The Group provides a wide range of products and services to personal, commercial and large corporate and institutional customers through its two main subsidiaries, The Royal Bank of Scotland and NatWest, as well as through a number of other well-known brands including Citizens, Charter One, Ulster Bank, Coutts, Direct Line and Churchill.
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Contents 02 Essential reading 04 Our Core businesses 06 Our approach to business 08 Our customers 10 Our business and our strategy 10 Chairman’s statement 12 Group Chief Executive’s review 14 Q&As 15 Our key targets 16 Progress on our Strategic Plan 18 The economic environment 19 Our approach to risk management 21 Divisional review 22 UK Retail 23 UK Corporate 24 Wealth 25 International Banking 26 Ulster Bank 27 US Retail & Commercial 28 Markets 29 Direct Line Group 30 Business Services 31 Central Functions 32 Non-Core Division 33 Sustainability 34 Governance 34 Stakeholder engagement 34 Sustainable policy development 35 Sustainable Business Principles 36 Business review 107 Risk and balance sheet management 294 Governance report 351 Financial statements 487 Additional information 516 Shareholder information 527 Abbreviations and acronyms 528 Glossary of terms 536 Index
Our Sustainable Business Principles recognise that balancing the needs of all of our stakeholders is the best way to deliver sustainable commercial success.
Upholding environmental responsibility within the bank, and through our customers and suppliers
Sustainability is central to how we are working to build a good company. Our Sustainable Business Principles are Group commitments that set out how we can operate responsibly. We will do this by being: RBS GROUP 2012
Loan:deposit ratio (%) 103 106 see page 22 for further information
Loan:deposit ratio (%) 44 44 see page 24 for further information
RBS is rooted in the UK serving personal, business and institutional customers in the UK and around the world. Our businesses are strong players in the markets in which we choose to compete. As a Group, the businesses are stronger together than apart, to the benefit of customers and shareholders.
Since we began the job of rebuilding RBS in 2009, our priorities have been: to serve customers well; to restore RBS to a sustainable and conservative risk profile; and to rebuild sustainable value for all shareholders.
We are building the new RBS on our Core businesses. They have competitive strengths in their markets. We are managing them so that their performance will improve and they can meet external challenges that arise. Separately, we manage the businesses that we are winding-down or plan to sell in our Non-Core Division.
Loan:deposit ratio (%) 130 143 see page 26 for further information
Loan:deposit ratio (%) 86 85 see page 27 for further information
Direct Line Group is a retail general insurer with leading market positions in the UK and businesses in Italy and Germany. Our brands include Direct Line, Green Flag, Churchill and Privilege.
We provide financing, risk management and advisory services to the Group’s corporate and institutional clients.
The job of creating the new RBS, a good company and a good bank, has three parts.
We have to make RBS safe and sound by restoring a sustainable and conservative risk profile.
These goals are linked and each one supports the others. After four years of our Strategic Plan, we have made progress in all three areas but there is more to do. In particular, we are intensifying our efforts to become a bank that is known for the quality of service we give our customers.
Rebuilding a sustainably valuable business is important not just from the conventional perspective of delivering shareholder value but in our case to enable the UK Government to recover the taxpayers’ investment.
Building sustainable value requires us first and foremost to demonstrate that we can operate safely and soundly and that we are serving our customers well. These are the cornerstones of our strategy. Each of our businesses must add value in its own right. They also provide a stronger, more stable and valuable whole because of the linkages between them. Among the strategic actions we have already taken to get to this position are: reshaping our business portfolio to concentrate on a select group of marketleading customer franchises; dramatically restructuring our investment banking business to adapt our business mix to the changing regulatory landscape; focusing relentlessly on cost control across all our businesses; and investing in our Core UK Retail and Commercial businesses to bring their capabilities towards the levels our customers expect.
We outline how each of our divisions are performing together to deliver our Strategic Plan on pages 16 to 17.
We recruit, develop and reward people based on their ability to do the job
We operate our processes, systems and controls to minimise loss from fraud or error
Most of us at RBS get up every day with the aim of serving our customers well.
Protection Insurance when sometimes we should not have done that. We have been fined £381 million in connection with inappropriate conduct relating to the setting of the LIBOR benchmark interest rate.
But better systems and controls are only part of the solution. All of our people need to know that, as most of them want to, our focus must be on serving customers well. How are we doing that?
It starts by setting the right example from the top. Words are important – our Board and
In Business & Commercial, ‘Working with You’ is our commitment that all of our relationship managers will spend time working in customers’ businesses. Chris Sullivan, Chief Executive of Corporate Banking, helped lead the way.
Les Matheson, one of our Managing Directors, was a pioneer for the programme, working as a Banking Hall Coordinator in our branch on Edinburgh’s Princes Street.
Next, we need to be sure our people understand what putting customers first means.
Our new UK Retail Chief Executive, Ross McEwan, has said that his business is going to obsess about the customer experience, delivering a consistently high level of service.
We need to reinforce these messages by training and developing our people so that they can do their best for customers.
The plan to rebuild RBS from 2009 has been based on two primary elements. The first was to stabilise the company, making it safe so that it could stand on its own feet. The second was to focus our energies on serving customers well. We were clear that the plan would take time and that it would take five years and more for key aspects to be delivered.
Four years on, I am pleased to report that we made more progress in 2012, passing a number of important milestones. Perhaps the most significant was when, with our regulator’s agreement, we exited the Asset Protection Scheme in October, the earliest date at which that was possible. We were able to do so because we have made RBS safer. Our Core Tier 1 capital ratio was 10.3% at the end of 2012, above our target, despite some large unplanned charges. The balance sheet is smaller, falling by a further £195 billion to £1,312 billion, as the run-down of Non-Core assets continued faster than we first planned. Our funding is more stable too, with the Group loan to deposit ratio at 100% or 90% in our
We have achieved all of this in the most testing economic environment for many decades. The UK economy is still smaller than before the crisis struck and the US economy is only slightly bigger. This weakness in the main economies where we operate was a headwind to our plans, and regulatory changes have further reduced our return on equity in some areas. In particular, lower returns from investment banking activities necessitated further restructuring.
At times like these, your Board and the senior management of the company have a duty to lead. Our response has been diligent and determined in tackling any hint of misconduct and other failings, past or present. Our job has been three-fold: to understand what had happened and why, to put it right and then to minimise the chance that such problems happen again.
As a Board, we are determined that RBS should be known in future for how we behave as well as for commercial success.
On LIBOR, IT and many other issues, my fellow directors have shouldered a considerable and growing burden of work. I wish to thank them for that and for their support throughout the year.
UK and continued, if moderate, expansion in the US. Compared with a year ago, the problems of the euro area appear less pressing though key challenges remain. Governments and central banks are now managing that crisis more effectively and they have started to put in place the financial infrastructure needed to sustain the euro. We are entitled to some confidence that the economic environment in 2013 will be better than at any time since the financial crisis struck in 2007.
RBS is four years into its recovery plan and good progress has been made. We are a much smaller, more focused and stronger bank. Our target is for 2013 to be the last big year of restructuring. There will be important work still to do, but an increasingly sound base from which to work. As the spotlight shifts to the ‘new RBS’ post restructuring, we are determined that it will show a leading UK bank striving to be a really good bank. By serving customers well RBS can become one of the most respected, valued and stable of banks. That is our goal.
2012 saw landmark achievements for RBS. It was also a chastening year. Along with the rest of the banking industry we faced significant reputational challenges as we worked with regulators to put right past mistakes. We are determined to overcome the cultural and reputational baggage of pre-crisis times with the same focus we have applied to the financial clean-up from that era.
We need to complete and sustain our return to a safe and conservative risk profile.
RBS has: Sustained its 33 million customer franchise in the face of substantial restructuring and other pressures. Lending balances to Core UK businesses and homeowners (excluding commercial real estate) were grown by over 3%, ahead of growth in the wider economy.
Reached a loan to deposit ratio - perhaps the clearest indicator of a bank’s funding prudence – of 1:1 from a worst point of 154%. Achieving this ‘golden rule’ of banking is a powerful symbol of our recovery.
The critical task of financial stabilisation passed milestones as RBS recommenced preference share dividends, completed the repayment of all crisis liquidity facilities from public authorities and exited the UK Government £282 billion Asset Protection Scheme without making any claim under it. The notable flotation of Direct Line Group represented the third of four EU state aid conditions and offset the disappointment of Santander withdrawing from its agreed purchase of 315 branches from RBS.
Underlining this progress, RBS 5 year bonds traded at c.1% credit spreads compared to their wide levels earlier in the year of c.4.5%. The resultant own-credit accounting charge of £4.6 billion reflects this huge improvement in the perceived credit quality of RBS.
There is no single solution or dramatic action able to address this problem. The best companies in the world in any industry develop, almost as part of their DNA, the consistent commitment to serve customers well and act accordingly. Our sights are set here. The facts and the culture that drives them will be established one piece at a time across many many issues. But we have no higher priority.
RBS is coming through an immense and wrenching restructuring. Much has been achieved and that should underpin our energy for what remains. Much is already good about our Core business, how it serves customers, how it performs. Our ambition is to be a really good bank – for all our stakeholders. Simple to say. A lot still to do. Many will benefit from our achieving that goal.
I thank our staff and all our stakeholders for their continued support in this effort.
Group net interest margin was broadly stable over the year meaning the profitability of taking in savings and lending to our customers stayed broadly constant. This is a struggle with interest rates so low but an important sign of financial resilience.
With the exception of certain securities issued by the RBS N.V. legal entity, this restriction has expired and the Group has resumed payment to date on hybrid securities.
Considerations around timing of any such decision will primarily be driven by, the Group’s operating environment and profitability; uncertainty around regulatory capital adequacy requirements, most notably the impact of Basel III; and the Dividend Access Share held by the UK Government
With the culmination of the restructuring phase of our strategic plan in 2013, these associated ‘exceptional costs’ should start to significantly reduce from next year.
We retain the conviction that the underlying businesses of RBS can deliver sustainable profitability using a more conservative business model.
Disciplined cost management has been a foundation of our strategic plan. The Group's cost reduction programme realised over £3.6 billion of sustainable savings to date, versus its original £2.5 billion target. This has seen Group operating costs reduce by 18%, or £3.2 billion, since 2008. We have embedded cost discipline across our Core businesses, where operating expenses are down 9% since 2009. Non-Core's costs have significantly reduced, and should continue to fall as we approach the end of the active run-down process.
Core Tier 1 ratio This is the most important measure of capital strength. We need to meet society’s expectation of a safe and sound banking system by maintaining a strong capital ratio >10%
Loan:deposit ratio We want to fund our customer lending with stable deposits from customers in order to maintain a sustainable balance sheet c.100%
We want to have proportionately low reliance on more volatile short-term money market funding <10% TPAs (7)
Liquidity portfolio (4) We want to hold a strong liquidity buffer to guard against unexpected funding emergencies >1.5x STWF (8)
Leverage ratio (5) A useful cross check to ensure that we are protected against risks that might turn out to be greater than we calculate
(1) Based on indicative Core attributable profit taxed at standard rates and Core average tangible equity per the average balance sheet (83% of Group tangible equity based on risk-weighted assets at 31 December 2012).
(6) Core Tier 1 ratio excluding benefit from the Asset Protection Scheme of 90 basis points in 2011.
Focus on implementing state of the art risk controls, run-off of excess risk concentrations and maintenance of strong equity capital.
The Group’s funded balance sheet was further managed down to £870 billion by the end of 2012. Non-Core and M&IB have driven the deleveraging to date, with Non-Core’s funded balance sheet standing at £57 billion, 22% of its starting point in 2008 and ahead of target for the year.
We had an excess of liquidity in 2012 with liquidity reserves of £147 billion, or 3.5x our short-term wholesale funding, surpassing our target.
In 2012, we passed a major milestone in our capital story when we exited the Asset Protection Scheme (“APS”), the Government scheme we entered in 2009 to provide capital relief and insurance against the possibility of a further significant deterioration in credit losses. Now, even without the benefit of APS, we have maintained a Core Tier 1 capital ratio of 10.3%, above our target.
Our capital ratio meets regulatory requirements well ahead of the internationally agreed implementation timeline and shows that the Group has sufficient capital to deal with future requirements.
Accurately deploy the Group’s capital and allocate appropriate costs to focus the divisions on sustainable returns, as well as on profit growth.
Our goal is for the new RBS to be built upon customer-driven businesses with substantial competitive strengths in their respective markets. We have top tier competitive positions across all of our enduring customer franchises. We continue to monitor closely and drive improvements in our customer satisfaction scores.
Achieving growth continues to be a major challenge in our operating environment. Put simply, if our customers are not growing, we will not grow. We have restructured and invested in our ongoing businesses to serve our customers better and deliver improved and enduring performance. We believe there is additional upside to these franchises when economic recovery takes hold.
Our leading UK retail and corporate customer franchises form the anchor of our strategy, strengthened by selected international businesses that provide deep local franchises with material synergies with the rest of the Group.
We undertook a major restructuring of our wholesale businesses this year, focusing on our strongest businesses and exiting loss-makers. We shed £29 billion of funded assets from Markets balance sheet. This will help improve the efficiency of our capital usage and strengthen our overall balance sheet and funding profile whilst ensuring we continue to provide our larger corporate customers with the access to global markets that they require.
We have decreased Non-Core’s funded balance sheet by £201 billion since the creation of the division in 2008 through run-off and disposals.
Approximately 20% of operating profit to come from our Markets activities
RBS management hallmarks to include an open, investor-friendly approach, discipline and proven execution effectiveness, strong risk management and central focus on serving our customers well, and better
Demonstrate execution effectiveness by setting clear performance targets for risk and returns, and give regular updates on progress against them.
Put serving our customers well, and better, at the heart of our agenda. Measure our progress on this with reference to a series of targets.
At the centre of its effort to rebuild the Group, RBS is dedicated to maintaining the strength of its Board and senior management teams.
Embed the new set of management disciplines to ensure that the RBS of the future is adequately protected, notably by its risk management processes and frameworks.
We provide detailed financial information, including disclosures on risk and balance sheet management, to the market each quarter.
Improving support for our customers was the top goal of our 2009 strategic plan. We track, and target improvements in, customer satisfaction and market position for all of our core franchises. In addition, we have implemented customer charters and have piloted training programmes for our front line staff. We plan to widen further the scope of these going forward.
A number of legacy conduct issues have had to be addressed, particularly in the last year. These highlight the importance of the cultural change we are undergoing in order for us to do better for our customers in the future.
More positively, unemployment fell, from around 8.3% at the turn of the year to 7.7% towards its end. That helped to offset the continuing squeeze on the spending power of earnings as wages grew by less than inflation.
Unemployment in Ireland averaged more than 14%. At the end of the year house prices were 4.5% lower than 12 months earlier and around 50% below their peak. The rate of decline was slower than at any time since 2008 and there were tentative signs that prices were stabilising.
Entering 2012, the greatest economic concern was how problems related to sovereign debt in the euro zone would be managed. By agreeing the outline of a banking union, undertaking to purchase sovereign debt to push down yields and making progress on fiscal rules, European leaders and the European Central Bank took some steps that are necessary if an economic and monetary union is to be sustained. At the end of the year the probability that some of the worse outcomes would be realised had fallen although they had not disappeared. Despite this progress, euro zone GDP contracted and unemployment had risen to almost 12% by December.
Sources: Datastream Note: Ireland growth rates are four quarters to Q3 2012 over four quarters to Q3 2011 and four quarters to Q3 2011 over four quarters to Q3 2010
Financial strength and resilience are at the heart of our Strategic Plan. The plan targets a credit rating in line with those of our strongest peers, without government support.
These strategic risk objectives link the Group’s business strategy to the way we set risk appetite and manage risk in our business. We set risk appetite at Group level.
This establishes the level and type of risks that we are able and willing to take to meet our strategic objectives and our wider obligations to stakeholders.
We cascade and embed this risk appetite across the Group, allowing: each business to understand its acceptable levels of risk; and commercial strategies to be aligned with the use of available financial resources.
Key developments in 2012 In 2012, we continued to strengthen our approach to risk management amidst a challenging and ever-changing external environment. Areas of progress included: refining our understanding of the risks we face and their scale; reducing our exposures in line with our objective of being safe and sustainable; improving the quality of our data, including forward-looking measures; developing a framework for the effective management of our conduct risk; strengthening our credit risk and country risk appetite and management frameworks and ensuring consistent application across the Group; and further realigning our Group Policy Framework to our business model and continuing assurance.
In the table on the following page, we summarise the risks we face. We provide a more detailed discussion of developments in 2012 in the ‘Risk and balance sheet management’ section of the Annual Report and Accounts.
Frequent small losses which are material in aggregate. Infrequent large material losses due to stress events.
Regulatory risk The risk arising from non-compliance with regulatory requirements, regulatory change or regulators’ expectations.
Conduct risk The risk that the conduct of the Group and its staff towards its customers, or within the markets in which it operates, leads to reputational damage and/or financial loss.
Can arise from actions taken or not taken by the Group or from its wider conduct, policies and practices.
May be caused by internal factors such as volatility in pricing, sales volumes and input costs, and/or by external factors such as exposure to macroeconomic, regulatory and industry risks.
Pension risk The risk arising from the Group’s contractual liabilities to or with respect to its defined benefit pension schemes, as well as the risk that it will have to make additional contributions to such schemes.
The main risk types facing the Group, which are covered by the risk appetite framework, are shown below: ARSFS12_ESS_READING_&_BUS_STRAT_AW_Layout 1 03/04/2013 11:45 Page 20
Our starting point in making UK Retail safer was understanding and agreeing how much risk we are prepared to take. We have done that and abide by the disciplines that imposes.
Despite our progress, in June, we let our customers down when our IT systems failed. We are sorry for that. We’ve investigated and understand where we need to improve.
In the latter part of 2012, we welcomed Ross McEwan, our new Chief Executive. Coming from Commonwealth Bank with an abundance of energy and experience, Ross has listened to our customers and people and has set a clear direction for 2013 with a focus on making it simple and easy for our customers to do business with us.
We want to put customers first and we made changes that help us do that.
Quick and convenient service. We cut average branch queuing time from almost five minutes to less than three and a half minutes. We open 1,263 branches on Saturdays and 254 open until 6pm on weekdays. We upgraded and improved our market-leading mobile app, growing our regular user base from 1.4 million to 2 million. It used to take three weeks to open an account with us, now it takes 24 hours. Our mobile branches average 7,000 miles each week to serve our customers in 347 remote communities.
In response to the Retail Distribution Review we’re building a simpler, nimbler, more customer focused advice business.
We made changes to our branches to make life easier for customers and help us reduce costs. We refurbished nine branches and refreshed 59 more. By introducing Banking Hall Coordinators and more Cash and Deposit Machines, we moved transactions away from branch counters, giving our people more time to talk to customers.
Every day, our people put our customers first, and often go to heroic efforts to do so. And we recognise them. Across our business our people nominate their colleagues for Helpful Banking Hero awards and winners are selected by a panel of frontline employees. They are our role models.
Our Helpful Leadership Academy gives leaders the skills, understanding and confidence to lead all of us towards becoming the UK's most Helpful Bank. We reward leaders for their contributions to service and risk management but also by how they provide leadership for their teams and how well they manage customers’ complaints.
Our customers are at the core of everything we do. Our sole purpose is to help them realise their ambitions, achieve growth, and become more efficient. We have the capital, the funding and the professional expertise within our people to deliver.
We are also helping larger businesses by investing in sector and asset class expertise, Our Manufacturing Fund has made £1 billion available for investment in technology, innovation, working capital and business acquisitions. Our Carbon Reduction Fund provides a further £200 million of ring-fenced funding for businesses undertaking energy-efficiency projects.
We are a leading provider of FLS and all other major lending initiatives including the Regional Growth Fund, Enterprise Finance Guarantee and the Business Growth Fund.
Lending is a vital part of our business, but we do much more than that.
We introduced a new enhanced telephony and online offering, Business Connect. We currently support over 170,000 small business customers, who have access to experienced Relationship Managers from 8am to 8pm. Bizcrowd is our new online business-tobusiness community. It helps businesses find new customers, and offers interactive business education. We are the first bank to support customers in this way and have over 5,000 customers involved in its pilot.
We recognise time is of the essence to our customers. Our new mobile banking apps allow them to manage multiple accounts, make payments and transfers, and see detailed statements going back seven years. We have over 70,000 customers using the apps on average twice a day and they have transferred more than £750 million since launch. Our turnaround plan relies on supporting the communities and local economies we serve. Our regional ‘Great place to do business’ events bring investors, local authorities and prominent members of the community together to stimulate growth in their area.
As part of our commitment to put qualified bankers back on the high street, our RMs go through an accreditation programme. It has been independently accredited by the Chartered Banking Institute. No other bank does this and it is a key differentiator for us. So far, 93% of our SME relationship managers have completed a minimum of foundation level training.
We understand the importance of knowing the sectors and people we work with. Our Women in Business (WiB) proposition, first of its kind, is industry-leading. We have over 120 accredited WiB specialists helping our female customers succeed by providing a bespoke and tailored service.
We launched Coutts Mobile in October. It means we can offer clients greater choice and flexibility in the way they manage their banking needs, providing them with the same access and convenience of Coutts Online on their smartphone or tablet.
The UK rollout of the Coutts global technology platform was completed in early 2012, enabling us to operate as an international organisation on unified and common information technology, transforming our ability to serve clients globally.
Throughout 2012, our UK business prepared to implement the Retail Distribution Review (RDR) regulations. This resulted in the introduction of the new advice model on 26 November, ahead of the required implementation date.
We significantly enhanced our Lombard lending programme in 2012, which will be central to our success and a source of important focus in 2013 and beyond. We set higher lending values for Chinese H-shares and Red Chips, and further increased lending values on Russian bonds. China, India and Russia were approved as ‘special emerging markets’, with a corresponding removal of the 50% emerging market cap for each country.
The ruble and renminbi were added as approved currencies and lending values were also agreed for renminbi cash and bonds.
In the UK, we launched the Coutts multi-asset funds comprising a range of seven UK and global RDR-compliant funds. These aim to deliver attractive long-term returns by investing in a broad range of asset classes including cash, bonds, equities, commodities and property that allow each client’s individual investment objectives to be matched to an appropriate investment strategy based on four separate asset allocation models.
We introduced a new client feedback programme in the UK in 2012 in order to improve the volume and quality of client feedback and enable us to react swiftly to any issues identified. We expect to roll out similar programmes with Adam & Company and the International business in 2013.
During the year we began the journey towards creating Coutts’ 'Crown Standard'. It reflects our values as we strive for excellence in everything we do. Whether our people serve clients at the front line, or work in a functional or support role, we must take pride in how we go about our tasks and work to the highest possible standards.
If we get this right for ourselves, we will get it right for our clients and we will earn their trust and loyalty for years to come. Each of us has a hand to play in building our Crown Standard and, as we continue with our transformation, there is every opportunity for us to define what this should look and feel like.
Operating profit increased by £5 million, or two per cent, to £253 million, driven by higher income partially offset by increased expenses and impairment losses. Total income increased by £66 million and expenses by £40 million. Impairments were £21 million higher. Return on equity increased to 13.7 per cent. The loan to deposit ratio was stable at 44 per cent.
International Banking is making RBS safer by: reducing third party assets from £69.9 billion in 2011 to £53.0 billion; boosting customer deposits by £1.1 billion as a result of an improved customer offering, including our Global Liquidity Solutions Portal.
Our core message to our people is that customers must be at the heart of what we do and how we do it. We have put in place a conduct risk framework with integrity of our staff at its centre. It emphasises the behaviour we expect from everyone in International Banking and its messages are reinforced regularly by our senior leaders.
International Banking is committed to treating our customers fairly, continually enhancing the risk and control framework and conducting business in an ethical manner. This is how we will continue to improve our culture and how we interact with customers.
We have embedded the principles of correct behaviour within staff job descriptions. They will be recognised for demonstrating compliance and integrity behind their achievements, as well as for the achievements themselves in their half-yearly and year-end performance reviews. These measures are supported by a suite of intranet-based learning tools.
Return on equity was lower than in 2011 at 9.2 per cent. The loan to deposit ratio improved to 85 per cent.
It was another testing year. There were some signs of improvement but the economy was weak. Unemployment remained high, house prices fell further and wages were flat. We continued to deal with the legacy of the past. Our review of how we operate confirmed that Ulster Bank has a sustainable future if we make the right changes.
Our systems failed in June. We are very sorry for the effects that had on our customers. We worked hard to support them and put things right.
We extended normal opening hours at 83 branches and Saturday hours at 60. We opened 22 branches on a Sunday. Our call centre extended its hours to 10pm.
We processed transactions manually if corporate customers could not use online banking.
In September, we announced how we were going to make amends to customers who were affected. We wrote to every Ulster Bank customer to apologise.
We improved our digital services. That makes it easier for customers to do business with us. With our apps for iPhone, BlackBerry and Android handsets you can: get an up-to-the-minute balance; view a mini-statement with your last six transactions; make transfers between your Ulster Bank accounts; pay your friends, family, credit card, or utility bills; and locate your nearest Ulster Bank branch or cash machine.
Customers used the service almost 18 million times making 1.2 million payments worth £282 million.
US Retail and Commercial continues to help make RBS a safer bank. We have delivered 12 straight quarters of operating profit and improving annual returns on equity. Our capital position is among the strongest in our peer group. For the first time since 2008, we were able to return capital to RBS Group.
We strengthened our balance sheet. Our loan to deposit ratio was 86% at year end and we have improved our deposit mix, adding core checking accounts while reducing more costly term and time deposits. Wholesale funding sources are greatly diminished.
In Consumer Banking, our commitment to customers is clear in the investments we have made.
We believe we can win and deepen customer relationships by delivering high levels of service. There is a dedicated team which continues to improve the customer experience.
This team examines data from customer surveys, feedback and complaints. This allows us to identify trends and sources of issues. We are able to understand what has not worked for customers and fix it. In one example, customer feedback led us to cut the wait time between when we mail a customer’s debit card and the associated PIN.
We jumped eight spots in 2012 to number 10 in a survey of bank reputations conducted by American Banker, an industry publication.
Operating profit of £754 million was £217 million (40 per cent) higher than in 2011. Total income increased by 2 per cent. Higher net interest income was driven by targeted commercial loan growth, deposit pricing and lower funding costs. Noninterest income was slightly higher despite a decline in debit card fees as a result of the Durbin Amendment legislation, lower securities fees and lower deposit fees. Expenses were 3 per cent higher, largely as a result of one-off items. Impairments fell sharply, by £235 million to £91 million. Return on equity was higher at 8.3 per cent. The loan to deposit ratio was broadly stable at 86%.
We took significant steps to reduce risk. We reduced our third party assets from £312.6 billion to £284.4 billion and we cut risk-weighted assets from £120.3 billion to £101.3 billion.
Changes we made to the structure of our business to reduce risk.
We are innovative. We helped UBS to raise US$2 billion. It was the first time the Swiss bank had issued contingent capital to institutional investors. We were the book runner on an offshore renminbi transaction for Veolia Environnement. This was the first renminbi transaction on Euronext Paris.
Proper conduct is a core principle for all our people. A continual emphasis on the need to ‘do the right thing in the right way’ is part of our drive to embed the right behaviours in our culture, and ‘treating customers fairly’ is a central principle in that culture We have changed how we manage people. The Accountability Review process ensures appropriate management of misconduct, including consequences for remuneration Diversity and Inclusion has been a key area for the Markets business. We launched the M&IB transformational leadership programme to develop leaders who are more agile, people-focused and commercially aware.
We successfully completed the sale of 35% of ordinary shares in Direct Line Group on the London Stock Exchange. Demand for our shares was strong.
Our risk-based capital coverage ratio was 151.4% at the end of the year, compared with our target of 125-150%.
Our Insurance Groups Directive (IGD) surplus was £1.8 billion and our IGD coverage ratio was 279.4%.
Direct Line Group made dividend payments of £1 billion to RBS Group in 2012. We enhanced efficiency and improved pricing and underwriting.
We made progress on our aim of cutting costs by £100 million per year by 2014. We will achieve that through a range of actions and we have already announced half of those initiatives. These savings come on top of cutting the number of UK sites from 32 to 16. We achieved that by mid-2012.
We made significant progress in developing our distribution capabilities. The partnership agreements that we renewed or expanded represent a substantial portion of our portfolio, especially in the home segment.
All of our employees were invited to take part in facilitated workshops as part of The Best Programme. These workshops engage our people and gather their ideas about how we can become ‘Best’. Our state of the art internal social media site – Best Quest – allows open discussion and lets people post their ideas for the changes we need to make if we are to achieve our goals.
One of the most important outputs of the programme was the creation of a set of values, conceived and written by a team representing all our people – from the bottom up.
Operating profit of £441 million was £13 million, three per cent, lower than in 2011 as improved underwriting results were more than offset by a £22 million reduction in investment income. Total income of £3,474 million was £333 million, nine per cent, lower. Net claims of £2,427 million were £345 million, 12 per cent, lower. Expenses of £849 million were broadly flat. Return on tangible equity was higher than in 2011 at 11.7 per cent. The combined operating ratio improved by 100 basis points to 100 per cent.
1.2m online web chats 16.8m transactions every day 4.2bn payments processed worldwide £11bn worth of payments and transfers using the mobile app
The Bank faced one of its biggest technical challenges ever when we had some IT problems in June. We are sorry for the disruption it caused our customers. To support our customers through this difficult period we opened our branches for longer, doubled the number of staff in our UK-based call centres and gave them greater authority to provide on-the-spot help to support our affected customers.
Our Pay Your Contacts feature allows customers to send instant payments of up to £300 to any of their phone contacts who have the NatWest or RBS app.
We helped our customers keep in touch with us and get access to their funds: Our helpdesks held over 1.2 million online web chats.
Our flexible working programme, Choice is helping us optimise our work spaces. We are now in the Top 10 Employers for Working Families in the UK.
Group Finance is responsible for the external reporting of the Group’s performance and financial position, including regulatory and central bank reporting. We manage the Group’s capital, ensure compliance with tax regulations and support executive decision making through financial analysis. Our external reporting is highly rated by stakeholders.
Our Strategy and Corporate Finance function helps ensure RBS has the right portfolio of businesses, developing the Group’s strategy and executing acquisitions and disposals. The team was instrumental in the successful Initial Public Offering of Direct Line Group.
Effectively embedding the risk appetite frameworks was central to convincing the Financial Services Authority and HM Treasury that we were strong enough to exit the Asset Protection Scheme.
Human Resources supported the implementation of the Group’s strategic plan, including the disposal of Non-Core businesses that are part of the wind down to make our balance sheet risk safe.
Non-Core has reduced its third party assets by over £200 billion since it was formed at the start of 2009. In 2012, we reduced third party assets by 39% to £57 billion. We disposed of £18 billion and negotiated run-off of £16 billion of funded assets during 2012. We also reduced our derivatives portfolio by 45% to £6 billion, down from £85 billion at the start of 2009.
Non-Core targets a balanced run-down of all the portfolio asset classes in parallel. For example, in 2012 Real Estate reduced by 30%, Markets by 48% and Corporates by 40%. Using diverse approaches across the portfolio gives us the flexibility to react to market conditions.
We completed a number of notable transactions across asset classes in 2012 including the sale of: RBS Aviation Capital to Sumitomo Mitsui Financial Group for approximately £5 billion, which also reduced RWAs by approximately £2 billion. The business is the world’s fourth largest aircraft lessor by owned and managed fleet value, including a portfolio of 203 owned aircraft; two buildings in Frankfurt and Berlin to AXA Real Estate investment Management and Norges Bank Investment Management for €784 million; sale of £275 million securitised real estate loans. This transaction improved the funding of the partnership with Blackstone to manage a fund of £1.4 billion of UK loans that we announced last year; over £300 million leveraged assets through auctions; and our Reverse Mortgages Services business in Australia to Macquarie.
Non-Core reduced its capital requirement in 2012 through running down the portfolio and pursuing targeted capital management actions. We reduced risk-weighted assets by £33 billion (35%) over 2012 to £60 billion from £93 billion in 2011 and also undertook transactions to avoid or reduce the amount of additional capital that we will require following the implementation of the new Basel III rules, including the fourth Capital Requirements Directive.
We also reduced our cost base by £351 million (27%) and operational risk through reducing the scope and headcount of the Division, particularly through the completion of business exits such as RBS Aviation Capital.
Sustainability at RBS is built on a robust governance framework that provides clarity around the development of our strategic sustainability objectives. The Group Sustainability Committee (GSC) is a Group Board Committee, chaired by our Senior Independent Director, Sandy Crombie. It consists of independent non-executive directors and all key business areas are represented at Committee meetings and the Group Chairman is also invited to attend. The GSC has overseen some progressive developments within the company. In 2012, the GSC focused on reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues. In 2013, the scope will widen to include sustainability and reputational issues related to customer and citizenship activities; oversight of the delivery of the Group purpose, vision and values cultural and behavioural change; and oversight of the sustainability aspects of the people agenda. The renewed GSC will also be responsible for overseeing and challenging how management is addressing sustainability and reputational issues relating to all stakeholder groups. For more information on the GSC or sustainability visit rbs.com/sustainable.
The GSC took part in three stakeholder sessions in 2012 on our themes of: Citizenship and environment; Supporting enterprise; and Employee engagement.
Addressing risks arising from Environmental, Social and Ethical (ESE) issues is an integral part of meeting our commitment to becoming a more responsible business. Over the last two years we have updated and improved our policy framework. We increased the transparency and disclosure of our business risk appetite and developed ESE policies for four sensitive sectors: defence, oil and gas, mining and metals, and forestry. These policies have been fully implemented and follow a clear governance structure and decision making process involving divisional Reputational Risk forums throughout the business. New policies for the Power Generation and Gambling sectors are currently being implemented, with further sector-specific policies also being considered. ESE reviews involve an assessment of a company's commitment, capacity and track record in managing ESE risks. We assessed our clients and transactions against the relevant ESE risk criteria and found that our risk management systems are in good health. A web-based training tool on our ESE policies was launched in 2012. This training was compulsory for all staff working in the relevant divisions and can also be accessed by all RBS Group staff to ensure they understand the Group’s ESE policies.
Our policy making also incorporates a number of voluntary global standards. We are members of the Equator Principles and follow its environmental and social impact assessment criteria in our Project Finance lending. We are also members of the UN Global Compact (UNGC) which brings companies together with UN agencies, labour organisations and civil society to support human rights, labour rights, the environment and anti-corruption. We adhere to the ten UNGC Principles and report against these each year.
A full sustainability update will be provided in our 2012 Sustainability Report, published in April 2013.
We want to build a good company and a good bank. Sustainability is central to achieving this goal and to making sure that the misconduct of the past is not repeated.
Open Consulting with and listening to our stakeholders Showing transparency in the way we run our business Publicly communicating our efforts to be responsible and sustainable
A Good Employer Providing our people with the tools and support to do their jobs effectively and develop their skills Valuing and promoting diversity in all areas of recruitment and employment Rewarding our people fairly for their work
Reportable major injuries decreased by 57% 22% reduction in fraud losses in 2012 against a corresponding 1% increase in fraud cases, compared with 2011 Eight million customers have downloaded our free online anti-fraud software Over 95% of employees have received Anti-Money Laundering training 3,700 UK business customers facing financial difficulty were returned to mainstream banking £3 million has been made available to organisations that help young people and women looking to start their own business 90% UK business customer Relationship Managers have been accredited to help provide customers with further business expertise We lent £2.7 billion to over 20,000 first time buyers in the UK
Our Group Sustainability Committee met with 14 different advocacy groups to discuss the issues that matter most to them We continue to be open and transparent in our reporting. The ‘Our financing of the energy sector’ reports have provided industry-leading analysis since 2009 The leadership of RBS has been pro-active in engaging with the media and our stakeholders to explain the role of RBS in society and how we are changing We have increased the number of visitors to the rbs.com website by 50%
In 2012, RBS was included in the Working Families top 10 Employers for quality of work-life balance We continue to promote diversity through internal employee networks and the number of female executives and senior managers have both increased by 1% We have reformed our remuneration policies to reflect a more appropriate approach to pay. Since 2009, the investment banking bonus pool has reduced by 70%
Sustainable Business Principles Our Sustainable Business Principles set out sixteen separate commitments that underline our commitment to operating responsibly. They are a recognition that balancing the needs of all our stakeholders is the best way to deliver sustainable commercial success. The following table sets out some of the work we are doing to meet those commitments:
Certain information in this report is presented separately for domestic and foreign activities. Domestic activities primarily consist of the UK domestic transactions of the Group. Foreign activities comprise the Group's transactions conducted through those offices in the UK specifically organised to service international banking transactions and transactions conducted through offices outside the UK.
In October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of the UK Financial Services and Markets Act 2000. Substantially all of the Netherlands and EMEA businesses were transferred in September 2012. Further transfers are expected to take place during 2013 but are subject to certain authorisations including regulatory approval where necessary. The Group now anticipates that the transfers in China will be completed at a later date.
Managed results The financial information on a managed basis, prepared using the Group’s accounting policies, shows the underlying performance of the Group which excludes certain one-off and other items. This information is provided in this form to give a better understanding of the results of the Group’s operations. Consistent with the manner in which the Group is managed, Group operating profit on a managed basis excludes: own credit adjustments; Asset Protection Scheme; Payment Protection Insurance (PPI) costs; Interest Rate Hedging Products redress and related costs; regulatory fines; sovereign debt impairment; interest rate hedge adjustments on impaired available-for-sale sovereign debt; amortisation of purchased intangible assets; integration and restructuring costs; gain on redemption of own debt; strategic disposals; bank levy; bonus tax; write-down of goodwill and other intangible assets; and
and includes the results of Direct Line Group on a managed basis, which are included in discontinued operations in the statutory results.
Revised allocation of Group Treasury costs The Group revised its allocation of funding and liquidity costs and capital. The new methodology is designed to ensure that the allocated costs more fully reflect the funding used by each division.
Divisional return on equity ratios Notional divisional equity is calculated as a percentage of the monthly average of divisional risk-weighted assets, adjusted for capital deductions. In 2012, 10% was used for both the Retail & Commercial divisions (2011 - 9%) and Markets division (Global Banking & Markets, 2011 - 10%).
Fair value of own debt and derivative liabilities The Group had previously excluded changes in the fair value of own debt (FVOD) in presenting the underlying performance of the Group on a managed basis given it is a volatile non-cash item. To better align our managed view of performance, movements in the fair value of own derivative liabilities, previously incorporated within Markets operating performance, are now combined with movements in FVOD in a single measure, ‘Own Credit Adjustments’. As a result, Group and Markets operating results on a managed basis have been adjusted to reflect this change which does not affect profit/(loss) before and after tax.
Reconciliations between managed and statutory results are detailed on pages 102 to 104.
Disposal groups Since 2011, the assets and liabilities relating to the RBS England and Wales and NatWest Scotland branch-based businesses, along with certain SME and corporate activities across the UK (‘UK branch-based businesses’), were classified within Disposal groups. Santander's withdrawal from the sale in October 2012 has led the Group to conclude that a sale within 12 months is unlikely; accordingly the balance sheet at 31 December 2012 does not classify the assets and liabilities of the UK branch-based businesses within Disposal groups. IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’ does not permit restatement on reclassification.
In particular, this document includes forward-looking statements relating, but not limited to: the Group’s restructuring plans, divestments, capitalisation, portfolios, net interest margin, capital ratios, liquidity, risk weighted assets (RWAs), return on equity (ROE), profitability, cost:income ratios, leverage and loan:deposit ratios, funding and risk profile; discretionary coupon and dividend payments; certain ring-fencing proposals; sustainability targets; regulatory investigations; the Group’s future financial performance; the level and extent of future impairments and write-downs, including sovereign debt impairments; and the Group’s potential exposures to various types of political and market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. These statements are based on current plans, estimates and projections, and are subject to inherent risks, uncertainties and other factors which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated.
At 31 December 2012, HM Treasury’s holding in the company’s ordinary shares was 65.3% and its economic interest was 81.1%.
The Group had total assets of £1,312.3 billion and owners' equity of £68.1 billion at 31 December 2012. The Group's risk asset ratios at 31 December 2012, were a Total capital ratio of 14.5%, a Core Tier 1 capital ratio of 10.3% and a Tier 1 capital ratio of 12.4%.
The changes include an exit from cash equities, corporate brokering, equity capital markets and mergers and acquisitions advisory businesses. Significant reductions in balance sheet, funding requirements and cost base in the remaining wholesale businesses will be implemented.
The domestic small and mid-size corporates previously served by GTS are now managed within RBS's domestic corporate banking businesses in the UK, Ireland (Ulster Bank) and the US (US Retail & Commercial).
The Group’s activities are organised on a divisional basis as follows: UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through a number of channels including: the RBS and NatWest network of branches and ATMs in the United Kingdom, telephony, online and mobile. UK Retail remains committed to delivering ‘Helpful and Sustainable’ banking and to the commitments set out in its Customer Charter - the results of which are externally assessed and published every six months.
International Banking serves the world’s largest companies with a leading client proposition focused on financing, transaction services and risk management. International Banking serves as the delivery channel for Markets products to corporate clients and serves international subsidiaries of both International Banking and clients from UK Corporate, Ulster Bank and US Retail & Commercial through its international network.
In 2010, the Group reached agreement with Santander UK plc (‘Santander’) on the sale of certain UK branch-based businesses broadly comprising the RBS branch-based business in England and Wales and the NatWest branch-based business in Scotland, along with certain SME and corporate activities across the UK. However, in October 2012, the Group announced that it had received notification of Santander’s decision to pull out of its agreed purchase of these businesses. Santander's decision followed extensive work by both parties to separate the businesses into a largely standalone form and to prepare the businesses, customers and staff for transfer. RBS is continuing to work to fulfil its obligations to divest these businesses.
Also in October 2012, the Group sold via an initial public offering 520.8 million ordinary shares in Direct Line Insurance Group plc, representing 34.7% of the total issued share capital. This is consistent with the European Commission’s requirement to cede control by the end of 2013 and complete full divestment from the Group by the end of 2014.
Risk factors Set out below is a summary of certain risks which could adversely affect the Group; it should be read in conjunction with the Risk and balance sheet management section of the Business review (pages 107 to 293). This summary should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. A fuller description of these and other risk factors is included on pages 503 to 515.
The Group’s businesses, earnings and financial condition have been and will continue to be negatively affected by global economic conditions, the instability in the global financial markets and increased competition and political risks including proposed referenda on Scottish independence and UK membership of the EU. Together with a perceived increased risk of default on the sovereign debt of certain European countries and unprecedented stresses on the financial system within the Eurozone, these factors have resulted in significant changes in market conditions including interest rates, foreign exchange rates, credit spreads, and other market factors and consequent changes in asset valuations.
As a result of the UK Government’s majority shareholding in the
The Group’s ability to implement its Strategic Plan depends on the success of its efforts to refocus on its core strengths and its balance sheet reduction programme. As part of the Group’s Strategic Plan and implementation of the State Aid restructuring plan agreed with the European Commission and HM Treasury, the Group is undertaking an extensive restructuring which may adversely affect the Group’s business, results of operations and financial condition and give rise to increased operational risk.
The Group could fail to attract or retain senior management, which may include members of the Group Board, or other key employees, and it may suffer if it does not maintain good employee relations.
(2) Operating profit on a managed basis excludes own credit adjustments, Asset Protection Scheme, PPI costs, Interest Rate Hedging Products redress and related costs, regulatory fines, sovereign debt impairment, interest rate hedge adjustments on impaired available-for-sale sovereign debt, amortisation of purchased intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, bank levy, bonus tax, write-down of goodwill and other intangible assets and RFS MI. Operating profit on a managed basis includes the results of Direct Line Group on a managed basis which are included in discontinued operations in the statutory results.
(Loss)/profit from discontinued operations, net of tax (172) 348 (809) (172) 348 (809)
Summary consolidated income statement for the year ended 31 December 2012 continued £m £m £m £m £m £m
Results summary 2012 compared with 2011 - managed Operating profit Group operating profit, excluding own credit adjustments, Asset Protection Scheme, Payment Protection Insurance (PPI) costs, Interest Rate Hedging Products (IRHP) redress and related costs, regulatory fines, sovereign debt impairment, interest rate hedge adjustments on impaired available-for-sale sovereign debt, amortisation of purchased intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, bank levy, bonus tax, write-down of goodwill and other intangible assets and RFS MI, and includes the results of Direct Line Group on a managed basis which are included in discontinued operations in the statutory results, was £3,462 million compared with £1,824 million in 2011. The improvement was driven by lower costs in Markets, reflecting reduced headcount and lower levels of variable compensation, and a better operating performance in Non-Core, where losses fell by 32%. These improvements were partially offset by weaker performance in Retail & Commercial, as economic conditions remained difficult.
Total income Total income, excluding own credit adjustments, Asset Protection Scheme, gain on redemption of own debt, strategic disposals and RFS MI, and including Direct Line Group on a managed basis, which is included in discontinued operations in the statutory results, fell by 7% to £25,787 million, primarily reflecting lower net interest income and a fall in insurance net premium income.
Operating expenses Total operating expenses, excluding Payment Protection Insurance costs, Interest Rate Hedging Products redress and related costs, regulatory fines, amortisation of purchased intangible assets, integration and restructuring costs, bank levy, bonus tax, write-down of goodwill and other intangible assets and RFS MI, and including Direct Line on a managed basis, which is included in discontinued operations in the statutory results, fell by 6% to £14,619 million, with staff costs down 6% as headcount fell by 9,600 to 137,200. The decline in expenses was largely driven by Non-Core run-down and lower variable compensation (particularly in Markets), including variable compensation award reductions and clawbacks following the settlements reached with UK and US authorities in relation to attempts to manipulate LIBOR. The run-off of discontinued businesses in Markets and International Banking, following the restructuring announced in January 2012, and simplification of processes and headcount reduction in UK Retail also yielded cost benefits. Group cost: income ratio was flat at 63%.
Integration and restructuring costs of £1,550 million increased by £486 million versus £1,064 million in 2011, primarily driven by costs incurred in relation to the strategic restructuring of Markets and International Banking (M&IB) that took place during 2012.
The UK bank levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The cost of the levy to the Group for 2012 was £175 million compared with £300 million in 2011.
Earnings per share Basic loss per ordinary and B share from continuing operations was 53.7p per share compared with 21.3p per share in 2011. Adjusted earnings per ordinary and B share from continuing operations was 6.3p compared with a loss per share of 0.8p in 2011.
Impairment losses Impairment losses were £5,279 million, compared with £8,707 million in 2011.
Risk elements in lending represented 9.1% of gross loans and advances to customers excluding reverse repos at 31 December 2012 (2011 - 8.6%).
Provision coverage of risk elements in lending was 52% (2011 - 49%).
Total income Total income, excluding own credit adjustments, Asset Protection Scheme, gain on redemption of own debt, strategic disposals and RFS MI, fell by 15% to £27,709 million, primarily reflecting lower net interest income, lower trading income in Markets and Non-Core and a fall in insurance net premium income.
Operating expenses Total operating expenses, excluding PPI costs, amortisation of purchased intangible assets, integration and restructuring costs, bank levy, bonus tax, write-down of goodwill and other intangible assets and RFS MI, fell by 7% to £15,478 million, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits. Staff costs fell 9%, driven by lower Markets and International Banking variable compensation as a result of its decrease in revenues, and in Non-Core, given the impact of a 32% reduction in headcount and continued business disposals and country exits. The Group cost: income ratio was 63% in 2011 compared with 60% in 2010.
Impairment losses Impairment losses fell to £7,439 million from £9,256 million in 2010, with Core impairments falling by £260 million and Non-Core by £1,557 million, despite continuing challenges in Ulster Bank and corporate real estate portfolios.
Risk elements in lending at 31 December 2011 represented 8.6% of loans and advances excluding reverse repos, compared with 7.3% a year earlier. Provision coverage was 49%, compared with 47% at 31 December 2010.
Non-operating items A gain on the movement in own credit adjustments of £1,914 million was recorded in 2011 as Group credit spreads widened. This compares with a smaller gain of £242 million in 2010.
Integration and restructuring costs remained broadly flat at £1,016 million, reflecting significant Markets restructuring in 2011.
The Finance Act 2011 introduced an annual bank levy in the UK. The levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The cost of the levy to the Group for 2011 was £300 million.
Operating expenses Operating expenses decreased to £17,134 million (2010 - £17,456 million) of which integration and restructuring costs were £1,016 million compared with £1,012 million in 2010.
Provision coverage of risk elements in lending was 49% (2010 - 47%).
Tax The tax charge for 2011 was £1,127 million (2010 - £703 million).
Loss per share Basic loss per ordinary share from continuing operations was 21.3p per share compared with 2.9p per share in 2010.
Analysis of results Net interest income £m £m £m £m £m £m
Gross yield on interest-earning assets of the banking business (9) 3.12 3.24 3.29 3.12 3.23 3.27 Cost of interest-bearing liabilities of the banking business (1.50) (1.63) (1.48) (1.50) (1.62) (1.48) Interest spread of the banking business (10) 1.62 1.61 1.81 1.62 1.61 1.79 Benefit from interest-free funds 0.31 0.31 0.20 0.30 0.28 0.18 Net interest margin of the banking business (11) 1.93 1.92 2.01 1.92 1.89 1.97
Notes: (1) Interest-earning assets and interest-bearing liabilities for 2010 exclude the Retail bancassurance long-term assets and liabilities attributable to policyholders, in view of their distinct nature. As a result, interest receivable has been increased by £6 million. (2) Interest receivable has been increased by £8 million (2011 - £8 million; 2010 - £11 million) and interest payable has been increased by £152 million (2011 - £150 million increase; 2010 - £30 million decrease) 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. (3) Interest receivable was decreased by £90 million in 2010 in respect of a non-recurring receivable. (4) Interest receivable was increased by £2 million in 2011 in respect of exceptional interest receivable. (5) Interest payable has been decreased by £138 million in respect of non-recurring adjustments (2011 - £143 million decrease; 2010 - £319 million increase). (6) Interest receivable has been increased by nil (2011 - £5 million increase; 2010 - £10 million decrease) and interest payable has been decreased by £15 million (2011 - £3 million; 2010 - £1 million) to exclude RFS Holdings minority interest. (7) Interest receivable has been increased by £307 million (2011 - £374 million; 2010 - £424 million) and interest payable has been increased by £29 million (2011 - £2 million decrease; 2010 - £3 million decrease) to include the discontinued operations of Direct Line Group. Related interest-earning assets and interest-bearing liabilities have also been adjusted. (8) Interest income includes £565 million (2011 - £627 million; 2010 - £588 million) in respect of loan fees forming part of the effective interest rate of loans and receivables. (9) Gross yield is the interest earned on average interest-earning assets of the banking book. (10) Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business. (11) Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business. (12) The analysis into UK and overseas has been compiled on the basis of location of office. (13) Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities. (14) Interest income includes amounts (unwind of discount) recognised on impaired loans and receivables. The average balances of such loans are included in average loans and advances to banks and loans and advances to customers.
Assets Loans and advances to banks - UK 36,442 263 0.72 31,985 293 0.92 - Overseas 40,488 246 0.61 41,840 404 0.97 Loans and advances to customers - UK 278,188 11,443 4.11 294,711 12,108 4.11 - Overseas 151,779 4,868 3.21 172,177 5,871 3.41 Debt securities - UK 56,807 1,169 2.06 62,416 1,454 2.33 - Overseas 40,943 856 2.09 59,093 1,295 2.19 Interest-earning assets - UK 371,437 12,875 3.47 389,112 13,855 3.56 - Overseas 233,210 5,970 2.56 273,110 7,570 2.77 Total interest-earning assets - banking business (1,2,4,6,7,8) 604,647 18,845 3.12 662,222 21,425 3.24 - trading business (13) 240,131 278,975 Interest-earning assets 844,778 941,197 Non-interest-earning assets (1,2) 585,594 593,958 Total assets 1,430,372 1,535,155
Assets Loans and advances to banks - UK 22,578 223 0.99 - Overseas 30,143 369 1.22 Loans and advances to customers - UK 311,060 11,907 3.83 - Overseas 197,340 6,936 3.51 Debt securities - UK 66,734 1,467 2.20 - Overseas 62,103 1,791 2.88 Interest-earning assets - UK 400,372 13,597 3.40 - Overseas 289,586 9,096 3.14 Total interest-earning assets - banking business (1,2,3,6,7,8) 689,958 22,693 3.29 - trading business (13) 276,330 Interest-earning assets 966,288 Non-interest-earning assets (1,2) 705,916 Total assets 1,672,204
Liabilities Deposits by banks - UK 21,816 334 1.53 - Overseas 59,542 996 1.67 Customer accounts: demand deposits - UK 120,796 621 0.51 - Overseas 39,218 609 1.55 Customer accounts: savings deposits - UK 68,142 935 1.37 - Overseas 25,587 213 0.83 Customer accounts: other time deposits - UK 42,818 431 1.01 - Overseas 45,080 914 2.03 Debt securities in issue - UK 123,729 2,186 1.77 - Overseas 72,247 1,065 1.47 Subordinated liabilities - UK 19,998 480 2.40 - Overseas 9,336 252 2.70 Internal funding of trading business - UK (41,451) (140) 0.34 - Overseas (6,864) (41) 0.60 Interest-bearing liabilities - UK 355,848 4,847 1.36 - Overseas 244,146 4,008 1.64 Total interest-bearing liabilities - banking business (1,2,5,6,7) 599,994 8,855 1.48 - trading business (13) 293,993 Interest-bearing liabilities 893,987 Non-interest-bearing liabilities: Demand deposits - UK 29,022 - Overseas 23,994 Other liabilities (2,9) 648,295 Owners' equity 76,906 Total liabilities and owners' equity 1,672,204
Assets Loans and advances to banks - UK 20,198 208 1.03 - Overseas 30,029 368 1.23 Loans and advances to customers - UK 310,112 11,736 3.78 - Overseas 196,417 6,894 3.51 Debt securities - UK 60,179 1,261 2.10 - Overseas 63,348 1,812 2.86 Interest-earning assets - UK 390,489 13,205 3.38 - Overseas 289,794 9,074 3.13 Total interest-earning assets - banking business (1,2,3,8) 680,283 22,279 3.27 - trading business (13) 276,330 Interest-earning assets 956,613 Non-interest-earning assets (1,2) 715,591 Total assets 1,672,204
2012 over 2011 - managed 2012 over 2011 - statutory Increase/(decrease) due to changes in: Increase/(decrease) due to changes in: Average volume
Interest-earning assets Loans and advances to banks UK 38 (68) (30) 32 (61) (29)
Total interest receivable of the banking business UK (751) (229) (980) (749) (167) (916)
Customer accounts: other time deposits UK 51 (92) (41) 51 (92) (41) Overseas 157 (70) 87 165 (75) 90 Debt securities in issue UK 1,292 (371) 921 1,287 (363) 924 Overseas 318 105 423 318 105 423 Subordinated liabilities UK 24 (132) (108) 33 (114) (81) Overseas 10 (10) — 10 (10) — Internal funding of trading business UK 99 (214) (115) 99 (214) (115) Overseas 13 12 25 13 12 25 Total interest payable of the banking business UK 1,270 (847) 423 1,275 (821) 454 Overseas 1,054 102 1,156 1,081 63 1,144 2,324 (745) 1,579 2,356 (758) 1,598
Movement in net interest income UK 519 (1,076) (557) 526 (988) (462)
Analysis of change in net interest income - volume and rate analysis continued 2011 over 2010 - managed 2011 over 2010 - statutory Increase/(decrease) due to changes in: Increase/(decrease) due to changes in: Average volume
Movement in net interest income UK (553) (219) (772) (539) (182) (721)
2012 compared with 2011 - managed Non-interest income was down 6% at £14,092 million with higher profits on available-for-sale bond disposals in Group Treasury more than offset by a 10% decline in fees and commissions, largely due to a decline in UK Retail fees as a result of weaker consumer spending volumes, and lower insurance net premium income.
Insurance net premium income fell by 13%, primarily reflecting lower written premiums in Direct Line Group.
The continuing strengthening of RBS’s credit profile resulted in a £4,649 million accounting charge in relation to own credit adjustment versus a gain of £1,914 million in 2011. This reflected a tightening of more than 340 basis points in the Group’s cash market credit spreads over the year.
APS is accounted for as a derivative and the movements in fair value are recorded each quarter. The fair value charge was £44 million in 2012 versus £906 million in 2011.
Non-interest income continued 2011 compared with 2010 - managed Non-interest income decreased by £3,374 million in 2011 principally driven by lower trading income in Markets and Non-Core and a fall in insurance net premium income.
2011 compared with 2010 - statutory Non-interest income decreased by £492 million in 2011 principally driven by lower trading income in Markets and Non-Core, partially offset by a higher gain on movements in own credit adjustments.
General insurance 2,427 2,968 4,698 — — — Bancassurance — — 85 — — 85 Insurance net claims 2,427 2,968 4,783 — — 85
2012 compared with 2011 - managed Operating expenses fell by £859 million, or 6%, with staff costs also down 6% (but broadly stable as a percentage of total income) as headcount fell by 9,600 to 137,200. The decline in expenses was largely driven by NonCore run-down and lower variable compensation (particularly in Markets), including bonus award reductions and clawbacks following the settlements reached with UK and US authorities in relation to attempted LIBOR manipulation. The run-off of exited businesses in Markets and International Banking, following the restructuring announced in January 2012, and simplification of processes and headcount reduction in UK Retail also yielded cost benefits.
2012 compared with 2011 - statutory Operating expenses increased by £693 million, or 4% primarily due to charges resulting from legacy conduct issues partially offset by Non-Core run-down and run-off of exited businesses in Markets and International Banking, following the restructuring announced in January 2012. Simplification of processes and headcount reduction in UK Retail also yielded cost benefits.
On 6 February 2013, RBS reached agreement with the Financial Services Authority, the US Department of Justice and the Commodity Futures Trading Commission in relation to the setting of LIBOR and other trading rates, including financial penalties of £381 million. The Group continues to co-operate with other bodies in this regard and expects it will incur some additional financial penalties.
2011 compared with 2010 - statutory Group expenses fell by 2% in 2011, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits, partially offset by Payment Protection Insurance costs.
2012 compared with 2011 Integration costs were nil compared with £106 million in 2011. Integration costs decreased primarily due to a reduction of RBS N.V. (formerly ABN AMRO) integration activity during the year.
2011 compared with 2010 Integration costs were £106 million compared with £376 million in 2010. Integration costs decreased primarily due to a reduction of RBS N.V. (formerly ABN AMRO) integration activity during the year.
Premises and equipment 11 (2) — 9 Other administrative expenses 3 2 — 5 14 — — 14
2011 compared with 2010 Restructuring costs were £788 million compared with £574 million in 2010. The increase is due to the number of Group restructuring projects increasing during the year.
2011 compared with 2010 Divestment costs of £165 million compared with £82 million in 2010 related to the European Commission mandated divestments.
Staff costs - redundancy 45 47 37 (41) (1) 87 Staff costs - other 1 64 — (19) — 46 Premises and equipment — (2) 11 (9) — — Other administrative expenses 21 62 37 (43) (4) 73 67 171 85 (112) (5) 206
New impairment losses 5,620 7,966 9,667 5,620 9,234 9,646 Less: recoveries of amounts previously written-off (341) (527) (411) (341) (527) (411)
Note: (1) Managed basis excludes sovereign debt impairment and interest rate hedge adjustments on available-for-sale sovereign debt.
2012 compared with 2011 - managed and statutory Loan impairment losses declined by £1,926 million to £5,315 million, primarily driven by a £1,518 million fall in Non-Core impairments, mostly in the Ulster Bank and commercial real estate portfolios.
2011 compared with 2010 - managed Impairment losses decreased by 20% compared with 2010, driven largely by a £1,569 million reduction in Non-Core loan impairments, despite continuing challenges in Ulster Bank and corporate real estate portfolios.
Retail & Commercial impairment losses fell by £153 million, driven by improving credit metrics in UK Retail and US Retail & Commercial partially offset by increases in Ulster Bank, largely reflecting a deterioration in credit metrics on the mortgage portfolio, and a single name provision in International Banking.
Retail & Commercial impairment losses fell by £227 million, driven by improving credit metrics in UK Retail and US Retail & Commercial partially offset by increases in Ulster Bank, largely reflecting a deterioration in credit metrics on the mortgage portfolio, and a single name provision in International Banking.
UK corporation tax rate 24.5 26.5 28.0 Effective tax rate nm nm nm nm = not meaningful
The actual tax charge differs from the expected tax credit computed by applying the standard rate of UK corporation tax as follows: £m £m £m
Expected tax credit 1,265 315 44 Sovereign debt impairment where no deferred tax asset recognised — (275) — Other losses in year where no deferred tax asset recognised (511) (530) (450) Foreign profits taxed at other rates (383) (417) (517) UK tax rate change impact (149) (112) (83) Unrecognised timing differences 59 (20) 11 Non-deductible goodwill impairment — (24) (3) Items not allowed for tax - losses on disposals and write-downs (49) (72) (311) - UK bank levy (43) (80) — - regulatory fines (93) — — - employee share schemes (9) (113) (32)
Non-taxable items - gain on sale of RBS Aviation Capital 26 — — - gain on sale of Global Merchant Services — 12 221 - gain on redemption of own debt — — 11 - other non-taxable items 104 242 341 Taxable foreign exchange movements (1) 4 4 Losses brought forward and utilised 2 2 2 Reduction in carrying value of deferred tax asset in respect of losses in - Australia (191) — — - Ireland (203) — — Adjustments in respect of prior years (47) 199 355 Actual tax charge (469) (1,127) (703)
UK Retail 529 788 1,160 UK Corporate 838 793 767 Wealth 46 25 18 International Banking 111 168 86 Ulster Bank 1,364 1,384 1,161 US Retail & Commercial 91 326 519 Retail & Commercial 2,979 3,484 3,711 Markets 37 38 65 Central items 40 (2) 4 Core 3,056 3,520 3,780 Non-Core 2,223 3,919 5,476 Group 5,279 7,439 9,256
UK Retail 45.7 48.4 48.8 UK Corporate 86.3 79.3 84.2 Wealth 12.3 12.9 12.5 International Banking 51.9 43.2 51.7 Ulster Bank 36.1 36.3 31.6 US Retail & Commercial 56.5 59.3 57.4 Retail & Commercial 288.8 279.4 286.2 Markets 101.3 120.3 110.3 Other 5.8 12.0 18.0 Core 395.9 411.7 414.5 Non-Core 60.4 93.3 153.7 Group before benefit of Asset Protection Scheme 456.3 505.0 568.2 Benefit of Asset Protection Scheme — (69.1) (105.6) Group before RFS Holdings minority interest 456.3 435.9 462.6 RFS Holdings minority interest 3.3 3.1 2.9 Group 459.6 439.0 465.5
Divisional performance continued Employee numbers at 31 December (full time equivalents rounded to the nearest hundred)
UK Retail 26,000 27,700 28,200 UK Corporate 13,300 13,600 13,200 Wealth 5,300 5,700 5,200 International Banking 4,400 5,400 5,300 Ulster Bank 4,500 4,200 4,200 US Retail & Commercial 14,700 15,400 15,900 Retail & Commercial 68,200 72,000 72,000 Markets 11,200 13,900 15,700 Direct Line Group 14,200 14,900 14,500 Central items 6,800 6,200 4,700 Core 100,400 107,000 106,900 Non-Core 3,100 4,700 6,900 103,500 111,700 113,800 Business Services 33,200 34,000 34,400 Integration and restructuring 500 1,100 300 Group 137,200 146,800 148,500
Operating profit before impairment losses 2,420 2,809 2,508 Impairment losses (529) (788) (1,160)
Analysis of impairments by sector Mortgages 92 182 177 Personal 307 437 682 Cards 130 169 301 Total impairment losses 529 788 1,160
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Mortgages 0.1% 0.2% 0.2% Personal 3.5% 4.3% 5.8% Cards 2.3% 3.0% 4.9% Total 0.5% 0.7% 1.1%
Performance ratios Return on equity (1) 24.4% 24.5% 16.3% Net interest margin 3.58% 3.95% 3.89% Cost:income ratio 51% 49% 53%
Capital and balance sheet Loans and advances to customers (gross) (2) - mortgages 99.1 95.0 90.6 - personal 8.8 10.1 11.7 - cards 5.7 5.7 6.1 113.6 110.8 108.4 Loan impairment provisions (2.6) (2.7) (2.7) Net loans and advances to customers 111.0 108.1 105.7
Customer deposits (2) 107.6 101.9 96.1 Assets under management (excluding deposits) 6.0 5.5 5.7 Loan:deposit ratio (excluding repos) 103% 106% 110% Risk-weighted assets 45.7 48.4 48.8
Continued to invest in simplifying processes to make it easier for customers to bank with us, including introducing more than 200 cash deposit machines and ATMs to further reduce queuing times in branches.
Net interest income was down 7% due to weaker deposit margins and reduction in unsecured balances, partly offset by mortgage growth. Unsecured balances now represent 13% of total loans and advances to customers compared with 23% in 2008, following realignment of risk appetite and strong mortgage growth. Net interest margin declined as a result of lower rates on current account hedges and increased competition on savings rates in the early part of the year, partly offset by widening asset margins.
Non-interest income was 19% lower mainly due to: lower unauthorised overdraft fees as we continue to help customers manage their finances by providing mobile text alerts and further improving mobile banking functionality; weak consumer confidence lowering spending and associated fees on cards; and lower investment income as a result of weak customer demand and less advisor availability due to restructuring and retraining in preparation for regulatory changes in 2013.
Impairment losses were £259 million or 33% lower, reflecting the continued benefit of risk appetite tightening in prior years and also a smaller unsecured loan book. Impairments as a percentage of loans and advances were 50 basis points versus 70 basis points in 2011.
2011 compared with 2010 UK Retail delivered strong full year results, as operating profit increased by £673 million to £2,021 million, despite continued uncertainty in the economic climate and the low interest rate environment. Profit before impairment losses was up £301 million or 12%, while impairments fell by £372 million, with further improvements in the unsecured book and continued careful mortgage underwriting. Return on equity improved to 24.5%. The division continued to focus on growing secured lending while at the same time building customer deposits, thereby reducing the Group’s reliance on wholesale funding. Loans and advances to customers grew 2%, with a change in mix from unsecured to secured as the Group actively sought to improve its risk profile. Mortgage balances grew by 5%, while unsecured lending contracted by 11%.
Net interest income increased by 6% to £4,302 million, driven by strong balance sheet growth. Net interest margin increased 6 basis points recovering asset margins more than offset by more competitive savings rates and lower long term swap rate returns adversely impacting liability margins.
Overall expenses decreased by 6%. Cost reductions were driven by a clear management focus on process re-engineering and operational efficiency together with benefits from the dissolution of the bancassurance joint venture, partly offset by higher inflation rates in utility and mail costs.
Impairment losses decreased 32% to £788 million reflecting the impact of a strengthened risk appetite, and a more stable economic environment.
Analysis of income by business Corporate and commercial lending 2,636 2,643 2,571 Asset and invoice finance 685 660 616 Corporate deposits 568 694 738 Other 834 866 871 Total income 4,723 4,863 4,796
Analysis of impairments by sector Financial institutions 15 20 20 Hotels and restaurants 52 59 52 Housebuilding and construction 143 103 131 Manufacturing 49 34 1 Private sector education, health, social work, recreational and community services 37 113 30 Property 252 170 245 Wholesale and retail trade, repairs 112 85 91 Asset and invoice finance 40 38 64 Shipping 82 22 4 Other 56 149 129 Total impairment losses 838 793 767
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Financial institutions 0.3% 0.3% 0.3% Hotels and restaurants 0.9% 1.0% 0.8% Housebuilding and construction 4.2% 2.6% 2.9% Manufacturing 1.0% 0.7% — Private sector education, health, social work, recreational and community services 0.4% 1.3% 0.3% Property 1.0% 0.6% 0.8% Wholesale and retail trade, repairs 1.3% 1.0% 0.9% Asset and invoice finance 0.4% 0.4% 0.6% Shipping 1.1% 0.3% 0.1% Other 0.2% 0.6% 0.5% Total 0.8% 0.7% 0.7%
Performance ratios Return on equity (1) 14.5% 15.2% 13.6% Net interest margin 3.06% 3.06% 2.89% Cost:income ratio 44% 44% 45%
Capital and balance sheet Loans and advances to customers (gross) (1) - financial institutions 5.8 5.8 6.2 - hotels and restaurants 5.6 6.1 6.8 - housebuilding and construction 3.4 3.9 4.5 - manufacturing 4.7 4.7 5.4 - private sector education, health, social work, recreational and community services 8.7 8.7 9.0 - property 24.8 28.2 29.5 - wholesale and retail trade, repairs 8.5 8.7 9.9 - asset and invoice finance 11.2 10.4 9.9 - shipping 7.6 7.8 7.5 - other 26.7 26.4 25.1 107.0 110.7 113.8 Loan impairment provisions (2.4) (2.1) (1.7) Net loans and advances to customers 104.6 108.6 112.1
Total third party assets 110.2 114.2 117.0 Risk elements in lending (1) 5.5 5.0 4.0 Provision coverage (2) 45% 40% 44%
Customer deposits (1) 127.1 126.3 124.5 Loan:deposit ratio (excluding repos) 82% 86% 90%
Notes: (1) Includes businesses outlined for disposal: loans and advances to customers £11.3 billion (2011 - £12.2 billion; 2010 - £13.9 billion), risk elements in lending £0.9 billion (2011 - £1.0 billion; 2010 - £1.2 billion) and customer deposits £13.0 billion (2011- £13.0 billion; 2010 - £15.0 billion). (2) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending.
During 2012, UK Corporate continued to support its customers and the UK economy and further demonstrated a commitment to the communities it operates in.
Throughout the year, UK Corporate has also continued to invest in the service it delivers to its customers through: The introduction of a new enhanced telephony and online offering,
Business Connect. This already supports over 170,000 small business customers, offering telephony access to experienced relationship managers from 8am to 8pm, in addition to its traditional branch and relationship manager network; New mobile banking apps that allow customers to manage multiple accounts, make payments and transfers, and view detailed statements. In 2012 over 70,000 users were using the app twice a day, transacting more than £700 million since launch; and
Operating profit decreased by 7%, with income down 3% and increased impairments, up 6%, partially offset by a 3% decrease in costs.
Non-interest income was broadly in line with 2011, with stable income from transaction services, asset finance, Markets revenue share and other lending fees.
Risk-weighted assets increased by 9% as regulatory changes to capital models during H2 2012 totalling £15 billion (primarily the implementation of the market-wide slotting approach on real estate and increases to default risk weights in other models) were partly offset by a fall in funded assets.
Not reflected in operating results was UK Corporate’s £350 million share of the provision for interest rate swap redress which relates to prior periods, mainly pre-2008.
Excluding the £29 million OFT penalty in 2010, total costs increased by 2%, largely reflecting increased investment in the business and higher costs of managing the non-performing book.
Net interest income 720 645 588 Net fees and commissions 366 375 376 Other non-interest income 84 84 71 Non-interest income 450 459 447 Total income 1,170 1,104 1,035 Direct expenses - staff (424) (413) (382)
Performance ratios Return on equity (1) 13.7% 13.1% 15.9% Net interest margin 3.73% 3.23% 3.26% Cost:income ratio 74% 75% 71%
Customer deposits 38.9 38.2 37.1 Loan:deposit ratio (excluding repos) 44% 44% 43% Risk-weighted assets 12.3 12.9 12.5
Wealth continued 2012 saw improved performance overall, with higher lending and deposit margins and volumes driving higher income.
In the UK, Q4 2012 saw the launch of Coutts’ new Retail Distribution Review (RDR)-compliant advice proposition and products. Significant investment was made during 2012 to ensure clients would continue to receive the best service, advice and products based on their specific needs. One example of this was the introduction of seven new UK and global RDR-compliant multi-asset funds, allowing clients to continue to invest in a broad range of asset classes matched to their needs and risk appetites.
Expenses were £40 million or 5% higher at £871 million, with significant investment in change programmes, including the development of new products and services capability and the implementation of RDR in the UK.
Client assets and liabilities fell by 1% with a £2 billion decrease in assets under management, primarily reflecting low margin client outflows of £1.4 billion and the impact of client transfers following the disposal of the Latin American, Caribbean and African businesses. This fall was partially offset by increases in lending and deposit volumes.
2011 compared with 2010 Operating profit decreased by 12% on 2010 to £248 million, driven by increases in expenses (13%) and impairments (39%) partially offset by a 7% growth in income.
Expenses increased by £97 million, largely driven by adverse foreign exchange movements and headcount growth to service the increased revenue base. Additional strategic investment in technology enhancement, rebranding and programmes to support regulatory change also contributed to the increase.
Operating profit before impairment losses 705 923 1,397 Impairment losses (111) (168) (86)
Note: (1) Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions), for the ongoing businesses.
Capital and balance sheet Loans and advances to customers (gross) (1) 42.2 57.7 62.9 Loan impairment provisions (0.4) (0.8) (0.8) Net loans and advances to customers 41.8 56.9 62.1 Loans and advances to banks 4.7 3.4 3.9 Securities 2.6 6.0 6.8 Cash and eligible bills 0.5 0.3 0.7 Other 3.4 3.3 4.4
Total third party assets (excluding derivatives mark-to-market) 53.0 69.9 77.9 Risk elements in lending 0.4 1.6 1.5 Provision coverage (2) 93% 52% 58%
Customer deposits (excluding repos) 46.2 45.1 43.7 Bank deposits (excluding repos) 5.6 11.4 7.3 Loan:deposit ratio (excluding repos and conduits) 85% 103% 112% Risk-weighted assets 51.9 43.2 51.7 £m £m £m
Run-off businesses (1) Total income 23 75 88 Direct expenses (31) (93) (125)
Notes: (1) Excludes disposal groups. (2) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending. (3) Run-off businesses consist of the exited corporate finance businesses.
Since its formation, the division has made significant progress in strengthening its balance sheet and making efficient use of resources. The loan portfolio decreased significantly due to strategic reduction initiatives and disciplined capital allocation. The division’s liability composition also improved, with additional customer deposits raised in the final quarter and the strategic run-off of commercial paper and shortterm bank deposits.
Income was 17% lower: Loan portfolio decreased by 32%, mainly due to a strategic reduction in assets, in order to allocate capital more efficiently, and the effect of portfolio credit hedging and lower corporate appetite for risk management activities.
Trade finance increased by 6% as a result of increased activity, particularly in Asia.
The restructuring in 2012 led to a reduction in activities undertaken in the division, which contributed to a decline in income.
Expenses declined by £215 million, reflecting planned restructuring initiatives following the formation of the International Banking division. Savings were achieved through headcount reduction, run-off of discontinued businesses and a resulting decrease in infrastructure support costs. Revenue-linked expenses also fell in line with the decrease in income.
Bank deposits were down 51%, mainly as a result of lower short-term balances, reflecting a strategic initiative to reduce liquidity outflow risk.
Excluding GMS income of £451, income was 10% lower despite the success of deposit-gathering initiatives, as customer deposits increased £1 billion in a competitive environment.
Impairment losses increased to £168 million compared with £86 million in 2010 reflecting a single name impairment.
Analysis of income by business Corporate 360 435 521 Retail 360 428 465 Other 125 84 67 Total income 845 947 1,053
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Mortgages 3.4% 2.9% 1.4% Corporate - property 6.4% 6.8% 6.9% - other corporate 5.0% 5.6% 4.9% Other lending 3.8% 3.5% 3.7% Total 4.2% 4.1% 3.1%
While impairment levels remained elevated during 2012, net interest margin and expense management improved. Further progress was made on Ulster Bank’s deposit gathering strategy with customer deposit balances increasing by 7% on a constant currency basis in Q4 2012, driving a significant reduction in the loan to deposit ratio.
Following the Group technology incident in June 2012, Ulster Bank made significant efforts to help customers who were affected, extending branch hours, tripling call centre staff and providing full redress.
The loan to deposit ratio improved from 143% to 130%, driven by a combination of deposit growth and a decrease in the loan book. At constant currency, the loan book decreased by 2% as a result of natural amortisation and limited new lending due to low levels of market demand. Retail and SME deposits increased by 8%; however, this was partly offset by outflows of wholesale balances driven by market volatility and the impact of a rating downgrade in the second half of 2011.
Expenses fell by 5% reflecting tight management of the cost base across the business. Impairment losses increased by 19% largely reflecting the deterioration in credit metrics on the mortgage portfolio driven by a combination of higher debt flow and further fall in asset prices.
Despite intense competition, retail and small business deposit balances have grown strongly throughout 2011, driven by the benefits of a focused deposit gathering strategy. However, total customer deposit balances fell by 6% largely driven by the outflow of wholesale customer balances due to rating downgrades.
Net interest income 3,087 3,048 2,940 1,948 1,900 1,902 Net fees and commissions 1,233 1,350 1,328 778 841 859 Other non-interest income 579 473 464 365 296 301 Non-interest income 1,812 1,823 1,792 1,143 1,137 1,160 Total income 4,899 4,871 4,732 3,091 3,037 3,062 Direct expenses - staff (1,313) (1,344) (1,238) (828) (838) (801)
Operating profit before impairment losses 1,341 1,384 1,342 845 863 868 Impairment losses (145) (524) (802) (91) (326) (519)
Analysis of income by product Mortgages and home equity 856 744 786 541 463 509 Personal lending and cards 643 709 761 405 442 492 Retail deposits 1,364 1,487 1,465 860 927 948 Commercial lending 965 936 901 609 584 583 Commercial deposits 698 667 627 441 416 406 Other 373 328 192 235 205 124 Total income 4,899 4,871 4,732 3,091 3,037 3,062
Notes: (1) Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions). (2) Excludes litigation settlement and net gain on sale of Visa B shares in 2012.
Customer deposits (excluding repos) 95.6 92.8 92.1 59.2 60.0 59.3 Bank deposits (excluding repos) 2.9 8.0 9.5 1.8 5.2 6.1 Loan:deposit ratio (excluding repos) 86% 85% 81% 86% 85% 81% Risk-weighted assets 91.3 91.8 89.1 56.5 59.3 57.4
Efforts in both the Consumer and Commercial businesses throughout 2012 were aligned with those priorities and our customers have acknowledged our efforts. According to a 2012 survey conducted by American Banker, RBS Citizens was ranked in the top ten of US banks for corporate reputation, an improvement of eight places from 2011.
RBS Citizens’ net promoter score, a measure of how likely customers are to recommend the bank, increased to 20% over the course of 2012 and was over ten percentage points above the peer average.
Commercial Banking took further significant steps towards strengthening its customer proposition with a more streamlined, efficient and integrated service and product offering by integrating the Treasury Solutions, Foreign Exchange and Interest Rate Derivatives functions into Commercial Banking.
Non-interest income was up £6 million. In US dollar terms non-interest income was down $11 million, or 1%, reflecting a decline in debit card fees as a result of the Durbin Amendment legislation and lower securities gains and deposit fees. This was largely offset by strong mortgage banking fees of £69 million ($109 million), up 71%, and the £47 million ($75 million) gross gain on the sale of Visa B shares.
Excluding the £88 million ($138 million) litigation settlement, relating to a class action lawsuit regarding the way overdraft fees were assessed on customer accounts prior to 2010, and the £8 million ($13 million) litigation reserve associated with the sale of Visa B shares, and a one-off £21 million ($33 million) pension gain in Q4 2012, total expenses were down 1%, reflecting lower loan collection costs and the elimination of the Everyday Points rewards programme for consumer debit card customers, partially offset by higher operational losses.
2011 compared with 2010 Operating profit increased to £537 million ($860 million) from £349 million ($540 million), an increase of £188 million ($320 million), or 54%. Excluding a credit of £73 million ($113 million) related to changes to the defined benefit plan in Q2 2010, operating profit increased £261 million ($433 million), or 95%, substantially driven by lower impairments and improved income.
Excluding the defined benefit plan credit of £73 million ($113 million) in Q2 2010, total expenses were down £93 million ($16 million), 4%, due to a number of factors including lower Federal Deposit Insurance Corporation (FDIC) deposit insurance levies, and lower litigation and marketing costs, partially offset by higher regulatory costs.
Impairment losses declined by £193 million ($278 million), or 37%, largely reflecting an improved credit environment slightly offset by higher impairments related to securities. Loan impairments as a percentage of loans and advances improved to 0.5% from 1.0%.
Net interest income from banking activities 113 79 605 Net fees and commissions receivable 318 603 731 Income from trading activities 3,912 3,602 4,785 Other operating income (net of related funding costs) 140 131 112 Non-interest income 4,370 4,336 5,628 Total income 4,483 4,415 6,233 Direct expenses - staff (1,453) (1,963) (2,082)
Operating profit before impairment losses 1,546 937 2,789 Impairment losses (37) (38) (65)
Capital and balance sheet (ongoing businesses) Loans and advances to customers (gross) 29.8 31.5 24.4 Loan impairment provisions (0.2) (0.2) (0.2) Net loans and advances to customers 29.6 31.3 24.2 Loans and advances to banks 16.6 29.9 44.4 Reverse repos 103.8 100.4 94.7 Securities 92.4 108.1 115.8 Cash and eligible bills 30.2 28.1 38.8 Other 11.8 14.8 20.1 Total third party assets (excluding derivatives mark-to-market) 284.4 312.6 338.0 Net derivative assets (after netting) 21.9 37.0 37.4
Customer deposits (excluding repos) 26.3 36.8 37.4 Bank deposits (excluding repos) 45.4 48.2 50.6
Notes: (1) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending. (2) Run-off businesses consist of the exited cash equities, corporate banking and equity capital market operations.
Against this backdrop, the division continued to focus on its strengths and client offering. In January 2012 RBS announced the creation of the Markets division and, at the same time, the exit of the cash equities and mergers & acquisitions businesses. Following further review in Q4 2012, the remaining Investor Products and Equity Derivatives (IPED) operation was moved into Rates to form a Derivative Product Solutions (DPS) business. In addition, Markets has also developed a range of measures to enhance its culture and control environment, focusing on improving both supervision and behaviours. Taken together, these actions reinforce Markets’ commitment to put the client at the centre of everything we do and to focus resources on meeting client needs.
Markets continued 2012 compared with 2011 Operating profit increased by 68% reflecting 2% growth in income and 20% decrease in direct expenses, most notably through a reduction in staff costs.
Rates benefited from a strong trading performance, while losses incurred in managing counterparty exposures during the third quarter of 2011 were not repeated during 2012. Revenues for the year were up 36% to £2.0 billion.
The division focused on controlling costs throughout 2012, driving total expenses down by 16%. Lower staff expenses, down 26%, reflect lower headcount and lower levels of variable compensation, including reductions and clawbacks following the Group’s LIBOR settlements reached on 6 February 2013, with the compensation ratio falling from 42% to 32%. Headcount reductions totalled 2,700 in the year, including that resulting from the exit of businesses announced in January. Other expenses fell by 3% as rigorous controls on discretionary expenditure and the exiting of product areas continued to take effect, partially offset by higher legal expenses.
2011 compared with 2010 Operating profit fell by 67%, from £2,724 million for 2010 to £899 million for 2011, driven by a 29% decrease in revenue. The year was characterised by volatile and deteriorating credit markets, especially during the second half of the year when the European sovereign debt crisis drove a sharp widening in credit spreads.
Due to this deterioration in the markets both the Rates and Credit businesses suffered significantly, and income from trading activities fell from £4,785 million in 2010 to £3,602 million in 2011. The heightened volatility increased risk aversion amongst clients and limited opportunities for revenue generation in the secondary markets.
Variable compensation accrued in the first half of the year were reduced in the second half of the year, leaving the former GBM 2011 variable compensation awards 58% lower than 2010.
Analysis of income by product Personal lines motor excluding broker - own brands 1,631 1,742 1,825 - partnerships 124 209 343 Personal lines home excluding broker - own brands 462 471 474 - partnerships 364 363 388 Personal lines rescue and other excluding broker - own brands 183 181 192 - partnerships 178 125 155 Commercial 322 315 314 International 315 340 316 Other (1) (105) 61 232 Total income 3,474 3,807 4,239
Notes: (1) ‘Other’ predominately consists of the personal lines broker business and from 2012 businesses previously reported in Non-Core. (2) Total in-force policies include travel and creditor policies sold through RBS Group. These comprise travel policies included in bank accounts e.g. Royalties Gold Account, and creditor policies sold with bank products including mortgage, loan and card payment protection. (3) Return on tangible equity is based on annualised operating profit after tax divided by average tangible equity adjusted for dividend payments. (4) Loss ratio is based on net claims divided by net premium income. (5) Commission ratio is based on fees and commissions divided by net premium income. (6) Expense ratio is based on expenses divided by net premium income. (7) Combined operating ratio is the sum of the loss, commission and expense ratios. (8) Consists of general and life insurance liabilities, unearned premium reserves and liability adequacy reserve.
During 2012, Direct Line Group made good progress despite competitive market conditions. The operating profit of £441 million was down £13 million compared with the previous year driven by lower investment returns, partially offset by an improved underwriting result.
Direct Line Group made further progress in executing its strategic plan with developments made in its pricing capability through the implementation of a new pricing model and rating engine across the Motor and Home divisions. The new claims management system introduced during 2011 is now operational for the majority of new Motor and Home claims. Benefits, including shorter settlement times for customers and improved legal case management, are being realised as a result of the improved claims process.
Direct Line Group operates in an industry that is under a significant amount of scrutiny and is preparing for substantial regulatory change. Direct Line Group is actively engaging with major stakeholders throughout the ongoing debates surrounding referral and legal fees, the increase in whiplash claims and the implementation of the gender directive in order to help deliver the best possible outcome for its customers and shareholders.
Gross written premium of £3,966 million was 3% lower, driven by the impact of de-risking in previous years and changes in the mix of the portfolio in Motor together with competitive market conditions in Home. International was also down reflecting adverse exchange rate movements.
Net claims of £2,427 million were £345 million, or 12% lower than 2011 reflecting lower exposure, higher releases of reserves from prior years and improved claims experience. The 2012 result includes approximately £105 million of Home weather event claims, significantly more than £20 million in 2011 under benign weather conditions.
Expenses of £849 million were broadly flat. Staff expenses were £50 million, or 17% higher partly reflecting the transfer of some head office functions costs to Direct Line Group ahead of separation from RBS Group, together with additional staff recruited to provide services previously provided by RBS Group.
Direct Line Group continued 2011 compared with 2010 Operating profit rose by £749 million in 2011, principally due to the non repeat of the bodily injury reserve strengthening in 2010, de-risking of the motor book, exit of certain business segments and more benign weather in 2011.
Total income fell £432 million, 10%, following the exit of personal lines broker, a decline in premiums reflecting reduced motor volumes and higher reinsurance costs to reduce the risk profile of the book.
Total in-force policies fell 6% in the year due to planned de-risking of the motor book and the exiting of certain other segments and partnerships, including personal lines broker.
2012 compared with 2011 Central items not allocated represented a credit of £143 million compared with £191 million in 2011.
2011 compared with 2010 Central items not allocated represented a credit of £191 million in 2011, a decline of £439 million compared with 2010.
Operating (loss)/profit before insurance net claims and impairment losses (656) (107) 498 Insurance net claims — (195) (737)
Analysis of income/(loss) by business Banking & portfolios 40 1,465 1,463 International businesses 250 411 778 Markets (2) (688) 513 Total income 288 1,188 2,754
Impairment losses Banking & portfolios 2,346 3,833 5,328 International businesses 56 82 200 Markets (179) 4 (52)
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) (3) Banking & portfolios 4.2% 4.9% 5.0% International businesses 5.1% 3.7% 4.4% Markets — (3.0%) 0.2% Total 4.2% 4.8% 4.9%
Total third party assets (excluding derivatives) 57.4 93.7 137.9 Total third party assets (including derivatives) 63.4 104.7 153.9
Gross customer loans and advances Banking & portfolios 54.5 77.3 104.9 International businesses 0.9 2.0 3.5 Markets — 0.1 — 55.4 79.4 108.4
Third party assets (excluding derivatives) Banking & portfolios 51.1 81.3 113.9
Commercial real estate 31.5 (5.0) (2.2) 0.1 (1.7) (0.6) 22.1 Corporate 42.2 (7.3) (9.8) 1.6 (0.4) (0.8) 25.5 SME 2.1 (1.0) (0.3) 0.2 — — 1.0 Retail 6.1 (0.8) (1.9) 0.1 (0.2) (0.1) 3.2 Other 1.9 (1.3) — — — (0.1) 0.5 Markets 9.8 (1.0) (3.9) 0.3 0.1 (0.2) 5.1 Total (excluding derivatives) 93.6 (16.4) (18.1) 2.3 (2.2) (1.8) 57.4 Markets - RBS Sempra Commodities JV 0.1 (0.1) — — — — — Total (4) 93.7 (16.5) (18.1) 2.3 (2.2) (1.8) 57.4
UK (excluding NI) 8.9 11.4 16.7 Ireland (ROI and NI) 5.8 7.7 10.2 Spain 1.4 1.8 1.3 Rest of Europe 4.9 7.9 9.4 USA 0.9 2.2 3.6 RoW 0.2 0.5 1.4 Total (excluding derivatives) 22.1 31.5 42.6 2012 2011 2010 Impairment losses by donating division and sector £m £m £m
UK Retail Mortgages — 5 5 Personal 4 (27) 8 Total UK Retail 4 (22) 13
US Retail & Commercial Auto and consumer 49 58 82 Cards 1 (9) 23 SBO/home equity 130 201 277 Residential mortgages 21 16 4 Commercial real estate (12) 40 185 Commercial and other (12) (3) 17 Total US Retail & Commercial 177 303 588
Other Wealth 1 1 51 Central items 1 3 2 Total Other 2 4 53
UK Retail Mortgages — 1.4 1.6 Personal — 0.1 0.4 Total UK Retail — 1.5 2.0
Markets Manufacturing and infrastructure 3.9 6.6 8.7 Property and construction 12.3 15.3 19.6 Transport 1.7 3.2 5.5 Telecoms, media and technology 0.4 0.7 0.9 Banking and financial institutions 4.7 5.6 12.0 Other 3.7 7.0 9.3 Total Markets 26.7 38.4 56.0
Other Wealth — 0.2 0.4 Direct Line Group — — 0.2 Central items — (0.2) (1.0) Total Other — — (0.4)
Impairment losses fell by £1,696 million to £2,223 million, with £1,366 million of this reduction from the Ulster Bank portfolio and £269 million from the real estate portfolio.
Income declined by £900 million as continued divestment and run-off reduced net interest income. Rental income was lower following the disposal of RBS Aviation Capital in Q2 2012.
2011 compared with 2010 Operating loss of £4,221 million in 2011 was £1,494 million lower than the loss recorded in 2010. The continued divestment of Non-Core businesses and portfolios has reduced revenue streams as well as the cost base.
Assets Cash and balances at central banks 79,290 79,269 57,014 Net loans and advances to banks 29,168 43,870 57,911 Reverse repurchase agreements and stock borrowing 34,783 39,440 42,607 Loans and advances to banks 63,951 83,310 100,518 Net loans and advances to customers 430,088 454,112 502,748 Reverse repurchase agreements and stock borrowing 70,047 61,494 52,512 Loans and advances to customers 500,135 515,606 555,260 Debt securities 157,438 209,080 217,480 Equity shares 15,232 15,183 22,198 Settlement balances 5,741 7,771 11,605 Derivatives 441,903 529,618 427,077 Intangible assets 13,545 14,858 14,448 Property, plant and equipment 9,784 11,868 16,543 Deferred tax 3,443 3,878 6,373 Prepayments, accrued income and other assets 7,820 10,976 12,576 Assets of disposal groups 14,013 25,450 12,484 Total assets 1,312,295 1,506,867 1,453,576
Liabilities Bank deposits 57,073 69,113 66,051 Repurchase agreements and stock lending 44,332 39,691 32,739 Deposits by banks 101,405 108,804 98,790 Customers deposits 433,239 414,143 428,599 Repurchase agreements and stock lending 88,040 88,812 82,094 Customer accounts 521,279 502,955 510,693 Debt securities in issue 94,592 162,621 218,372 Settlement balances 5,878 7,477 10,991 Short positions 27,591 41,039 43,118 Derivatives 434,333 523,983 423,967 Accruals, deferred income and other liabilities 14,801 23,125 23,089 Retirement benefit liabilities 3,884 2,239 2,288 Deferred tax 1,141 1,945 2,142 Insurance liabilities — 6,312 6,794 Subordinated liabilities 26,773 26,319 27,053 Liabilities of disposal groups 10,170 23,995 9,428 Total liabilities 1,241,847 1,430,814 1,376,725
Commentary on consolidated balance sheet - managed and statutory 2012 compared with 2011 Total assets of £1,312.3 billion at 31 December 2012 were down £194.6 billion, 13%, compared with 31 December 2011. This was principally driven by a decrease in loans and advances to banks and customers led by Non-Core disposals and run off, decreases in debt securities and the continuing reduction in the mark-to-market value of derivatives.
Debt securities were down £51.6 billion, 25%, to £157.4 billion, driven mainly by reductions within Markets and Group Treasury in holdings of UK and Eurozone government securities and financial institution bonds.
Insurance liabilities of £6.2 billion relating to Direct Line Group were transferred to liabilities of disposal groups at 31 December 2012.
Subordinated liabilities increased by £0.5 billion, 2% to £26.8 billion, primarily as a result of the net increase in dated loan capital. Issuances of £1.4 billion and redemptions of £0.3 billion were partly offset by a net decrease of £0.6 billion arising from the liability management exercise completed in March 2012, which consisted of redemptions of £3.4 billion offset by the issuance of £2.8 billion new loan capital.
2011 compared with 2010 Total assets of £1,506.9 billion at 31 December 2011 were up £53.3 billion, 4%, compared with 31 December 2010. This principally reflects an increase in cash and balances at central banks and the mark-to-market value of derivatives in Markets, partly offset by decreases in debt securities and equity shares and the continuing disposal and run-off of Non-Core assets.
Debt securities were down £8.4 billion, 4%, to £209.1 billion driven mainly by a reduction in holdings of government and financial institution bonds in Markets and Group Treasury.
Deposits by banks increased £10.0 billion, 10%, to £108.8 billion, with higher repurchase agreements and stock lending (‘repos’), up £6.9 billion, 21%, to £39.7 billion and higher inter-bank deposits, up £3.1 billion, 5%, to £69.1 billion.
The Group’s non-controlling interests decreased by £0.5 billion, 28%, to £1.2 billion, primarily due to the disposal of the majority of the RBS Sempra Commodities JV business, £0.4 billion.
Net cash inflows from investing activities of £27,175 million related to the net inflows from sales of securities of £26,092 million, the sale of property, plant and equipment of £2,215 million and investments in business interests and intangible assets of £352 million offset by net cash outflows from the purchase of property, plant and equipment of £1,484 million.
2011 The major factors contributing to the net cash inflow from operating activities of £3,325 million were the elimination of foreign exchange differences of £2,702 million, depreciation and amortisation of £1,875 million and inflow from other items of £2,900 million, partially offset by the net operating loss before tax of £708 million from continuing and discontinued operations and the decrease of £3,444 million in operating assets and liabilities.
Net cash inflows from investing activities of £14 million related to the net inflows from sales of securities of £3,074 million, and sale of property, plant and equipment of £1,840 million offset by net cash outflows from investments in business interests and intangible assets of £1,428 million and from the purchase of property, plant and equipment of £3,472 million.
Capital resources The following table analyses the Group's regulatory capital resources on a fully consolidated basis at 31 December as monitored by the FSA for regulatory purposes.
It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the Financial Services Authority (FSA). 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%. At 31 December 2012, the Group's total RAR was 14.5% (2011 - 13.8%) and the Tier 1 RAR was 12.4% (2011 13. 0%). For further information refer to Balance sheet management: Capital management on pages 127 to 136.
Net interest income 12,689 (10) (376) 12,303 Non-interest income (excluding insurance net premium income) 10,764 1,238 346 12,348 Insurance net premium income 4,256 — (4,256) — Non-interest income 15,020 1,238 (3,910) 12,348 Total income 27,709 1,228 (4,286) 24,651 Operating expenses (15,478) (2,548) 892 (17,134) Profit before insurance net claims and impairment losses 12,231 (1,320) (3,394) 7,517 Insurance net claims (2,968) — 2,968 — Operating profit before impairment losses 9,263 (1,320) (426) 7,517 Impairment losses (7,439) (1,270) 2 (8,707)
Own credit adjustments 1,914 (1,914) — — Asset Protection Scheme (906) 906 — — Payment Protection Insurance costs (850) 850 — — Sovereign debt impairment (1,099) 1,099 — — Interest rate hedge adjustments on impaired available-for-sale sovereign debt (169) 169 — — Amortisation of purchased intangible assets (222) 222 — — Integration and restructuring costs (1,064) 1,064 — — Gain on redemption of own debt 255 (255) — — Strategic disposals (104) 104 — — Bank levy (300) 300 — — Bonus tax (27) 27 — — Write-down of goodwill and other intangible assets (11) 11 — — RFS Holdings minority interest (7) 7 — — Operating loss including the results of Direct Line Group discontinued operations (766) — (424) (1,190) Direct Line Group discontinued operations (1) (424) — 424 — Operating loss before tax (1,190) — — (1,190) Tax charge (1,127) — — (1,127) Loss from continuing operations (2,317) — — (2,317) Profit from discontinued operations, net of tax - Direct Line Group 301 — — 301 - Other 47 — — 47 Profit from discontinued operations, net of tax 348 — — 348 Loss for the year (1,969) — — (1,969) Non-controlling interests (28) — — (28) Loss attributable to ordinary and B shareholders (1,997) — — (1,997)
Net interest income 14,200 9 (427) 13,782 Non-interest income (excluding insurance net premium income) 13,266 (735) 195 12,726 Insurance net premium income 5,128 — (5,014) 114 Non-interest income 18,394 (735) (4,819) 12,840 Total income 32,594 (726) (5,246) 26,622 Operating expenses (16,710) (1,518) 772 (17,456) Profit before insurance net claims and impairment losses 15,884 (2,244) (4,474) 9,166 Insurance net claims (4,783) — 4,698 (85) Operating profit before impairment losses 11,101 (2,244) 224 9,081 Impairment losses (9,256) — 21 (9,235)
Loss from discontinued operations, net of tax (809) — — (809) Loss for the year (1,666) — — (1,666) Non-controlling interests 665 — — 665 Preference share and other dividends (124) — — (124) Loss attributable to ordinary and B shareholders (1,125) — — (1,125)
Note: (1) Included within Direct Line Group discontinued operations are the managed basis divisional results of Direct Line Group (DLG), certain DLG related activities in Central items and Non-Core; and related one-off and other items including integration and restructuring costs and strategic disposals.
Assets Cash and balances at central banks 79,290 18 79,308 79,269 127 79,396 57,014 184 57,198 Net loans and advances to banks 29,168 2,112 31,280 43,870 87 43,957 57,911 651 58,562 Reverse repurchase agreements and stock borrowing 34,783 — 34,783 39,440 — 39,440 42,607 — 42,607 Loans and advances to banks 63,951 2,112 66,063 83,310 87 83,397 100,518 651 101,169 Net loans and advances to customers 430,088 1,863 431,951 454,112 19,405 473,517 502,748 5,013 507,761 Reverse repurchase agreements and stock borrowing 70,047 — 70,047 61,494 — 61,494 52,512 — 52,512 Loans and advances to customers 500,135 1,863 501,998 515,606 19,405 535,011 555,260 5,013 560,273 Debt securities 157,438 7,186 164,624 209,080 — 209,080 217,480 — 217,480 Equity shares 15,232 5 15,237 15,183 5 15,188 22,198 20 22,218 Settlement balances 5,741 — 5,741 7,771 14 7,785 11,605 555 12,160 Derivatives 441,903 15 441,918 529,618 439 530,057 427,077 5,148 432,225 Intangible assets 13,545 750 14,295 14,858 15 14,873 14,448 — 14,448 Property, plant and equipment 9,784 223 10,007 11,868 4,749 16,617 16,543 18 16,561 Deferred tax 3,443 — 3,443 3,878 — 3,878 6,373 — 6,373 Other financial assets — 924 924 1,309 — 1,309 1,306 — 1,306 Prepayments, accrued income and other assets 7,820 742 8,562 9,667 456 10,123 11,270 704 11,974 Assets of disposal groups 14,013 (13,838) 175 25,450 (25,297) 153 12,484 (12,293) 191 Total assets 1,312,295 — 1,312,295 1,506,867 — 1,506,867 1,453,576 — 1,453,576
Selected financial data Gross loans and advances to customers 451,224 1,875 453,099 473,872 20,196 494,068 520,803 5,049 525,852 Customer loan impairment provisions (21,136) (12) (21,148) (19,760) (791) (20,551) (18,055) (36) (18,091) Net loans and advances to customers 430,088 1,863 431,951 454,112 19,405 473,517 502,748 5,013 507,761
Notes: (1) Primarily Direct Line Group. (2) Primarily UK branch-based businesses, RBS Aviation Capital, sold in 2012, and remainder of RBS Sempra Commodities JV. (3) Primarily RBS Sempra Commodities JV, Non-Core project finance assets and certain interests in Latin America, Europe and the Middle East.
Given this central aim, in 2009 the Group Board set out four key strategic objectives, aligned to the Group’s Strategic Plan. These are to: Maintain capital adequacy: to ensure that the Group has sufficient capital resources to meet regulatory requirements and to cover the potential for unexpected losses in its asset portfolio; Deliver stable earnings growth: to ensure that strategic growth is based around a longer-term risk versus reward consideration, with significantly lower volatility in underlying profitability than was seen over the previous five years; Ensure stable and efficient access to funding and liquidity: such that the Group has sufficient funding to meet its obligations, taking account of the constraint that some forms of funding may not be available when they are most needed; and
Maintain stakeholder confidence: to ensure that stakeholders have confidence in the Group’s recovery plan, its ability to deliver its strategic objectives and the effectiveness of its business culture and operational controls.
Each objective is essential in its own right, but also mutually supportive of the others.
These strategic risk objectives are the bridge between the Group-level business strategy and the frameworks, limits and tolerances that are used to set risk appetite and manage risk in the business divisions on a day-to-day basis.
We set risk appetite at Group level. This establishes the level and type of risks that we are able and willing to take to meet our strategic objectives and our wider obligations to stakeholders. We cascade and embed this risk appetite across the Group, allowing: each business to understand its acceptable levels of risk; and commercial strategies to be aligned with the use of available financial resources.
Key developments In 2012, the Group continued to strengthen its approach to risk management amidst a challenging and ever-changing external environment. Areas of progress included: reducing exposures in line with the objective of being safe and sustainable; improving the quality of data, including forward-looking measures; developing a framework for the effective management of conduct risk; strengthening the credit risk and country risk appetite and management frameworks and ensuring consistent application across the Group; and further realigning the Group Policy Framework to the business model and continuing assurance.
More detailed discussions on how the Group strengthened its approach to risk management in 2012 and the areas of focus going forward is contained within the relevant sub-sections on the following pages.
Strategic risk objectives* continued Top and emerging risk scenarios* As part of its risk management process, the Group identifies and monitors its top and emerging risk scenarios. Such risk scenarios are those the materialisation of which would lead to a significant unexpected negative outcome, thereby causing the Group as a whole or a particular division to fail to meet one or more strategic risk objectives. In assessing the potential impact of risk materialisation, the Group takes into account both financial and reputational considerations.
Impact on the Group If borrowers are unable to refinance existing debt, they may default.
Further, if the value of collateral they have provided continues to decline, the resulting impairments may be larger than expected. In addition, as other lenders seek to sell assets, the Group may find it more difficult to meet its own targets for a reduction in its exposure to certain sectors.
Mitigants The Group is mitigating its risks by monitoring exposures carefully and achieving reductions through a combination of repayments, rolloffs and asset sales whenever possible. In addition, it has placed limits on the origination of new business of this type.
(ii) The risk of a eurozone event Europe was of concern throughout the year owing to a combination of slow growth in major economies and negative growth in peripheral countries labouring under high public debt burdens. As a result, several risks might materialise, including the default of one or more eurozone sovereigns, the exit from the eurozone of one or more member countries or the redenomination of the currency of a eurozone country followed by the devaluation of that country’s currency. Although the Group’s direct exposure to most peripheral eurozone countries is modest, it has material exposure to Ireland through its ownership of Ulster Bank. In addition, it has material exposure to core eurozone countries such as Germany, the Netherlands, France and, to a lesser extent, Italy. Details of the Group’s eurozone exposures appear on pages 256 to 280. All divisions are affected by this risk.
Mitigants The Group has taken a number of steps to mitigate the impact of these risks.
Finally, to mitigate the impact of redenomination, the Group has reduced exposures and sought where possible to reduce mismatches between the currencies in which assets and liabilities are denominated.
(iii) The risk of a more severe or protracted economic downturn Following the financial crisis of 2007, economies in the UK, Europe and the US have struggled to recover and return to growth. An unexpectedly severe downturn could result from economic weakness in the emerging markets of Asia, spreading to the US, the UK and Europe. A slowdown in or reversal of economic growth could undermine the austerity plans of the UK and other countries in Europe. The risk to the UK is of particular concern. While all divisions are potentially affected, those most at risk include UK Corporate, UK Retail, Markets, Non-Core and Ulster Bank.
A worsening of the already difficult economic environment in Ireland could result in increased impairments in Ulster Bank. In addition, it could make the sale or refinancing of related exposures in Non-Core more difficult, slowing progress towards the elimination of these exposures.
If the value of the pension scheme assets is not adequate to fund pension scheme liabilities, the Group may be required to set aside additional capital in support of the schemes. The amount of additional capital that may be required depends on the size of the shortfall when the assets are valued. However, as asset values are lower and liabilities higher than they were when the fund was last valued, an increase in capital required is a possibility.
In addition, the Group may be required to increase its cash contributions to the schemes. Similarly, the amount of additional cash contributions that may be required depends on the size of the shortfall when the assets are valued. If interest rates fall further, the value of the schemes’ assets may decline as the value of their liabilities increases, leading to the need to increase cash contributions still further.
Mitigants In order to mitigate the risk, the Group has taken a number of steps, including changing the terms of its pension schemes to reduce the rate at which liabilities are increasing. These include: capping the growth rate of pensionable salary at two percent, and changing the retirement age to 65 with same contributions, with the option for individuals to retire at age 60 and pay an extra five percent of their salary to fund it.
(i) A failure to demonstrate compliance with existing regulatory requirements related to conduct The Group is subject to regulation governing the conduct of its business activities. For example, it must ensure that it sells its products and services only to informed and suitable customers and handles complaints efficiently and effectively. This risk affects all divisions.
If the Group fails to handle customer complaints appropriately, it may incur regulatory censure, including fines. In addition, it may incur increased costs as it investigates these complaints and compensates customers. Further, it may suffer serious reputational damage.
(ii) A failure to demonstrate compliance with other existing regulatory requirements The Group is also subject to regulation governing its business activities more broadly. For example, it is required to take the steps necessary to ensure that it complies with rules in place to prevent money laundering, bribery and other forms of unlawful activity. It is also required to comply with certain regulations regarding the timely provision of banking services to customers. This risk affects all divisions.
If the Group, as a result of a systems failure, is unable to provide banking services to customers, it may incur regulatory fines and censure as well as suffer significant reputational damage.
Mitigants The Group defends claims against it to the best of its ability.
(iv) A failure to demonstrate compliance with new requirements arising from structural reform In addition to existing regulation, the Group will be subject to new regulation arising from structural reform. For example, legislation creating the Single European Payment Area (SEPA) will require the Group to develop and implement the infrastructure necessary to effect domestic and cross border payments. This risk affects Markets, International Banking and Ulster Bank in particular.
Mitigants The Group has a project in train to design, develop and deliver the required systems changes.
A failure could also prevent the Group from managing its liquidity position, giving rise to the risk of illiquidity.
A failure could also leave the Group vulnerable to cyber crime. The
Impact on the Group If one or more individuals deviate from procedures, the Group may take excessively large positions. If market prices change adversely, the Group may incur losses. Such losses may be substantial if the positions themselves are very large relative to the relevant market.
Mitigants Markets has developed a plan for addressing identified weaknesses, has benchmarked it against those of its peers and is implementing it.
Risk appetite is cascaded and embedded across the Group. It provides a greater understanding of the acceptable levels of risk for each business, aligning commercial strategies with the use of scarce financial resources, such as capital and funding. It provides a solid platform from which RBS can focus on its key business strengths and competitive advantages over the long term.
A strong risk culture is a key part of ensuring risk appetite is effectively embedded across the Group. The link between risk appetite and strategic objectives encourages people at all levels of the business to think about risk, how they apply it and how they manage it. It incorporates the quantitative and qualitative aspects of risk, and uses both absolute and relative risk measures.
The risk appetite framework is based upon four main pillars: Risk envelope metrics - RBS has set sustainable business goals over a medium-term horizon (refer to page 15, including a target for the capital ratio, leverage ratio, loan:deposit ratio, liquidity portfolio and use of wholesale funding. These effectively set the broad boundaries within which the Group operates. The Non-Core division also acts as a primary driver for reducing risk and the size of the balance sheet.
Quantitative risk appetite targets - Risk appetite is also aligned to potential risk exposures and vulnerabilities under severe but plausible stress conditions. Quantitative targets, under stress conditions, are set around the Group’s strategic risk objectives (refer to page 109).
The Board Risk Committee reviews the framework and its targets on a regular basis to ensure they remain aligned to strategic objectives, business performance, emerging risks and changes in the external environment.
Granular tolerances and limits, consistent with the high level targets, are set and used to manage risk on a day-to-day basis
The strategic objectives are translated into high-level target measures that set the risk appetite boundaries
A range of different but complementary tools have been developed to measure whether strategic plans are consistent with risk appetite, to test broader ‘what if’ questions and to assess the impact of changes in key assumptions: Integrated stress testing - (refer to page 121) assesses how earnings, capital and funding positions change under an unfavourable, yet plausible, scenario. Stress scenarios can differ by theme, geographical location or severity.
In 2011, a number of key enhancements were delivered including the following: The Group’s policy standards were rewritten to ensure they clearly express the existing mandatory controls required to mitigate the key risks the Group faces; All of the Group’s policy standards were externally benchmarked; and
For each policy standard, appropriate risk-based assurance activity was introduced to ensure each division is appropriately controlled and compliance with policy can be demonstrated.
The Group’s key credit risk policies and mandatory controls were restructured and realigned to reflect the two distinct portfolios of credit risk: wholesale and retail. These changes are aimed at simplifying the policy structure and making it clearer to divisions which standards are applicable to their respective businesses.
RBS Risk Management is designed to align as closely as possible with the customer-facing businesses and support functions while maintaining an appropriate level of independence, which underpins the Group’s approach to risk management and is reinforced through the Group by appropriate reporting lines.
Within RBS Risk Management, Group functional heads (e.g. the Group Chief Credit Officer for the credit risk discipline, the Group Head of Operational Risk for the operational risk discipline) report directly into the Head of Restructuring and Risk and are responsible for firm-wide risk appetite and standards under their respective disciplines. For example, Group Compliance is responsible for conduct risk policy ownership, change management, assurance and training frameworks at Group level, including anti-money laundering, sanctions, terrorist financing, antibribery and corruption.
Risk management within divisions focuses on all material risks including credit, market, operational, regulatory and country risk, and business activities. Liquidity risk and the day-to-day management of liquidity and funding of the book is Group Treasury’s responsibility.
Divisions mirror the Group set-up for risk management, i.e. the Divisional Executive Committees are responsible for setting and owning their risk appetite within Group constraints. The Divisional Risk Committees oversee the businesses relative to divisional and Group risk appetite and focus on ensuring that risks are adequately monitored and controlled.
The Divisional CROs provide independent oversight to this process, with support from the Group Chief Risk Officer, the Deputy Group CRO and Group functional heads as appropriate. Additional challenge and oversight is provided by Group functional heads on an ongoing basis and by Divisional Risk and Audit Committees on a periodic review basis.
Three lines of defence Having a strong three lines of defence model is important in a strong control environment. The Executive Committee approved a refreshed model in February 2012 and work is underway to embed this across the Group. The model’s main purpose is to define accountabilities and responsibilities for managing risk across the Group.
Risk governance* The Group is committed to achieving the highest standards of corporate governance in every aspect of the business, including risk management. A key aspect of the Group Board’s responsibility as the main decision-making body at Group level is the setting of Group risk appetite to ensure that the levels of risk that the Group is willing to accept in the attainment of its strategic business and financial objectives are clearly understood.
To enable the Group Board to carry out its objectives, it has delegated authority to senior Board and executive committees, as required and appropriate. A number of key committees specifically consider risk across the Group, as set out in the diagram below.
Notes: (1) The following sub-committees report directly to the Group Asset and Liability Management Committee: Capital and Stress Testing Committee, Pension Risk Committee, Balance Sheet Management
Committee. (2) The following sub-committees report directly to the Group Risk Committee: Global Market Risk Committee, Group Country Risk Committee, Group Models Committee, Group Credit Risk Committee and Operational Risk Executive Committee. In addition, Divisional Risk Committees report to the Group Risk Committee. The Capital and Stress Testing Committee also provides monthly updates to the Group Risk Committee, escalating issues as necessary.
During 2012, the Conduct Risk Committee was created as a subcommittee of the Executive Risk Forum. Effective conduct risk management is not only a commercial imperative for the Group; customers, clients and counterparties demand it as a precursor to building trust. For more information on conduct risk and the Group’s management of this risk type, refer to page 290.
The Group Board ensures that the Group manages risk effectively by approving and monitoring the Group’s risk appetite, considering Group stress scenarios and agreed mitigants and identifying longer-term strategic threats to the Group’s business operations.
Group Chief Executive Group Finance Director Chief Administration Officer Chief Executive Officers of divisions Head of Restructuring and Risk
At least three independent non-executive directors, at least one of whom is a financial expert as defined in the SEC rules under the US Exchange Act.
The Group Performance and Remuneration Committee has oversight of the Group’s policy on remuneration and receives advice from RBS Risk Management and the Board Risk Committee to ensure that there is thorough risk input into incentive plan design and target setting, as well as risk review of performance bonus pools and clawback. It operates under delegated authority from the Group Board.
The Group Sustainability Committee is responsible for overseeing and challenging how management is addressing sustainability and reputation issues related to all stakeholder groups. This includes customer and related citizenship activities, oversight of the delivery of the Purpose, Vision and Values cultural and behavioural change, and oversight of the sustainability aspects of the people agenda. It operates under delegated authority from the Group Board.
The Executive Risk Forum has full authority to act on all material and/or enterprise-wide risk and control matters across the Group. It approves the most material limits and decisions above defined thresholds and delegates decisions below these thresholds to sub-committees and appropriate individuals. It operates under delegated authority from the Executive Committee.
The Group Asset and Liability Management Committee is responsible for identifying, managing and controlling Group balance sheet risks in executing its business strategy. It operates under delegated authority from the Executive Risk Forum.
Group Finance Director Group Treasurer Chief Executive Officers of divisions Head of Restructuring and Risk Key Group Finance function heads Chief Executive Officer, Markets, M&IB
Deputy Group Chief Risk Officer Divisional Chief Risk Officers Key Group Risk function heads
Head of Restructuring and Risk Group General Counsel Deputy Group Chief Risk Officer Global Head of Compliance Director, Group Regulatory Affairs Chief Executive Officer, Wealth Management Managing Director, Products and Marketing, UK Retail Chief Executive Officer, Corporate Banking Vice Chairman, RBS Citizens Financial Group Co-Head, M&IB Americas Director, Group Operations, Business Services Chief Operating Officer, Ulster Bank Group Chief Executive Officer, RBS England & Wales and NatWest Scotland Head of Group Internal Audit
Group Finance Director Head of Restructuring and Risk Group Treasurer Global Head of Market and Insurance Risk Group Chief Accountant Chief Executive Officer, Markets, M&IB Global Head of Markets, M&IB Group Head of Pension Risk Deputy Group Chief Risk Officer Head of Group Pensions
The Capital and Stress Testing Committee leads the integrated development and maintenance of risk capital approaches, frameworks and standards. It reviews positions and plans, agrees approaches and standards and provides cross-functional challenge on the topics outlined in its terms of reference. It is responsible to the Group Finance Director and the Head of Restructuring and Risk for many of these activities. It provides updates to the Group Asset and Liability Management Committee and Group Risk Committee and seeks approvals where necessary. It operates under delegated authority from the Group Asset and Liability Management Committee.
The Executive Credit Group decides on requests for the extension of existing or new credit limits on behalf of the Group Board where the proposed aggregate facility limits are in excess of the credit approval authorities granted to individuals in divisions or in RBS Risk Management, or where an appeal against a decline decision of the Group Chief Credit Officer (or delegates) or Group Chief Risk Officer is referred for final decision.
Group B members (1) Group Chief Executive Group Finance Director Deputy Chief Executive Officers, M&IB
Stress testing forms part of the Group's risk and capital management framework and is a major component of the Basel III requirements. It highlights to senior management potential unexpected adverse outcomes related to a mixture of risks and provides an indication of how much capital might be required to absorb losses should adverse scenarios materialise. Stress tests, part of the financial planning process are conducted and presented to senior management semi-annually. Stress tests are also conducted to meet regulatory requirements as well as to assess the impact of business decisions on the Group's capital position. Examples of the former include the European Banking Authority’s EUwide stress tests, the International Monetary Fund’s Financial Sector Assessment Program and the UK Financial Services Authority’s anchor stress tests while examples of the latter include stress tests conducted in connection with the transfer of assets from The Royal Bank of Scotland N.V. to The Royal Bank of Scotland plc.
Scenario stress testing is conducted throughout the Group as detailed below: As part of the financial planning and strategy cycle, stress tests are conducted by divisions and aggregated to produce firm-wide results. These stress tests are also used for monitoring divisional and Group risk appetite.
Division-specific stress testing is undertaken to support risk identification and risk management decision-making.
The Group met or exceeded its medium term strategic funding and liquidity targets by 2012 year end. This included a loan:deposit ratio of 100%, short-term wholesale funding (STWF) of £42 billion, representing 5% of funded assets (target: less than 10%) and £147 billion liquidity portfolio which covered STWF 3.5 times (target: greater than 1.5 times STWF).
During 2012, loan impairment charges were 27% lower than in 2011 despite continuing challenges in Ulster Bank Group (Core and Non-Core) and commercial real estate portfolios. Credit risk associated with legacy exposures continued to be reduced, with a further 34% decline in Non-Core credit RWAs during the year. The Group also continued to make progress in reducing key credit concentration risks, with exposure to commercial real estate declining 16% during 2012.
Country risk The risk of material losses arising from significant countryspecific events.
Can arise from sovereign events, economic events, political events, natural disasters or conflicts.
Primarily present in credit portfolios of Markets, International Banking, Ulster Bank (Ireland), Group Centre (mainly Treasury) and NonCore.
In the context of several sovereign downgrades, the Group has made continued progress in managing down its sovereign exposures. Having recognised an impairment on its holding of Greek government bonds in 2011, the Group participated in the restructuring of Greek sovereign debt in the first quarter of 2012 and no longer holds Greek government bonds. During 2012, the Group brought nearly all advanced countries under country limit control and further restricted its country risk appetite. Balance sheet exposures to periphery eurozone countries decreased by 13% or £9 billion to £59 billion with £20 billion outside of Ireland. Funding mismatches in Ireland and Spain reduced to approximately £9 billion and £4 billion respectively. Mismatches in other periphery eurozone countries were modest.
Insurance risk The risk of financial loss through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting.
During 2012, the Group continued to reduce its risk exposures; market risk limits were lowered accordingly. Average trading VaR was £97 million, 8% lower than 2011, largely reflecting asset sales in Non-Core and decreases in ABS trading inventory in Markets.
Operational risk The risk of loss resulting from inadequate or failed processes, people, systems or from external events.
The Group aims to manage operational risk to an acceptable level by taking into account the cost of minimising the risk against the resultant reduction in exposure.
During 2012, the Group continued to make good progress in enhancing its operational risk framework and risk management capabilities. Key areas of focus have included: embedding risk assessments, increasing the coverage of the scenario analysis portfolio, and improving statistical capital modelling capabilities.
The level of operational risk remains high due to the scale of change occurring across the Group (both structural and regulatory), macroeconomic stresses (e.g. eurozone distress) and other external threats such as e-crime. In June 2012 the Group was affected by a technology incident as a result of which the processing of certain customers accounts and payments were subject to considerable delay.
It may also arise from the failure to meet customers’ or regulators’ expectations of the Group.
A defined and measurable appetite for conduct risk has been established to ensure commercial decisions take account of conduct risk implications.
A management framework has been developed to enable the consistent identification, assessment and mitigation of conduct risks. Embedding of this framework started during 2012 and is continuing in 2013.
Grouped under four pillars (employee conduct, corporate conduct, market conduct and conduct towards the Group’s customers), each conduct risk policy is designed to ensure the Group meets its obligations and expectations.
Awareness initiatives and targeted conduct risk training for each policy, aligned to the phased policy roll-out, have been developed and are being delivered to help embed understanding and provide the necessary clarity. These actions are designed to facilitate effective conduct risk management, and address shortcomings identified through recent instances of inappropriate conduct.
The Group operates a rolling forecast process which identifies projected changes in, or risks to, operating profit and ensures appropriate action is taken.
The Group manages the risk it faces as a sponsor of its defined benefit pension schemes using a framework that encompasses risk reporting and monitoring, stress testing, modelling and an associated governance structure. This helps ensure the Group is able to fulfil its obligation to support the defined benefit pension schemes to which it has exposure.
Capital resources 130 Flow statement (Basel 2.5) 130 Reconciliation between accounting and regulatory consolidation 131 Reconciliation between accounting equity and regulatory capital 132
The appropriate level of capital is determined based on the dual aims of: (i) meeting minimum regulatory capital requirements; and (ii) ensuring the Group maintains sufficient capital to uphold investor and rating agency confidence in the organisation, thereby supporting the business franchise and funding capacity.
The Group has developed its stress testing capability to identify the impact of a wider set of potential scenarios. The stress outcomes show that the de-risking in the Group has been effective in reducing the impacts of stress scenarios and at the same time the capital ratios have been improving, resulting in increased capital buffers. The changes to the risk profiles as a result of de-risking include run-down of Non-Core, reduction in concentrations, and revising the strategic footprint of the Markets division.
Governance and approach The Group Asset and Liability Management Committee (GALCO) is responsible for ensuring the Group maintains adequate capital at all times. The Capital and Stress Testing Committee (CAST) is a crossfunctional body driving and directing integrated risk capital activities including determination of the amount of capital the Group should hold, how and where capital is allocated and planning for actions that would ensure that an adequate capital position would be maintained in a stressed environment. These activities have linkages to capital planning, risk appetite and regulatory change. CAST reports through GALCO and comprises senior representatives from Risk Management, Group Finance and Group Treasury.
The Group’s own determination of how much capital is sufficient is derived from the desired credit rating level, risk appetite and reflects the current and emerging regulatory requirements of the Group. It is evaluated through the application of both internally and externally defined stress tests that identify potential changes in capital ratios to a range of scenarios.
The Group identifies the management and recovery actions that could be applied to stress environments. These form an important part of the capital management approach and the contingency planning arrangements, complementing the established buffers.
Capital ratios* The Group’s capital, RWAs and risk asset ratios, calculated in accordance with FSA definitions, are set out below.
Core Tier 1 47.3 46.3 49.6 Core Tier 1 (excluding Asset Protection Scheme (APS)) 47.3 49.1 53.8 Tier 1 57.1 57.0 60.1 Total 66.8 60.7 65.3 2012 2011 2010 Risk-weighted assets by risk £bn £bn £bn
Credit risk - non-counterparty 323.2 344.3 385.9 - counterparty 48.0 61.9 68.1 Market risk 42.6 64.0 80.0 Operational risk 45.8 37.9 37.1 459.6 508.1 571.1 APS relief — (69.1) (105.6)
Core Tier 1 10.3 10.6 10.7 Core Tier 1 (excluding APS) 10.3 9.7 9.5 Tier 1 12.4 13.0 12.9 Total 14.5 13.8 14.0
Key point The Core Tier 1 ratio, excluding relief provided by APS, has improved to 10.3% at 31 December 2012 driven by continued run-down and disposal of Non-Core assets and the reshaping of the balance sheet and capital usage in Markets.
Capital management continued Capital resources* Flow statement (Basel 2.5) The table below analyses the movement in Core Tier 1, Other Tier 1 and Tier 2 capital during the year.
At 1 January 2012 46,341 Attributable loss net of movements in fair value of own credit (2,647) Ordinary shares issued 120 Share capital and reserve movements in respect of employee share schemes 821 Foreign exchange reserve movements (867) Decrease in non-controlling interests (24) Decrease in capital deductions including APS first loss 4,307 Decrease in goodwill and intangibles 1,313 Defined pension fund movement (net of prudential filter adjustment) (977) Other movements (1,067)
Other Tier 1 capital At 1 January 2012 10,649 Foreign currency reserve movements (189) Decrease in Tier 1 deductions (252) Other movements (393)
Assets Cash and balances at central banks 79,290 — 544 79,834 Loans and advances to banks 63,951 (30) 48 63,969 Loans and advances to customers 500,135 1,438 2,883 504,456 Debt securities 157,438 (12) 743 158,169 Equity shares 15,232 (194) — 15,038 Settlement balances 5,741 — — 5,741 Derivatives 441,903 — — 441,903 Intangible assets 13,545 — — 13,545 Property, plant and equipment 9,784 (1,320) 32 8,496 Deferred tax 3,443 — — 3,443 Prepayments, accrued income and other assets 7,820 (77) (320) 7,423 Assets of disposal groups 14,013 (10,544) — 3,469 1,312,295 (10,739) 3,930 1,305,486
Liabilities Deposits by banks 101,405 — 92 101,497 Customer accounts 521,279 — 3,486 524,765 Debt securities in issue 94,592 — — 94,592 Settlement balances 5,878 — — 5,878 Short positions 27,591 — — 27,591 Derivatives 434,333 — — 434,333 Accruals, deferred income and other liabilities 14,801 (100) 253 14,954 Retirement benefit liabilities 3,884 — — 3,884 Deferred tax 1,141 (5) — 1,136 Subordinated liabilities 26,773 — 99 26,872 Liabilities of disposal groups 10,170 (9,267) — 903 1,241,847 (9,372) 3,930 1,236,405
Non-controlling interests 2,318 (1,367) — 951 Owners’ equity 68,130 — — 68,130 Total equity 70,448 (1,367) — 69,081
Other Tier 1 capital Preference shares - equity transferred from shareholders’ equity 4,313 4,313 4,313 Preference shares - debt transferred from subordinated liabilities 1,054 1,094 1,097 Innovative securities transferred from shareholders’ equity 431 431 431 Innovative securities transferred from non-controlling interests 548 548 548 Innovative/hybrid securities transferred from subordinated liabilities 3,146 3,688 3,683 9,492 10,074 10,072 Tier 1 deductions 50% material holdings (295) (340) (310) Tax on excess of expected losses over impairment provisions 618 915 758 323 575 448 Total Tier 1 capital 57,135 56,990 60,124
Unrealised gains on AFS equity shares 63 108 25 Collectively assessed impairment provisions 399 635 778 Non-controlling Tier 2 capital — 11 11 16,076 17,119 19,411
Supervisory deductions Unconsolidated Investments - Direct Line Group (2,081) (4,354) (3,962)
Key points Core Tier 1 capital increased by £1 billion during 2012. Excluding
UK Retail 37.9 — — 7.8 45.7 UK Corporate 77.7 — — 8.6 86.3 Wealth 10.3 — 0.1 1.9 12.3 International Banking 46.7 — — 5.2 51.9 Ulster Bank 33.6 0.6 0.2 1.7 36.1 US Retail & Commercial 50.8 0.8 — 4.9 56.5 Retail & Commercial 257.0 1.4 0.3 30.1 288.8 Markets 14.0 34.7 36.9 15.7 101.3 Other 4.0 0.4 — 1.4 5.8 Core 275.0 36.5 37.2 47.2 395.9 Non-Core 45.1 11.5 5.4 (1.6) 60.4 Group before RFS Holdings MI 320.1 48.0 42.6 45.6 456.3 RFS Holdings MI 3.1 — — 0.2 3.3 Group 323.2 48.0 42.6 45.8 459.6
UK Retail 41.1 — — 7.3 48.4 UK Corporate 71.2 — — 8.1 79.3 Wealth 10.9 — 0.1 1.9 12.9 International Banking 38.9 — — 4.3 43.2 Ulster Bank 33.6 0.6 0.3 1.8 36.3 US Retail & Commercial 53.6 1.0 — 4.7 59.3 Retail & Commercial 249.3 1.6 0.4 28.1 279.4 Markets 16.7 39.9 50.6 13.1 120.3 Other 9.8 0.2 — 2.0 12.0 Core 275.8 41.7 51.0 43.2 411.7 Non-Core 65.6 20.2 13.0 (5.5) 93.3 Group before RFS Holdings MI 341.4 61.9 64.0 37.7 505.0 RFS Holdings MI 2.9 — — 0.2 3.1 Group 344.3 61.9 64.0 37.9 508.1 APS relief (59.6) (9.5) — — (69.1)
UK Retail 41.7 — — 7.1 48.8 UK Corporate 76.4 — — 7.8 84.2 Wealth 10.4 — 0.1 2.0 12.5 International Banking 44.0 — — 7.7 51.7 Ulster Bank 29.2 0.5 0.1 1.8 31.6 US Retail & Commercial 52.1 0.9 — 4.4 57.4 Retail & Commercial 253.8 1.4 0.2 30.8 286.2 Markets 21.5 34.5 44.7 9.6 110.3 Other 16.4 0.4 0.2 1.0 18.0 Core 291.7 36.3 45.1 41.4 414.5 Non-Core 91.3 31.8 34.9 (4.3) 153.7 Group before RFS Holdings MI 383.0 68.1 80.0 37.1 568.2 RFS Holdings MI 2.9 — — — 2.9 Group 385.9 68.1 80.0 37.1 571.1 APS relief (88.2) (17.4) — — (105.6)
Flow statement The table below analyses the movement in credit risk, market risk and operational risk RWAs by key drivers during the year.
Notes: (1) Represents changes in book size, composition, position changes and market movements. (2) Refers to implementation of a new model or modification of an existing model after approval from the FSA.
Key Points The £75 billion decrease due to business and market movements is driven by: - Market risk and counterparty risk decreased by £16 billion and £20 billion due to reshaping the business risk profile; - Run-off of balances in Non-Core; - Declines in Retail and Commercial due to loans migrating into default and customer deleveraging; and - Reduction in credit risk in the Group liquidity portfolio as European peripheral exposures were sold.
Aviation Capital and exposures relating to credit derivative product companies, monolines and other counterparties.
In December 2010, the BCBS issued the final text of the Basel III rules, providing details of the global standards agreed by the Group of Governors and Heads of Supervision, the oversight body of the BCBS and endorsed by the G20 leaders at their November 2010 Seoul summit.
The new capital requirements regulation and capital requirements directive that implement Basel III proposals within the European Union (EU) (collectively known as CRD IV) are in two parts, Capital Requirements Directive (CRD) and the Capital Requirements Regulation. Further technical detail will be provided by the European Banking Authority through its Implementing Technical Standards and Regulatory Technical Standards.
The CRD IV has not yet been finalised and consequently the Basel III implementation date of 1 January 2013 has been missed. While it is anticipated that agreement of the CRD IV will be achieved during 2013, the implementation date remains uncertain.
Notes: (1) The capital conservation buffer is set at 2.5% of RWAs and is intended to be available in periods of stress. Drawing on the buffer would lead to a corresponding reduction in the ability to make discretionary payments such as dividends and variable compensation. (2) The counter-cyclical buffer is institution specific and depends on the Group's geographical footprint and the macroeconomic conditions pertaining in the individual countries in which the Group operates. As there is a time lag involved in determining this ratio, it has been assumed that it will be zero for the time being. (3) The G-SIB buffer is dependent on the regulatory assessment of the Group. The Group has been provisionally assessed as requiring additional CET1 of 1.5% in the list published by the Financial
Subordinated debt instruments which do not meet the new eligibility criteria will be will be grandfathered on a reducing basis over ten years.
The Group is well advanced in its preparations to comply with the new requirements based on the draft rules. Given the phasing of both capital requirements and target levels, in advance of needing to comply with the fully loaded end state requirements, the Group will have the opportunity to continue to generate additional capital from earnings and take management actions to mitigate the impact of CRD IV.
The Group is expected to have a lower wholesale funding requirement going forward. The Group will continue to look at accessing the market opportunistically from time to time to further support the Group’s overall funding strategy.
Highlights of 2012 include: The Group’s credit profile improved markedly during the year reflecting the success of its restructuring efforts. Credit default swaps spreads fell by 60% from their 2011 peak and secondary bond spreads on five year maturity have narrowed from c.450 basis points to c.100 basis points.
The Group and RBS plc issued a combined £1.0 billion in term debt net of buy-backs, a fraction of the £20.9 billion issued in 2011. Short-term wholesale funding was actively managed down to £41.6 billion from £102.4 billion.
The Group has taken advantage of market conditions through the course of the year to further supplement its capital base.
The Group successfully undertook two public liability management exercises targeting Lower Tier 2 and senior unsecured debt in support of ongoing balance sheet restructuring initiatives.
These policies are reviewed at least annually or sooner if the Group’s own liquidity position changes or if market conditions and/or regulatory rules warrant further amendment or refinement.
In the case of the credit rating downgrade by Moody’s, the Group was given adequate notice to plan for such an outcome and challenge Moody’s analytical approach. Potential or actual changes in the Group’s or any of its subsidiaries ratings prompt an intensive internal review of the likelihood and magnitude of such an outcome on customer and counterparty behaviours. These include stress testing and scenario modelling. This analysis was reviewed internally and shared with the FSA. As a precautionary measure the Group increased the size of its liquidity buffer in the period leading up the conclusion of the rating review. Such actions proved unnecessary once Moody’s concluded their rating review as there was very limited impact on customer or counterparty behaviour.
The Group’s appetite for liquidity risk is set by the Board and then managed by various functions within the business. For example, measurement of the Group’s liquidity risk is managed on a daily basis within Group Finance, policy compliance and development is managed within the Group Risk framework.
The Group’s principal regulator, the FSA, has a comprehensive set of liquidity policies the cornerstone of which is Policy Statement (PS) 09/16. In order to comply with the FSA regulatory process, the Group: Must complete and keep updated an Individual Liquidity Adequacy
Assessment (ILAA); Submit itself to the Supervisory Liquidity Review Process which is a review of the ILAA and the Group’s liquidity policies and operational capacity and capability; and
Liquidity risk: Policy, framework and governance continued The ILAA is the cornerstone of the Group’s assessment process and informs the Group Board and the FSA of the assessment and quantification of the Group’s liquidity risks and their mitigation and how much current and future liquidity is required to manage those risks.
Finally, external stakeholders such as market counterparties, debt and equity investors and credit rating agencies actively review and challenge the Group’s approach, their views being reflected through their ongoing support of the Group.
The Group actively monitors ongoing regulatory developments in the international arena. Whilst most individual country regulators have implemented or refined specific country liquidity regulations, much work continues at an international level to agree common standards.
In January 2013, the Basel Committee on Banking Supervision issued its revised draft guidance for calculating the LCR, which is currently expected to come into force from 1 January 2015 on a phased basis. Pending the finalisation of the definitions, the Group monitors the LCR and the NSFR in its internal reporting framework based on its interpretation and expectation of the final rules. On this basis, as of 31 December 2012, the Groups LCR was over 100% and the NSFR 117%.
The Group also uses appropriate transfer pricing of liquidity costs to foster appropriate pricing behaviour and decision making. The Group’s internal transfer pricing policy helps to manage the balance sheet mix and composition of contingent and actual liabilities and to ensure that liquidity risk is reflected in product pricing and divisional business performance measurement. This also ensures that divisions are being correctly incentivised to source the most appropriate mix of funding.
The Group actively monitors a range of market and firm-specific early warning indicators of emerging liquidity stresses. Some of these indicators will be actual performance of the business against pre-agreed limits, for example customer deposit outflows. Others will be based around general or specific market movements such as movements in the Group’s credit default swap spreads.
Liquidity risks are reviewed at legal entity daily, and performance reported to Divisional and Group Asset and Liability Committees. Any breach or material deterioration of these metrics will set in motion a series of actions and escalations that could lead to activation of the contingency funding plan. Any breach of these metrics that subsequently means that the Group can no longer comply with its ILG will necessitate notification to the FSA and the eventual submission of a liquidity remediation plan.
The Group’s liquidity risk framework is subject to internal oversight, challenge and governance both at Board level and via internal control functions such as Internal Audit. The Group is also subject to regulatory review and challenge from the FSA through its supervisory programme.
The Group’s actual experiences from the 2008 and 2009 period have factored heavily into the liquidity analysis in the past, although more recent market conditions and events provide more up-to-date data for scenario modelling. Stress tests are augmented from time to time to reflect firm-specific or emerging market risks that could have a material impact on the Group’s liquidity position.
The results of stress testing are an active part of management and strategy in balance sheet management and inform allocation, target and limit discussions. In short, limits in the business-as-usual environment are bounded by capacity to satisfy the Group’s liquidity needs in the stress environments.
Net wholesale funding - Outflows at contractual maturity of wholesale funding and conduit commercial paper, with no rollover/new issuance. Prime Brokerage, 100% loss of excess client derivative margin and 100% loss of excess client cash.
Secured financing and increased haircuts - Loss of secured funding capacity at contractual maturity date and incremental haircut widening, depending upon collateral type.
Group could be seen as a greater credit risk than competitors.
Intra-day cashflows - Liquid collateral held against intra-day requirement at clearing and payment systems is regarded as encumbered with no liquidity value assumed. Liquid collateral is held against withdrawal of unsecured intra-day lines provided by third parties.
Funding concentrations - Additional outflows recognised against concentration of providers of wholesale secured financing.
Franchise viability - Group liquidity stress testing includes additional liquidity in order to meet outflows that are non-contractual in nature, but are necessary in order to support valuable franchise businesses.
Management action - Unencumbered marketable assets that are held outside of the Core liquidity buffer and are of verifiable liquidity value to the firm, are assumed to be monetised (subject to haircut/valuation adjustment).
Liquidity risk continued Contingency planning The Group has a Contingency Funding Plan (CFP), which is updated as the balance sheet evolves and forms the basis of analysis and actions to remediate adverse circumstances as and if they arise. The CFP is linked to stress test results and forms the foundation for liquidity risk limits. The CFP provides a detailed description of the availability, size and timing of all sources of contingent liquidity available to the Group in a stress event. These are ranked in order of economic impact and effectiveness to meet the anticipated stress requirement. The CFP includes documented processes for actions that may be required to meet the outflows. Roles and responsibilities for the effective implementation of the CFP are also documented.
Certain of the Group's significant operating subsidiaries - RBS N.V., RBS Citizens Financial Group Inc. (CFG) and Ulster Bank Ireland Limited - hold locally managed portfolios of liquid assets that comply with local regulations but may differ with FSA rules. These portfolios are the responsibility of the local Treasurer who reports to the Group Treasurer.
The Group analyses its liquidity buffer including its locally managed liquidity pools into primary and secondary liquidity groups.
The primary liquidity group generally reflects eligible liquid assets, such as cash and balances at central banks, treasury bills and other high quality government and agency bonds, and other local primary qualifying liquid assets for each of the significant operating subsidiaries that maintain a local liquidity pool.
Secondary liquidity assets represent other qualifying liquid assets that are eligible for local central bank liquidity facilities but do not meet the core local regulatory definition. For example, secondary liquid assets include self-issued securitisations or covered bonds that are retained on balance sheet and pre-positioned with a central bank so that they can be converted into additional sources of liquidity at very short notice.
Funding risk As noted earlier, the Group actively participates in the broader international debate and process regarding further reform and refinement of liquidity risk oversight and policies, and will seek to adopt commonly agreed upon measures where there is consistent alignment between domestic and international regulators.
Diversity in funding is provided by its active role in the money markets, along with access to global capital flows through the Group’s international client base. These funding programmes allow the Group (or its subsidiaries) to issue secured or unsecured, senior or subordinated securities. Over time the Group’s wholesale funding franchise has been diversified by currency, geography, maturity and type.
During 2012, the Group drew down €10 billion of funding under the European Central Bank’s Long Term Refinancing Operation and £750 million of treasury bills under the Bank of England’s Funding for Lending Scheme.
Diversification of the Group’s funding base is central to its balance sheet management strategy. The Group’s businesses have developed large customer franchises based on strong relationship management and high quality service. These customer franchises are strongest in the UK, the US and Ireland, but extend into Europe and Asia. Customer deposits provide large pools of stable funding to support the majority of the Group’s lending.
Liquidity and funding risk: Analyses Funding sources The table below shows the Group’s principal funding sources excluding repurchase agreements. 2012 2011 2010 £m £m £m
Deposits by banks derivative cash collateral 28,585 31,807 28,074 other deposits 28,489 37,307 38,243 57,074 69,114 66,317 Debt securities in issue conduit asset-backed commercial paper (ABCP) — 11,164 17,320 other commercial paper (CP) 2,873 5,310 8,915 certificates of deposit (CDs) 2,996 16,367 37,855 medium-term notes (MTNs) 66,603 105,709 131,026 covered bonds 10,139 9,107 4,100 securitisations 11,981 14,964 19,156 94,592 162,621 218,372 Subordinated liabilities 27,302 26,319 27,053 Notes issued 121,894 188,940 245,425 Wholesale funding 178,968 258,054 311,742 Customer deposits cash collateral 7,949 9,242 10,433 other deposits 426,043 427,511 420,433 Total customer deposits 433,992 436,753 430,866 Total funding 612,960 694,807 742,608
Short-term wholesale funding (1) Total wholesale funding Net inter-bank funding (2)
Notes: (1) Short-term wholesale balances denote those with a residual maturity of less than one year and include longer-term issuances. (2) Excludes derivative collateral. (3) Primarily short-term balances.
Notes issued The table below shows the Group’s debt securities in issue and subordinated liabilities by residual maturity.
Less than 1 year 17,320 46,051 30,589 — 88 94,048 964 95,012 39 1-3 years — 702 47,357 1,078 12 49,149 754 49,903 20 1-5 years — 12 21,466 1,294 34 22,806 8,476 31,282 13 More than 5 years — 5 31,614 1,728 19,022 52,369 16,859 69,228 28 17,320 46,770 131,026 4,100 19,156 218,372 27,053 245,425 100
2012 2011 2010 Deposits Repos Deposits Repos Deposits Repos £m £m £m £m £m £m
Financial institutions - central and other banks 57,074 44,332 69,114 39,691 66,317 32,739 - other financial institutions 64,237 86,968 66,009 86,032 65,532 75,782 Personal and corporate deposits 369,755 1,072 370,744 2,780 365,334 6,312 491,066 132,372 505,867 128,503 497,183 114,833 £173 billion or 40% of the customer deposits included above are insured through the UK Financial Services Compensation Scheme, US Federal Deposit Insurance Corporation Scheme and other similar schemes. Of the personal and corporate deposits above, 42% related to personal customers and 58% to corporate customers.
Divisional loan:deposit ratios and funding gaps The table below shows divisional loans, deposits, customer loan:deposit ratios and customer funding gaps.
Other 3,264 3,340 98 76 Core 386,807 430,694 90 43,887 Non-Core 45,144 3,298 nm (41,846)
Retail & Commercial 372,551 393,200 95 20,649 Markets 31,254 36,776 85 5,522 Other 1,196 2,496 48 1,300 Core 405,001 432,472 94 27,471 Non-Core 68,516 4,281 nm (64,235)
UK Corporate 112,037 124,529 90 12,492 Wealth 16,065 36,449 44 20,384 International Banking (4) 49,186 44,271 111 (4,915)
Public - unsecured 1,237 5,085 12,887 - secured 2,127 9,807 8,041 Private - unsecured 4,997 12,414 17,450 - secured — 500 — Gross issuance 8,361 27,806 38,378 Buy-backs (1) (7,355) (6,892) (6,298)
Liquidity Liquidity portfolio The table below analyses the Group’s liquidity portfolio by product and between the UK Defined Liquidity Group (UK DLG), RBS Citizens Financial Group Inc. (CFG) and other subsidiaries, by liquidity value. Liquidity value is lower than carrying value principally as it is stated after the discounts applied by the Bank of England and other central banks to loans, within secondary liquidity portfolio, eligible for discounting.
Cash and balances at central banks 64,822 891 4,396 70,109 81,768 Central and local government bonds AAA rated governments and US agencies 3,984 5,354 547 9,885 18,832 AA- to AA+ rated governments (2) 9,189 — 432 9,621 9,300 governments rated below AA — — 206 206 596 local government — — 979 979 2,244 13,173 5,354 2,164 20,691 30,972 Treasury bills 750 — — 750 202 Primary liquidity 78,745 6,245 6,560 91,550 112,942 Other assets (3) AAA rated 3,396 7,373 203 10,972 17,304 below AAA rated and other high quality assets 44,090 — 557 44,647 24,674 Secondary liquidity 47,486 7,373 760 55,619 41,978 Total liquidity portfolio 126,231 13,618 7,320 147,169 154,920
Cash and balances at central banks 55,100 1,406 13,426 69,932 74,711 Central and local government bonds AAA rated governments and US agencies 22,563 7,044 25 29,632 37,947 AA- to AA+ rated governments (2) 14,102 — — 14,102 3,074 governments rated below AA — — 955 955 925 local government — — 4,302 4,302 4,779 36,665 7,044 5,282 48,991 46,725 Treasury bills — — — — 5,937 Primary liquidity 91,765 8,450 18,708 118,923 127,373 Other assets (3) AAA rated 17,216 4,718 3,268 25,202 21,973 below AAA rated and other high quality assets 6,105 — 5,100 11,205 12,102 Secondary liquidity 23,321 4,718 8,368 36,407 34,075 Total liquidity portfolio 115,086 13,168 27,076 155,330 161,448
Liquidity value Period end UK DLG (1) CFG Other Total 2010 £m £m £m £m
Net stable funding ratio* The table below shows the composition of the Group’s net stable funding ratio (NSFR), estimated by applying the Basel III guidance issued in December 2010. The Group’s NSFR will also continue to be refined over time in line with regulatory developments and related interpretations. It may also be calculated on a basis that may differ from other financial institutions.
Key point NSFR improved from 111% at 31 December 2011 to 117% at the end of 2012. Long-term wholesale funding declined by £15 billion in line with
Encumbrance The Group reviews all assets against the criteria of being able to finance them in a secured form (encumbrance) but certain asset types lend themselves more readily to encumbrance. The typical characteristics that support encumbrance are an ability to pledge those assets to another counterparty or entity through operation of law without necessarily requiring prior notification, homogeneity, predictable and measurable cash flows, and a consistent and uniform underwriting and collection process. Retail assets including residential mortgages, credit card receivables and personal loans display many of these features.
From time to time the Group encumbers assets to serve as collateral to support certain wholesale funding initiatives. The three principal forms of encumbrance are own asset securitisations, covered bonds and securities repurchase agreements. The Group categorises its assets into three broad groups; assets that are: already encumbered and used to support funding currently in place via own asset securitisations, covered bonds and securities repurchase agreements.
Total 18 19 Excluding balances relating to derivative transactions 22 26 Excluding balances relating to derivative and securities financing transactions 13 19
Own-asset securitisations The Group has a programme of own-asset securitisations where assets are transferred to bankruptcy remote special purpose entities (SPEs) funded by the issue of debt securities. The majority of the risks and rewards of the portfolio are retained by the Group and these SPEs are consolidated and all of the transferred assets retained on the Group’s balance sheet. In some own-asset securitisations, the Group may purchase all the issued securities which are available to be pledged as collateral for repurchase agreements with major central banks. The following table shows the asset categories together with the carrying amounts of the assets and associated liabilities, for both own-asset securitisations where the debt securities issued are held by third parties and those where the debt securities issued are held by the Group.
Total assets 1,312 Total assets excluding derivatives 870 Total assets excluding derivatives and reverse repos 766
Mismatches in these sensitivities give rise to net interest income (NII) volatility as interest rates rise and fall. For example, a bank with a floating rate loan portfolio and largely fixed rate deposits will see its net interest income rise, as interest rates rise and fall as rates decline. Due to the long-term nature of many banking book portfolios, varied interest rate repricing characteristics and maturities, it is likely the NII will vary from period to period, even if interest rates remain the same. New business volumes originated in any period, will alter the interest rate sensitivity of a bank if the resulting portfolio differs from portfolios originated in prior periods.
The Group assesses interest rate risk in the banking book (IRRBB) using a set of standards to define, measure and report the risk. These standards incorporate the expected divergence between contractual terms and the actual behaviour of fixed rate loan portfolios due to refinancing incentives and the risks associated with structural hedges of interest rate insensitive balances, which relates to the stability of the underlying portfolio.
The VaR does not provide a dynamic measurement of interest rate risk since static underlying repricing gap positions are assumed. Changes in customer behaviour under varying interest rate scenarios are captured by way of earnings risk measures. IRRBB VaR for the Group’s Retail and Commercial banking activities at 99% confidence level and currency analysis of period end VaR were as follows: Average Period end Maximum Minimum £m £m £m £m
Key points Interest rate exposure at 31 December 2012 was considerably lower than at 31 December 2011 and average exposure was 27% lower in 2012 than in 2011.
It is estimated that the change in methodology reduced VaR by £13.8 million (33%) on implementation.
Liquidity and funding risk: Analyses: Non-traded interest rate risk continued Sensitivity of net interest income* Earnings sensitivity to rate movements is derived from a central forecast over a twelve month period. Market implied forward rates and new business volume, mix and pricing consistent with business assumptions are used to generate a base case earnings forecast.
Euro Sterling US dollar Other Total 2012 £m £m £m £m £m
+ 100 basis points shift in yield curves 25 186 11 10 232 100 basis points shift in yield curves (33) (212) (99) (8) (352)
Changes in foreign currency exchange rates affect equity in proportion to structural foreign currency exposure. A 5% strengthening in foreign currency against sterling would result in a gain of £1.3 billion (2011 and 2010 - £1.3 billion) in equity, while a 5% weakening would result in a loss of £1.1 billion (2011 and 2010 - £1.2 billion) in equity.
Liquidity and funding risk: Analyses continued Non-traded equity risk Non-traded equity risk is the potential variation in the Group’s non-trading income and reserves arising from changes in equity valuations.
The risk arising from these holdings is mitigated by proper controls and identification of risk prior to investing.
Valuation At Group level, positions are monitored by and reported quarterly to GALCO.
Equity positions are measured at fair value. Fair value calculations are based on available market prices where possible. In the event that market prices are not available, fair value is based on appropriate valuation techniques or management estimates.
The following table shows the balance sheet value and fair value of the Group’s non-traded book equity positions.
The exposures may take the form of listed and unlisted equity shares, linked equity fund investments, private equity and venture capital investments, preference shares classified as equity or Federal Home Loan Bank stock. The following table shows the net realised and unrealised gains from these positions: Net realised gains arising from disposals 89 150 Unrealised gains included in Tier 1, 2 or 3 capital 168 235
Cumulative gains on equity shares designated at fair value through profit or loss but not held for trading purposes were £84 million at 31 December 2012 (2011 - £230 million).
Credit risk measurement – Probability of default/customer credit grade 162 – Exposure at default models 162 – Loss given default models 162 – Changes to wholesale credit risk models 162
Settlement risk - the intra-day risk that arises when the Group releases funds prior to confirmed receipt of value from a third party.
Issuer risk - the risk of loss on a tradable instrument (e.g. a bond)
Credit mitigation risk - the risk that credit risk mitigation (for example, taking a legal charge over property to secure a customer loan) is not enforceable or that the value of such mitigation decreases, thus leading to unanticipated losses.
Commercial real estate While progress has been made in reducing the overall exposure and rebalancing the portfolio, commercial real estate remains a key credit concentration risk for the Group. The Group has continued to strengthen its approach to managing sector concentration risk, with a particular focus on additional controls for the commercial real estate portfolio.
However, the credit performance remains sensitive to the economic environment in the UK and Ireland. Although some improvements have been seen in commercial real estate values across prime locations, secondary and tertiary values remain subdued.
Further details on the Group’s exposure to commercial real estate can be found on pages 181 to 185.
Further details on the Group’s shipping portfolio can be found on page 166.
Retailers Given the cyclical nature of the retail corporate sector and its sensitivity to stressed economic conditions, the Group has continued to apply heightened scrutiny to this portfolio. Despite some high-profile failures of UK high street retailers, loss experience on the RBS retail portfolio remained low during 2012 as a result of active management. The portfolio is generally well diversified by geography and by counterparty.
In response to this industry change, the Group has developed a tailored risk appetite and risk control framework. The Group’s central counterparty exposure is dominated by a small number of well-established, high quality and reputable clearing houses.
Renegotiations and forbearance Loan modifications take place in a variety of circumstances including but not limited to a customer’s current or potential credit deterioration. Where the contractual payment terms of a loan have been changed because of the customer’s financial difficulties, it is classified as ‘renegotiated’ in the wholesale portfolio and as ‘forbearance’ in the retail portfolio.
RBS uses renegotiations and forbearance as management tools to support viable customers through difficult financial periods in their lives or during business cycles. Used wisely, they can reduce the incidence of personal insolvency, as well as bankruptcies for otherwise successful enterprises. On a broader scale they can also help reduce the impact of “fire sale” pricing on real economic assets. However, they must be used selectively and require additional management vigilance throughout the loan life cycle. The Group has continued to take steps to improve its management and reporting of such loans within both corporate and retail businesses. More details of the Group’s approach can be found on pages 173 to 180.
Objectives, organisation and governance The existence of a strong credit risk management function is vital to support the ongoing profitability of the Group. The potential for loss through economic cycles is mitigated through the embedding of a robust credit risk culture within the business units and through a focus on the importance of sustainable lending practices. The role of the RBS credit risk management function is to own the credit approval, concentration and credit risk control frameworks and to act as the ultimate authority for the approval of credit. This, together with strong independent oversight and challenge, enables the business to maintain a sound lending environment within approved risk appetite.
The divisional credit risk management functions work together with GCR to ensure that the risk appetite set by the Group Board is met, within a clearly defined and managed control environment. The credit risk function within each division is managed by a Chief Credit Officer, who reports jointly to a divisional Chief Risk Officer and to the Group Chief Credit Officer. Divisional activities within credit risk include credit approval, transaction and portfolio analysis, ongoing credit risk stewardship, and early problem recognition and management.
Material aspects of the Group’s credit risk management framework, such as credit risk appetite and limits for portfolios of strategic significance, are considered and approved by the Executive Risk Forum (ERF). The ERF has delegated approval authority to the Group Credit Risk Committee, a functional sub-committee of the Group Risk Committee, to act on credit risk matters. These include, but are not limited to, credit risk appetite and limits (within the overall risk appetite set by the Board and the ERF), credit risk strategy and frameworks, credit risk policy and the oversight of the credit profile across the Group.
Oversight of the Group’s provision adequacy is provided by the Group Audit Committee.
Key trends in the credit risk profile of the Group, performance against limits and emerging risks are set out in the RBS Risk Management Monthly Report provided to the Group Board, the Executive Committee and the Board Risk Committee.
In order to strengthen this framework and ensure consistent application across the Group, during 2012 the GCR function launched a set of credit control standards, to supplement the existing policy suite. These standards address divisional governance and policy requirements and reflect a set of behavioural, organisational and management norms that drive a sound divisional control environment and embed a strong risk culture.
Risk appetite and concentration risk management Risk appetite has been expressed by the Group Board through the setting of specific quantitative risk appetite targets under stress (refer to page 121). Of particular relevance in the management of credit risk are the targets for earnings volatility and capital adequacy. The Group’s credit risk framework has therefore been designed around the factors that influence the Group’s ability to meet these targets. These include the limiting of excess credit risk concentrations by product/asset class, industry sector, customer or counterparty (i.e. single name) and country any of which could generate higher volatility under stress and, if not adequately controlled, can undermine capital adequacy.
The frameworks are supported by a suite of Group-wide and divisional policies that set out the risk parameters within which business units must operate.
The management of concentration risk and associated limits are firmly embedded in the risk management processes of the Group and form a pivotal part of the Risk function’s engagement with the businesses on the appropriateness of risk appetite choices. The ERF, or delegated committee, has reviewed all material industry and product portfolios and agreed a risk appetite commensurate with the franchises represented in these reviews. In particular, limits have been reviewed and re-sized, to refine the Group’s risk appetite in areas where it faces significant balance sheet concentrations or franchise challenges. The need to control concentrations must at all times be balanced against the need to ensure sufficient capacity within credit limits to support customers of sound credit quality, in particular within retail and small business customer segments.
During 2012, the credit risk function expanded the scope of its credit risk appetite controls through the active management of non-financial risks in the Group’s lending decisions. The development of Environmental, Social and Ethical (ESE) risk policies for sectors considered to present a higher reputational risk (such as the defence, oil and gas sectors) provide a framework within which the Group can better manage its reputational risks. This ESE framework forms part of a wider initiative by the Group to improve reputational risk management and build trust with its stakeholders (for more information on reputational risk management, refer to page 291).
Product/asset class Retail - A formal framework establishes Group-level statements and thresholds that are cascaded through all retail franchises in the Group and to granular business lines. These include measures that relate both to aggregate portfolios and to asset quality at origination, which are tracked frequently to ensure consistency with Group standards and appetite. This appetite setting and tracking then informs the processes and parameters employed in origination activities, which require a large volume of small-scale credit decisions, particularly those involving an application for a new product or a change in facilities on an existing product. The majority of these decisions are based upon automated strategies utilising credit and behaviour scoring techniques. Scores and strategies are typically segmented by product, brand and other significant drivers of credit risk. These scores and strategies are data driven and utilise a wide range of credit information relating to the customer including, where appropriate, information on the customer’s credit performance across their existing account holdings both with the bank and with other lenders. A small number of credit decisions are subject to additional manual underwriting by authorised approvers in specialist units. These include higher-value, more complex, small business and personal unsecured transactions and some residential mortgage applications.
A number of credit risk mitigation techniques are available to reduce single name concentrations. To be considered suitable, credit risk mitigants must be effective in terms of legal certainty and enforceability and maturity/expiry dates must be the same or later than the underlying obligations. Typical mitigant types include, cash, bank/government guarantees, and credit default swaps (CDS).
Since 2009, the Group has been managing its corporate exposures to reduce concentrations and align its appetite for future business to the Group’s broader strategies for its large corporate franchises. The Group is continually reviewing its single name concentration framework to ensure that it remains appropriate for current economic conditions and in line with improvements in the Group’s risk measurement models.
Country For information on how the Group manages credit risk by country, refer to the Country risk section on pages 252 to 280.
The second component is a policy assurance activity that GCR undertakes to provide the Group Chief Credit Officer with evidence of the effectiveness of the controls in place across the Group to manage credit risk. The results of these reviews are presented to the Group Credit Risk Committee on a regular basis in support of the self-certification that GCR is obliged to complete under the GPF.
Finally, a strong independent assurance function is an important element of a sound control environment. During 2011, the Group took the decision to strengthen its credit quality assurance (CQA) activities and moved all divisional CQA resources under the centralised management of GCR. The benefits of this action are already apparent in greater consistency of standards and cross-utilisation of resources, ensuring that subject matter experts bring their expertise to bear where relevant.
Exposure at default models Exposure at default (EAD) models estimate the level of use of a credit facility at the time of a borrower’s default, recognising that customers may make more use of their existing credit facilities as they approach default. For revolving and variable draw-down type products that are not fully drawn, the EAD is higher than the current utilisation. This estimate of exposure can be reduced with financial collateral provided by the obligor or a netting agreement.
Key points 56% of the £49 billion reduction in total credit risk assets was in the
Credit risk assets in Retail & Commercial continued to increase as a proportion of the total portfolio. At the year end the Retail & Commercial divisions increased to 62% of the total credit risk assets (2011 - 60%). UK Retail mortgage exposure increased by £4 billion during the year, partially offset by reduced unsecured exposures. The fall in exposure in International Banking was spread across all sectors and geographies.
Non-Core declined £27 billon (30% of the 2011 portfolio) during 2012 driven by material disposals, repayments and run off. Reduction has taken place across all material segments as the Group continues to de-risk the portfolio. Significant actions were taken to reduce exposure within the property, transport and other financial institution sectors. These sectors accounted for 69% of the reduction in Non-Core.
Other predominantly relates to Group Treasury’s exposure to central banks in the UK, USA and Germany and is a function of the Group’s liquidity requirements and cash positions.
Credit risk assets* continued Sector and geographical regional analyses The table below details credit risk assets by sector and geographical region. Sectors are based on the Group’s sector concentration framework. Geographical region is based on country of incorporation.