending taking some time to feed through to the back book.
Operating expenses Total operating expenses were reduced by 4% to £15,916 million, with cost growth in the Group’s core retail and commercial banking franchises offset by efficiency programmes and a significant reduction in Global Banking & Markets staff costs. The Group cost:income ratio deteriorated to 59.2%, compared with 49.5% in 2007, largely reflecting the impact on income of the year’s difficult market conditions.
Write-down of goodwill and other intangible assets After reviewing the carrying value of goodwill and other purchased intangible assets, the Group has recorded an impairment charge of £16,196 million, net of a tax credit of £715 million. Of this charge, £7,678 million relates to part of the goodwill in respect of the acquisition of ABN AMRO, while other significant impairments have been recorded on part of the Citizens/Charter One goodwill of £4,382 million, part of the NatWest goodwill (principally allocated to Global Banking & Markets) of £2,742 million and other goodwill of £720 million. Other intangible asset impairments of £1,389 million principally relate to the write-down in the value of customer relationships recognised on the acquisition of ABN AMRO.
Taxation The Group recorded a tax credit of £1,280 million in 2008, compared with a tax charge of £1,709 million in 2007.
Earnings Basic earnings per ordinary share decreased from 40.8p to (61.0p). Adjusted earnings per ordinary share fell from 44.5p to a loss of 5.2p per share. The number of shares in issue increased to 39,456 million at 31 December 2008, compared with 10,006 million in issue at 31 December 2007, reflecting the Group’s capital raisings in June and December and the capitalisation issue in lieu of the interim dividend for 2008.
Loans and advances to customers were up £31.0 billion, 4%, at £731.2 billion. Within this, reverse repos decreased by 72%, £102.8 billion to £39.3 billion. Excluding reverse repos, lending rose by £133.8 billion, 24% to £691.9 billion reflecting both organic growth of £44.8 billion, 7% and the effect of exchange rate movements of £89.0 billion following the weakening of sterling during the second half of 2008.
On a proportionally consolidated basis, the Group’s Core Tier 1 ratio at 31 December 2008 was 6.1%, compared with 4.0% at 1 January 2008, on a Basel II basis. The Tier 1 ratio was 9.9% at 31 December 2008 (6.8% at 1 January 2008) and the total capital ratio 14.2% (10.9% at
Non-interest income decreased to £7,193 million principally due to the credit market write-downs of £7,781 million offset by a movement in the fair value of own debt of £1,232 million, and represents 28% of total
Impairment losses Impairment losses were £8,072 million, compared with £1,968 million in 2007.
Taxation The effective tax rate for 2008 was 5.7% compared with 20.8% in 2007.
Earnings Basic earnings per ordinary share decreased from 64.0p to a loss of 145.7p.
Capital ratios at 31 December 2008 were 6.8% (Core Tier 1), 10.0% (Tier 1) and 14.1% (Total).
Gross yield on interest-earning assets of the banking business (3) 5.69 6.16 5.63 6.21 Cost of interest-bearing liabilities of the banking business (3.83) (4.55) (3.81) (4.36) Interest spread of the banking business (4) 1.86 1.61 1.82 1.85 Benefit from interest-free funds 0.24 0.39 0.23 0.42 Net interest margin of the banking business (5) 2.10 2.00 2.05 2.27
The Royal Bank of Scotland plc base rate (average) 4.67 5.51 4.67 5.51 London inter-bank three month offered rates (average): Notes: (1) Interest-earning assets and interest-bearing liabilities exclude the Retail bancassurance assets and liabilities attributable to policyholders, in view of their distinct nature. As a result, net interest income has been adjusted by £84 million (2007 – £85 million).
(2) Interest income has been adjusted by £332 million (2007 – £313 million) and interest expense by £860 million (2007 – £536 million) to record interest on financial assets and liabilities designated as at fair value through profit or loss. Related interest-earning assets and interest-bearing liabilities have also been adjusted.
Assets Loans and advances to banks – UK 18,909 939 4.97 22,172 1,066 4.81
Total interest-earning assets 1,162,626 1,060,524 Non-interest-earning assets (2, 3) 661,549 372,688
Customer accounts: demand deposits – UK 99,852 2,796 2.80 95,379 3,369 3.53
Customer accounts: savings deposits – UK 42,870 1,691 3.94 36,519 1,655 4.53
Debt securities in issue – UK 111,099 4,617 4.16 67,651 3,595 5.31
Internal funding of trading business – UK (85,664) (3,445) 4.02 (59,334) (2,956) 4.98
Total interest-bearing liabilities 1,157,285 1,021,508 Non-interest-bearing liabilities: Demand deposits – UK 24,300 20,421
(2) Interest-earning assets and interest-bearing liabilities exclude the Retail bancassurance assets and liabilities attributable to policyholders, in view of their distinct nature. As a result, net interest income has been adjusted by £84 million (2007 – £85 million).
Assets Loans and advances to banks – UK 18,909 943 4.99 20,999 1,028 4.90
Customer accounts: demand deposits – UK 99,852 2,829 2.83 93,764 3,296 3.52
Total interest-bearing liabilities – banking business (2, 3) 832,350 31,707 3.81 474,691 20,719 4.36
Analysis of change in net interest income – volume and rate analysis Volume and rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and rate are allocated pro rata to volume and rate movements.
Note: (1) Pro forma excludes credit market write-downs and one-off items.
Within non-interest income, fees and commissions receivable decreased by £332 million, 3%, to £8,839 million, while fees and commissions payable increased by £244 million, 11%, to £2,391 million.
Income from trading activities was down £6,455 million to a loss of £1,647 million. Currency trading activities benefitted from increased volatility in the markets. However, this improvement was more than offset by credit markets write downs and reduced interest rate income impacted by the reduction of base interest rates.
2008 compared with 2007 – statutory Non-interest income, decreased by 61%, £11,104 million to £7,193 million. Non-interest income was severely affected by the weakness in financial markets experienced over the course of the year. While the decline was particularly marked in Global Banking & Market's credit markets and equities businesses, with reduced business volumes and mounting mark-to-market trading losses, Regional Markets also saw non-interest income fall in the latter part of the year as declining consumer confidence led to lower demand for credit and other financial products.
Within non-interest income, fees and commissions receivable increased by 19% or £1,553 million, to £9,831 million, while fees and commissions payable increased by 9%, £193 million to £2,386 million.
Income from trading activities was down from £1,292 million to a loss of £8,477 million. Currency trading activities benefited from increased volatility in the markets. However, this improvement was more than offset by substantial credit markets write downs during the year.
Other operating income also decreased, falling by 61%, £2,934 million to £1,899 million. This was principally due to a fall in the fair value of securities and other financial assets and liabilities partially offset by profits from the sale of subsidiaries and associates.
Insurance premium income, after reinsurance, increased by 4% to £6,326 million primarily reflecting a full year of ABN AMRO businesses in comparison with 76 days in 2007. This was partly offset by the discontinuation of less profitable partnership contracts.
Net Write-downs Average Net Average exposure (1) before tax price exposure(1) price
Additional disclosures on these and other related exposures can be found in the rest of this document as follows: Disclosure Section Sub-section Page Further analysis (1) Risk management Credit market and related disclosures 122 – 144 Valuation aspects (1) Financial statements Note 11 Financial instruments 201 – 206 Valuation of financial instruments (1) Financial statements Critical accounting policies 186 – 187 (general and level 3) Note 11 Financial instruments 199 – 206 Reclassification of financial instruments Financial statements Note 11 Financial instruments 208 Asset-backed CDOs Risk management Market risk 109
Administrative expenses: Write-down of goodwill and other intangible assets — — 32,581 —
At Currency Charge Utilised At 31 December translation to income during 31 December 2007 adjustments statement the year 2008 £m £m £m £m £m
Business review continued 2008 compared with 2007 – pro forma Credit impairment losses (excluding reclassified assets) increased to £6,962 million in 2008, compared with £2,104 million in 2007. The Group experienced a pronounced deterioration in impairments during the year, as financial stress spread to a broad range of customers. The greatest increase in impairments occurred in Global Banking & Markets. However, the Regional Markets businesses in all geographies also experienced a noticeable increase in impairments during the year, particularly in the UK SME and US personal segments.
Total provision coverage (the ratio of total balance sheet provisions for impairment to total risk elements in lending) decreased from 60% to 50%. The ratio of total balance sheet provisions for impairment to total risk elements in lending and potential problem loans also decreased to 50% compared with 59% in 2007.
Total provision coverage (the ratio of total balance sheet provisions for impairment to total risk elements in lending) decreased from 60% to 52%. The ratio of total balance sheet provisions for impairment to total risk elements in lending and potential problem loans also decreased to 51% compared with 57% in 2007.
Impairment Pro forma (1) Statutory £m £m £m £m less: recoveries of amounts previously written-off (261) (275) (319) (342) Charge to income statement 6,962 2,104 8,072 1,968
The actual tax charge differs from the expected tax charge computed by applying the standard rate of UK corporation tax as follows: Pro forma Statutory £m £m £m £m
On a statutory basis, the effective tax rate for the year was 5.7% (2007 – 20.8%). The tax credit is lower than that arising from applying the standard rate of UK corporation tax of 28.5% to the loss for the period, principally due to non-deductible goodwill impairment and certain carried forward losses on which no tax relief has been recognised. The effective tax rate on a pro forma basis was 15.7% (2007 – 19.1%).
Total Global Markets (excluding credit market write-downs and one-off items) (2,231) 5,839 (8,697) 4,968 Regional Markets UK Retail & Commercial Banking 3,283 3,985 5,679 6,225 US Retail & Commercial Banking 524 1,143 883 1,479 Europe & Middle East Retail & Commercial Banking 70 463 429 769 Asia Retail & Commercial Banking (113) (20) 127 91
Group Manufacturing — — (4,793) (3,773) Central items (excluding one-off items) (2,233) (1,777) (675) (552) Share of shared assets — — (300) (73) RFS Holdings minority interest — — 41 163
Credit market write-downs and one-off items (6,107) (1,026) — — Amortisation of purchased intangibles — — (443) (262) Integration and restructuring costs — — (1,357) (108) Write-down of goodwill and other intangible assets — — (32,581) — Group operating (loss)/profit (6,027) 9,288 (40,667) 9,832
Risk-weighted assets of each division were as follows: Basel II Basel II Basel I 31 December 1 January 31 December £bn £bn £bn
Global Markets – Global Banking & Markets Pro forma Statutory £m £m £m
Allocation of manufacturing costs (1) 479 448 — Operating (loss)/profit (10,994) 3,203 3,653
Total third party assets (excluding derivatives mark to market) 691.9 873.8 873.9 Net derivative assets (after netting) 146.0 64.1 64.1 Customer deposits (excluding repos) 105.0 106.7 106.7 Non-performing loans 6.2 1.0 1.0 * includes fair value of own debt but excludes reclassified asset impairments.
In a reduced market for debt origination, credit markets improved its market positions in a number of key areas such as international bond issuance. Results, however, were severely affected by the continuing market weakness, with income, even excluding write-downs on previously disclosed credit market exposures and one-off items, falling by 50% to £1,366 million.
GBM’s total third party assets were reduced by £182 billion to £692 billion at 31 December 2008, a reduction of 21% from a year earlier, or 31% at constant exchange rates. Within this total, loans and advances to customers were £354 billion, an increase of 14% at constant exchange rates. This increase was more than offset by significant reductions in reverse repos and securities holdings, both of which have been managed down over the course of the year. Net derivative assets totalled £146 billion, compared with £64 billion at the end of 2007.
Globally, the intention is for GBM to move increasingly towards a “huband -spoke” model. Risk will be managed from regional hubs. It is intended that distribution and coverage will be delivered from a mix of hub countries and a scaled-back presence in some local offices. The aim, over time, will be to reduce much of the on-shore trading activity outside the key financial centres.
Total income before credit market write-downs and one-off items and trading asset write-downs was £10,214 million, up 19%. The increase reflects good performances in a number of businesses, most notably in rates and currencies and the inclusion of the ABN AMRO businesses for a full twelve months. After credit market write-downs and one-off items and trading asset write-down, GBM recorded negative income of £2,520 million. Direct costs were up by 40%, with the inclusion of the acquired business of ABN AMRO for a full year outweighing reduced bonus payments. Credit impairments rose sharply from a very low level (£67 million) to £3,177 million, resulting in a 2008 operating loss of £10,994 million.
Total third party assets 24.0 22.5 22.5 Loans and advances 18.6 18.7 18.7
2008 compared with 2007 – pro forma Global Transaction Services grew income by 12% to £2,472 million and operating profit by 12% to £1,339 million for the full year 2008, reflecting the strength and enhanced international capability of its cash management, trade finance and merchant acquiring platforms. The income growth rate was maintained in the second half of the year, despite difficult market conditions.
Growth was driven by a strong performance in cash management, where income rose 9% to £1,514 million with good growth in international cash management markets and steadier growth in UK and US domestic markets. Average customer deposits were 14% higher mitigating the impact of lower interest rates. International overdrafts have been re-priced, reflecting the increased cost of funds and higher risk premia during the second half of the year. Fee income from payment transactions increased strongly, particularly in the US and internationally. The division was successful throughout the year in winning new international cash management mandates from existing RBS Group clients due to the strength of the international payments platform and network.
Merchant services and commercial cards delivered a 6% increase in income to £694 million. Acquiring transaction volumes were up 23% in the year driven by good growth in online volumes, but weaker consumer confidence in the latter part of the year meant that average transaction values decreased, slowing income growth. Commercial cards income saw strong second half growth of 26% and rose 16% for the full year, driven by higher interchange income particularly in the small and middle markets.
Direct expenses rose by 9% to £594 million, with second half cost growth lower than the first half. The full year cost growth reflected investment in staffing and infrastructure to support GTS’s development.
Impairment losses were £60 million, up from £15 million in 2007, reflecting in particular the downturn in the global economy and some growth in defaults amongst mid-corporates and SMEs.
Direct expenses rose by 32% to £594 million, reflecting the full year costs of the ABN AMRO business.
Impairment losses were £60 million, up from £14 million in 2007, reflecting in particular the downturn in the global economy and some growth in defaults amongst mid-corporates and SMEs.
Total banking assets 249.4 232.8 232.8 Loans and advances to customers – gross – UK Retail Banking 117.5 111.0 111.0 – UK Corporate & Commercial Banking 110.4 99.3 99.3
Net interest income 4,390 4,172 4,172 Net fees and commissions – banking 2,186 2,351 2,351 Other non-interest income* 218 271 271 Non–interest income 2,404 2,622 2,622
Investment management assets – excluding deposits 5.7 7.0 7.0 Non-performing loans 4.8 4.3 4.3 * net of insurance claims ** customer deposits exclude bancassurance 2008 compared with 2007 – pro forma and statutory Despite an economic environment which became markedly weaker in the second half of the year, UK Retail Banking, which includes both personal and small business banking, held income and direct costs in line with 2007. However the deterioration in the macroeconomic environment resulted in an 8% increase in impairment losses. Consequently, operating profit decreased 12%, £243 million, to £1,764 million. In the personal segment, RBS retained top position and NatWest was again joint second for customer satisfaction amongst main high street banks. The business segment has continued to grow, maintaining market leadership with a share of 26%, alongside 23% of the start-up market. UK Retail continues to maintain availability of lending while managing risk exposure and focusing on supporting customers through a difficult economic environment.
UK Retail mortgage balances grew 11% despite more muted demand in the second half, and net mortgage lending market share increased to 19% (2007 – 2%). Small business lending grew 7% despite a significant contraction in demand. Personal unsecured lending slowed, however, particularly in the second half of the year. Further, the sale of Tesco Personal Finance (TPF) reduced personal unsecured balances at 31 December 2008 by £1.9 billion, though income of £285 million from TPF was included up to the date of the sale completion on 19 December.
Non-interest income net of claims declined 8% to £2,404 million. Bancassurance sales grew 3% to £353 million annual premium equivalent in the year however the negative performance of debt and equity markets reduced investment income by £48 million. Excluding this, underlying non-interest income declined 6% reflecting reduced demand for unsecured lending and lower sales of payment protection insurance.
Direct expenses increased 1% to £1,832 million. Direct staff costs reduced 1% reflecting increased efficiency. Other direct costs rose by 5% as a result of increased investment in selected business lines.
During 2008 the division almost doubled the number of branches open on a Saturday and introduced 1,000 MoneySense advisers into branches to provide impartial advice to customers on managing their money.
Impairment losses increased 8% to £1,281 million, with an increase in small business delinquencies and personal impairments reflecting the changed economic environment, particularly in the second half. In the small business segment impairments increased to £158 million (2007 – £80 million). In the personal segment the increase in impairments has been more modest, with mortgage impairment charges at £33 million (2007 – £21 million) on a total book of £74.9 billion, while unsecured personal lending impairments remained level with 2007 at £1,091 million (2007 – £1,084 million). Higher Loan-to-Value ratio mortgages have been restricted and affordability criteria tightened. The average LTV for new business was 67% (2007 – 62%). Repossessions represented 0.06% of outstanding mortgage balances at 31 December 2008, compared with a Council of Mortgage Lenders’ average at December
Average deposit balances increased 3%. The deposit market continues to see acute competition in a number of sectors affecting margins. Overall net interest margin decreased from 2.39% to 2.15% due to increased funding and liquidity costs and strong growth in relatively lower margin Corporate products.
Direct expenses increased 13% to £1,015 million, reflecting a 26% rise in operating lease depreciation to £401 million, due to higher volumes as well as additional provisions of £54 million for lower residual values in the Lombard vehicle leasing business. Direct expenses, excluding operating lease depreciation, increased by 6% to £614 million with cost growth reflecting the recruitment of additional relationship managers in 2007.
RWA growth has been constrained by improvements in Basel II methodologies and active risk management, which have offset growth in the underlying balance sheet and the impacts of procyclicality.
Net interest income 2,130 1,990 1,990 Net fees and commissions 450 425 425 Other non-interest income 581 592 592 Non–interest income 1,031 1,017 1,017
Business review continued 2008 compared with 2007 – pro forma and statutory UK Wealth delivered robust growth, with total income increasing by 9% to £859 million and operating profit increasing by 5% to £403 million.
Direct expenses rose by 13% to £324 million partly due to increased headcount and higher deposit protection scheme contributions.
Impairments rose from £4 million in 2007 to £12 million and represented approximately 0.1% of the total UK lending book.
Regional Markets – US Retail & Commercial Banking Pro forma Statutory £m £m £m
Overall, net interest income grew modestly, offset by a small decline in non-interest income. Average loans and advances to retail customers decreased as a result of the slowing economy and tighter underwriting standards, but this decline was offset by continued strong growth in corporate and commercial lending. Core customer deposits declined by 5% and the division further reduced its reliance on brokered deposits by 80%, leading to an overall decline of 11% in total customer deposits. Net interest margin was held steady at 2.73%, reflecting widening asset margins and management of savings rates in a competitive deposit market.
In the core US Retail & Commercial portfolio, 2008 impairment losses totalled $1,337 million, with a marked increase in the second half. Consumer non-performing loans represented 0.37% of core home equity balances and 1.20% of residential mortgage balances. While there has been a decline in some customers’ credit scores in line with weakening economic conditions, refreshed weighted average FICO scores for consumer real estate-secured lending at 31 December 2008 was approximately 740 with a weighted average LTV of 63%. Stress has emerged in all consumer segments during the second half of the year, with increased delinquency in core home equity (up 10bps to 0.86%), and auto (up 94bps to 2.78%). US Retail & Commercial does not originate negative amortization mortgages or option adjustable rate mortgages. Closing provision balances for the core portfolio were $1,303 million compared with $777 million at the end of 2007.
The overall commercial loan portfolio has begun to show signs of stress, with a marked deterioration in the commercial real estate book. Impairments in the commercial and industrial portfolio, including lease financing, totalled $212 million, or 0.74% of balances. Total impairments within the commercial real estate portfolio were $177 million, or 1.63% of balances.
Regional Markets – Europe & Middle East Retail & Commercial Banking Pro forma Statutory £m £m £m
Net interest income 1,152 1,066 1,014 Net fees and commissions 320 265 219 Other non-interest income 46 107 113 Non-interest income 366 372 332
Ulster Bank operating profit fell 76% to £117 million. Total income decreased by 2% to £1,269 million; net interest income increased by 1%, with average loans and advances to customers up 12% in the year. The benefit from the growth in lending, particularly in the first half of the year has been offset by increased funding costs associated with the wholesale funding market dislocation. Other income was 12% lower than in 2007, reflecting a slowdown in particular in the bancassurance and wealth businesses.
Average deposit balances in Ulster Bank were largely flat year-on-year reflecting the highly competitive market for resources in Ireland in 2008. Deposit flows in Ulster Bank were strong in the latter part of the year and into the early months of 2009. During 2008, we opened 119,000 new current accounts driven by particularly successful current account switcher and student campaigns.
Impairment losses in Ulster Bank rose to £394 million, reflecting the impact on credit quality of the slowdown in the Irish economy, with the final quarter showing notable decline in both activity and sentiment. This was reflected in a significantly increased flow of cases into the problem debt management process.
Ulster Bank has launched a series of initiatives to support its customers in this difficult economic period. We announced in February 2009 that we will be making significant funds available to the Northern Ireland (‘NI’) SME market. A similar announcement will be made in the coming weeks regarding the RI SME market. Ulster Bank has also indicated that it is adopting the RBS Group pledge regarding certainty of overdraft limits for this sector.
2008 compared with 2007 – statutory Total income was up £172 million, 13% at £1,518 million benefiting from the full year of the ABN AMRO businesses and movements in exchange rates. Direct expenses rose by £104 million, 23%.
Loans and advances to customers – gross 5.8 4.5 4.5 Investment management assets – excluding deposits 21.2 19.9 19.9
Non-performing loans 0.3 0.5 0.5 2008 compared with 2007 – pro forma Asia Retail & Commercial Banking increased income by 12% to £781 million, but the continued deterioration in market conditions during the second half of the year resulted in an operating loss of £113 million. Comparisons with the previous year are affected by the marked weakening of sterling over the course of the year.
Credit cards and consumer finance credit metrics have continually been reviewed over the period resulting in further tightening of consumer lending policies. This has led to lower levels of card and loan acquisition. There has also been a slowdown in the number of card transactions. Despite this, the cards and consumer finance business reported income growth of 20% with a corresponding increase in consumer net receivables.
Business banking has seen strong growth across most regions with revenue increasing by 28%, having performed particularly well in the Indian, Pakistani and Chinese markets.
Direct expenses rose by 30% to £483 million, reflecting higher collection costs and continued investment in the Group’s infrastructure in the region, including the recruitment of additional experienced private bankers in RBS Coutts Asia.
Strategic review Asia Retail & Commercial Banking has operations in a number of countries across the region. However the franchise is thinly spread and in general has not yet achieved significant scale. The Retail and Commercial businesses in Asia will be transferred to the non-core division. We have commenced a review to consider future options for these businesses, including options for sale. RBS Coutts will remain a core business.
2008 compared with 2007 – statutory Total income rose by £426 million to £781 million largely reflecting the full year contribution from the acquired ABN AMRO businesses.
General insurance reserves – total (£m) 8,159 8,192 8,192 2008 compared with 2007 – pro forma and statutory RBS Insurance made good progress in 2008, with operating profit rising by £99 million to a record £780 million, an increase of 15%. Excluding the net impact of the 2007 floods and prior year reserve releases, operating profit grew by 6%. Total income was £90 million lower at £5,566 million, reflecting a fall in insurance premium income following the continuation of the strategic decision to exit less profitable partnership contracts and the effect of financial market conditions on investment income.
For RBS Insurance as a whole, insurance premium income, net of fees and commissions, was broadly maintained at £4,892 million, reflecting 7% growth in the Group’s own brands offset by a 10% decline in the partnerships and broker segment. Other income declined by 8% to £674 million, reflecting the effect of depressed financial markets on investment income.
Direct expenses grew by 4% to £771 million, in part as a result of accelerated marketing development in own brands, including the launch of Direct Line for Business.
Net claims fell by 7% to £3,733 million, benefiting from ongoing claims containment and more benign weather conditions. Impairments of £42 million reflect impairments recognised in corporate bond and equities investment portfolios.
The UK combined operating ratio for 2008, including manufacturing costs, decreased to 93.8% from 98.0%.
Strategic review The Group has decided to retain RBS Insurance, reflecting the strength of its franchise as the leading UK personal lines insurer. It provides high quality earnings, which are differentiated from the Group’s banking businesses, providing valuable diversity and strong returns. The business plans to pursue additional growth opportunities through building its position in the online insurance aggregator channel, through the bank channels and in the commercial market. The business retains competitive advantage through its market leading brands, low cost operating model and the benefits of scale on its claims costs.
Total manufacturing costs 4,793 4,481 3,773 Allocated to divisions (4,793) (4,481) —
— — 3,773 Analysis of manufacturing costs: Technology Services and support functions 1,757 1,717 1,336
Increasing business volumes have been absorbed through improvements in productivity. Group Manufacturing has maintained high levels of customer satisfaction while continuing to invest in the further development of the business. Staff costs reduced by 2% (7% reduction at constant exchange rates) primarily reflecting improvements in productivity.
Technology Services and support functions costs increased by 2% (reduced by 3% at constant exchange rates) with increases in business demand balanced by savings delivered across the business.
Global Operations costs increased by 5% (2% at constant exchange rates). Further improvements in productivity enabled us to continue to absorb increases in volumes and global inflationary pressure. Ongoing investment in process re-engineering across our operational centres under the ‘Work-Out’ banner continues to deliver efficiency gains.
2008 compared with 2007 – statutory Group Manufacturing costs increased by 27% to £4,793 million in 2008. This growth reflects the inclusion of a full year of ABN AMRO related costs (£937 million) in 2008 whereas 2007 includes only the post acquisition element of costs (£193 million).
Other corporate costs amounted to a net credit of £1,320 million, compared with a net credit of £509 million in 2007. The increase reflects higher gains in the fair value of own debt and the profit on sale of Tesco Personal Finance in 2008.
Liabilities of disposal groups — 6 859 29,228 Share of shared assets 2,047 27,222 — —
Reverse repurchase agreements and stock borrowing Loans and advances to banks 58,771 174,444 58,771 175,941 Loans and advances to customers 39,289 142,116 39,313 142,357
Overview of condensed consolidated balance sheet – pro forma Total assets of £2,218.7 billion at 31 December 2008 were up £623.6 billion, 39%, compared with 31 December 2007. At constant exchange rates the increase was £313 billion or 16%.
Loans and advances to banks decreased by £81.6 billion, 39%, to £129.4 billion. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were down by £115.7 billion, 66% to £58.8 billion. Excluding reverse repos, bank placings increased by £34.1 billion, 93%, to £70.6 billion.
Debt securities increased by £12.3 billion, 5%, to £253.1 billion and equity shares decreased by £24.6 billion, 53%, to £22.1 billion principally due to changes in Global Banking & Markets.
Intangible assets declined by £11.2 billion, 41% to £16.4 billion, reflecting an impairment of £16.9 billion partially offset by exchange rate movements of £5.7 billion and goodwill of £0.2 billion arising on the Sempra joint venture.
Prepayments, accrued income and other assets were up £4.1 billion, 25% to £20.7 billion.
Deferred taxation liabilities decreased by £0.8 billion, 21% to £2.9 billion due in part to the sale of Angel Trains.
Subordinated liabilities were up £15.6 billion, 56% to £43.7 billion reflecting the issue of £2.0 billion dated loan capital, the allocation of £6.5 billion ABN AMRO subordinated liabilities from consortium shared assets, and the effect of exchange rate and other adjustments, £8.1 billion, partially offset by the redemption of £1.0 billion of dated loan capital.
Owners’ equity increased by £5.8 billion, 11% to £58.9 billion. Net proceeds of £12.0 billion from the rights issue, and net proceeds of £19.7 billion from the placing and open offer, together with exchange rate movements of £6.8 billion were partially offset by the attributable loss for the period of £23.5 billion, a £4.6 billion decrease in availablefor -sale reserves, net of tax, reflecting £1.0 billion in the Group’s share in the investment in Bank of China and £3.6 billion in other securities, the majority of which related to Global Banking & Markets, actuarial losses net of tax of £1.3 billion, the payment of the 2007 final ordinary dividend of £2.3 billion and other dividends of £0.6 billion, and a reduction in the cash flow hedging reserve of £0.3 billion.
Overview of consolidated balance sheet – statutory Total assets of £2,401.7 billion at 31 December 2008 were up £560.8 billion, 30%, compared with 31 December 2007.
Debt securities decreased by £27.1 billion, 9%, to £267.5 billion and equity shares decreased by £26.7 billion, 50%, to £26.3 billion principally due to lower holdings in Global Banking & Markets.
Movements in the value of derivatives, assets and liabilities, primarily reflect changes in interest and exchange rates, together with growth in trading volumes.
Deferred tax assets increased £4.0 billion to £7.1 billion principally due to carried forward trading losses.
Prepayments, accrued income and other assets were up £8.7 billion, 56% to £24.4 billion.
Assets and liabilities of disposal groups decreased following completion of the sales of the Asset Management business of ABN AMRO to Fortis, Banca Antonveneta to Monte dei Paschi di Sienna and the majority of ABN AMRO’s Private Equity business to third parties.
Deposits by banks declined by £54.3 billion, 17% to £258.0 billion. This reflected decreased repurchase agreements and stock lending (‘repos’), down £79.4 billion, 49% to £83.7 billion partly offset by increased inter-bank deposits, up £25.1 billion, 17% to £174.4 billion.
Deferred taxation liabilities decreased by £1.2 billion, 23% to £4.2 billion due in part to the sale of Angel Trains.
Subordinated liabilities were up £11.1 billion, 29% to £49.2 billion. The issue of £2.4 billion dated loan capital and the effect of exchange rate and other adjustments, £11.3 billion, were partially offset by the redemption of £1.6 billion of dated loan capital, £0.1 billion undated loan capital and £0.9 billion in respect of the disposal of the Banco Real and other businesses of ABN AMRO to Santander.
Owners’ equity increased by £5.8 billion, 11% to £58.9 billion. Proceeds of £12.0 billion from the rights issue, net of £246 million expenses, and £19.7 billion from the placing and open offer, net of expenses of £265 million, together with exchange rate movements of £6.8 billion were partially offset by the attributable loss for the period of £23.5 billion, a £4.6 billion decrease in available-for-sale reserves, net of tax, reflecting £1.0 billion in the Group’s share in the investment in Bank of China and £3.6 billion in other securities, the majority of which related to Global Banking & Markets, actuarial losses net of tax of £1.3 billion, the payment of the 2007 final ordinary dividend of £2.3 billion and other dividends of £0.6 billion, and a reduction in the cash flow hedging reserve of £0.3 billion.
Proceeds on disposal of discontinued activities of £20,113 million was the largest element giving rise to net cash flows of investing activities of £16,997 million. Outflow from net purchases of securities of £1,839 million and net disposals of property, plant and equipment, £3,529 million less the net cash inflow of £2,252 million in respect of other acquisitions and disposals represented the other principle factors.
The major factors contributing to the net cash inflow from operating activities of £25,604 million were the increase of £28,261 million in operating liabilities less operating assets and the profit before tax of £9,900 million, partly offset by the elimination of foreign exchange differences of £10,282 million and income taxes paid of £2,442 million.
Risk-weighted assets Credit risk 551,400 Counterparty risk 61,100 Market risk 46,500 Operational risk 36,800
(2) The data for 2004 are under UK GAAP as previously published and regulated. As from 1 January 2005, the Group is regulated on an IFRS basis.
UK banking sector, comparing a bank’s capital resources with its riskweighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31 December 2008, the Group’s total RAR was 14.1% (2007 – 11.2%) and the Tier 1 RAR was 10.0% (2007 – 7.3%).
Reconciliations of pro forma to statutory income statements and balance sheets
• the cost of funding the ABN AMRO acquisition within Central items. Whilst part of the acquisition consideration was funded by the issue of preference shares, the pro forma results for 2007 assume that the cash element of the consideration was debt funded. The results for 2008 reflect the actual amounts of interest and dividends on preference shares.
RFS Share write-downs integration and and other minority of shared and one-off restructuring intangible
Non-interest income (excluding insurance net premium income) 5,227 1,299 (18) (5,641) — — 867 Insurance net premium income 5,709 617 — — — — 6,326 Non-interest income excluding credit market write-downs
Credit market write-downs and one-off items (5,641) — — 5,641 — — —
Amortisation of purchased intangible assets 443 — — — (443) — — Write down of goodwill and other intangible assets 16,911 — — — — (16,911) — Integration costs 1,050 — — — (1,050) — — Restructuring costs 307 — — — (307) — — Share of shared assets 300 — (300) — — — — Loss before tax (25,038) (15,629) — — — — (40,667)
Loss from continuing operations (23,043) (15,301) — — — — (38,344) Profit/(loss) from discontinued operations, net of tax — 4,057 (86) — — — 3,971 Loss for the period (23,043) (11,244) (86) — — — (34,373)
Preference dividends 596 — — — — — 596 Loss attributable to ordinary shareholders (24,051) — (86) — — — (24,137)
Income statement for the year ended 31 December 2007 Credit Intangibles 289 days 76 days 76 days market amortisation RBS share RBS share RFS write-downs and of ABN Funding of shared minority and one-off integration
Loss from discontinued operations, net of tax — — — — (76) — — (76)
Preference dividends 246 — — — — — — 246 Profit attributable to ordinary shareholders 6,823 132 345 — 3 — — 7,303
Net customer accounts 460,318 121,051 — 581,369 Repurchase agreements and stock lending 58,143 — — 58,143
Debt securities in issue 269,188 30,831 270 300,289 Settlement balances and short positions 54,264 13 — 54,277
Debt securities in issue 220,577 38,003 15,592 274,172 Settlement balances and short positions 89,829 739 453 91,021
(2) The pro forma and statutory balance sheets as at 31 December 2007 have been restated to reflect the finalisation of the purchase accounting adjustments in respect of ABN AMRO and the netting of certain derivative contracts.
On pages 78 to 144 of the Business review certain information has been audited and is labelled as such.
Risk, capital and liquidity management (unaudited) 2008 has been one of the most challenging years for banks. The financial markets turmoil, which started in the second half of 2007 following concerns over the US sub-prime mortgage market, resulted in a global reduction in liquidity and the availability of term-funding. Confidence in financial institutions was eroded through 2008 as a result of an increased perception of counterparty risk following notable banking and insurance failures.
During the recent market turbulence, in common with other banks, the Group saw the availability of long term funding from both the capital markets and money markets decline significantly during the second half of 2008. As a result, reliance on shorter term funding increased with a consequent deterioration in the Group’s liquidity profile. In response to the market stress, central banks increased liquidity through a number of facilities and schemes available to support their respective banking systems. In addition, governments around the world have provided capital to financial institutions and moved to offer guarantees and increase deposit insurance to reassure investors and depositors. As a global bank, the Group has access to a number of those facilities and schemes which, in common with many other banks, it has used to support funding.
The Board, in the light of the severe and increasing deterioration in market conditions, the worsening economic outlook and difficulties in the credit markets, concluded that it was appropriate for the Group to strengthen its capital position.
Risk governance (unaudited) Risk and capital management strategy is owned and set by the Group’s Board of Directors, and implemented by executive management led by the Group Chief Executive. There are a number of committees and executives that support the execution of the business plan and strategy.
Group Audit Committee Financial reporting and the application of accounting Independent non-executive directors (GAC) policies as part of the internal control and risk assessment process. GAC monitors the identification, evaluation and management of all significant risks throughout the Group.
Executive Risk Forum Acts on all strategic risk and control matters across Group Chief Executive (ERF) the Group including, but not limited to, credit risk, Group Finance Director market risk, operational risk, compliance and regulatory Group Chief Risk Officer risk, enterprise risk, treasury and liquidity risk, Chairman, Regional Markets reputational risk, insurance risk and country risk. Chief Executive, RBS UK
Group Risk Committee Recommends limits and approves processes and Group Chief Risk Officer (GRC) policies to ensure the effective management of all Group head of each risk type material risks across the Group. Group Treasurer Chief Executive and Chief Risk Officer from each division Group General Counsel and Group Secretary Group Chief Economist
Group Asset and Liability Identifies, manages and controls the Group balance Group Finance Director Management Committee sheet risks. Chairman/Chief Executive from each division (GALCO) Group Treasurer
Group Chief Risk Officer Group General Counsel and Group Secretary Group Directors, Strategy, Communications and Human Resources
Management responsibilities (unaudited) All staff have a role to play in the day to day management of risk, in line with Group policy, which is set and managed by specialist staff in: • Risk Management: credit, market, operational, regulatory, enterprise and insurance risk, together with risk analytics.
Group Internal Audit (GIA) supports the GAC in providing an independent assessment of the design, adequacy and effectiveness of internal controls.
• Qualitative: focusing on ensuring that the Group applies the correct principles, policies and procedures.
Reputation Working within laws and regulation. Investing in the community. Conducting sustainable business. Maintaining key services and processes.
The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. The Group has complied with the FSA’s capital requirements throughout the year. A number of subsidiaries and subgroups within the Group, principally banking and insurance entities are subject to additional individual regulatory capital requirements in the UK and overseas.
Capital allocation As part of the annual planning and budgeting cycle, each division is allocated capital based upon risk-weighted assets (RWAs) and their associated regulatory deductions. The budgeting process considers risk appetite, available capital resources, stress testing results and business strategy. The budget is agreed by the Board and allocated to the divisions to manage their allocated RWAs.
Group Treasury and GALCO monitor actual utilisation by tracking capital available and the utilisation of capital by divisions. GALCO makes the necessary decisions around re-allocation of budget and changes in RWA allocations.
For operational risk, the Group uses The Standardised Approach (TSA), which calculates operational risk-weighted assets based on gross income. In line with other banks, the Group is considering adopting the Advanced Measurement Approach (AMA) for all or part of the business.
Regional Markets – UK Retail & Commercial Banking 152.5 153.1 179.0 – US Retail & Commercial Banking 78.0 53.8 57.1 – Europe & Middle East Retail & Commercial Banking 30.9 30.3 36.7 – Asia Retail & Commercial Banking 6.4 4.9 3.3
Group before RFS Holdings minority interest 577.8 486.1 490.0 RFS Holdings minority interest 118.0 147.4 119.0
The AIRB approach to Basel II is based on the following metrics.
• Probability of default (PD) models estimate the likelihood that a customer will fail to make full and timely repayment of credit obligations over a one year time horizon. Customers are assigned an internal credit grade which corresponds to PD. Every customer credit grade across all grading scales in the Group can be mapped to a Group level credit grade.
In addition to minimum capital calculated, for credit, market and operational risk, banks are required to undertake an Individual Capital Adequacy Assessment Process (ICAAP) for other risks. The Group’s ICAAP, in particular, focuses on pension fund, interest rate risk in the banking book together with stress tests to assess the adequacy of capital over one year and the economic cycle.
Stress and scenario testing Stress testing is central to the Group’s risk and capital framework and integral to Basel II. Stress testing is used at divisional and Group level to assess risk concentrations, estimate the impact of earnings on capital, determine the overall capital adequacy under stress conditions and identify mitigating actions. The principal business benefits of the stress testing framework are: understanding the impact of recessionary scenarios; assessing material risk concentrations; and forecasting the impact of market stress scenarios on the Group’s balance sheet liquidity.
• Integrated stress testing considers firm wide stress tests to measure the Group’s exposure to exceptional but plausible economic and geopolitical events. Stress testing supports the identification and quantification of material risks that may arise under stress scenarios, and provides information to support management decision-making around risk appetite and control.
Cross divisional stress testing, undertaken to support the Group’s framework for managing industry and geographical sector concentrations, is performed through the identification of scenarios which are likely to affect groups of inter-related (correlated) sectors. These stress tests are discussed with senior divisional management and are reported to GRC, GEMC, GALCO and GAC. The Group manages to a trigger limit on the stressed impairment charge for an individual scenario.
Funding and liquidity The risk of losses through being unable to meet Potential to disrupt the business model and stop normal risk obligations as they fall due. functions of the Group.
Credit risk Principles for credit risk management (audited) The key principles for credit risk management in the Group are as follows: • A credit risk assessment of the customer and credit facilities is undertaken prior to approval of credit exposure. Typically, this includes both quantitative and qualitative elements including, the purpose of the credit and sources of repayment; compliance with affordability tests; repayment history; ability to repay; sensitivity to economic and market developments; and risk-adjusted return based on credit risk measures appropriate to the customer and facility type.
• Credit risk authority is specifically granted in writing to individuals involved in the granting of credit approval, whether this is individually or collectively as part of a credit committee. In exercising credit authority, individuals are required to act independently of business considerations and must declare any conflicts of interest.
• Credit exposures, once approved, are monitored, managed and reviewed periodically against approved limits. Lower quality exposures are subject to more frequent analysis and assessment.
• Credit risk management works with business functions on the ongoing management of the credit portfolio, including decisions on mitigating actions taken against individual exposures or broader portfolios.
• Stress testing of portfolios is undertaken to assess the potential credit impact of non-systemic scenarios and wider macroeconomic events on the Group’s income and capital.
Assessments of corporate borrower and transaction risk are undertaken using fundamental credit analysis and the application of general corporate and certain specialist counterparty credit risk models. Financial markets counterparties are approved by a dedicated credit function which specialises in traded market product risk. Specialist credit grading models exist for certain bank and non-bank financial institutions.
Model validation (audited) The performance and accuracy of credit models is critical, both in terms of effective risk management and also the calculation of risk parameters (PD, LGD and EAD) used by the Group to calculate RWAs. The models are subject to frequent validation internally and, if used as part of the AIRB Basel II framework (see page 82), have been reviewed and approved for use by the FSA.
• Process verification: whether the methods used in the credit risk models are being used, monitored and updated in the way intended in the design of the model. Initial testing and validation is performed when the model is developed with the performance of models being assessed on an ongoing basis.
• Financial collateral: is taken to support credit exposures in the nontrading book. Financial collateral is also taken in Global Markets and Regional Markets to support trading book exposures and is incorporated in E* (adjustment to the exposure value) calculations.
• Other physical collateral: the Group takes a wide range of other physical collateral including business assets (stock and inventory, plant and machinery, equipment), project assets, intangible assets which provide a future cashflow and real value, commodities, vehicles, rail stock, aircraft, ships and receivables (not purchased).
• Minimum standards (for example loan to value, legal certainty) are ensured through the policy framework.
Credit risk assets as at 31 December 2008 were £855.0 billion (2007 – £626.6 billion), an increase of £228.4 billion during the year.
It is the Group’s policy to monitor and control country risk exposures and to avoid excessive concentrations. The Group’s appetite is expressed by a matrix of limits by country risk grade and is approved by GEMC. The Group’s exposure is managed and measured within this appetite by the Group Country Risk Management Committee (GCRMC), that has delegated authority from the GRC to manage country risk and agree related policy. Membership of GCRMC comprises the Group Chief Credit Officer, Heads of Credit and business representatives from those divisions with material country risk exposures. GCRMC sets limits for each country based on a risk assessment taking into account the Group’s franchise and business mix in that country. Additional limitations – on product types with higher loss potential and longer tenor transactions, for example – may be established depending on the country outlook and business strategy. A country watch list framework is in place to proactively monitor emerging issues and facilitates the development of mitigation strategies.
Consumer Sovereign institutions Corporate Total Risk countries (unaudited) £m £m £m £m £m
(unaudited) The outlook for developing markets in 2009 is very challenging, as developed economy demand is weak, liquidity conditions are tight and risk appetite is yet to return. Asian growth is slowing sharply as trade contracts, but generally, both sovereign and private sector leverage is lower than during the 1998 crisis, providing scope for recovery. The Middle East is more insulated from the effects of economic disruption but certain high growth countries, such as UAE, will face challenges. Eastern Europe faces a deep correction as large economic imbalances unwind. Falling commodity prices and US weakness will also affect Latin America, but the region is more resilient than during previous downturns due to reform progress and policy orthodoxy in its largest economies.
Asset quality by industry and geography (unaudited) Industry analysis plays an important part in assessing potential concentration risk in the loan portfolio. Particular attention is given to industry sectors where the Group believes there is a high degree of risk or potential for volatility in the future.
As at 31 December 2008, 38% of credit risk assets (2007 – 46%) related to the United Kingdom. Western Europe comprised 27% of credit risk assets (2007 – 23%). North America comprised 21% of credit risk assets (2007 – 19%).
Credit risk asset quality (audited) Internal reporting and oversight of risk assets is principally differentiated by credit grades. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures used for internal management reporting across disparate portfolios. Accordingly, measurement of risk is easily aggregated and can be reported at increasing levels of granularity depending on audience and business need.
Note: (1) Graph data are shown net of provisions, reverse repurchase agreements and issuer risk for 2008.
Expressed as an annual PD, the upper and lower boundaries and the midpoint for each of these Group level asset quality grades are as follows: Annual probability of default
Key credit portfolios (unaudited) All exposures are monitored closely, but in the current environment the following are under specific scrutiny: Property lending (unaudited) Commercial property The commercial property portfolio totals £97 billion. The bulk of this is concentrated in GBM (£31 billion) and RBS UK (£42 billion) with the remainder in Ulster Bank (£17 billion) and CFG (£6 billion).
Lending falls into different categories and is spread across Investment (72.6%), Development (24.1%) and Other (3.3%). Speculative lending represents 1.6% of this portfolio. 58% of the lending is in the UK, 30%
The outlook for commercial property will remain challenging during 2009 with further falls in capital values expected due to a lack of liquidity and weak demand for assets. There is emerging evidence of falling rents and increasing vacancy rates although downward pressure on rents and longer void periods can be expected due to the weakening economic climate. The Group’s strategy throughout 2008 has been to reduce its exposures wherever prudent, continuing the process of tightening lending parameters begun in the second half of 2007.
UK residential mortgages The UK mortgage portfolio totalled £74.4 billion (as at 31 December 2008) an increase of 11% during the year due to strong sales growth and lower redemption rates. The main brands are the Royal Bank, NatWest, the One Account, First Active and Direct Line. The assets comprise prime mortgage lending and include 7.0% (£5.2 billion) of exposure to residential buy-to-let. There is a very small legacy selfcertification book (0.5% of total assets) which was withdrawn from sale in 2004.
The Group exited the 100% LTV market in the first quarter of 2008, further restricted the proportion of highest LTV loans and reviewed affordability criteria during the year. The average LTV for new business increased from 62% to 67% in 2008 mainly due to a reduction in the proportion of business within the lowest LTV bands.
Repossessions totalled 1,141 in 2008 (compared with 758 in 2007) with similar volumes in each half of the year.
US real estate Citizens Financial Group’s (CFG) residential real estate portfolio totalled $50.1 billion at 31 December 2008 (2007 – $53.1 billion) comprising $13.8 billion of first mortgages and $36.3 billion of Home Equity loans and lines. This reduction includes the sale of $1.4 billion of real estate assets to the Federal National Mortgage Association in December 2008.
CFG has historically adopted conservative risk policies in comparison to the general market. Small exposures to sub-prime (FICO <=620, approximately 0.6%) and Alt-A / other non-conforming (4.5%) from past bank acquisitions are in run-off. The average indexed LTV was 69% as at 31 December 2008 (2007 – 62%). Loan acceptance criteria were further tightened during 2008 to address deteriorating economic conditions.
Financial institutions The confidence and liquidity crisis affecting the banking sector saw the near collapse of some major banks in Western countries along with the fall of Lehman Brothers and the Icelandic banking system, which in turn threatened the stability of national and global banking systems. Government actions to restore stability by providing guarantees, liquidity facilities, capital injections and facilitating the consolidation of weaker banks with stronger ones met with some success. There remains a high level of risk in the banking sector in 2009, particularly due to the deepening recession that many countries face and increasing corporate defaults.
Financial Institutions constitute the largest segment of the Group’s wholesale credit portfolio with exposure of £181 billion. Due to difficulties faced by the sector, the portfolio quality has weakened during 2008. 92% of exposure is to counterparties in developed OECD countries while 90% of exposure is to investment grade counterparties.
The Banks portfolio is the biggest sub-sector with exposure of £86 billion. At the time of default, the Group’s exposures to Lehman Brothers and the Icelandic banks totalled £802 million and £494 million respectively and represented less than 1% of the total Banks portfolio.
The Group’s exposure to leveraged funds (including hedge funds) totalled £10.3 billion. The majority of hedge funds are domiciled in the UK and US but the portfolio is diversified by fund strategy. The Group’s activities with hedge funds are primarily collateralised derivatives trading. Exposures to funds encountering problems were reduced, collateral margining was reviewed upwards to further mitigate risk and the appropriateness of limits is regularly reviewed.
During 2009, the Group will continue to place emphasis on the proactive management of financial institutions at counterparty and portfolio levels, recognising that liquidity is likely to remain tight and credit quality is likely to deteriorate further across a range of portfolios.
Original equipment manufacturer/commercial vehicles 3.3 23 Captive finance companies 1.1 8 Component suppliers 2.4 16 Retailers/services 5.1 35
The automotive sector faces numerous challenges with a heavy reliance on discretionary consumer spending, high leverage, volatile input prices and an ongoing pressure to reduce fuel emissions resulting in a shift to smaller cars and overseas production. The Group has maintained a cautious approach to this sector and focus on the largest, most diversified and financially strong counterparties with a wide product offering. Notwithstanding this approach, due to the scale of the downturn in this sector the Group can expect further pressure to be seen across the portfolio. Of particular concern are exposures to the captive finance companies where credit impaired limits total £1.4 billion. The Group continues to seek ongoing limit reductions and improved security.
Following an unprecedented rise in ship values over recent years there has been a material correction since mid 2008 with the dry bulk index falling by c.90% which may affect owners’ ability to meet collateral calls. Combined with record ship deliveries for 2009-10 the Group has seen a significant decline in asset values. The Group’s exposure to new build assets is significant with commitments relating to 236 vessels in the dry bulk and tanker segment.
The Group currently has £0.5 billion of limits to clients on watch list, but the portfolio comprises modern assets (86% of exposures are secured on vessels built since 2000), which exhibit, for the most part, good cash flow and liquidity.
Oil and gas The Group’s exposure to this sector totals £24.0 billion across the following sectors and geographies: Credit book Sector £bn %
ABN AMRO and RBS have a number of common clients in this sector, and the Group is working to reduce exposures back within Group concentration limits, primarily in relation to investment grade, vertically integrated counterparties and several of the larger, global exploration and production companies. The Group’s exposures to exploration and production companies are principally secured borrowing base facilities referenced to conservative forward looking oil price assumptions that are adjusted on a regular basis. Unsecured exposures are primarily to oil majors and state owned entities.
GRG brings together previously disparate functions across the Group. Its primary function is to work closely with the Group’s customer facing businesses to support the proactive management of any problem lending. This is based on a clear process (watch listing) which requires the transfer of problem credits to GRG. GRG reports to the Group Chief Risk Officer.
• Define the Group’s role in the turnaround situation and assess the risk/return dimension of the Group’s participation.
• Return customers to the originating business unit in a sound and stable condition or, if such recovery can not be achieved, avoid additional losses and maximise recoveries.
Retail collections and recoveries (audited) There are collections and recoveries functions in each of the four regional markets. Their role is to provide support and assistance to customers who are currently experiencing difficulties meeting their financial obligations.
Where possible, the aim of collections and recoveries teams is to return the customer to a satisfactory position, by working with them to restructure their finances and/or business. If this is not possible, the team has the objective of reducing the loss to the Group.
Preventative measures have also been a key focus throughout 2008, and as a result, the Group has announced the introduction of over 1,000 dedicated Money Sense advisers in its branch network who will provide free financial counselling to both customers and non-customers. The Group has also implemented a programme to proactively contact customers who exhibit early signs of financial stress but are not yet in Collections to offer them assistance in managing their finances more effectively.
Accruing Non- Impairment AQ1 AQ2 AQ3 AQ4 AQ5 past due accrual provision Total 2008 £m £m £m £m £m £m £m £m £m
Other financial instruments 691 — 161 — — — — — 852
Notes: (1) Credit risk assets as reported internally to senior management exclude certain exposures and take account of netting agreements including master netting arrangements that provide a right of legal set off but do not meet the criteria for offset in IFRS. The analysis of credit risk assets on page 91 uses the same risk bands as above and is a sub-set of the full analysis given above.
Service industries and business activities 88,420 10,154 13,278 1,471 113,323 7,624
Service industries and business activities 28,232 1,498 8,535 907 39,172 2,346 Agriculture, forestry and fishing 30 — 3 1 34 —
Finance leases and instalment credit 3,066 — — — 3,066 —
Service industries and business activities 60,179 11,754 2,823 92 74,848 780 Agriculture, forestry and fishing 5,750 50 1 — 5,801 —
(2) This column shows the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
Service industries and business activities 74,399 16,801 4,412 — 95,612 6,687
Loans and Debt advances to banks securities and Netting and and customers equity shares Derivatives Other(1) Total offset(2) 2007 £m £m £m £m £m £m
Service industries and business activities 46,500 540 481 — 47,521 24,648 Agriculture, forestry and fishing 4,650 2 42 — 4,694 —
Individuals: Finance leases and instalment credit 1,620 — — — 1,620 —
Total Rest of the World 83,249 37,918 5,575 1,255 127,997 6,166
Service industries and business activities 151,822 21,356 5,787 1 178,966 31,456
Individuals: Finance leases and instalment credit 19,498 131 281 45 19,955 5
Both REIL and PPL are reported gross of the value of any security held, which could reduce the eventual loss should it occur, and gross of any provision marked. Therefore impaired assets which are highly collateralised, such as mortgages, will have a low coverage ratio of provisions held against reported impaired balance.
REIL PPL PPL provision REIL PPL REIL PPL PPL provision REIL PPL
Accrual loans past due 90 days (2) 1,782 1,709 369 302
(3) Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully collateralised advances and revolving credit facilities where identification as 90 days overdue is not feasible.
REIL as at 31 December 2008 was £21,261 million (2007 – £10,731 million). Excluding RFS Holdings minority interest, REIL was £18,791 million, an increase of £10,540 million during the year. As a percentage of customer lending, REIL and PPL in aggregate, excluding RFS Holdings minority interest was 2.69% of customer loans and advances
Impairment loss provision methodology (audited) Provisions for impairment losses are assessed under three categories: • Individually assessed provisions: provisions required for individually significant impaired assets which are assessed on a case by case basis, taking into account the financial condition of the counterparty and any guarantor and collateral held after being stressed for downside risk. This incorporates an estimate of the discounted value of any recoveries and realisation of security or collateral. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off.
Provision analysis (audited) The Group’s consumer portfolios, which consist of high volume, small value credits, have highly efficient largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods. Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements. Provisions are assessed on a case by case basis by experienced specialists with input from professional valuers and accountants. The Group operates a clear provisions governance framework which sets thresholds whereby suitable oversight and challenge is undertaken and significant cases will be presented to a committee chaired by the Group Chief Executive or the Group Finance Director.
Impairment charge (audited) The following table shows total impairment losses charged to the income statement.
New impairment losses 8,391 2,310 less: recoveries of amounts previously written-off (319) (342) Charge to income statement 8,072 1,968
Comprising: Loan impairment losses 7,091 1,946 Impairment losses on available-for-sale securities 981 22 Charge to income statement 8,072 1,968
Regional Markets – UK Retail & Commercial Banking 1,964 1,368 – US Retail & Commercial Banking 1,041 340 – Europe & Middle East Retail & Commercial Banking 526 118 – Asia Retail & Commercial Banking 171 24
Notes: (1) Excludes loan impairment charge against loans and advances to banks of £118 million (2007 – nil).
Notes: (1) Excludes provisions against loans and advances to banks of £127 million (2007 – £3 million).
Movement in loan impairment provisions (audited) The following table shows the movement in the provision for impairment losses for loans and advances.
Net increase in provisions of discontinued operations — — — — — — — — — 46
Charged to the income statement 3,318 2,391 769 6,478 2,082 3,663 2,606 822 7,091 1,946
Note: (1) The provision for impairment losses at 31 December 2008 include £127 million relating to loans and advances to banks (2007 – £3 million).
Acquisition of subsidiaries — — — — — — — — — — 2,221 Disposal of subsidiaries — — (108) — (70) — — — — (178) — Net increase in provisions of discontinued operations — — — — — — — — — — 46
Management of term structure The Group evaluates on a regular basis its structural liquidity risk and applies a variety of balance sheet management and term funding strategies to maintain this risk within its normal policy parameters. The degree of maturity mismatch within the overall long-term structure of the Group’s assets and liabilities is managed within internal policy guidelines, aimed at ensuring term asset commitments may be funded on an economic basis over their life. In managing its overall term structure, the Group analyses and takes into account the effect of retail and corporate customer behaviour on actual asset and liability maturities where they differ materially from the underlying contractual maturities.
Potential sources include cash inflows from maturing assets, new borrowings or the sale of various debt securities held (after allowing for appropriate haircuts). Short-term liquidity risk is generally managed on a consolidated basis with liquidity mismatch limits in place for subsidiaries and non-UK branches which have material local treasury activities, thereby assuring that the daily maintenance of the Group’s overall liquidity risk position is not compromised. ABN AMRO, Citizens Financial Group and RBS Insurance manage liquidity locally, given different regulatory regimes, subject to review by Group Treasury. As integration of ABN AMRO’s businesses within the Group proceeds, the liquidity risk policies, parameters and metrics used will be progressively aligned within a single framework.
• In October 2008 the UK Government announced recapitalisation plans for a number of UK banks including RBS.
• In January 2009, the FSA has announced that it will ensure that the application of the current International Basel Accord does not create any unnecessary or unintended pro-cyclical effects.
Liquidity management in 2008 (audited) The exposure of the Group to wholesale market funding increased markedly in 2008 following the acquisition of the wholesale banking business of ABN AMRO in the latter half of 2007. The amount of unsecured wholesale funding represented by bank funding and debt securities increased from £154 billion in June 2007 to £362 billion in December 2007. The gap between customer loans and customer deposits increased over this period from £86 billion to £121 billion.
The market disruption during 2008 had a marked effect on the Group’s liquidity and funding which was at its most acute in the autumn of 2008 following the collapse of Lehman Brothers. During that period, the Group’s credit ratings were downgraded constraining both access to and tenor of wholesale funding and there was an outflow of customer deposits. The effective closure of the term funding markets and sharp reduction in the quantity and maturity of short term bank funding had profound consequences for the Group.
Whilst the Group’s customer funding sources remain well diversified and its retail franchise proved resilient, the availability of longer term funding diminished. The Group therefore increased its shorter term wholesale funding exposure, increased its access to central bank funding and issued government guaranteed debt to fund the balance sheet. The government schemes have enabled the mitigation of the financial crisis as the Group rebalances its asset and liability structure.
Customer accounts – the principal source of funds for the Group is its core customer deposits gathered by its retail banking, private client, corporate and SME franchises. The underlying strength of the franchise is demonstrated by the performance of the Group in these markets as customer deposits increased from £437 billion in December 2007 to £460 billion at the end of December 2008. There was a fluctuation in balances at the height of the market disruption in October 2008 but this was recovered by the year end. The Group’s multi-brand offering and strong client focus is a key part of the funding strategy and continues to benefit the Group’s funding position.
Short positions in various securities are held primarily by GBM including RBS Greenwich Capital in the US.
Debt securities in issue over one year, subordinated liabilities and equity – during 2008, the debt markets saw reduced activity, in both the term and the securitisation markets; as a result the maturity profile of the Group’s wholesale funding has become shorter in duration over the course of the year. This was partly offset by issues of government guaranteed debt in the latter part of 2008. The maturity profile of debt securities is predominantly concentrated under one year and this is a source of refinancing risk in the coming twelve months.
Short term debt and bank deposits – the Group saw considerable pressure and risk aversion in the short term debt and bank deposit markets. In order to relieve funding shortages in the market, central banks across the world allowed banks to pledge assets to access funding. The Group has used central bank schemes to support its funding and pledged assets into several of these schemes in a number of countries in which it operates. The Group has set up a series of initiatives to improve the liquidity value of its assets to assist in relieving funding pressures.
Total customer accounts (excluding repos) 581,369 43 460,318 38 547,447 38 437,060 35 Debt securities in issue over one year
Conduits – the Group’s most significant multi-seller conduits have thus far continued to fund the vast majority of their assets solely through ABCP issuance. There were significant disruptions to the liquidity of the financial markets during the year following the bankruptcy filing of Lehman Brothers in September 2008 and this required a small amount of the assets held in certain conduits to be funded by the Group rather than through ABCP issuance. By the end of 2008 there had been an improvement in market conditions, supported by central bank initiatives, which enabled normal ABCP funding to replace this Group funding of the conduits.
The average maturity of ABCP issued by the Group’s conduits as at 31 December 2008 was 72.1 days (2007– 60.9 days).
Group balance sheet (audited) The following tables show the contractual undiscounted cash flows receivable and payable up to a period of twenty years including future receipts and payments of interest.
Cash and balances at central banks 12,333 25 — — 2 29 Loans and advances to banks 61,630 19,369 2,673 921 111 70 Loans and advances to customers 195,553 81,054 138,378 125,621 160,271 152,084
Held-for-trading assets and liabilities – held-for-trading assets and liabilities amounting to £1,226.8 billion (assets) and £1,146.7 billion (liabilities) (2007 – £678.6 billion assets, £478.6 billion liabilities) have been excluded from the table in view of their short term nature.
• the sum of: sterling wholesale net outflows contractually due within five working days (offset up to a limit of 50%, by 85% of sterling certificates of deposit held which mature beyond five working days); and 5% of retail deposits with a residual contractual maturity of five working days or less. The FSA also sets an absolute minimum level for the stock of qualifying liquid assets that the Group is required to maintain each day.
• Individual liquid assessments that will include mandatory scenarios and an analysis of principal liquidity exposure factors.
• Reporting standards improved both in scope and frequency by enhanced mismatch reporting.
Other contractual cash obligations The table below summarises the Group’s other contractual cash obligations by payment date.
The Group’s undrawn formal facilities, credit lines and other commitments to lend were £352,398 million (2007 – £332,811 million). While the Group has given commitments to provide these funds, some facilities may be subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.
VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels. For internal risk management purposes, the Group’s VaR assumes a time horizon of one trading day and a confidence level of 95%. The trading book market risk is calculated using VaR at a confidence level of 99% and a time horizon of ten trading days. From 2009, the Group is adopting 99% confidence limits, in line with industry practice.
The Group calculates VaR using historical simulation models but does not make any assumption about the nature or type of underlying loss distribution. The methodology uses the previous 500 trading days of market data and calculates both general market risk (i.e. the risk due to movement in general market benchmarks) and idiosyncratic market risk (i.e. the risk due to movements in the value of securities by reference to specific issuers). All VaR models have limitations, which include: • Historical data may not provide the best estimate of the joint distribution of risk factor changes in the future and may fail to capture the risk of possible extreme adverse market movements which have not occurred in the historical window used in the calculations.
Traded portfolios (audited) The primary focus of the Group’s trading activities is client facilitation. The Group also undertakes: • Market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes.
• Arbitrage – entering into offsetting positions in different but closely related markets in order to profit from market imperfections.
The Group participates in exchange traded and over the counter (OTC) derivatives markets. The Group buys and sells financial instruments that are traded or cleared on an exchange, including interest rate swaps, futures and options. Holders of exchange traded instruments provide margin daily with cash or other security at the exchange, to which the holders look for ultimate settlement. The Group also buys and sells financial instruments that are traded OTC, rather than on a recognised exchange. These instruments range from commoditised transactions in derivative markets, to trades where the specific terms are tailored to the requirements of the Group’s customers. In many cases, industry standard documentation is used, most commonly in the form of a master agreement, with individual transaction confirmations.
The Group calculates the VaR of trading portfolios at the close of business and positions may change substantially during the course of a trading day. Further controls are in place to limit the Group’s intra-day exposure, such as the calculation of the VaR for selected portfolios. The Group cannot guarantee that losses will not exceed the VaR amounts indicated due to the limitations and nature of VaR measurements.
The VaR for the Group’s 2008 trading portfolios segregated by type of market risk exposure is shown below.
January February March April May June July August September October November December £ million (unaudited)
Average Period end Maximum Minimum Average Period end Maximum Minimum £m £m £m £m £m £m £m £m
Note: (1) The traded market risk VaR excludes super senior tranches of asset backed CDOs.
The average total VaR utilisation increased in 2008 compared with 2007 as a result of increased market volatility. This increase was offset by a reduction in trading book exposure throughout the period, due to a reduction in the size of the inventory held on the balance sheet as a result of sales, reclassification of assets to the non-trading book and write-downs. The average equity VaR increased in 2008 compared with 2007, due to the integration of ABN AMRO from 17 October 2007.
Stress testing is also undertaken at key trading strategy level, for those strategies where the associated market risks are not adequately captured by VaR. Stress test exposures are discussed with senior management and are reported to GRC, GEMC and the Board. Breaches in the Group`s market risk stress testing limits are monitored and reported.
Limits form part of the dealing authorities and constitute one of the cornerstones of the market risk management framework. Upon notification of a limit breach, the appropriate body must take one of the following actions: • Instructions can be given to reduce positions so as to bring the Group within the agreed limits.
Group Treasury is responsible for setting and monitoring the adequacy and effectiveness of management, using a framework that identifies, measures, monitors and controls the underlying risk. GALCO approves the Group’s non-traded market risk appetite, expressed as statistical and non-statistical risk limits, which are delegated to the businesses responsible.
Non-trading interest rate risk is calculated in each business on the basis of establishing the repricing behaviour of each asset, liability and offbalance sheet product. For many retail and commercial products, the actual interest rate repricing characteristics differ from the contractual repricing. In most cases, the repricing maturity is determined by the market interest rate that most closely fits the historical behaviour of the product interest rate. For non-interest bearing current accounts, the repricing maturity is determined by the stability of the portfolio. The repricing maturities used are approved by Group Treasury and divisional asset and liability committees at least annually. Key conventions are reviewed annually by GALCO.
A static maturity gap report is produced as at the month-end for each business, in each functional currency based on the behavioural repricing for each product. It is Group policy to include in the gap report, non-financial assets and liabilities, mainly property, plant and equipment and the Group’s capital and reserves, spread over medium and longer term maturities. The report includes hedge transactions, principally derivatives.
Any residual non-trading interest rate exposures are controlled by limiting repricing mismatches in the individual business balance sheets. Potential exposures to interest rate movements in the medium to longterm are measured and controlled using a version of the same VaR methodology that is used for the Group’s trading portfolios. Net accrual income exposures are measured and controlled in terms of sensitivity over time to movements in interest rates.
Equity Risk in the Banking Book (ERBB) is defined as the potential variation in the Group’s non-trading income and reserves arising from changes in equity prices/income. This risk may crystallise during the course of normal business activities or in stressed market conditions. Equity positions in the Group’s banking book are retained to achieve strategic objectives, support venture capital transactions or in respect of restructuring arrangements. From an economic perspective, it is the Group’s policy to ensure that equity exposures in the banking book are identified, monitored and controlled, with the aim of maximising their potential strategic or business value.
The commercial decision to invest in equity holdings is taken by GEMC, GCC or an appropriate sub-committee within delegated authority. Investments of a strategic nature are referred to GEMC for approval; those involving the purchase or sale by the Group or subsidiary companies also require Board approval, after consideration by GEMC.
A breakdown of the Group’s non-trading VaR on a statutory basis by currency is shown below.
Carrying Carrying Principal (1) amount Principal (1) amount US$m US$m US$m US$m
MBS – retail – high grade (AA or AAA rated) 24,015 23,804 24,643 24,361 – rated C to A 602 600 — —
Residential Mortgage and Home Equity Loans (non-securitised, fixed rate and ARM, prepayable) 36,672 36,672 43,100 43,100
Note: (1) The principal on MBS is the redemption amount on maturity or, in the case of an amortising instrument, the sum of future redemption amounts through the residual life of the security.
In addition to VaR, the following measures are reported to CFG ALCO, Group Treasury, GALCO and the Board: • The sensitivity of net accrual earnings to a variety of parallel and non-parallel movements in interest rates.
The interest rate sensitivities in the table above are illustrative only and are based on simplified scenarios.
The figures represent the effect on pro forma net interest income of movements of the yield curve based on the Group’s current non-trading interest rate risk profile. This effect however does not incorporate actions that would be taken by the business units to mitigate the effect of this interest rate risk. In reality the business units proactively seek to change the interest rate risk profile to minimise losses and optimise net revenues.
The projections do not take into account the effect on net interest income of anticipated differences in changes between interest rates and interest rates linked to other bases (such as central bank rates or product rates for which the entity has discretion over the timing and extent of rate changes). The projections make other simplifying assumptions, including that all positions run to maturity and that there are no negative interest rates.
The table below sets out the effect on future net interest income of a sustained +/-100bp parallel rise/fall in all yield curves.
The tables below set out the Group’s structural foreign currency exposures: Net Structural Net assets investments Net foreign of overseas Minority in foreign investment currency operations interests operations hedges exposures 2008 £m £m £m £m £m
Equity risk (audited) Equity positions are measured at fair value. Fair value calculations are based on available market prices wherever possible. In the event that market prices are not available, fair value is based on appropriate valuation techniques or management estimates.
For both IRRBB and FXRBB information is included in regulatory and statutory returns.
Insurance risk (unaudited) The Group is exposed to insurance risk directly through its general and life insurance businesses.
• Claims risk management: is handled using a range of automated controls and manual processes.
• Reserving risk management: is the risk that the technical reserves are assessed incorrectly such that insufficient funds have been retained to handle and pay claims as the amounts fall due, both in relation to those claims which have already occurred or will occur in future periods of insurance. Claims development data provides information on the historical pattern of reserving risk.
The aggregate amount of business by product and entity is determined through the business plans.
Overall, insurance risk is predictable over time, given the large volumes of data. Uncertainty does exist, especially around predictions such as the variations in weather. Risk is minimised through the application of documented risk policies, coupled with governance frameworks.
• Other commercial insurance contracts: risk arises from business interruption and loss arising from the negligence of the insured (liability insurance). Business interruption claims arise from the losses of income, revenue and/or profit as a result of property damage claims. Liability insurance includes employer’s liability and public/products liability.
Most general insurance contracts are written on an annual basis, which means that the Group’s liability extends for a 12 month period, after which the Group is entitled to decline to renew or can impose renewal terms by amending the premium, terms and conditions.
Life insurance business The Group’s three regulated life companies, National Westminster Life Assurance Limited, Royal Scottish Assurance plc (RSA) and Direct Line Life Insurance Company Limited, are required to meet minimum capital requirements at all times under the FSA Prudential Sourcebook.
The key factors that increase the frequency of claims include epidemics or widespread changes in lifestyle.
Operational Risk – three lines of defence model 1st Line of defence
The three lines of defence model and the Operational Risk Policy and Principles (ORPP) apply throughout the Group and are implemented taking into account the nature and scale of the underlying business. The ORPP provides the direction for delivering effective operational risk management. It comprises principles, minimum standards and processes that enable the consistent identification, assessment, management, monitoring and reporting of operational risk across the Group. The objectives of the ORPP are to protect the Group from financial loss or damage to its reputation, its customers or staff and to ensure that it meets all necessary regulatory and legal requirements.
The Group-wide processes defined in the ORPP are supported by the following key operational risk management techniques: • Risk and control assessments: business units identify and assess operational risks to ensure that they are effectively managed, prioritised, documented and aligned to risk appetite.
• Loss data management: each business unit`s internal loss data management process captures all operational risk loss events above £10,000. This is used to enhance the adequacy and effectiveness of controls, identify opportunities to prevent or reduce the impact of reoccurrence, identify emerging themes, enable formal loss event reporting and inform risk and control assessments and scenario analysis. Escalation of individual events to senior management is determined by the seriousness of the event. Operational loss events are categorised under the following headings: – Clients, products and business practices; – Technology and infrastructure failures; – Employment practices and workplace safety; – Internal fraud; – External fraud; – Execution, delivery and process management; – Malicious damage; and
• New product approval process: ensures that all new products or significant variations to existing products are subject to a comprehensive risk assessment. Products are evaluated and approved by specialist areas and are subject to executive approval prior to launch.
In 2008, the Group introduced a new self-certification process, which requires management to regularly monitor and report on the internal control framework for which they are responsible and regularly review and confirm its adequacy and effectiveness. This includes certifying compliance with the requirements of Group policies.
The ORPP requires each business unit to determine appropriate mitigation techniques to reduce its risk exposure to an acceptable level, and that the adequacy and effectiveness of controls and other risk mitigants (e.g. insurance) are tested regularly and the results documented. Where unacceptable control weaknesses are identified, action plans must be produced and tracked to completion.
The Group purchases insurance to provide the business with financial protection against specific losses and to comply with statutory or contractual requirements. Insurance is primarily used as an additional risk mitigation tool in controlling the Group’s exposures. However, as insurance only provides protection against financial loss once a risk has crystallised, it is used as a complement to other controls.
Operational risk events by risk category – % of total risk events by count The chart below shows a similar distribution of loss event numbers across the risk categories in 2008 as those in 2007.
Operational risk metrics Reporting forms an integral part of operational risk management. The Group’s risk management processes are designed to ensure that operational risk issues are identified, escalated and managed on a timely basis. Operational risk exposures for each division are reported through monthly risk and control reports, which provide detail on the risk exposures and action plans for each significant business process.
Operational risk events that have an actual or potential financial impact in excess of £1 million, or which have a material impact on the Group’s reputation or customers, are escalated and reported to divisional and Group executive.
Operational risk events by category – % of total by value The charts below show that execution, delivery, and process management accounted for over 60% of losses by value during 2008. This differs from 2007 where a single large value event meant that clients, products and business practices was the largest category. The data is on a statutory basis.
Information security The Group is committed to protecting customer and Group information. Under a Group-wide policy framework, Group Information Security is developing, maintaining and implementing policies and systems to secure such information. All employees and agents of the Group are responsible for the protection of Group assets, systems and information. All customer information is treated as confidential and appropriate security is applied to protect the information. The Group Information Security Policies are aligned to international standards and regulatory requirements.
Business continuity The management of crisis situations and the need to ensure the continuity of business across the Group is a key activity within the risk function. A consistent crisis and incident management framework has been rolled out across the Group, to ensure that any incident is identified, managed and resolved through skilled divisional, country, regional and global teams. A six step methodology is in place within the Group for managing incidents.
Key risks and threats that the Group is consistently monitoring from the crisis and incident management perspective include pandemics, terrorism, environmental impacts and technology disruptions.
Business continuity plans have been implemented to ensure that the Group can continue key services, products and operations.
Other risks (unaudited) Regulatory risk Regulatory risk is managed by designing, maintaining and implementing policies and systems in order to ensure effective compliance with all regulatory and legal requirements in the jurisdictions in which the Group operates. The Group’s approach to regulatory risk has three distinct elements: • The review of potential changes in regulation to ensure that the Group addresses the risks arising from such changes and responds appropriately; • The monitoring of compliance with existing rules and regulations and the mitigation of the consequences of any inadvertent non compliance; and
The Group will only enter into a commercial transaction or customer relationship which is legal and complies with regulatory requirements, has economic substance or business purpose and is not designed or used for inappropriate accounting or tax purposes. The Group takes care to understand the issues that matter most to stakeholders, balance the views of all stakeholders and address them coherently. Risks to the reputation of the Group are identified, assessed, managed, monitored and reported. The Group pays particular attention to the reputation risks associated with the introduction of new products or customer relationships.
The largest of the schemes, and the main source of pension obligation risk, is the RBS Group Pension Fund. In October 2006, this scheme was closed to new employees.
The Group maintains an independent review of risk within the Pension Funds.
The most recent funding valuation was carried out as at 31 March 2007. This showed the fund to be in surplus, and therefore there was no need in 2008 for additional payments over and above the regular contributions. The next funding valuation is scheduled to be carried out as at 31 March 2010.
In preparing these disclosures, the Group took into consideration the leading practice disclosure recommendations of the Financial Stability Forum issued in April 2008.
14 Nov 07 22 Feb 08 01 June 08 09 Sep 08 18 Dec 08 28 Mar 08 0.8 ABX.HE.A
The first quarter of 2008 saw a further credit and liquidity shortages experienced during 2007, culminating in the collapse of Bear Stearns in March. The centre of the credit issues remained the ABS market with worsening US economic data supporting higher levels of default expectation in the property market. However, these default expectations started to go beyond the sub-prime market with Alt A and other nonconforming classes of loans particularly seeing significant price deterioration. In addition, wider economic concerns led to heavy fair value losses in the commercial mortgage backed securities (CMBS) market, in corporate debt and in leveraged loan exposures. Following this tightening of conditions, the Group incurred significant losses in March and took steps in April to materially strengthen its capital base through a £12 billion rights issue which was completed in June.
During the fourth quarter there was a continued lack of confidence in the inter-bank market, with demand for stable investments resulting in US treasuries reaching negative spreads. Corporate and ABS prices fell further particularly in the last two months of the year increasing pressure on banks’ capital positions. The Group moved to strengthen its capital position through an open offer to raise £15 billion, underwritten by the UK government. The year concluded with S&P downgrading the credit ratings of eleven global banks, including the Group.
Asset-backed exposures Significant risk concentrations (audited) The Group’s credit markets activities gives rise to risk concentrations that have been particularly affected by the market turmoil experienced since the second half of 2007. The Group structures, originates, distributes and trades debt in the form of loan, bond and derivative instruments in all major currencies and debt capital markets in North America, Western Europe, Asia and major emerging markets.
Held-for-trading Available-for-sale Loans and receivables Designated at fair value All ABS
Net exposure (1) £m £m £m £m £m £m £m £m £m £m
Notes: (1) Net exposure is carrying value after taking account of hedge protection purchased from monolines and other counterparties but excludes the effect of counterparty credit valuation adjustment. The protection provides credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default by the debt security counterparty. The value of the protection is based on the underlying instrument being protected.
(2) Carrying value is the amount recorded on the balance sheet.
Asset backed securities (ABS) are securities that represent an interest in an underlying pool of referenced assets. The referenced pool can comprise any assets which attract a set of associated cash flows but are commonly pools of residential or commercial mortgages and, in the case of Collateralised Debt Obligations (CDOs), the referenced pool may be ABS or other classes of assets. The process by which the risks and rewards of the pool are passed on to investors via the issuance of securities with varying seniority is commonly referred to as securitisation.
The net exposure of the Group’s holdings of ABS increased from £86.3 billion at 31 December 2007 to £91.9 billion by 31 December 2008, where underlying reductions have been more than offset by the effect of exchange rates. The net exposure incorporates hedge protection but excludes counterparty credit valuation adjustments. All hedge protection referred to in the credit market and related exposures section relates to economic hedges that do not qualify for hedge accounting.
Through a sustained de-risking exercise the Group made reductions to the overall risk through a combination of direct asset sales and switching to lower risk assets through trading activities. As a large proportion of the ABS are denominated in US dollars, these reductions in exposure were partially offset due to the movement in the exchange rate against sterling.
• £10.0 billion of European mortgage covered bonds issued by financial institutions
(3) Instruments in this category have been valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data.
Loans and receivables — — — — 626 — — 626 Designated at fair value 2 — — — — 17 — 19
Available-for-sale — — — — — 20 284 304 Designated at fair value — — — — — 2 186 188
Of which: Notes: (1) Carrying values at 31 December 2007 above include ABN AMRO’s liquidity portfolio of £18.6 billion of ABS which were part of shared assets then; this portfolio was transferred to RBS Group Treasury in the first half of 2008.
Sub-prime mortgages: are loans to sub-prime borrowers typically having weakened credit histories that include payment delinquencies, and potentially more severe problems such as court judgements and bankruptcies. They may also display reduced repayment capacity as measured by credit scores, high debt-to-income ratios, or other criteria indicating heightened risk of default.
Non-conforming mortgages (or ‘Alt-A’ used for US exposure) have a higher credit quality than sub-prime mortgages, but lower than those prime borrowers. Within the US mortgage industry, non-conforming mortgages are those that do not meet the lending criteria for US agency mortgages (described below). For non-US mortgages, judgement is applied in identifying loans with similar characteristics to US nonconforming loans and also include self-certified loans. Alt-A describes a category of mortgages in which lenders consider the risk to be greater than prime mortgages though less than sub-prime. The offered interest rate is usually representative of the associated risk level.
Guaranteed mortgages are mortgages that form part of a mortgage backed security issuance by a government agency, or in the US an entity that benefits from a guarantee (direct or indirect) provided by the US government. For US RMBS, this category includes, amongst others, RMBS issued by Ginnie Mae, Freddie Mac and Fannie Mae. For European RMBS, this includes mortgages guaranteed by the Dutch Government.
Covered mortgage bonds are debt instruments that have recourse to a pool of mortgage assets, where investors have a preferred claim if a default occurs. These underlying assets are segregated from the other assets held by the issuing entity. These underlying assets are segregated from other assets held by the issuing entity.
The tables below show the Group’s RMBS net exposures and carrying values by measurement classification, underlying asset type, the main geographical locations of the property that the mortgage is secured against, and the year in which the underlying mortgage was originated.
Loans and receivables 3 — — 215 218 — — — — —
Sub-prime Guaranteed Covered Other Total Sub-prime Guaranteed Covered Other Total Europe £m £m £m £m £ml £m £m £m £m £m
Loans and securities 313 — — 208 521 — — — — —
• RMBS carrying values of £381 million (2007 – £454 million) comprising: held-for-trading £67 million (2007 – £322 million); available-for-sale £308 million (2007 – £132) and loans and receivables £6 million (2007 – nil).
• RMBS non-conforming available-for-sale net exposures and carry values of nil (2007 – £68 million).
The Group’s largest concentration of RMBS assets relate to a portfolio of US agency asset backed securities comprising mainly current year vintage positions of £33.5 billion at 31 December 2008 (2007: £26.0 billion). Due to the US government backing explicit or implicit in these securities, the counterparty credit risk exposure is low. The losses arising from the movements in fair value recorded for these assets were comparatively lower than other RMBS. Financial markets and economic conditions have been extremely difficult in the US throughout 2008, particularly in the last quarter. Credit conditions have deteriorated and financial markets have experienced widespread illiquidity and elevated levels of volatility due to forced de-leveraging. Transaction activity in the securities portfolio has been reduced due to general market illiquidity. Residential mortgages have been affected by the stress that consumers experienced from depreciating house prices, rising unemployment and tighter credit conditions, resulting in higher levels of delinquencies and foreclosures. In particular, the deteriorating economy and financial markets have negatively impacted the valuation, liquidity, and credit quality of private-label securities.
The Group has other portfolios of RMBS from secondary trading activities, warehoused positions previously acquired with the intention of further securitisation and a portfolio of assets from the unwinding of a securities arbitrage conduit. This conduit was established to benefit from the margin between the assets purchased and the notes issued. The majority of these held-for-trading RMBS have been grouped together for management purposes.
The Group accumulated CMBS for the purpose of securitisation and secondary trading. The largest holding of CMBS arose as a result of the Group’s purchase of senior tranches in mezzanine and high grade CMBS structures from third parties. These securities are predominantly hedged with monoline insurers. As a result, the Group’s risk is limited to the counterparty credit risk exposure to the hedge. The Group also holds CMBS arising from securitisations of European commercial mortgages originated by the Group.
The following table shows the composition of the Groups holdings of CMBS portfolios.
High grade Mezzanine Total High grade Mezzanine Total £m £m £m £m £m £m
Write-downs on net open position (3,019) (2,885) (5,904) (492) (537) (1,029)
(2) Credit ratings are based on those from rating agencies Standard & Poor’s (S&P), Moody’s and Fitch and have been mapped onto S&P scale.
Super senior CDOs Super senior CDOs represent the most senior positions in a CDO, having subordination instruments (usually represented by a combination of equity, mezzanine and senior notes) which absorb losses before the super senior note is affected. Losses will only be suffered by the super senior note holders after a certain threshold of defaults of the underlying reference assets has been reached. The threshold is usually referred to in percentage terms of defaults of the remaining pool, and known as the ‘attachment point’. These super senior instruments carry an AAA rating at point of origination, or are senior to other AAA rated notes in the same structure. The level of defaults occurring on recent vintage sub-prime mortgages and other asset classes has been higher than originally expected. This has meant that the subordinate positions have diminished significantly in value, credit quality and rating and, as a result, the super senior tranches of the CDOs have a higher probability of suffering losses than at origination. The ratings of the majority of the underlying collateral are now below investment grade.
Depending on the quality of the underlying reference assets at issuance, the super senior tranches will be either classified as high grade or mezzanine. The majority of the Group’s total exposure relates to high grade super senior tranches of ABS CDOs. This is based upon the original classification of the deals derived from the underlying reference asset rating quality. The table below summarises the carrying amounts and net exposures after hedge protection of the Group’s super senior CDOs as at 31 December 2008. The collateral rating is determined with reference to S&P ratings where available. Where S&P ratings are not available the lower of Moody’s and Fitch ratings have been used.
The change in net exposure during the year is analysed below.
Net income statement effect (1,836) (1,140) (2,976) Foreign exchange and other movements 486 31 517
The fair value of these assets has fallen significantly during the period, representing the decline in performance in the underlying reference assets and the lack of an active market for the securities. Some of the Group’s holdings (£3.4 billion) have been hedged with monoline counterparties (see page 135).
Mezzanine super senior CDOs The tranches of CDOs have suffered a greater level of price decline than high grade tranches due to the relative credit quality of the underlying assets. As shown in the table below, the majority of the Group’s mezzanine super senior net exposures represent securities retained in CDO structures originated by the Group.
Other CDOs The net exposure of the Group’s other senior CDOs was £1.5 billion after hedge protection with bank or monoline counterparties. The unhedged exposures comprise CDOs representing smaller positions with various types of underlying collateral, rating and vintage characteristics. The positions hedged with derivative protection from banks include a number of positions referencing early vintages of RMBS and other ABS assets. The Group therefore has no net exposure to certain CDOs before credit valuation adjustment. Due to the early vintage, the assets underlying these structures have not deteriorated to the same degree as the more recently issued securities. The protection purchased is from banks as opposed to monoline insurers and the credit valuation adjustment on banks is less than on monoline insurers.
Additionally, the Group has one exposure that, while not structured as a super senior security, incorporates similar risk characteristics. The exposure results from options sold to a third-party conduit structure on a portfolio of ABS. The Group assumed the risk of these securities only after the first loss protection of had been eroded. The Group also has protection purchased against the remainder of this exposure through a CDS purchased from a monoline insurer.
The Group holds other subordinated note positions in CDO vehicles which have experienced significant reductions in value since inception. The majority of these positions are junior notes that have been fully written down by the Group with no ongoing exposure remaining at the balance sheet date.
CLOs Collateralised loan obligations represent securities in special purpose entities (SPEs), the assets of which are primarily cash flows from underlying leveraged loans.
£2.3 billion of these assets were reclassified from the held-for-trading category to the loans and receivables (£0.8 billion) and available-forsale (£1.5 billion) categories during the year.
The widening of credit spreads of corporate and financial institution counterparties during the year contributed to a significant increase in the level of CVA adjustments recorded across all counterparties particularly monoline insurers and credit derivative product companies.
The covered bonds comprise asset-backed securities issued by several Spanish financial institutions. These securities benefit from additional credit enhancement provided by the issuing institutions. The other major asset types that increased since 2007 include other consumer loans by £1.8 billion, leases by £0.5 billion and student loans by £0.2 billion. These and other increases were driven by the weakening of sterling against the US dollar and euro.
Counterparty valuation adjustments (audited) Credit valuation adjustments Credit valuation adjustments (CVAs) represent an estimate of the adjustment to fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures. During 2008, as credit spreads have widened, there has been a significant increase in the CVA as set out in the table below.
The tables below analyse the Group’s holdings of CDS with monoline counterparties.
Gross exposure to monolines 11,581 3,409 Hedges with bank counterparties (789) — Credit valuation adjustment (5,988) (862) Net exposure to monolines 4,804 2,547
The Group also has indirect exposure through wrapped securities and assets which have an intrinsic credit enhancement from a monoline insurer. These securities are traded with the benefit of this credit enhancement and therefore any deterioration in the credit rating of the monoline is reflected in the market prices for these assets.
CVA realised in 2008 (1,737) Net benefit on counterparty hedges 304 Foreign currency movements 1,086 Net benefit on reclassified debt securities 1,916 Net income statement effect 3,557 Balance at 31 December 2008 5,988
Gross exposure to CDPCs 4,776 863 Credit valuation adjustment (1,311) (44) Net exposure to CDPCs 3,465 819
The movement in the year in CDPC CVA is analysed below: £m
The Group has £4.8 billion of exposures with CDPCs which predominatly relates to tranched credit derivatives. Tranched credit derivatives have exposure to certain default losses that arise in reference portfolio of assets. The Group has bought protection on tranched credit derivatives from CDPCs. The reference portfolios of assets are predominantly investment grade loans and bonds and on average, the trades have exposure to total portfolio default losses that exceed 16% of the portfolio notional up to a level of 50%. CDS spreads have widened and credit protection has become more valuable and the gross exposure to CDPC counterparties has increased. At the same time, the credit quality of CDPC counterparties has declined, reflecting the negative impact of their concentrated credit risk in a declining market. As a result CVA adjustments taken against exposures to these counterparties have increased significantly as described above.
Americas UK Europe ROW Total Americas UK Europe ROW Total £m £m £m £m £m £m £m £m £m £m
Of which: Of which: Note: (1) Leveraged finance as disclosed above for 31 December 2007 has been aligned with definitions used in 2008 and is consequently £76 million higher than previously published.
The table below analyses the movement in the amounts reported above.
Drawn Undrawn Total Drawn Undrawn Total £m £m £m £m £m £m
Realised losses on sales (298) — (298) (197) — (197) Funded deals 1,298 (1,298) — — — —
The Group’s syndicated loan book represent amounts retained from underwriting positions where the Group was lead manager or underwriter, in excess of the Group’s intended long term participation.
Since the beginning of the credit market dislocation in the second half of 2007, investor appetite for leveraged loans and similar risky assets has fallen dramatically, with secondary prices falling due to selling pressure and margins increasing, thus also affecting the primary market. There were a small number of deals executed in the first half of 2008 which were much less significant in overall quantum and leverage and which were priced at less than mid-2007 levels. Concerted efforts to sell positions during the first half of 2008 were only partially successful due to the rapid change in market conditions since origination of the loans. Most of the leveraged finance loans were reclassified from the held-for-trading category to loans and receivables category in the second half of 2008.
In general residential and commercial mortgages and credit card receivables form the types of assets generally included in cash securitisations, while corporate loans and commercial mortgages typically serve as reference obligations in synthetic securitisations.
The Group typically does not retain the majority of risks and rewards of own-asset securitisations set up for the purposes of risk diversification and capital efficiency, where the majority of investors tend to be third parties. Therefore, the Group is typically not required to consolidate the related SPEs.
Conduits (audited) The Group sponsors and administers a number of asset-backed commercial paper (ABCP) conduits. A conduit is an SPE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed either by further commercial paper issuance, repayment of assets or liquidity drawings. Commercial paper is typically short-dated – the length of time from issuance to maturity of the paper is typically up to three months.
The total assets held by the Group’s sponsored conduits are £49.9 billion (2007 – £48.1 billion). Since these liquidity facilities are sanctioned on the basis of total conduit purchase commitments, the liquidity facility commitments will exceed the level of assets held, with the difference representing undrawn commitments.
Multi-seller conduits The multi-seller conduits were established by the Group for the purpose of providing its clients with access to diversified and flexible funding sources. A multi-seller conduit typically purchases or funds assets originated by the banks’ clients. The multi-seller conduits form the vast majority of the Group’s conduit business (69.4% of the total liquidity and credit enhancements committed by the Group). The Group sponsors six multi-seller conduits which finance assets from Europe, North America and Asia-Pacific.
The third-party assets financed by the conduits are structured with a significant degree of first-loss credit enhancement provided by the originators of the assets. This credit enhancement, which is specific to each transaction, can take the form of over-collateralisation, excess spread or subordinated loan, and typically ensures the conduit asset has a rating equivalent to at least a single-A credit. In addition, and in line with general market practice, the Group provides a small secondloss layer of programme-wide protection to the multi-seller conduits. Given the nature and investment grade equivalent quality of the first loss enhancement provided to the structures, the Group has only a minimal risk of loss on its program wide exposure. The issued ABCP is rated P-1/A1 by Moody’s and Standard & Poor’s.
The Group provides liquidity back-up facilities to the conduits it sponsors. These facilities can be drawn upon by the conduits in the event of a disruption in the ABCP market, or when certain trigger events occur such that ABCP cannot be issued. For a very small number of transactions within two of the multi-seller conduits sponsored by the
• £10.7 billion assets (corporate loans) and £10.5 billion commercial paper issued relating to a shared conduit – see below.
• £1.3 billion assets relating to reactivated conduits which started to issue commercial paper in the second half of 2008.
CDOs — — — — — — — — — — —
Structured investment vehicles (unaudited) The Group does not sponsor any structured investment vehicles.
The funds have been authorised by the Irish Financial Services Regulatory Authority as UCITS pursuant to the UCITS Regulations (UCITS Regulations refer to the European Communities’ Undertakings for Collective Investment in Transferable Securities Regulations) and are therefore restricted in the types of investments and borrowings they can make. The structure of the assets within the funds is designed to meet the liabilities of the funds to their investors who have no recourse other than to the assets of the funds. The risks to the Group as a result are restricted to reputational damage if the funds were unable to meet withdrawals when requested on a timely basis or in full.
Money market funds had total assets of £13.6 billion at 31 December 2008 (2007 – £11.2 billion). The sub categories of money market funds are: • £8.0 billion (2007 – £5.1 billion) in Money Funds denominated in sterling, US dollars and euro, which invest in short-dated, highly rated money market securities with the objective of providing security, performance and liquidity.
• £4.9 billion (2007 – £5.5 billion) in multi-manager money market funds denominated in sterling, US dollars and euro, which invest in short dated, highly rated securities.
• £0.7 billion (2007 – £0.6 billion) in Money Funds Plus denominated in sterling, US dollars and euro, which invest in longer-dated, highly rated securities with the objective of providing security, enhanced performance and liquidity.
• £1.6 billion (2007 – £1.3 billion) in committed capital to private equity investments, which invests primarily in equity and debt securities of private companies.
• £1.1 billion (2007 – £1.1 billion) in credit investments, which invests in various financial instruments.
The Group’s maximum exposure to non-money market funds is represented by the investment in the shares of each fund and was
Appointed to the Board on 19 January 2009, Philip Hampton is currently chairman of J Sainsbury plc. Previously, he was group finance director of Lloyds TSB Group plc, BT Group plc, BG Group plc, British Gas and British Steel plc, an executive director of Lazards and a non-executive director of RMC Group plc. He is also former chairman of UK Financial Investments Limited, the company established to manage the UK Government's shareholding in banks subscribing to its recapitalisation fund, and is a non-executive director of Belgacom SA.
Key to abbreviations A member of the Audit Committee N member of the Nominations Committee R member of the Remuneration Committee * independent non-executive director
Appointed to the Board on 1 October 2008 and as Group Chief Executive on 21 November 2008, Stephen Hester was chief executive of The British Land Company PLC. He was previously chief operating officer of Abbey National plc and prior to that he held positions with Credit Suisse First Boston including Chief Financial Officer, Head of Fixed Income and co-Head of European Investment Banking. In February 2008, he was appointed non-executive deputy chairman of Northern Rock plc, a position he relinquished on 1 October 2008. He is also a trustee of The Foundation and Friends of the Royal Botanical Gardens, Kew.
Appointed to the Board in March 2000, Gordon Pell was formerly group director of Lloyds TSB UK Retail Banking before joining National Westminster Bank Plc as a director in February 2000 and then becoming Chief Executive, Retail Banking. He is also a director of Race for Opportunity and a member of the FSA Practitioner Panel. He was appointed chairman of the Business Commission on Racial Equality in the Workplace in July 2006 and deputy chairman of the Board of the British Bankers Association in September 2007.
Appointed to the Board in June 2002, Colin Buchan was educated in South Africa and spent the early part of his career in South Africa and the Far East. He has considerable international investment banking experience, as well as experience in very large risk management in the equities business. He was formerly a member of the group management board of UBS AG and head of equities of UBS Warburg, and was the former chairman of UBS Securities Canada Inc. He is chairman of Standard Life Investments Limited and a director of Standard Life plc and Black Rock World Mining Trust Plc.
Appointed to the Board in September 2004, Archie Hunter is a chartered accountant. He was Scottish senior partner of KPMG between 1992 and 1999 and president of The Institute of Chartered Accountants of Scotland in 1997/1998. He has extensive professional experience in the UK and North and South America. He is currently chairman of Macfarlane Group plc, a director of Edinburgh US Tracker Trust plc and a governor of the Beatson Institute for Cancer Research.
Appointed to the Board in September 2004, Joe MacHale is currently a non-executive director and chairman of the remuneration committee of Brit Insurance Holdings plc, and a trustee and treasurer of MacMillan Cancer Support. He held a number of senior executive positions with J P Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region. He is a fellow of the Institute of Chartered Accountants.
Appointed to the Board on 1 October 2008, John McFarlane is former chief executive officer of Australia and New Zealand Banking Group Limited. Previously he was a group executive director of Standard Chartered and was head of Citicorp/Citibank in the UK and Ireland. He is currently a non-executive director of Westfield Holdings Limited and a director of Old Oak Holdings Limited. He is a former president of the International Monetary Conference and a former chairman of the Australian Bankers Association. He has previously served as a director of the London Stock Exchange and a member of the Auditing Practices Board.
Miller McLean was appointed Group Secretary in August 1994. He is a trustee of the Industry and Parliament Trust, non-executive chairman of The Whitehall and Industry Group, and president of the Chartered Institute of Bankers in Scotland.
The directors present their report together with the audited accounts for the year ended 31 December 2008.
Following a placing and open offer in December 2008, HM Treasury now holds approximately 58% of the enlarged issued ordinary share capital of the company. In addition, HM Treasury holds £5 billion noncumulative sterling preference shares in the company.
Results and dividends The loss attributable to the ordinary shareholders of the company for the year ended 31 December 2008 amounted to £24,137 million compared with a profit of £7,303 million for the year ended 31 December 2007, as set out in the consolidated income statement on page 174.
The Group is currently undertaking a strategic review that is expected to re-focus the Group on those businesses with clear competitive advantages and attractive marketing positions, primarily in stable, lowto -medium risk sectors.
Risk factors The Group’s future performance and results could be materially different from expected results depending on the outcome of certain potential risks and uncertainties. Details of the principal risk factors the Group faces are given in the Business review on pages 27 to 34.
Financial performance A review of the Group’s performance during the year ended 31 December 2008, including details of each division, and the Group’s financial position as at that date is contained in the Business review on pages 50 to 67.
Business developments In October 2007, RFS Holdings B.V. (RFS Holdings), a company jointly owned by the company, Fortis N.V., Fortis SA/NV and Banco Santander S.A. and controlled by the company, completed the acquisition of ABN AMRO Holding N.V. (ABN AMRO).
On 3 October 2008, the State of the Netherlands acquired Fortis Bank Nederland (Holding) N.V. (including the Fortis interest in RFS Holdings that represents the remaining Fortis-acquired businesses of ABN AMRO) as well as Fortis’ participation in certain Dutch insurance activities. On 24 December 2008, the Fortis interest in RFS Holdings was transferred from Fortis Bank Nederland (Holding) N.V. into the direct ownership of the State of the Netherlands, subject to completion of certain formalities. On the same date, the State of the Netherlands executed a Deed of Accession with the company, Banco Santander S.A., and RFS Holdings pursuant to which it acceded to the Consortium and Shareholders’ Agreement dated 28 May 2007 (as subsequently amended from time to time).
RFS Holdings is implementing an orderly separation of the business units of ABN AMRO with the company retaining the following ABN AMRO business units: • Continuing businesses of Business Unit North America; • Business Unit Global Clients (excluding the Brazil Global Clients Business) and wholesale clients in the Netherlands (including former Dutch wholesale clients) and Latin America (excluding Brazil); • Business Unit Asia including Private Clients India and Indonesia; and Interest in Prime Bank, Pakistan (excluding the interest in Saudi Hollandi); • Business Unit Europe (excluding Antonveneta); Employees As at 31 December 2008, the Group employed over 199,000 employees (full-time equivalent basis) throughout the world. Details of employee related costs are included in Note 3 on the accounts on page 190.
The Group Chief Executive and other senior Group executives regularly communicate with employees across a range of channels.
Diversity The Group's Diversity policy and associated policy standards set a framework for broadening the Group’s talent base, achieving the highest levels of performance and enabling all employees to reach their full potential irrespective of age, disability, gender, marital status, political opinion, race, religion or belief or sexual orientation.
The Group is also committed to ensuring that all prospective applicants for employment are treated fairly and equitably throughout the recruitment process and its comprehensive resourcing standards cover the attraction and retention of individuals with disabilities. Reasonable adjustments are provided to support applicants in the recruitment process where these are required. The Group provides reasonable workplace adjustments for new entrants into the Group and for existing employees who become disabled during their employment.
Safety, health and wellbeing Protecting its employees and customers from harm is a fundamental principle of the way the Group operates and its goal is to minimise work related injuries and ill health. The Group also recognises that the general health and wellbeing of its employees impacts on their engagement and productivity. Promoting good health, and providing support to its employees when they need it, is therefore also core to its approach.
Code of conduct The Code of Conduct and related policies forms part of the terms and conditions of employment for all those employed by the Group and sets standards for those not directly employed such as contractors and agency workers.
Corporate responsibility The Group believes that meeting high standards of environmental, social and ethical responsibility is key to the way it does business.
Further details of the Group’s corporate responsibility policies will be contained in the 2008 Corporate Responsibility Report.
Going concern The Group’s business activities and financial position; the factors likely to affect its future development and performance; and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Business review.
As set out in the Business review, recent economic conditions have seen severe dislocation in many financial markets and an unprecedented reduction in liquidity globally. ‘Liquidity risk’ describes the measures governments and central banks in the UK and around the world have taken to provide capital and liquidity to banks. The Group used a number of these funding facilities during 2008 and its funding and capital plans for the next twelve months from the date of approval of these accounts assume continuing reliance on and the continuation of these measures. These plans have been shared with the Tripartite Authorities in the UK.
Following the rights issue in June 2008 and the open offer in December 2008, the Group’s capital ratios are at historically high levels and will be further strengthened by the restructuring of the UK Government’s preference shares. The UK Government owns 57.9% of the ordinary share capital of the Group. This could increase to 70.4% following the fully underwritten open offer announced in January 2009 and provides tangible evidence of the UK Government’s support for the Group reflecting its importance to the UK economy and financial system.
Corporate governance The company is committed to high standards of corporate governance. Details are given on pages 153 to 158.
Ordinary share capital In June 2008, the company issued 6,123 million ordinary shares of 25p each through a rights issue on the basis of 11 new ordinary shares for every 18 existing shares held, at an issue price of £2 per share, raising £12 billion.
In September 2008, the company issued 403 million ordinary shares of 25p to existing shareholders by way of a capitalisation issue on the basis of one new ordinary share for every 40 shares held.
In December 2008, the company issued 22,910 million ordinary shares of 25p each by way of a Placing and Open Offer on the basis of 18 new ordinary shares for every 13 existing shares held, at an issue price of 65.5 pence per share, raising £14.7 billion. HM Treasury acquired 22,854 million of these shares and now holds 57.9% of the enlarged ordinary share capital of the company.
During the year, the ordinary share capital was also increased by 13.5 million ordinary shares allotted as a result of awards and the exercise of options under the company’s share schemes.
Preference share capital In December 2008, the company issued 5 million non-cumulative sterling preference shares to HM Treasury at £1,000 per preference share, raising £5 billion.
As discussed on page 148, the company, subject to shareholder approval, intends to issue new ordinary shares by way of an open offer, the proceeds from which will be used to redeem the preference shares issued to HM Treasury, together with the accrued dividend.
Additional information Where not provided previously in the Report of the directors, the following provides the additional information required to be disclosed by Part 7 of the Companies Act 1985 as amended.
On a show of hands at a general meeting of the company every holder of ordinary shares and cumulative preference shares present in person or by proxy and entitled to vote shall have one vote. On a poll, every holder of ordinary shares present in person or by proxy and entitled to vote shall have one vote for every share held. On a poll, holders of
The Royal Bank of Scotland Group plc 2001 Employee Share Trust, The Royal Bank of Scotland Group plc 2007 US Employee Share Trust and The Royal Bank of Scotland plc 1992 Employee Share Trust hold shares on behalf of the Group’s employee share plans. The voting rights are exercisable by the Trustees, however, in accordance with investor protection guidelines, the Trustees abstain from voting. The Trustees would take independent advice before accepting any offer in respect of their shareholdings for the company in a takeover bid situation.
Directors The names and brief biographical details of the directors are shown on pages 146 and 147.
Sir Fred Goodwin and Mark Fisher ceased to be directors on 21 November 2008.
Larry Fish ceased to be a director on 31 December 2008.
Sir Tom McKillop ceased to be Chairman on 3 February 2009.
Jim Currie, Bill Friedrich, Bud Koch, Janis Kong, Sir Steve Robson, Bob Scott and Peter Sutherland ceased to be directors on 6 February 2009.
Directors’ interests The interests of the directors in the shares of the company at 31 December 2008 are shown on page 169. None of the directors held an interest in the loan capital of the company or in the shares or loan capital of any of the subsidiary undertakings of the company, during the period from 1 January 2008 to 25 February 2009.
Directors' indemnities In terms of section 236 of the Companies Act 2006, the directors of the company, members of the Group Executive Management Committee and Approved Persons of the Group (under the Financial Services and Markets Act 2000) have been granted Qualifying Third Party Indemnity Provisions by the company.
(b) the director has taken all the steps that he ought to have taken as a director to make himself aware of any relevant audit information and to establish that the company’s auditors are aware of that information.
Political donations At the Annual General Meeting in 2006, shareholders gave authority for the company to make political donations and incur political expenditure up to a maximum aggregate sum of £500,000 as a precautionary measure in light of the wide definitions in The Political Parties, Elections and Referendums Act 2000, for a period of four years. These authorities have not been used.
At 31 December 2008, the Group’s trade creditors represented 30 days (2007 – 30 days) of amounts invoiced by suppliers.
Shareholdings The table below shows the shareholders that have notified the Group that they hold more than 3% of the voting rights in the undernoted classes of shares as at 31 December 2008.
Throughout the year ended 31 December 2008, the company has complied with all of the provisions of the Combined Code issued by the Financial Reporting Council in June 2006 (the “Code”) except in relation to the provision that the Remuneration Committee should have delegated responsibility for setting remuneration for the Chairman and executive directors. The company considers that this is a matter which should rightly be reserved for the Board. No director is involved in decisions regarding his or her own remuneration.
The company has also complied with the Financial Reporting Council Guidance on Audit Committees issued in October 2008 in all material respects.
The New York Stock Exchange As a foreign issuer with American Depositary Shares (ADS) representing ordinary shares, preference shares and debt securities listed on the New York Stock Exchange (NYSE), the company must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under the NYSE’s corporate governance listing standards. In addition, the company must comply fully with the provisions of the listing standards that relate to the composition, responsibilities and operation of audit committees. These provisions incorporate the relevant rules concerning audit committees of the US Securities Exchange Act of 1934.
The roles of the Chairman and Group Chief Executive are distinct and separate, with a clear division of responsibilities. The Chairman leads the Board and ensures the effective engagement and contribution of all executive and non-executive directors. The Group Chief Executive has responsibility for all Group businesses and acts in accordance with the authority delegated by the Board. Responsibility for the development of policy and strategy and operational management is delegated to the Group Chief Executive and other executive directors.
The Board is aware of the other commitments of its directors and has established procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest are being operated effectively. With effect from 1 October 2008, the Companies Act 2006 introduced a statutory duty on directors to avoid conflicts of interest. Since that date, the Board has considered, and where appropriate authorised, any actual or potential conflicts of interests that directors may have.
Board balance and independence The Board currently comprises the Chairman, three executive directors and five non-executive directors. The Board functions effectively and efficiently and is considered to be of an appropriate size. The directors provide the Group with the knowledge, mix of skills, experience and networks of contacts required. The Board Committees comprise directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.
Re-election of directors Directors must stand for re-election by shareholders at least once every three years. Any non-executive directors who have served for more than nine years will also stand for annual re-election and the Board will consider their independence at that time. The proposed re-election of directors is subject to prior review by the Board.
In addition, the former Chairman evaluated the individual performance of each director. The former senior independent director canvassed the views of the executive directors and met with the non-executive directors as a group without the former Chairman present to consider his performance.
The terms of reference of the Audit, Remuneration and Nominations Committees and the standard terms and conditions of appointment of non-executive directors are available on the Group’s website (www.rbs.com) and copies are available on request.
Audit Committee All members of the Audit Committee are independent non-executive directors. The Audit Committee holds at least five meetings each year. The Audit Committee’s report is set out on pages 157 and 158.
Meetings The number of scheduled meetings of the Board and the Audit, Remuneration and Nominations Committees and individual attendance by members in 2008 is shown below.
Mr Fish 8 — — — Mr Fisher (2) 6 — — —
Mr MacHale 9 6 — — Mr McFarlane (5) 3 — — — Mr Pell 9 — — — Sir Steve Robson (4) 7 6 — — Mr Ryan (5) 3 — — —
Notes: (1) Sir Tom McKillop ceased to be a director on 3 February 2009.
(3) Johnny Cameron ceased to be a director on 13 October 2008.
The Board commissions a survey of investor perceptions periodically. The survey is undertaken on behalf of the Board by independent consultants and the outcomes of the study are considered by the Board.
Internal control over financial reporting The Group is required to comply with Section 404 of the US SarbanesOxley Act of 2002 and assess the effectiveness of internal control over financial reporting as of 31 December 2008.