“The Bank’s purpose is to serve customers well. The better we do this the better the results will be for all our stakeholders”
(1) Operating profit before tax, own credit adjustments, Asset Protection Scheme, Payment Protection Insurance costs, Interest Rate Hedging Products redress and related costs, regulatory fines, amortisation of purchased intangible assets, integration and restructuring costs, gain on redemption of own debt, strategic disposals, bank levy, write-down of goodwill and other intangible assets and RFS Holdings minority interest, and includes the results of Direct Line Group, which are included in discontinued operations in the statutory results.
(2) 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).
(3) Cost:income ratio is based on total income excluding own credit adjustments, Asset Protection Scheme, gain on redemption of own debt, strategic disposals and RFS Holdings minority interest, and 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, write-down of goodwill and other intangible assets and RFS Holdings minority interest; and after netting insurance claims against income.
Sustainable Business Principles business customer Relationship Managers accredited to help customers further 184k+ hours given to employees to volunteer in the community 95%+ employees received Anti-Money Laundering training 104k+ start-up businesses in the UK supported £200m Carbon Reduction Fund launched advocacy groups had face to face meetings with Group Sustainability Committee 340,000+ young people received a MoneySense lesson for the first time £3m made available to organisations who help young people and women looking to start their own business
Secure Maintaining our financial health whilst meeting our responsibilities to customers, employees and suppliers
Loan:deposit ratio (%) 85 103 see page 25 for further information
Cost:income ratio (%) 64 77 see page 28 for further information
Combined operating ratio (%) 100 101 see page 29 for further information
Core income by division – 2012 Total income by region – 2012
We provide financial services primarily in the Northeastern, Mid-Atlantic and Midwest United States through the Citizens Bank, Charter One and RBS Citizens brands. We are engaged in retail and corporate banking activities.
Serving customers well is what a really good bank does. In the past the banking industry, including RBS, has simply not been good enough at it. Putting that right needs hard work, determination and focus. It will not happen overnight. But at RBS, we are resolutely committed to making sure we put customers first.
Examples of the steps we took in 2012 to put customers first included: strengthening our customer culture through customer charters and commitments across our businesses; introducing a training and accreditation programme for all of our front-line SME bankers to ensure they are better equipped to serve our customers; and making sure we regularly and actively monitor customer satisfaction levels, customer complaints and customer feedback across our divisions.
While we are encouraged by our progress, we are not complacent. We understand the need to keep improving, particularly in light of the challenging and competitive environment in which we operate. And we will not waver in our commitment to embed serving customers well into our DNA.
We must operate safely and soundly if we are to serve all those who rely on us. This aim has underpinned our recovery plan. Our progress can be measured by our capital, how we fund ourselves and the reserves we hold in case of emergencies.
In 2012: we increased our Core Tier 1 capital ratio to 10.3% and were able to exit the Asset Protection Scheme (APS); we have reached our target of sustainable funding, with a loan to deposit ratio of 100%; and we now have an excess of liquidity which we are keen to lend to our customers, if loan demand picks up.
The focus is now on absorbing the upcoming regulatory changes to emerge from our fiveyear turnaround at the end of next year with a Core Tier 1 capital ratio of at least 10%.
We took a first step by repaying the liquidity and credit support that we needed from the government at the start of the financial crisis.
We need to complete these three jobs if RBS is to be a really good bank. Alongside this, we have to be clear about how we want do business. That is why we aspire to standards of behaviour in six areas around our customers, finances, people, reputation, risk and security. These are summarised opposite.
Successful companies put their customers first. If they do not serve customers well they have no purpose. Without satisfied customers there is no return for shareholders, no jobs for employees, no sales for suppliers and no taxes to support public services.
Failing to act in the right way is not just dishonourable or unethical. It is unprofitable. We have had to set aside £1.1 billion in 2012 to recompense people to whom we sold Payment
In rebuilding RBS, we want to make it safe and to serve customers well. Part of making RBS safe involves putting in place the systems and controls that would have helped to stop many of the errors of the past. That job is well underway, although we are not complacent.
Executive Committee have made it clear that customers come first – but actions are more powerful.
UK Retail aspires to be the UK’s most helpful bank. Feedback from customers, including their complaints, gives our leaders real insights into what works for customers and what doesn’t. But there is no substitute for direct experience. ‘Back to the Frontline’ takes senior people from across RBS, not just UK Retail, and puts them in branches and call centres, meeting customers and working shoulder to shoulder with colleagues.
During 2012, Coutts developed its ‘Crown Standard’. It reflects Coutts’ values of striving for excellence and operating to the highest possible standards so that it earns clients’ trust and loyalty. Coutts also expects its Private Bankers to have a passion for client service.
On their first day in the job, new starts in Corporate Banking Division hear from Chris Sullivan. He tells them unequivocally that, ‘our entire focus has to be on adding value to customers.’
In UK Retail, we are training Customer Service Officers and Customer Contact people using courses accredited by the Chartered Banker Institute. That will give our people the knowledge, skills and confidence to help customers.
Across Business & Commercial Banking over 90% of Relationship Managers (RMs) have successfully completed the Chartered Banker Institute’s comprehensive Accreditation programme. This is part of our commitment to put properly trained bankers back on the High Street. It means our RMs are: better equipped to respond to customers’ business needs and opportunities – delivering their business and sector expertise; and confidently providing the right solutions at the right time – sharing in SME customers’ ambitions.
We try to choose carefully who joins us, tell them what we expect and train them to do the job. We also need to give them the correct incentives. RBS has led the industry in reforming how we reward people, better aligning that with the interests of our stakeholders. Now we have gone further. In UK Retail, we have changed how we reward people, putting more emphasis on customer service and feedback.
Becoming a really good bank starts and ends with the customer. Every one of us at RBS has an impact one way or another on how we serve customers. We need to become a company that has a simple, overriding determination to serve customers well. This must be our obsession. If we do this, it will become our visible point of differentiation. It will define the way we think, how we work together and how we make the most of our efforts. Doing the right thing for customers also means ensuring we are a positive part of the fabric of our communities – because we know that when they succeed, so do we.
Core business and our liquidity portfolio is 3.5x times short-term wholesale funding.
Much of what RBS has accomplished since 2009 has been down to the hard work, professionalism and commitment of our people. I would like to thank every one who did their best for our customers in 2012.
However, it became painfully clear during the year that some of our employees had behaved in ways that do not represent the values of RBS. Their misconduct casts a shadow across our progress and the good work of many thousands in the Group. I have already spoken about the behaviour of some people in RBS in making LIBOR submissions. It was wrong. The RBS Board has acknowledged that there were serious shortcomings in our risk and control systems, and also in the integrity of a small group of our employees, and has taken action to ensure full and proper accountability.
The failure of one of our IT systems in June had unacceptable consequences for many of our customers in the UK and the Republic of Ireland. The Board Risk Committee has led a rigorous review of what went wrong. The Committee has sought to ensure that customers who were affected are appropriately compensated. It will continue to oversee the management of technology risks and lead our communication with customers, regulators and others when the investigations conclude. The response of our staff in branches, call centres and elsewhere in dealing with the problems we had caused to our customers was outstanding.
While these failings show our continuing need to improve our risk and control systems, they at times had a deeper cause. Some employees put their own interests well ahead of customers’ and shareholders’, ignoring the difference between right and wrong. Your Board expects our people to demonstrate the highest standards of personal and professional conduct. We know that our shareholders, our customers and others will hold us to high standards. It is a matter of great regret that the conduct and values of a very small number of our people fell so far short of what we expect.
That is why your Board is determined to ensure that RBS exemplifies the culture you would expect in a bank that serves customers well and makes an important contribution to the communities where we operate. It is why we have taken steps to manage more effectively what the industry now calls conduct risk. In short, this is the risk that the company is damaged because our people do not behave properly. The Board Risk Committee has supervised the development of our approach to conduct risk management. Together, the Board Risk Committee and Remuneration and Performance Committee have developed proposals that mean our reward policies will support good conduct.
We know our future performance will be heavily influenced by economic conditions. Consensus forecasts for 2013 give some hope that this year will see a return to modest growth in the
We are delivering what we said we would do in our strategic plan. We have made RBS safer. It is much closer now to being in the good financial health that would allow shareholders to receive a dividend and the Government to start to sell its stake. The challenge that remains is to serve customers better and to do business in a way that makes you and us proud to be part of RBS.
The Bank’s purpose is to serve customers well. The better we do this the better the results will be for all our stakeholders over time.
And these priorities need in turn to produce a sustainable result for shareholders, and to create the opportunity for taxpayer share sales.
If we make continued progress across these priorities, and do it in the right way, we can become a really good bank and serve our stakeholders and society well.
Rebuilt financial resilience. RBS’s huge restructuring process is moving successfully to its later stages. From their worst point, total assets are down £906 billion, shortterm wholesale borrowing is £255 billion down. Risk concentrations are well down. Balance sheet leverage is reduced from 21x to 15x. In each case we are well ahead of original targets. And a Core Tier 1 capital ratio of 10.3% provides us some 3.5 times more capital per unit of equivalent risk than pre-crisis levels.
Produced £43 billion in pre-impairment profits from Core businesses. These have been used to self fund the majority of £52 billion of legacy losses, loan impairments, restructuring charges, regulatory costs and other clean-up items.
2012 saw landmark achievements in our restructuring plan. It saw sustained customer lending support. A 61% share price rise during the year (and 215% versus the January 2009 low point) underlined an improvement of investor belief in our future and that of the banking sector generally.
Core Bank operating profits were £6.3 billion of which Retail and Commercial businesses were £5.3 billion (excluding Ulster Bank) and Markets £1.5 billion. Non-Core losses declined again (32% to £2.9 billion) and Non-Core assets also fell ahead of target to £57 billion. We expect to slow the pace and cost of the remaining run-down once we hit the £40 billion asset target for the end of 2013. Exceptional charges in relation to Payment Protection Insurance claims, LIBOR settlements and interest rate hedging product redress, together with the own credit adjustment, resulted in a loss before tax of £5,165 million.
In a tough economic environment, most of the banking industry’s ongoing businesses are running hard to stand still, and so it was at RBS. But the existing level of operating performance is essential to fund our historic clean-up with the moment coming ever closer when these costs are behind us and rewards flow directly once more to shareholders.
Our industry faces a tough challenge rebuilding its reputation. 2012 was a wrenching year on that front as the cultural clean-up came to the fore which was always a companion to physical changes required from pre-crisis times.
Expectations are changing fast and even past ones have not been lived up to often enough. And the mistakes of some, grievous in cases, are tainting the efforts of the majority of bank staff. Most banks have past failings on a range of fronts. For RBS the two worst in the past year were LIBOR and our IT incident - quite different though they are.
The new RBS is a leading UK bank anchored in retail and commercial business lines. Our businesses are shaped around customer needs with substantial competitive strengths in their respective fields. Each unit is being retooled to provide improved and enduring performance and to meet new external challenges. We sustain strong capabilities internationally and in financial markets to support the needs of our customers and shareholders. Our businesses are managed to add value in their own right but to provide a stronger, more balanced and valuable whole through vital cross-business linkages.
The physical weaknesses uncovered by the financial crisis - of leverage, risk concentration and business stretch - are close to being fixed. RBS’s total assets have already been reduced by £906 billion from their peak in 2008 - more than any other entity worldwide has achieved.
The principles behind this strategy are sound and working. But it will continue to evolve. A much slower economic recovery and tougher set of regulatory and policy pressures need to be absorbed. We have done this with more emphasis on customer service, balance sheet conservatism and while asking staff to do more with less during a period of significant change. Our business ambitions have been trimmed as a necessary reaction.
But whatever the outside conditions and evolution of strategy we are clear about the interrelated nature of our priorities. To serve customers well, run only prudent risk and reward shareholders over the longer term.
In this context we have set a new medium-term target for our Markets business, which is an important part of our service to corporate and institutional customers. We aim to further reduce its scale and scope, targeting capital consumption of £80 billion RWAs whilst sustaining the service provided to our customer base.
Additionally, the Board has decided it is now the right time to begin work on a partial flotation of Citizens, our US banking business, targeted probably at around 2 years from now. Citizens is a good business, serving around 5 million customers in the north east of the United States where it is has a strong market position. It has been substantially improved since 2009 and a local public listing will help to highlight its growing value. This provides a positive opportunity for Citizens and its 14,700 employees, as well as being a sensible move for RBS as a whole.
The banking industry has come down to earth hard. While a more balanced global economy has clear merits, the changes, pressures and adjustments asked of our people remain high. And successful results are vital for the many who rely on us. The engagement, dedication and professionalism of RBS employees remains outstanding and has much to be commended.
Over the last two years RBS has been subject to dividend restrictions imposed by the European Commission. This prevented us from paying dividends on ordinary shares, B shares and hybrid securities, unless we had a legal obligation to do so.
With the resumption of payments on hybrid securities, the Board is in the legal position to consider the payment of dividends on ordinary shares.
The Dividend Access Share entitles the Government to a dividend on issued B Shares at the higher of 7%, or 2.5x the ordinary dividend. This could be a barrier to resuming ordinary dividends in the near term. Resolution of this issue could be achieved via engagement with the Government at some time in the future, when the Group feels it is closer to announcing the resumption of ordinary dividends.
UKFIs overarching objective is to manage these shareholdings commercially and to devise and execute a strategy for realising value in an orderly and active way over time. For further details please see: As a consequence, the decision of when to sell, and to whom, is at the full discretion of UKFI and the Government.
To best facilitate this process, the Group remain focussed on delivering a sustainable, attractive and profitable business with a strong investment proposition.
RBS has been profitable on an operating basis for the past three years. However the Group has continued to incur significant costs in resolving the ‘sins of the past’, such as: restructuring costs, conduct related fines, and impairments on legacy portfolios.
Return on equity (1) We need to earn solid returns that consistently cover our cost of capital in the long run in order to justify our shareholders’ support Core >12%
(4) Eligible assets for contingent liquidity purposes including cash, Government issued securities and other eligible securities with central banks.
RBS to deliver its strategy from a stable risk profile and balance sheet, with each banking business self-funding
Continue to de-risk and shrink our Non-Core balance sheet. Careful control of future asset growth to support Core customers’.
Throughout the restructuring process we have been able to shrink our assets while sustaining a strong capital base. Our Tier 1 leverage ratio of 15.0x times in 2012 comfortably met our target.
Our Core bank continued to take in more than £1 of deposits for every £1 of loans made in 2012 with a loan to deposit ratio of 90%. The Group met its target of 100% loan to deposit ratio at the end of 2012.
Our reliance on short-term wholesale funding has been further reduced to £42 billion or 5% of funded assets.
RBS to be based on enduring customer franchises with each business capable of generating a sustainable return in excess of its cost of capital
Focus on businesses capable of delivering sustainable growth and achieve market-level growth in each
So far, through our cost reduction programme, we have taken £3.6 billion annualised out of our cost base. This, along with lower than originally projected programme spend, has allowed us to invest in our Core franchises in order to enhance our customer service and product offerings through improvements to our technology and infrastructure.
In 2012 our Core cost:income ratio of 59% showed a further improvement towards our target.
All our principal Core businesses sustain positions amongst the leaders in their chosen fields.
Re-balance and shrink our markets activities, focusing on the businesses that form key aspects of our customer proposition and where we have strength.
Expeditious run-off or sale of businesses and asset portfolios while maximising the value obtained for the Group.
Our business mix has made strong progress towards being dominated by high quality, stable customer franchises. We have moved from 64% retail and commercial operating profit in 2007 to 83% (operating profit before impairment losses) operating profit this year, in line with our target.
We believe that having a focused international presence adds value, allowing us to access additional growth opportunities and benefit from long-term globalisations trends, although we want to be anchored in the UK. In 2012 we have met our target geographical business mix with the UK contributing 66% to income.
Approximately 80% of operating profit to come from our retail and commercial banking activities and approximately 60% of income to come from UK businesses
Rebuild confidence and trust with investors by combining clear performance targets with improved disclosure.
In 2011, we revisited our targets in light of the economic and regulatory landscape being significantly different to what was forecast back in 2009 when the original targets were communicated. We strengthened many of our balance sheet and risk targets, and the revised income targets indicate that we remain committed to earning sustainable returns from all our ongoing businesses.
We are transparent in explaining our progress towards targets, reporting this in our quarterly results. Further details can be found on page 13.
We believe that the majority of our people want to, and do, serve our customers well already. However, we need to do more to ensure that customers receive the best possible service consistently.
Since the start of the financial crisis we have overhauled RBS’s management. We believe that we now have a strong and qualified team in place to finish restoring RBS to a normal bank, then to build on our core franchises from there.
We are committed to restoring the Group to a sustainable and conservative risk profile. The RBS risk management framework, and our risk management teams, are clearly aligned with the Group priority. For an overview of how this is working in practice, see pages 19 and 20.
We have noted before that when economies are emerging from recessions rooted in high levels of debt and stresses in the financial system, growth is slower than in the typical recovery. That was the experience of our major markets again in 2012.
The Bank of England continued its ultra-loose monetary policy stance. Although inflation remained above target, the Bank kept interest rates at 0.5%. In fact, its greater concern was that the weak economy would cause inflation to be too low and in both February and July it increased its asset purchase programme by £50 billion taking the total value of assets purchased to £375 billion. The Government’s decision to transfer the coupon payments from the Asset Purchase Facility to HM Treasury, which will use these proceeds to reduce the stock of Government debt, has a similar effect to further quantitative easing.
In the United States, GDP growth was slightly stronger at 2.2% compared with 1.8% in 2011. Uncertainty about how leaders might resolve immediate and longer-term fiscal challenges weighed on growth during much of the year.
There was encouraging news on the job market, where unemployment had fallen to 7.8% in December, and the housing market, where prices and construction activity started to rise.
However, concerned that the recovery remained too slow to return unemployment to rates consistent with its mandate to foster maximum employment, the Federal Open Market Committee changed policy in two ways. In September it agreed to increase monetary accommodation by purchasing mortgagebacked securities at a pace of $40 billion per month. Second, it announced in December it anticipates the Fed Funds rate remaining exceptionally low as long as the unemployment rate is above 6.5%, inflation one to two years ahead is expected to be no more than 2.5% and inflation expectations are well anchored.
Ireland’s GDP grew by 1.3% in the four quarters to Q3 2012 as the economy continued its slow recovery from deep recession. The export sector continued to benefit from the boost to competitiveness delivered by falling real wages.
For Ireland, gross national product (GNP) is a better measure of people's material well-being. It reflects the income residents receive rather than the value of the incomes generated in the country, an important distinction where there is a large foreign-owned sector that remits profits overseas. GNP increased by 1.1%.
An integral role for Risk Management Risk Management is essential to making RBS safe and sustainable. A strong culture of risk management and control provides the foundation for this.
In 2009, the Group Board set four strategic risk objectives aligned to the Strategic Plan.
These are to: maintain capital adequacy; deliver stable earnings growth; ensure stable and efficient access to funding and liquidity; and maintain stakeholder confidence.
By setting a clear risk appetite and embedding a strong risk culture throughout our businesses, we can identify, measure and control risk exposures and respond effectively to shocks.
Capital adequacy risk The risk that the Group has insufficient capital. Potential to disrupt the business model and stop normal functions of the Group.
Credit risk The risk that the Group will incur losses due to the failure of a customer to meet its obligation to settle outstanding amounts.
Country risk The risk of material losses arising from significant country-specific events.
Frequent small losses which are material in aggregate. Infrequent large material losses.
Market risk The risk arising from fluctuations in interest rates, exchange rates, credit spreads, equity prices, commodity prices, and risk-related factors such as market volatilities.
Operational risk The risk of loss resulting from inadequate or failed processes or systems, from inappropriate human actions, or from external events.
Arises from breaches of regulatory rules or laws by individual employees or as a result of the Group’s retail or wholesale market conduct.
Reputational risk The risk of brand damage and/or financial loss due to failure to meet stakeholders’ expectations of the Group.
We know we will be safer if we do business properly. That is why we improved how we manage conduct risk by putting the customer at the heart of all we do, focusing on customer outcomes through the advice we give, the products we sell and the services we provide.
We have improved our liquidity risk by reducing our funding gap. We now hold £100 of deposits for every £103 we lend. Large portions of our mortgage portfolio are now available for use in the event of a stress situation.
Our knowledgeable staff will put our customers’ needs first. The Chartered Banker Institute accredits our training to help ensure our staff have the knowledge to help customers. Help when they need it most. Emergency Cash allows customers to get cash if their cards are lost or stolen. More than 80,000 people used the service in 2012.
Our people are vital in ensuring we become the Helpful and Sustainable Bank we want to be. We’re changing our culture to get the whole organisation focused on the needs of our customers. That starts when we recruit new people who have a great approach to helping customers. From day one, our Big Welcome induction makes clear our commitment to customers and how best to meet their needs.
A new incentive approach has been introduced for our frontline people which is all about meeting customer needs and encouraging sustainable and profitable growth.
Operating profit of £1,891 million was six per cent lower than in 2011. A ten per cent decline in income was only partly offset by lower costs, down six per cent, and a 33 per cent fall in impairment losses. Return on equity was broadly stable at 24.4 per cent. Deposit growth of six per cent contributed to a further reduction in the loan to deposit ratio, which improved to 103 per cent.
In Corporate Banking, we understand the importance of managing risk well. We have enhanced our approach to risk, introducing improved frameworks and processes; reducing risk concentrations and bringing key risks closer to within appetite.
In August, we were the first bank to launch the Funding for Lending Scheme (FLS) to UK businesses. We used FLS to make in excess of £1.7 billion in allocated funds available to over 11,000 SME customers strengthening our position as the UK’s leading bank for SMEs, through discounted interest rates and no arrangement fees.
Our Working with You (WwY) initiative shows our dedication to understanding our customers and helping them realise their ambitions. All our SME relationship managers and leaders are committed to spending at least two days working for their customers at their premises. Our relationship managers have undertaken over 10,000 WwY visits since the initiative launched in June 2011.
Operating profit of £1,796 million was seven per cent lower than in 2011. That reflected a decline in income of three per cent and increased impairments, up six per cent, which were partly offset by a three per cent fall in costs. Return on equity was slightly lower than in 2011 at 14.5 per cent. The loan to deposit ratio was 82 per cent.
Our strategic priorities mean that we will continue to contribute to making RBS safer. One of these is our sharpened focus on scalable markets following the introduction of a refreshed strategy in 2011. During the year we sold our Latin American, Caribbean and African businesses to Royal Bank of Canada, an important step in concentrating on core geographies.
Together with RBS Group Risk, we introduced the Coutts Conduct programme in order to deliver new standards and frameworks by the end of 2013. The intent of the programme is to safeguard clients and the business from breaches of regulatory rules or law.
We introduced a new Sales Management Framework for the International business focusing on recruitment and induction, coaching, training and development, target setting, performance management and monitoring.
We held our first Diversity & Inclusion Week in November. Led by our Diversity & Inclusion Council, it recognises that at the heart of our business are our people who represent a variety of different cultures and beliefs. We celebrate these differences and want to embed Diversity and Inclusion in the DNA of our people and our business.
As a result of this reduction in third-party assets and increase in our deposits, our loan to deposit ratio has moved from 103% to 85%.
In the Euromoney Cash Management Survey clients voted us number one cash management manager in the UK and number two in Europe. In addition RBS was number two in Europe and North America for handling sterling transactions. RBS was the Greenwich Quality Leader in Large Corporate Trade Finance in the UK. It also ranked us number one for Large Corporate Trade Finance Penetration in the UK. Trade & Forfaiting Review named us Best Trade Bank, Western Europe.
Global Finance rated us Best Supply Chain Finance Provider, Western Europe, and we won its Best Customer Implementation of Supply Chain Financing award for work carried out for brewer Carlsberg.
These successes came in our first year as we built the new division. Customer service was our priority but we still managed to complete a complex restructuring and to reduce our costs by £215 million while maintaining our global reach. We have restructured our business which puts us in a strong position to serve customers well in the future.
In addition, we aim to run International Banking openly and transparently.
The M&IB transformational leadership programme is designed to develop more agile, commercially-aware and peoplefocused leaders.
We have made our graduate recruitment process more robust and graduates now receive more training, with greater emphasis on what our regulators expect. We believe that we will serve customers better if our people look more like our clients. That is why we increased the proportion of women in our graduate programme.
Operating profit of £594 million was £161 million (21 per cent) lower than in 2011 as a 17 per cent decline in income was only partially offset by lower expenses, down 13 per cent, and impairment losses, down 34 per cent.
Corporate customers were able to withdraw up to £5,000 or €5,000 with the agreement of their relationship manager.
Our appointment of a board-level Chief Risk Officer and a new Risk Leadership Team show how we are contributing to making RBS safer. The Chief Risk Officer has led a Group-wide review of risk as well as playing a central role in our strategic review.
We moved most of our mortgage accounts to a new system, which reduces operational risk.
We know that Ulster Bank has a sustainable future. But that depends on us changing how we work and dealing with the past so that we focus on serving customers well. Our review told us our business was too complicated and our costs too high. We are making changes that will reduce costs by £80 million by the end of 2013.
The most significant action we took was dealing with loans we sold before the crisis. We gave more effort to managing unsecured loans, mortgages, SME facilities and larger corporate exposures. In particular, we are supporting customers who are finding it hard to pay their mortgage.
After the IT failure we ran Listening Groups with our people. We wanted to make sure that their views on what went well and what didn't could be incorporated into our future strategy.
Through our Culture and Engagement Team we listen to our people, take their feedback and use it to drive improvement.
Operating loss of £1,040 million was £56 million higher than in 2011. This primarily reflected a reduction in income driven by lower interest earning asset volumes. Total expenses fell by £26 million as a result of cost saving initiatives. Impairment losses remained high. Falling asset prices and high levels of unemployment coupled with weak domestic demand continued to depress the property market. The loan to deposit ratio improved and net interest margin increased slightly. Retail and SME deposits increased by eight per cent, although this was partly offset by outflows of wholesale balances.
Strong risk management remains a top strategic priority. We have a clearly defined credit risk appetite, driven by disciplined underwriting, which has led to consistently improving credit risk ratios. Asset quality has improved in all portfolios as evidenced by loss rates that are near or below pre-crisis levels.
We continued to upgrade our ATM network. The new “Intelligent Deposit Machines” provide customers with more convenience, including enhanced deposit capabilities. We enhanced our online and mobile services. Our iPhone and Android applications earned a combined 4.25 out of 5 rating from consumers. We tied for first in a ratings analysis of 25 large banks conducted by financial services consulting firm Javelin Strategy & Research.
Our deposit and credit products help customers achieve their goals. Through our branches we opened 455,000 new checking accounts in 2012.
In Commercial Banking, our goal is to help business customers grow and prosper. We continue to improve client service and build strong relationships. The strategy is paying off. We were lead arranger in 109 deals, up from 83 in 2011. We are now within the top 10 arrangers of middle market syndicated debt transactions. These deals earned us more than $52 million in fees compared with $40 million in 2011. We are building our treasury management capabilities as well. Now, four out of five of our middle market credit clients also use our cash management products.
People lost confidence in banks during the financial crisis. We have taken steps over the past few years to strengthen our culture, which we believe is the foundation of a good bank. In 2009, we launched our ‘back to basics’ strategy. It keeps us focused on our customers and what they want and need. Alongside it, we created a vision, purpose and credo, emphasizing customers, colleagues and community.
Operating profit of £1,509 million was 68 per cent higher than in 2011. Income increased by 2 per cent and expenses were sharply lower, falling 16 per cent, with staff expenses down by 26 per cent. Return on equity was up on 2011 at 10.0 per cent.
We moved out of the cash equities and equity risk trading businesses that had made losses. We transferred a substantial part of RBS N.V. to RBS plc. That made our structure simpler and reduced the capital we need to hold.
Improvements we made to internal controls make clear to our leaders that it is important to manage their teams effectively. We have improved oversight of our traders through better supervision and tighter checks and controls.
Our job is to help clients find the money they need so that they can invest. Across Europe in 2012, we were the leading bank in supporting clients issuing investment grade corporate bonds, running c.£20 billion of issues of these bonds.
We: worked with the International Banking division to organise a £1 billion refinancing for the holiday company Center Parcs; helped to raise US$2.2 billion for Formula 1; we were a structuring adviser on a three-part hybrid bond, helping BG Group strengthen its capital structure, maintain its credit rating and diversify its funding; underwrote and arranged €700 million loan and £466 million fund raising to allow DS Smith to buy SCA Packaging to create Europe’s second-biggest packaging company.
The Euromoney Awards for Excellence named us Best Debt House in the UK. We were Best for Sterling Issues and Best for Liability Management in the Euromoney Primary Debt Survey.
International Financing Review named us EMEA Structured Finance House of the Year for an unprecedented second year in succession.
Euromoney FX Survey 2012 rated us number one for overall client service in the EMEA time zone. The Derivatives Intelligence Awards named us Interest Rate Derivatives House of the Year.
We recorded these achievements while creating Markets as a new division and reducing costs by £541 million. Our focus is now on serving clients in businesses where we have marketleading products.
We took several actions to make RBS safer and to make Direct Line Group more robust for its future.
Direct Line Group manages its capital levels with the objective of maintaining a credit rating in the "A" range.
We continued to roll out our claims transformation programme. It is a more efficient way of managing claims. Our new system for managing claims is handling 400,000 motor and own brand home claims.
One of our assets is the large amount of data we hold. We are using it to price products more accurately by understanding better still the risks we are taking.
We expanded our agreement with Sainsbury’s Bank. Now we provide its customers with home insurance as well as motor insurance. We agreed a distribution agreement with the UK Retail division that will last five years. That means we will continue to provide general insurance products when we are divested. We launched Churchill and Privilege on comparethemarket.com. That means their motor and home insurance products are available on the UK’s four major price comparison websites. This reinforces our strategy of delivering products through a range of channels.
We started The Best Programme in 2011, continuing it last year. It is our cultural transformation programme. The Best Programme focuses our people on how to achieve our ambition – to be Best for Customer, Best for Shareholder and Best for our People.
Business Services are the people who keep RBS running. We put money in the ATMs, keep the Bank’s technology systems operating, help keep our customers safe from fraud, process billions of pounds worth of payments across the world, and provide call centre and on-line services to customers.
Business Services is behind many of the innovations that make life easier for our customers.
During the year, we made further improvements to our mobile banking app which more than three million customers have used, making over £11 billion worth of payments and transfers.
We processed over 4.2 billion payments worldwide. That’s 16.8 million transactions every day.
The Treasury function drives efficient and prudent management of our balance sheet resources, playing a central role in the Group’s participation in the UK Government’s Funding for Lending Scheme in 2012.
We delivered risk appetite frameworks and the tool-kits to help staff implement them. These have helped embed the risk appetite statements agreed with the board in 2011. They help further to reduce the balance sheet and ensure that all divisions work within their agreed risk appetite.
During 2012, we recognised that if RBS is to become a really good bank, one that serves customers well, we would need to be much clearer to our people about our purpose, vision and values. Human Resources has led this work. While we have some way to travel, the pace of activity has been intense. By the end of 2012, 200 of our top leaders had participated in sessions to help establish what they will do to embed a culture that meets our aspiration of putting customers first.
We simplified human resources policies in 2012. They are clearer and more accessible to our managers, who now know better what we expect of them.
Communications manages our relationships with external stakeholders and makes sure we keep our employees informed about developments in the business. RBS wants to be open to stakeholders and, during the year, Communications helped elected officials, commentators and others gain a better understanding of our business and our plans.
Non-Core has reduced funded assets by over £200 billion to date. In 2012, funded assets reduced by £36 billion (39 per cent) to £57 billion and risk-weighted assets reduced by £33 billion (35 per cent) to £60 billion. An operating loss of £2.9 billion was £1.3 billion lower than 2011, partly due to a £1.7 billion reduction in impairments to £2.2 billion and a £351 million (27 per cent) reduction in costs. As a net result, the Division released capital back to the Group through the net impact of lowering risk-weighted assets, partially offset by a smaller pre-tax loss.
Non-Core aims to run down its portfolio in a capital efficient manner at a pace the Group can afford. We make RBS safer through reducing our funded assets, capital requirement, provisions, costs, losses and operational risk.
We reduced our impairments again in 2012. This reflects the run-down of the portfolio and our recognition of impairments in prior years, as well as how we managed the remaining portfolio. We continue to remain cautious on our Ulster Bank real estate portfolios which accounted for 40% of the 2012 impairments.
We are helping to change the culture of RBS by addressing transparently the legacy of the past. We do that through: detailed analysis of the risks in the portfolio so we can mitigate them; making capital the prime driver of decisionmaking to ensure that the Division focuses on shareholder value; transparent accountability and responsibility for asset management; and maintaining rigorous controls over the management and run-down of the portfolio.
Balancing the needs of stakeholders means understanding the views of all those who have an interest in our business. As an international company we have many stakeholders and we engage with them in a variety of ways. These discussions inform decision making across the Group.
WWF, the Tax Justice Network, Transparency International, Big Issue Invest, the Confederation of British Industry and Unite are just a few of the groups that attended. These sessions are an open forum for organisations to present the issues they most care about to the senior people from RBS who sit on the GSC. We do not set the agenda. Others do that and we go out of our way to involve people who are highly and constructively critical of RBS. We will hold more of these sessions as a clear illustration of our commitment to our openness to stakeholders.
Supportive Meeting our customers needs Supporting sustainable and inclusive economic growth Helping customers in financial difficulty
A Responsible Citizen Working within both the letter and spirit of legislation and abiding by relevant codes of practice and voluntary standards Supporting the communities we work in Respecting human rights throughout our sphere of influence Upholding environmental responsibility within the Bank, and through our customers and suppliers
We are longstanding members and contributors to the development of the Equator Principles and UN Global Compact We supported over 41,000 members of staff to take time off to support the communities in which we live and work We have looked at ESE risk issues across a range of sectors and developed ESE appetite position staements for six of the more sensitive sectors Our total scope 1 emissions were 66,586 and scope 2 emissions were 497,762 tonnes CO�e (from Q4 2011 to Q3 2012), a decrease of 6% and 15% respectively compared with 2011
Divisional reorganisation and Group reporting changes Comparative data have been restated to reflect the divisional reorganisation (see page 40) and certain Group reporting changes (see below) during 2012.
Statutory results The statutory results of the Group include the one-off and other items in the appropriate captions in the income statement.
Discontinued operations The Group sold the first tranche (34.7%) of the share capital of Direct Line Insurance Group plc (DLG) in October 2012 via an Initial Public Offering (IPO), consistent with the plan to cede control by the end of 2013. In accordance with IFRS 5, DLG has been recognised as a discontinued operation with consequent changes to the presentation of comparative information. The assets and liabilities relating to DLG are included in Disposal groups as at 31 December 2012.
Share consolidation Following approval at the Group’s Annual General Meeting on 30 May 2012, the sub-division and consolidation of the Group’s ordinary shares on a one-for-ten basis took effect on 6 June 2012. Consequently, prior year disclosures relating to or affected by numbers of ordinary shares or share price have been restated.
Glossary A glossary of terms is provided on pages 528 to 535.
Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: global economic and financial market conditions and other geopolitical risks, and their impact on the financial industry in general and on the Group in particular; the ability to implement strategic plans on a timely basis, or at all, including the disposal of certain Non-Core assets and of certain assets and businesses required as part of the State Aid restructuring plan; organisational restructuring in response to legislative and regulatory proposals in the United Kingdom (UK), European Union (EU) and United States (US); the ability to access sufficient sources of capital, liquidity and funding when required; deteriorations in borrower and counterparty credit quality; litigation, government and regulatory investigations including investigations relating to the setting of LIBOR and other interest rates; costs or exposures borne by the Group arising out of the origination or sale of mortgages or mortgage-backed securities in the US; the extent of future write-downs and impairment charges caused by depressed asset valuations; the value and effectiveness of any credit protection purchased by the Group; unanticipated turbulence in interest rates, yield curves, foreign currency exchange rates, credit spreads, bond prices, commodity prices, equity prices and basis, volatility and correlation risks; changes in the credit ratings of the Group; ineffective management of capital or changes to capital adequacy or liquidity requirements; changes to the valuation of financial instruments recorded at fair value; competition and consolidation in the banking sector; the ability of the Group to attract or retain senior management or other key employees; regulatory or legal changes (including those requiring any restructuring of the Group’s operations) in the UK, the US and other countries in which the Group operates or a change in UK Government policy; changes to regulatory requirements relating to capital and liquidity; changes to the monetary and interest rate policies of central banks and other governmental and regulatory bodies; changes in UK and foreign laws, regulations, accounting standards and taxes, including changes in regulatory capital regulations and liquidity requirements; the implementation of recommendations made by the Independent Commission on Banking and their potential implications and equivalent EU legislation; impairments of goodwill; pension fund shortfalls; general operational risks; HM Treasury exercising influence over the operations of the Group; insurance claims; reputational risk; the ability to access the contingent capital arrangements with HM Treasury; the conversion of the B Shares in accordance with their terms; limitations on, or additional requirements imposed on, the Group’s activities as a result of HM Treasury’s investment in the Group; and the success of the Group in managing the risks involved in the foregoing.
Organisational structure and business overview Organisational change In January 2012, the Group announced changes to its wholesale banking operations in light of a changed market and regulatory environment. The changes saw the reorganisation of the Group’s wholesale businesses into ‘Markets’ and ‘International Banking’ and the exit from and downsizing of selected activities. The changes ensure the wholesale businesses continue to deliver against the Group’s strategy.
Global Banking & Markets (GBM) and Global Transaction Services (GTS) divisions have been reorganised as follows: The ‘Markets’ business maintains its focus on fixed income, with strong positions in debt capital raising, securitisation, risk management, foreign exchange and rates. It will serve the corporate and institutional clients of all Group businesses.
UK Corporate is a leading provider of banking, finance and risk management services to the corporate and SME sector in the United Kingdom. It offers a full range of banking products and related financial services through a nationwide network of relationship managers, and also through telephone and internet channels. The product range includes asset finance through the Lombard brand.
In the UK, Direct Line Group utilises a multi-brand, multi-product and multi-distribution channel business model that covers most major customer segments for personal lines general insurance. The Group also has a focused presence in the commercial market. The Group occupies leading market positions in terms of in-force policies and has the most highly recognised brands in the UK for personal motor and home insurance including Direct Line and Churchill. Other primary Direct Line Group brands include Privilege and Green Flag; NIG, a provider of insurance solutions to UK SMEs and Direct Line For Business (“DL4B”), the Group’s direct commercial brand. The Group is also a major provider of insurance through a number of strategic partnerships. In Italy and Germany the Group operates under the Direct Line brand. It is planned for control of DLG to be ceded by the end of 2013.
Non-Core division manages separately assets that the Group intends to run off or dispose of. The division contains a range of businesses and asset portfolios primarily from the legacy GBM businesses, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses including regional markets businesses that the Group has concluded are no longer strategic.
Business divestments To comply with the European Commission State aid requirements the Group agreed a series of restructuring measures to be implemented over a four year period from December 2009. These measures supplement the Strategic Plan previously announced by the Group. These include the divestment of Direct Line Insurance Group plc, the sale of 80.01% of the Group’s Global Merchant Services business (completed in 2010) and the sale of substantially all of the RBS Sempra Commodities joint venture business (largely completed in 2010), as well as the divestment of the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct SME customers across the UK.
Recent developments Liability Management Exercise In January 2013, The Royal Bank of Scotland plc completed a cash tender offer for approximately £2 billion principal amount of certain US Dollar, Euro, Sterling, Swiss Franc and Singapore Dollar denominated senior unsecured securities.
Markets & International Banking Executive changes On 6 February 2013, the Group announced that John Hourican, Chief Executive, Markets & International Banking, will leave the Group once he has completed a handover of his responsibilities. With effect from 1 March 2013, Suneel Kamlani and Peter Nielsen will be co-heads of the Markets division and John Owen will continue to lead the International Banking division and will all report directly to the Group Chief Executive.
Competition The Group faces strong competition in all the markets it serves. Banks’ balance sheets have strengthened whilst loan demand remains subdued as many customers continue to delever and the UK economy has remained weak. Competition for retail deposits remains strong as institutions continue to target strong and diverse funding platforms for their balance sheets.
In the personal banking segment, the Group competes with UK clearing banks and building societies, major retailers and life assurance companies. In the mortgage market, the Group competes with UK clearing banks and building societies. The ambitions of non-traditional players in the UK market remain strong, with new entrants active and potentially seeking to build their platforms by acquiring businesses made available through restructuring of incumbents. The Group distributes life assurance products to banking customers in competition with independent advisors and life assurance companies.
Direct Line Group competes in personal lines insurance and, to a more limited extent, in commercial insurance. There is strong competition from a range of insurance companies which now operate telephone and internet direct sales businesses. Competition in the UK motor market remains intense, and price comparison internet sites now play a major role in the marketplace. These sites have extended their scope to home insurance and other lines. Direct Line Group also competes with local insurance companies in the direct motor insurance markets in Italy and Germany.
The actual or perceived failure or worsening credit of the Group’s counterparties or borrowers and depressed asset valuations resulting from poor market conditions have adversely affected and could continue to adversely affect the Group.
The Group is subject to a number of regulatory initiatives which may adversely affect its business, including the UK Government’s implementation of the final recommendations of the Independent Commission on Banking’s final report on competition and possible structural reforms in the UK banking industry, the US Federal Reserve’s proposal for applying US capital, liquidity and enhanced prudential standards to certain of the Group’s US operations.
Group it can, and in the future may decide to, exercise a significant degree of influence over the Group including on dividend policy, modifying or cancelling contracts or limiting the Group’s operations. The offer or sale by the UK Government of all or a portion of its shareholding in the company could affect the market price of the equity shares and other securities and acquisitions of ordinary shares by the UK Government (including through conversions of other securities or further purchases of shares) may result in the delisting of the Group from the Official List.
Key financials Managed Statutory for the year ended 31 December 2012 £m
Total income (1) 25,787 27,709 32,594 17,941 24,651 26,622 Operating profit before impairment losses (2) 8,741 9,263 11,101 114 7,517 9,081 Operating loss before tax (5,165) (1,190) (154) (5,165) (1,190) (154) Loss attributable to ordinary and B shareholders (5,971) (1,997) (1,125) (5,971) (1,997) (1,125) Cost:income ratio (3) 63% 63% 60% 99% 70% 66% Basic loss per ordinary and B share from continuing operations (pence) (4) (53.7p) (21.3p) (2.9p) (53.7p) (21.3p) (2.9p) Adjusted earnings/(loss) per ordinary and B share from continuing operations (pence) (4,5) 6.3p (0.8p) 6.1p — — —
Notes: (1) Total income on a managed basis excludes own credit adjustments, Asset Protection Scheme, gain on redemption of own debt, strategic disposals and RFS MI. In the statutory consolidated income statement, these items are included in total income. Total income on a managed basis includes Direct Line Group on a managed basis, which is included in discontinued operations in the statutory results.
(3) Cost:income ratio on a managed basis represents operating expenses excluding PPI 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 includes Direct Line Group on a managed basis which is included in discontinued operations in the statutory results, expressed as a percentage of total income as defined in (1) above and after netting insurance claims against income. On a statutory basis, cost:income ratio represents operating expenses expressed as a percentage of total income.
(4) Prior year data have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares, which took effect in June 2012. (5) Adjusted earnings/(loss) per ordinary and B share is based on earnings from continuing operations adjusted for 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 and write-down of goodwill and other intangible assets.
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 to give a better understanding of the results of the Group’s operations.
Summary consolidated income statement for the year ended 31 December 2012 In the income statement set out below, 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 Holdings minority interest are shown separately. In the statutory consolidated income statement on page 353, these items are included in the appropriate captions. The results of Direct Line Group on a managed basis, which are included in discontinued operations in the statutory results, are included in the appropriate captions on a managed basis.
Net interest income 11,695 12,689 14,200 11,402 12,303 13,782 Fees and commissions receivable 5,715 6,384 8,194 5,709 6,379 8,193 Fees and commissions payable (1,269) (1,460) (2,211) (834) (962) (1,892) Other non-interest income 5,928 5,840 7,283 1,664 6,931 6,425 Insurance net premium income 3,718 4,256 5,128 — — 114 Non-interest income 14,092 15,020 18,394 6,539 12,348 12,840 Total income 25,787 27,709 32,594 17,941 24,651 26,622 Operating expenses (14,619) (15,478) (16,710) (17,827) (17,134) (17,456) Profit before insurance net claims and impairment losses 11,168 12,231 15,884 114 7,517 9,166 Insurance net claims (2,427) (2,968) (4,783) — — (85) Operating profit before impairment losses 8,741 9,263 11,101 114 7,517 9,081 Impairment losses (5,279) (7,439) (9,256) (5,279) (8,707) (9,235)
Own credit adjustments (4,649) 1,914 242 — — — Asset Protection Scheme (44) (906) (1,550) — — — Payment Protection Insurance costs (1,110) (850) — — — — Interest Rate Hedging Products redress and related costs (700) — — — — — Regulatory fines (381) — — — — — Sovereign debt impairment — (1,099) — — — — Interest rate hedge adjustments on impaired available-for-sale sovereign debt — (169) — — — — Amortisation of purchased intangible assets (178) (222) (369) — — — Integration and restructuring costs (1,550) (1,064) (1,032) — — — Gain on redemption of own debt 454 255 553 — — — Strategic disposals 113 (104) 171 — — — Bank levy (175) (300) — — — — Bonus tax — (27) (99) — — — Write-down of goodwill and other intangible assets (518) (11) (10) — — — RFS Holdings minority interest (20) (7) (150) — — — Operating loss including the results of Direct Line Group discontinued operations* (5,296) (766) (399) (5,165) (1,190) (154) Direct Line Group discontinued operations** 131 (424) 245 — — — Operating loss before tax (5,165) (1,190) (154) (5,165) (1,190) (154)
(Loss)/profit from discontinued operations, net of tax - Direct Line Group (184) 301 (176) (184) 301 (176)
** 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 write-down of goodwill, integration and restructuring costs and strategic disposals.
Basic loss per ordinary and B share from continuing operations (1) (53.7p) (21.3p) (2.9p) (53.7p) (21.3p) (2.9p)
Note: (1) Prior year data have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares, which took effect in June 2012.
Net interest income Group net interest income declined by 8% to £11,695 million largely reflecting lower interest-earning asset balances. Group net interest margin (NIM), despite very low interest rates and strong deposit competition, remained stable.
Insurance net claims General insurance claims were £541 million lower, primarily reflecting lower volumes, higher reserve releases and improved claims experience, more than offsetting an increase of £85 million in Home weather events claims.
In 2011, the Group recorded an impairment loss of £1,099 million in respect of its AFS portfolio of Greek government debt. In 2012, the vast majority of this portfolio was exchanged for Greek sovereign debt and European Financial Stability Facility notes; the Greek sovereign debt received in the exchange was sold.
Liability management exercises undertaken by the Group during 2012 resulted in a net gain of £454 million (2011 - £255 million).
2012 compared with 2011 - statutory Operating loss Operating loss before tax for the year was £5,165 million compared with £1,190 million in 2011.
Net interest income Net interest income decreased by 7% to £11,402 million.
Results summary continued Operating expenses Operating expenses increased to £17,827 million from £17,134 million in 2011. This included PPI costs of £1,110 million (2011 - £850 million), IRHP redress and related costs of £700 million, regulatory fines of £381 million, integration and restructuring costs of £1,415 million compared with £1,016 million in 2011, and write-down of goodwill and other intangible assets of £124 million, principally as a result of exits from selective countries and lower revenue projections by Markets. Excluding these items, operating expenses were down 8% driven by cost savings achieved as a result of the cost reduction programme.
Tax The tax charge for 2012 was £469 million (2011 - £1,127 million).
Loss 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.
Net interest income Group net interest income fell 11% to £12,689 million largely driven by the run-off of balances and exit of higher margin, higher risk segments in Non-Core. Group NIM was 9 basis points lower, reflecting the cost of carrying a higher liquidity portfolio and by the impact of non-performing assets in the Non-Core division. However, R&C NIM was up 6 basis points, with strengthening asset margins in the first half of the year offsetting the impact of a competitive deposit market.
Non-interest income 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. Volatile market conditions led to a reduction in Markets trading income, driven by the deterioration in global credit markets as sovereign difficulties in the eurozone grew. Non-Core trading losses increased by £690 million, reflecting costs incurred as part of the division’s focus on reducing capital trading assets.
Impairments represented 1.5% of gross loans and advances excluding reverse repos compared with 1.7% in 2010.
The Asset Protection Scheme is accounted for as a credit derivative and movements in the fair value of the contract are taken as non-operating items. The APS fair value charge was £906 million in 2011. The cumulative charge for the APS was £2,456 million as at 31 December 2011.
An impairment of £1,099 million was taken on the Group’s AFS bond portfolio in 2011 as a result of the decline in the value of Greek sovereign bonds. As of 31 December 2011, the bonds were marked at 21% of par value.
Tax The tax charge was £1,127 million in 2011, compared with £703 million in 2010. The high tax charge for the year reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.
Earnings Basic loss per ordinary and B share from continuing operations increased from a loss of 2.9p per share to a loss of 21.3p per share. Adjusted earnings per ordinary and B share fell from, 6.1p per share to a loss of 0.8p per share.
2011 compared with 2010 - statutory Operating loss Operating loss before tax for the year was £1,190 million compared with £154 million in 2010.
Net interest income Net interest income decreased by 11% to £12,303 million.
Impairment losses Impairment losses were £8,707 million, compared with £9,235 million in 2010.
Gross yield (9) - Group 3.12 3.24 3.29 3.12 3.23 3.27 - UK 3.47 3.56 3.40 3.49 3.56 3.38 - Overseas 2.56 2.77 3.14 2.56 2.77 3.13 Interest spread (10) - Group 1.62 1.61 1.81 1.62 1.61 1.79 - UK 1.81 1.87 2.04 1.84 1.87 2.02 - Overseas 1.41 1.26 1.50 1.40 1.26 1.49 Net interest margin (11) - Group 1.93 1.92 2.01 1.92 1.89 1.97 - UK 2.00 2.05 2.19 1.98 2.01 2.14 - Overseas 1.83 1.73 1.76 1.82 1.72 1.75
The Royal Bank of Scotland plc base rate (average) 0.50 0.50 0.50 0.50 0.50 0.50 London inter-bank three month offered rates (average) - Sterling 0.82 0.87 0.70 0.82 0.87 0.70 - Eurodollar 0.43 0.33 0.34 0.43 0.33 0.34 - Euro 0.53 1.36 0.75 0.53 1.36 0.75
Liabilities Deposits by banks - UK 18,276 195 1.07 17,224 242 1.41 - Overseas 20,129 384 1.91 46,890 735 1.57 Customer accounts: demand deposits - UK 121,252 643 0.53 112,522 664 0.59 - Overseas 35,087 210 0.60 43,177 483 1.12 Customer accounts: savings deposits - UK 84,972 1,479 1.74 76,719 1,177 1.53 - Overseas 26,989 133 0.49 25,257 130 0.51 Customer accounts: other time deposits - UK 39,813 522 1.31 44,243 481 1.09 - Overseas 26,038 509 1.95 34,447 596 1.73 Debt securities in issue - UK 69,272 1,834 2.65 119,735 2,755 2.30 - Overseas 22,469 342 1.52 42,473 765 1.80 Subordinated liabilities - UK 16,377 517 3.16 17,345 409 2.36 - Overseas 5,891 189 3.21 6,226 189 3.04 Internal funding of trading business - UK (21,140) 264 (1.25) (40,242) 149 (0.37) - Overseas 11,992 (65) (0.54) (8,783) (40) 0.46 Interest-bearing liabilities - UK 328,822 5,454 1.66 347,546 5,877 1.69 - Overseas 148,595 1,702 1.15 189,687 2,858 1.51 Total interest-bearing liabilities - banking business (1,2,5,6,7) 477,417 7,156 1.50 537,233 8,735 1.63 - trading business (13) 248,647 307,564 Interest-bearing liabilities 726,064 844,797 Non-interest-bearing liabilities: Demand deposits - UK 46,420 46,495 - Overseas 27,900 19,909 Other liabilities (2,9) 556,728 548,915 Owners' equity 73,260 75,039 Total liabilities and owners' equity 1,430,372 1,535,155
Assets Loans and advances to banks - UK 33,656 248 0.74 29,843 277 0.93 - Overseas 40,342 245 0.61 41,716 403 0.97 Loans and advances to customers - UK 277,336 11,326 4.08 294,187 11,973 4.07 - Overseas 151,740 4,862 3.20 171,986 5,857 3.41 Debt securities - UK 50,457 1,023 2.03 55,259 1,263 2.29 - Overseas 40,221 834 2.07 58,347 1,271 2.18 Interest-earning assets - UK 361,449 12,597 3.49 379,289 13,513 3.56 - Overseas 232,303 5,941 2.56 272,049 7,531 2.77 Total interest-earning assets - banking business (1,2,3,8) 593,752 18,538 3.12 651,338 21,044 3.23 - trading business (13) 240,131 278,975 Interest-earning assets 833,883 930,313 Non-interest-earning assets (1,2) 596,489 604,842 Total assets 1,430,372 1,535,155
Liabilities Deposits by banks - UK 18,276 196 1.07 17,224 242 1.41 - Overseas 20,200 404 2.00 47,371 740 1.56 Customer accounts: demand deposits - UK 121,252 643 0.53 112,777 666 0.59 - Overseas 35,087 210 0.60 43,177 483 1.12 Customer accounts: savings deposits - UK 84,972 1,479 1.74 76,719 1,177 1.53 - Overseas 26,989 133 0.49 25,257 130 0.51 Customer accounts: other time deposits - UK 39,813 522 1.31 44,243 481 1.09 - Overseas 25,558 504 1.97 34,371 594 1.73 Debt securities in issue - UK 69,272 1,831 2.64 119,735 2,755 2.30 - Overseas 22,469 342 1.52 42,473 765 1.80 Subordinated liabilities - UK 16,006 490 3.06 17,345 409 2.36 - Overseas 5,891 189 3.21 6,226 189 3.04 Internal funding of trading business - UK (21,140) 264 (1.25) (40,242) 149 (0.37) - Overseas 11,992 (65) (0.54) (8,783) (40) 0.46 Interest-bearing liabilities - UK 328,451 5,425 1.65 347,801 5,879 1.69 - Overseas 148,186 1,717 1.16 190,092 2,861 1.51 Total interest-bearing liabilities - banking business (1,2,5) 476,637 7,142 1.50 537,893 8,740 1.62 - trading business (13) 248,647 307,564 Interest-bearing liabilities 725,284 845,457 Non-interest-bearing liabilities: Demand deposits - UK 46,420 46,495 - Overseas 27,900 19,909 Other liabilities (2,9) 557,508 548,255 Owners' equity 73,260 75,039 Total liabilities and owners' equity 1,430,372 1,535,155
Liabilities Deposits by banks - UK 21,816 334 1.53 - Overseas 59,799 999 1.67 Customer accounts: demand deposits - UK 121,186 624 0.51 - Overseas 39,127 607 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 356,238 4,850 1.36 - Overseas 244,312 4,009 1.64 Total interest-bearing liabilities - banking business (1,2,5) 600,550 8,859 1.48 - trading business (13) 293,993 Interest-bearing liabilities 894,543 Non-interest-bearing liabilities: Demand deposits - UK 29,022 - Overseas 23,994 Other liabilities (2,9) 647,739 Owners' equity 76,906 Total liabilities and owners' equity 1,672,204
Analysis of change in net interest income - volume and rate analysis Volume and rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and rate are allocated pro rata to volume and rate movements.
Loans and advances to customers UK (665) — (665) (677) 30 (647)
Interest-bearing liabilities Deposits by banks UK (14) 61 47 (14) 60 46 Overseas 486 (135) 351 505 (169) 336 Customer accounts: demand deposits UK (49) 70 21 (48) 71 23 Overseas 78 195 273 78 195 273 Customer accounts: savings deposits UK (133) (169) (302) (133) (169) (302)
Interest-earning assets Loans and advances to banks UK 87 (17) 70 91 (22) 69 Overseas 124 (89) 35 124 (89) 35 Loans and advances to customers UK (645) 846 201 (626) 863 237 Overseas (863) (202) (1,065) (844) (193) (1,037)
Total interest receivable of the banking business UK (656) 914 258 (643) 951 308 Overseas (822) (704) (1,526) (855) (688) (1,543)
Interest-bearing liabilities Deposits by banks UK 66 26 92 67 25 92 Overseas 201 60 261 197 62 259 Customer accounts: demand deposits UK 45 (88) (43) 47 (89) (42) Overseas (57) 183 126 (58) 182 124 Customer accounts: savings deposits UK (125) (117) (242) (126) (116) (242) Overseas 3 80 83 3 80 83 Customer accounts: other time deposits UK (15) (35) (50) (15) (35) (50) Overseas 196 122 318 197 123 320 Debt securities in issue UK 73 (642) (569) 72 (641) (569) Overseas 502 (202) 300 503 (203) 300 Subordinated liabilities UK 63 8 71 63 8 71 Overseas 92 (29) 63 92 (29) 63 Internal funding of trading business UK (4) (285) (289) (4) (285) (289)
Total interest payable of the banking business UK 103 (1,133) (1,030) 104 (1,133) (1,029)
Fees and commissions receivable 5,715 6,384 8,194 5,709 6,379 8,193 Fees and commissions payable (1,269) (1,460) (2,211) (834) (962) (1,892) Income from trading activities - excluding Asset Protection Scheme 3,531 3,313 6,070 1,719 3,607 6,067 - Asset Protection Scheme — — — (44) (906) (1,550) Gain on redemption of own debt — — — 454 255 553 Other operating income 2,397 2,527 1,213 (465) 3,975 1,355 Non-interest income (excluding insurance net premium income) 10,374 10,764 13,266 6,539 12,348 12,726 Insurance net premium income 3,718 4,256 5,128 — — 114 Total non-interest income 14,092 15,020 18,394 6,539 12,348 12,840
Note: (1) Managed basis excludes movements in own credit adjustments, Asset Protection Scheme, gain on redemption of own debt, strategic disposals and RFS MI and includes Direct Line Group on a managed basis which is included in discontinued operations in the statutory results.
Markets trading income was sustained, despite the significant reduction in trading assets through balance sheet management and optimisation.
Markets trading income was sustained, despite the significant reduction in trading assets following its restructuring early in 2012.
Insurance net premium income fell by 17% largely driven by Direct Line Group’s exit from certain business segments, along with reduced volumes driven by the de-risking of the motor book. Insurance net premium income in Non-Core also decreased as legacy policies ran-off.
Volatile market conditions led to a reduction in Markets trading income, driven by the deterioration in global credit markets as sovereign difficulties in the eurozone grew.
A gain in own credit adjustments of £1,914 million was recorded as a result of Group credit spreads widening. This compares with a smaller gain of £242 million in 2010.
Operating expenses and insurance claims £m £m £m £m £m £m
Note: (1) Managed basis excludes PPI 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 includes Direct Line Group on a managed basis which included discontinued operations in the statutory results.
Business Services costs were down 6% in the year, reflecting increased benefits from earlier cost saving programmes as a number of initiatives reached their full run rate. Technology Services costs were 8% lower and Corporate Services costs 6% lower. Headcount was 2% down on 2011.
Insurance net claims decreased by 18% as lower volumes, higher reserve releases and improved claims experience more than offset an increase of £85 million in Home weather events claims.
Staff expenses were cut by 3%. Excluding integration and restructuring costs of £811 million (2011 - £464 million), staff costs were down 8%, as headcount fell by 9,600 to 137,200.
To reflect current experience of Payment Protection Insurance complaints received, RBS increased its PPI provision by £1,110 million in 2012, bringing the cumulative charge taken to £2.2 billion, of which £1.3 billion in redress had been paid by 31 December 2012.
Operating expenses and insurance claims continued 2011 compared with 2010 - managed Group expenses were 7% lower 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. 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.
Staff costs fell 11%, driven by lower Markets and International Banking discretionary 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’s cost reduction programme delivered cost savings with an underlying run rate of over £3 billion by the end of 2011.
Staff costs — 38 210 Premises and equipment (2) 6 3 Other administrative expenses 2 51 143 Depreciation and amortisation — 11 20 — 106 376
Staff costs 737 356 353 Premises and equipment 145 156 117 Other administrative expenses 270 276 104 Depreciation and amortisation 142 — — 1,294 788 574 2012 compared with 2011 Restructuring costs were £1,294 million compared with £788 million in 2011. The increase was primarily driven by costs incurred in relation to the strategic restructuring of Markets and International Banking announced in January 2012.
Staff costs - redundancy 126 5 626 37 (336) (24) 434 Staff costs - other 40 — 74 — (3) — 111 Premises and equipment 166 — 141 4 (22) — 289 Other administrative expenses 110 (2) 261 9 (107) (7) 264 Depreciation and amortisation — — 142 — (142) — — 442 3 1,244 50 (641) (31) 1,067
Staff costs 148 95 51 Premises and equipment 9 11 6 Other administrative expenses 99 59 25 256 165 82 2012 compared with 2011 Divestment costs were £256 million compared with £165 million in 2011 as the preparation for the European Commission mandated divestments continued throughout 2012.
Loan impairment provisions rose to £21.3 billion, increasing coverage of risk elements in lending to 52%, compared with 49% in 2011.
The Group held Greek government bonds with a notional amount of £1.45 billion. As a result of Greece’s continuing fiscal difficulties, the Group recorded impairment charges on these bonds totalling £1,099 million during the year. These charges were recorded to write the bonds down to their market price as at 31 December 2011 (c.21% of notional).
2012 compared with 2011 - managed and statutory The high tax charge in 2012 reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland), the reduction in the carrying value of deferred tax assets in Ireland in view of continuing losses, the reduction in the carrying value of deferred tax assets in Australia following the strategic changes to the Markets and International Banking businesses announced in January 2012, and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2012 and July 2012 on the net deferred tax balance.
2011 compared with 2010 - managed and statutory The high tax charge in 2011 reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.
Divisional performance The results of each division on a managed basis are set out below. The results are stated before movements in own credit adjustments, Asset Protection Scheme, Payment Protection Insurance costs, Interest Rate Hedging Products redress and related costs, regulatory fines, sovereign debt impairment, interest rate hedge adjustments on impaired availablefor -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, RFS MI and includes the results of Direct Line Group on a managed basis which are included in discontinued operations in the statutory results.
UK Retail 1,891 2,021 1,348 UK Corporate 1,796 1,924 1,893 Wealth 253 248 283 International Banking 594 755 1,311 Ulster Bank (1,040) (984) (683) US Retail & Commercial 754 537 349 Retail & Commercial 4,248 4,501 4,501 Markets 1,509 899 2,724 Direct Line Group 441 454 (295) Central items 143 191 630 Core 6,341 6,045 7,560 Non-Core (2,879) (4,221) (5,715) Operating profit 3,462 1,824 1,845 Own credit adjustments (4,649) 1,914 242 Asset Protection Scheme (44) (906) (1,550) Payment Protection Insurance costs (1,110) (850) — Interest Rate Hedging Products redress and related costs (700) — — Regulatory fines (381) — — Sovereign debt impairment — (1,099) — Interest rate hedge adjustments on impaired available-for-sale sovereign debt — (169) — Amortisation of purchased intangible assets (178) (222) (369) Integration and restructuring costs (1,550) (1,064) (1,032) Gain on redemption of own debt 454 255 553 Strategic disposals 113 (104) 171 Bank levy (175) (300) — Bonus tax — (27) (99) Write-down of goodwill and other intangible assets (518) (11) (10) RFS Holdings minority interest (20) (7) (150) Operating loss including the results of Direct Line Group discontinued operations (5,296) (766) (399) Direct Line Group discontinued operations* 131 (424) 245 Operating loss before tax (5,165) (1,190) (154)
* Included within Direct Line Group discontinued operations are the managed bases 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 write-down of goodwill, integration and restructuring costs and strategic disposals.
UK Retail 3.58 3.95 3.89 UK Corporate 3.06 3.06 2.89 Wealth 3.73 3.23 3.26 International Banking 1.64 1.73 1.92 Ulster Bank 1.88 1.87 2.03 US Retail & Commercial 3.00 3.06 2.82 Retail & Commercial 2.92 2.97 2.91 Non-Core 0.31 0.63 1.02
Net interest income 3,990 4,302 4,054 Net fees and commissions 884 1,066 1,100 Other non-interest income (net of insurance claims) 95 140 237 Non-interest income 979 1,206 1,337 Total income 4,969 5,508 5,391 Direct expenses - staff (800) (839) (889)
Analysis of income by product Personal advances 916 1,089 993 Personal deposits 661 961 1,102 Mortgages 2,367 2,277 1,984 Cards 863 950 962 Other, including bancassurance in 2010 162 231 350 Total income 4,969 5,508 5,391
Risk elements in lending (2) 4.6 4.6 4.6 Provision coverage (3) 58% 58% 59%
Over the last four years UK Retail has undertaken stretching initiatives and undergone significant change in order to meet its goal to consistently improve the service it offers to its customers. Highlights in 2012 include: Continued progress on the RBS and NatWest Customer Charter commitments supporting our goal of becoming Britain’s most helpful retail bank; Providing more than £500 million of cheaper mortgages through the
Government’s Funding for Lending Scheme (FLS), launched at the end of June 2012 and opened for drawings in August 2012, which represents 14% of all completions in the last quarter of 2012; Seeking and responding to customer feedback to enhance the retail mobile banking app which is used by more than two million customers to manage their money and complete over one million transactions every week; Increasing online banking webchat functionality to allow customers real-time access to an advisor, direct from their computer, who can answer queries and action basic account services 24 hours a day; and
Ross McEwan joined UK Retail as its new Chief Executive in September 2012 and spent considerable time engaging with customers and employees around the country and reviewing business processes and performance. With his management team, he has developed a range of initiatives, building upon existing efforts, which focus on simplifying processes and providing a better experience for all customers. Ultimately, with a lot of hard work, the goal is to be the best retail bank in the UK.
Mortgage balances grew by £4.1 billion with the share of new business at 10%, ahead of our stock level of 8%. Growth as a result of FLS was starting to appear by the end of the year as mortgage applications moved through the pipeline to completion. Deposit growth of 6% was in line with the market and drove a 300 basis point improvement in the loan:deposit ratio to 103%.
Costs were down £150 million, 6%, driven by the ongoing simplification of processes across the business, lower headcount and lower FSCS levy.
Customer deposits grew 6%, outperforming the market total deposit growth of 3%. Savings balances grew by £6 billion, or 9%, with 1.5 million accounts opened, demonstrating the strength of our customer franchise and our strategy to further develop primary banking relationships.
Risk-weighted assets were broadly stable, with volume growth in lower risk secured mortgages more than offset by a decrease in the unsecured portfolio.
Net interest income 2,974 3,092 3,000 Net fees and commissions 1,365 1,375 1,353 Other non-interest income 384 396 443 Non-interest income 1,749 1,771 1,796 Total income 4,723 4,863 4,796 Direct expenses - staff (928) (922) (912)
Operating profit before impairment losses 2,634 2,717 2,660 Impairment losses (838) (793) (767)
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).
RBS was the first bank to support the Government’s Funding for Lending Scheme (FLS). The division is using the FLS to stimulate loan demand through reduced interest rates for its customers. Since the scheme’s launch, UK Corporate has supported over 11,000 SMEs with over £1.7 billion of allocated funds through FLS initiatives. In addition, UK Corporate is providing targeted support to manufacturers through its Manufacturing Fund. This has made £1 billion available to customers, facilitating investment in technology and innovation and freeing up working capital. UK Corporate launched a Carbon Reduction Fund which provides £200 million of ring-fenced funding for businesses undertaking energy-efficiency projects. The division has also supported its clients in accessing the corporate bond markets. Corporate clients raised a total of £19 billion of bonds in 2012.
Regional ‘Great place to do business’ events which bring investors, local authorities and prominent members of the community together to identify opportunities for stimulating growth in the community.
UK Corporate has invested significantly to further enhance the skills of its people. As part of improvements to its specialist sector propositions, the business is tailoring its industry leading accreditation programme with industry specific modules. The bespoke modules are endorsed by key sector bodies such as the National Farmers’ Union.
UK Corporate was the first high street bank to support the Evening Standard and City Gateway apprenticeship initiative, hiring an initial 16 young people onto its scheme.
UK Corporate continued 2012 compared with 2011 With economic factors continuing to suppress business confidence, 2012 saw lower income and operating profit. Nonetheless, the business delivered a return on equity of 14.5%, slightly below the prior year and comfortably ahead of the cost of capital.
2011 compared with 2010 Operating profit increased by 2% to £1,924 million, as higher income was partially offset by higher impairments and an increase in expenses.
Net interest income increased by 3%. Net interest margin improved 17 basis points with benefits from re-pricing the lending portfolio and the revision to income deferral assumptions in Q1 2011 partially offset by increased funding costs together with continued pressure on deposit margins. A 1% increase in deposit balances supported an improvement in the loan:deposit ratio to 86%.
Non-interest income decreased by 1% as a result of lower Markets crosssales and fee income, partially offset by increased Invoice Finance and Lombard income.
Impairments of £793 million were 3% higher due to increased specific impairments and collectively assessed provisions, partially offset by lower latent loss provisions.
Operating profit before impairment losses 299 273 301 Impairment losses (46) (25) (18)
Analysis of income Private banking 956 902 836 Investments 214 202 199 Total income 1,170 1,104 1,035
Capital and balance sheet Loans and advances to customers (gross) - mortgages 8.8 8.3 7.8 - personal 5.5 6.9 6.7 - other 2.8 1.7 1.6 17.1 16.9 16.1 Loan impairment provisions (0.1) (0.1) (0.1) Net loans and advances to customers 17.0 16.8 16.0
Risk elements in lending 0.2 0.2 0.2 Provision coverage (2) 44% 38% 30% Assets under management (excluding deposits) 28.9 30.9 33.9
In 2012 the Coutts businesses continued to focus on implementing and delivering the new divisional strategy outlined in 2011. The sale of Coutts’ Latin American businesses and the completion of the rollout of Coutts global technology platform in the UK were tangible examples of this. By the end of the year the division had exited over 100 countries since the strategy was introduced and was serving clients in the remaining countries through one central operating platform, a clear demonstration of the division’s commitment to its strategy.
In the International business, the division further invested in Dubai, Singapore and Mumbai as it continued to embed its targeted growth strategy. Clients also benefited from enhancements to the collateralised lending programme, where higher lending limits and a greater number of currencies available has increased its relevance to clients.
2012 compared with 2011 Operating profit increased by £5 million, or 2% to £253 million driven by higher income partially offset by increased expenses and impairment losses.
Total income increased by £66 million, with net interest income up £75 million, largely driven by improvements in margins and strong divisional treasury income, particularly during H1 2012.
Non-interest income fell by 2% as the gain from the disposal of the Latin American, Caribbean and African businesses was more than offset by a decline in fee income in the UK and lower investment volumes, driven by continued economic uncertainty.
Income increased by £69 million with a strong treasury income and increases in lending and deposit volumes. Non-interest income rose 3%, with investment income growing 2% despite turbulent market conditions.
Net interest income 922 1,199 1,353 Non-interest income 1,200 1,356 1,924 Total income 2,122 2,555 3,277 Direct expenses - staff (577) (706) (871)
Analysis of income by product Cash management 943 940 1,368 Trade finance 291 275 243 Loan portfolio 865 1,265 1,578 Ongoing businesses 2,099 2,480 3,189 Run-off businesses 23 75 88 Total income 2,122 2,555 3,277
Analysis of impairments by sector Manufacturing and infrastructure 42 254 (17) Property and construction 7 17 102 Transport and storage (3) 11 — Telecommunications, media and technology 12 — 7 Banks and financial institutions 43 (42) 49 Other 10 (72) (55)
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) 0.3% 0.3% 0.2%
International Banking was formed in January 2012 to create an integrated, client-focused business which serves RBS’s large global customers’ financing, risk management, trade finance, payments and cash management needs internationally.
Performance in 2012 was restricted by macroeconomic pressures and additional regulatory requirements across the industry. Given these constraints, International Banking kept its focus on cost control throughout the year.
Despite these headwinds, the division was recognised externally for its efforts in serving its customers’ needs, helping RBS Group gain awards such as: Top European investment grade corporate bond bookrunner
Number one cash management manager in the UK and number two in Europe (Euromoney Cash Management Survey).
Quality Leader in Large Corporate Trade Finance in the UK, and number one for Large Corporate Trade Finance Penetration in the UK (Greenwich).
Deposit margins declined following reductions in both three month LIBOR and five year fixed rates across Europe; however, this was offset by lower liquidity costs due to the strategic initiative to reduce short-term bank deposits.
Impairment losses decreased by £57 million with the non-repeat of a single name impairment.
Third party assets declined by 24%, with targeted reductions in the lending portfolio following a strategic reduction in assets.
Customer deposits increased by 2%. Successful efforts to rebuild customer confidence following the Moody’s credit rating downgrade and the Group technology incident in June 2012 outweighed economic pressures. This, coupled with the managed reduction in loans and advances to customers, improved the loan:deposit ratio to 85%.
Risk-weighted assets increased by 20%, reflecting the impact of regulatory uplifts partially offset by successful mitigation through balance sheet reduction. Risk-weighted asset intensity in the loan book has increased significantly given the uplifts, which will result in strategic adjustments going forward.
2011 compared with 2010 Operating profit was down 42%, partly reflecting the sale of Global Merchant Services (GMS) which completed on 30 November 2010. Adjusting for the disposal, operating profit decreased 32%, driven by a decrease in income and an impairment provision on a single name in 2011.
Net interest income 649 736 839 Net fees and commissions 145 142 156 Other non-interest income 51 69 58 Non-interest income 196 211 214 Total income 845 947 1,053 Direct expenses - staff (211) (221) (237)
Analysis of impairments by sector Mortgages 646 570 294 Corporate - property 276 324 375 - other corporate 389 434 444 Other lending 53 56 48 Total impairment losses 1,364 1,384 1,161
Note: (1) Divisional return on equity is based on divisional operating loss after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions).
Risk elements in lending - mortgages 3.1 2.2 1.5 - corporate - property 1.9 1.3 0.7 - other corporate 2.3 1.8 1.2 - other lending 0.2 0.2 0.2 Total risk elements in lending 7.5 5.5 3.6 Provision coverage (1) 52% 50% 45%
Customer deposits 22.1 21.8 23.1 Loan:deposit ratio (excluding repos) 130% 143% 152% Risk-weighted assets 36.1 36.3 31.6
Total expenses fell by £26 million, reflecting the benefits of cost saving initiatives.
Income fell by 10% driven by a contracting performing loan book coupled with higher funding costs. Loans and advances to customers decreased by 8% during 2011.
Analysis of impairments by sector Residential mortgages (2) 44 85 (1) 28 55 Home equity 150 165 164 95 103 106 Corporate and commercial (120) 88 354 (77) 55 228 Other consumer 104 101 146 65 61 96 Securities 13 126 53 9 79 34 Total impairment losses 145 524 802 91 326 519
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector Residential mortgages — 0.5% 0.9% — 0.5% 0.9% Home equity 0.7% 0.7% 0.7% 0.7% 0.7% 0.7% Corporate and commercial (0.3%) 0.2% 1.1% (0.3%) 0.2% 1.1% Other consumer 0.8% 0.8% 1.4% 0.8% 0.8% 1.4% Total 0.2% 0.5% 1.0% 0.2% 0.5% 1.0%
Performance ratios Return on equity (1) 8.3% 6.3% 3.7% 8.3% 6.3% 3.7% Adjusted return on equity (2) 8.9% 6.3% 3.7% 8.9% 6.3% 3.7% Net interest margin 3.00% 3.06% 2.82% 3.00% 3.06% 2.82% Cost:income ratio 73% 72% 72% 73% 72% 72% Adjusted cost:income ratio (2) 71% 72% 72% 71% 72% 72%
US Retail & Commercial continued 2012 2011 2010 2012 2011 2010 US$bn US$bn US$bn £bn £bn £bn
Capital and balance sheet Loans and advances to customers (gross) - residential mortgages 9.4 9.4 9.4 5.8 6.1 6.1 - home equity 21.5 23.1 23.6 13.3 14.9 15.2 - corporate and commercial 38.5 35.3 31.7 23.8 22.9 20.5 - other consumer 13.5 12.0 10.7 8.4 7.7 6.9 82.9 79.8 75.4 51.3 51.6 48.7 Loan impairment provisions (0.9) (1.1) (1.2) (0.5) (0.7) (0.8) Net loans and advances to customers 82.0 78.7 74.2 50.8 50.9 47.9
In the first quarter of 2012, RBS Citizens implemented five strategic priorities to sharpen the division’s back-to-basics strategy. The strategy is founded on the belief that building an engaged workforce which is focused on the customer experience and on being their primary banking partner, with an embedded culture of risk management, will position the franchise to deliver financial results consistent with a top performing regional bank.
Consumer Banking further improved and expanded its distribution channels and product capabilities including the roll-out of intelligent deposit machines and the on-going build out of its mortgage capabilities, reaching the top 20 nationally for mortgage originations in 2012. The business made enhancements to its mobile banking services and subsequently its apps for both iPhone and Android were rated the ‘best integrated apps’ in the industry based on an analysis of consumer ratings conducted by Javelin Strategy & Research.
In 2012, Commercial Banking responded to client feedback, introducing its own core Client Commitments and developing a new Commercial Client on-boarding process to improve the way clients are welcomed to RBS Citizens.
The business made good progress towards expanding its capital markets capabilities. At the end of 2012, RBS Citizens ranked #4 in the new capital markets business for middle market customers within the footprint, and ranked in the top ten nationally.
During the year, RBS Citizens offered former employees a one-time opportunity to receive the value of future pension benefits as a single lump sum payment. The transaction allowed RBS Citizens to partially derisk its pension plan and future liability under the plan. A strong participant take-up rate of 60% enabled RBS Citizens to reduce its pension liability by 17% and recognise a £21 million ($33 million) accounting gain.
The macroeconomic operating environment remained challenging, with low rates, high unemployment, a soft housing market, sluggish consumer activity and the continuing impact of legislative changes including the Durbin Amendment in the Dodd-Frank Act which became effective on 1 October 2011.
The Durbin Amendment lowers the allowable interchange on debit transactions to $0.23-$0.24 per transaction. The current annualised impact of the Durbin Amendment is estimated at £94 million ($150 million).
Net interest income was down £2 million. In US dollar terms, net interest income increased by $108 million, or 4%. Net interest margin improved by 24 basis points to 3.06% reflecting changes in deposit mix, continued discipline around deposit pricing and the positive impact from the balance sheet restructuring programme carried out during Q3 2010 combined with strong commercial loan growth, partially offset by run-off of consumer loans.
Non-interest income was down £23 million. In US dollar terms, non interest income increase by $31 million, or 2%. The increase was primarily driven by higher account and transaction fees, partially offset by the impact of legislative changes on debit card and deposit fees.
Analysis of income by product Rates 2,006 1,474 2,312 Currencies 757 1,060 1,047 Asset backed products (ABP) 1,318 1,254 1,479 Credit markets 862 616 1,350 Investor products and equity derivatives 224 593 672 Total income ongoing businesses 5,167 4,997 6,860 Inter-divisional revenue share (691) (767) (883) Run-off businesses 7 185 256 Total income 4,483 4,415 6,233
Memo - fixed income and currencies Rate/currencies/ABP/credit markets 4,943 4,404 6,188 Less: primary credit markets (568) (688) (863) Total fixed income and currencies 4,375 3,716 5,325
Performance ratios (ongoing businesses) Return on equity (1) 10.0% 6.1% 19.1% Cost:income ratio 64% 77% 53% Compensation ratio (2) 32% 42% 31%
During 2012, the economic environment was dominated by weak prospects for global growth and the uncertain outlook for Eurozone sovereign debt. However, positive central bank activity and a more stable credit environment resulted in marginally improved trading opportunities.
Asset Backed Products continued to perform strongly as markets were sustained throughout the year by investors’ search for yield. Revenues for the year were £1.3 billion, up 5% from a strong performance of £1.25 billion in 2011.
A 40% increase in Credit Markets revenue to £862 million was driven by Flow Credit which, as a result of improved risk management and more benign market conditions, recorded good profitability compared with a loss in 2011. This was partially offset by weaker earnings from credit origination.
The 62% decrease in IPED followed significantly weaker client volumes in key markets. The business has been restructured and rationalised. It will be reported within Rates going forward.
The reduction in third party assets reflected management action to optimise and de-risk the balance sheet, consistent with previously disclosed medium-term objectives.
Total costs increased by 1% due to increased investment costs in 2011, which included a programme to meet new regulatory requirements. The compensation ratio in Markets was 42%, driven by fixed salary costs and prior year deferred awards.
Third party assets fell from £338.0 billion in 2010 to £312.6 billion in 2011 as a result of lower levels of activity and careful management of balance sheet exposures.
A 9% increase in risk-weighted assets reflected the impact of significant regulatory changes, with a £21 billion uplift as a result of CRD III, largely offset by the impact of the division’s focus on risk management.
Net premium income 3,718 3,969 4,311 Fees and commissions (430) (400) (410) Instalment income 126 138 159 Other income 60 100 179 Total income 3,474 3,807 4,239 Net claims (2,427) (2,772) (3,932)
In-force policies (000s) Personal lines motor excluding broker - own brands 3,714 3,787 4,162 - partnerships 336 320 645 Personal lines home excluding broker - own brands 1,754 1,811 1,797 - partnerships 2,485 2,497 2,530 Personal lines rescue and other excluding broker - own brands 1,803 1,844 1,966 - partnerships 7,628 7,307 7,497 Commercial 466 422 352 International 1,462 1,387 1,082 Other (1) 50 1 644 Total in-force policies (2) 19,698 19,376 20,675
Performance ratios Return on tangible equity (3) 11.7% 10.3% (6.8%) Loss ratio (4) 65% 70% 91% Commission ratio (5) 12% 10% 10% Expense ratio (6) 23% 21% 20% Combined operating ratio (7) 100% 101% 121% Balance sheet Total insurance reserves (£m) (8) 8,066 7,284 7,643
In October 2012, the Group completed the successful initial public offering of Direct Line Group, selling 520.8 million of its existing ordinary shares. This represented 34.7% of the issued share capital, generating gross proceeds of £911 million.
Following launch on comparethemarket.com, Churchill and Privilege motor and home products are now available on all four major price comparison websites in the UK. This reinforces Direct Line Group’s multichannel distribution strategy.
Direct Line Group continues to focus on reducing operational costs, targeting the delivery of gross annual cost savings of £100 million in 2014 through overall improvements in operational efficiency including claims handling, continued efforts to simplify internal structures and better managing customer acquisition costs. Steps announced during the second half of the year included measures to reduce costs in central functions as well as the reduction of around 70 senior leadership roles across the organisation.
Roll-out of a new e-trading platform in Commercial began in Q3 2012 and was launched in January 2013. This new platform has been developed to aid with internal cost efficiency and provide new routes to market as well as to significantly improve the interface with brokers and customers.
International consolidated its direct market position in Italy and Germany with a total of 1.5 million in-force policies at the end of 2012. Gross written premium for 2012 was up 4% in local currency on 2011 and followed a period of strong growth in 2010 and 2011.
Direct Line Group further improved its capital efficiency following a number of initiatives including the consolidation of four underwriting entities into one. The combined entity, U K Insurance Limited, received inaugural credit ratings of ‘A’ from Standard and Poor’s and ‘A2’ from Moody’s. Direct Line Group also issued £500 million of Tier 2 debt and paid £1 billion of dividends to RBS Group.
Separation and divestment update From 1 July 2012, Direct Line Group has operated on a substantially standalone basis with independent corporate functions and governance following the successful implementation of a comprehensive programme of separation initiatives. During 2012, these included launching a new corporate identity and the Direct Line Group Board became fully compliant with the UK Corporate Governance Code following further nonexecutive director appointments. New contracts of employment have been agreed and issued to staff, independent HR systems have been implemented and an arm’s length transitional services agreement has been reached with RBS Group for residual services. In January 2013, it was announced that Capgemini would design, deliver and operate Direct Line Group’s IT infrastructure.
The Group sold the first tranche of ordinary shares representing 34.7% of the share capital of Direct Line Group in October 2012 via an Initial Public Offering. This is consistent with the Group’s plan to cede control of Direct Line Group by the end of 2013 and a step toward complete disposal by the end of 2014, as required by the European Commission.
In accordance with IFRS 5, Direct Line Group has been recognised as a discontinued operation with consequent changes to the presentation of comparative information. The assets and liabilities relating to Direct Line Group are included in Disposal groups as of 31 December 2012. The Group has written down its investment in Direct Line Group at 31 December 2012 to 216 pence per share, the market value on that date, which resulted in a £394 million goodwill write-down.
A full year preliminary statement of results for Direct Line Insurance Group plc is available on the company website. A full Annual Report and Accounts will be available in March 2013.
Investment income of £243 million was £22 million lower, primarily as a result of £27 million financing costs relating to the Tier 2 debt issued in April 2012 and lower reinvestment rates during 2012. This was mostly offset by higher realised gains arising from portfolio management initiatives, including those arising from business previously reported in Non-Core.
Direct Line Group’s reported Return on Tangible Equity was 11.7% in 2012. On a pro forma basis, assuming the capital management initiatives had taken place prior to the start of the year, the Return on Tangible Equity would have been 13.2%.
At the end of 2011, Direct Line Group's investment portfolios comprised primarily cash, gilts and investment grade bonds. Within the UK portfolio, £8.9 billion, and the International portfolio, £827 million, there was no exposure to sovereign debt issued by Portugal, Ireland, Italy, Greece or Spain.
Net interest income 346 863 1,749 Net fees and commissions 105 (38) 471 Loss from trading activities (654) (721) (31) Insurance net premium income — 286 702 Other operating income - rental income 421 743 752 - other (1) 70 55 (889) Non-interest income (58) 325 1,005 Total income 288 1,188 2,754 Direct expenses - staff (272) (375) (731)
Loss from trading activities Monoline exposures (205) (670) (5) Credit derivative product companies (205) (85) (139) Asset-backed products (2) 101 29 235 Other credit exotics (28) (175) 77 Equities (2) (11) (17) Banking book hedges (38) (1) (82)
Notes: (1) Includes losses on disposals of £14 million for 2012 (2011 - £127 million; 2010 - £504 million). (2) Asset-backed products include super asset backed structures and other asset-backed products. (3) Includes disposal groups.
Performance ratios Net interest margin 0.31% 0.63% 1.02% Cost:income ratio nm 109% 82% Adjusted cost:income ratio (1) nm 130% 112% nm = not meaningful £bn £bn £bn
Capital and balance sheet Loans and advances to customers (gross) (2) 55.4 79.4 108.4 Loan impairment provisions (11.2) (11.5) (10.3) Net loans and advances to customers 44.2 67.9 98.1
Risk elements in lending (2) 21.4 24.0 23.4 Provision coverage (3) 52% 48% 44% Customer deposits (2) 2.7 3.5 6.7 Risk-weighted assets 60.4 93.3 153.7
Notes: (1) Adjusted cost:income ratio represents operating expenses expressed as a percentage of total income after netting insurance claims against income. (2) Excludes disposal groups. (3) Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending. (4) Disposals of £0.2 billion have been signed as at 31 December 2012 but are pending completion (2011 - £0.2 billion; 2010 - £12 billion).
2012 2011 2010 Commercial real estate third party assets £bn £bn £bn
UK Corporate Manufacturing and infrastructure 19 76 26 Property and construction 88 224 437 Transport 16 52 3 Financial institutions (38) 5 69 Lombard 48 75 129 Other 107 96 166 Total UK Corporate 240 528 830
Ulster Bank Mortgages — — 42 Commercial real estate - investment 288 609 630 - development 611 1,552 1,759 Other corporate 77 173 251 Other EMEA 7 15 52 Total Ulster Bank 983 2,349 2,734
Markets Manufacturing and infrastructure 3 57 (290) Property and construction 623 752 1,296 Transport 199 (3) 33 Telecoms, media and technology 32 68 9 Banking and financial institutions (58) (98) 196 Other 18 (19) 14 Total Markets 817 757 1,258
2012 2011 2010 Gross loans and advances to customers (excluding reverse repurchase agreements) by donating division and sector £m £m £m
UK Corporate Manufacturing and infrastructure 0.1 0.1 0.3 Property and construction 3.6 5.9 11.4 Transport 3.8 4.5 5.4 Financial institutions 0.2 0.6 0.8 Lombard 0.4 1.0 1.7 Other 4.2 7.5 7.4 Total UK Corporate 12.3 19.6 27.0
Ulster Bank Commercial real estate - investment 3.4 3.9 4.0 - development 7.6 8.5 8.4 Other corporate 1.6 1.6 2.2 Other EMEA 0.3 0.4 0.4 Total Ulster Bank 12.9 14.4 15.0
Gross loans and advances to customers (excluding reverse repurchase agreements) 55.4 79.3 108.2
Non-Core continued Non-Core third party assets fell to £57 billion, a reduction of £36 billion, or 39%, during the year and an overall reduction of £200 billion, or 78%, since the division was set up. This was achieved through a mixture of disposals, run-off and impairments. By the end of 2012, the Non-Core funded balance sheet was under 7% of the Group’s funded balance sheet compared with 21% when the division was created. Non-Core remains on target to reach its third party asset target of c.£40 billion, a reduction of approximately 85% of its original portfolio, by the end of 2013.
2012 compared with 2011 Third party assets declined by £36 billion, or 39%, largely reflecting disposals of £18 billion and run-off of £16 billion. The disposal of RBS Aviation Capital in Q2 2012 contributed c.£5 billion of this reduction.
An operating loss of £2,879 million was £1,342 million lower than 2011, principally due to lower impairments and expenses, partially offset by lower net interest income following run-off and disposals.
Headcount declined by 34% to 3,100 reflecting the divestment activity and run-off across the business.
Risk-weighted assets were £60 billion lower than 2010, principally driven by significant disposal activity on trading book assets combined with runoff.
Headcount declined by 2,200 (32%) to 4,700 in 2011, largely reflecting the divestment activity in relation to Asia, Non-Core Insurance and RBS Sempra Commodities.
Non-controlling interests 2,318 1,234 1,719 Owners’ equity 68,130 74,819 75,132 Total equity 70,448 76,053 76,851
Loans and advances to banks decreased by £19.4 billion, 23%, to £64.0 billion. Excluding reverse repurchase agreements and stock borrowing (‘reverse repos’), down £4.7 billion, 12%, to £34.8 billion, bank placings declined £14.7 billion, 34%, to £29.2 billion.
Movements in the value of derivative assets, down £87.7 billion, 17%, to £441.9 billion, and liabilities, down £89.7 billion, 17%, to £434.3 billion, primarily reflect decreases in interest rate and credit derivative contracts, together with the effect of currency movements, with Sterling strengthening against both the US dollar and the Euro.
Property, plant and equipment decreased by £2.1 billion, 18%, to £9.8 billion driven largely by the disposal of investment property in Non-Core.
Non-controlling interests increased by £1.1 billion, 88%, to £2.3 billion, predominantly due to the sale of 34.7% of the Group’s investment in Direct Line Group during the fourth quarter.
Owner’s equity decreased by £6.7 billion, 9%, to £68.1 billion, driven by the £6.0 billion attributable loss for the period together with movements in foreign exchange reserves, £0.9 billion, the recognition of actuarial losses in respect of the Group’s defined benefit pension schemes, net of tax, £1.9 billion, and other reserve movements of £0.2 billion. Partially offsetting these reductions were gains in available-for-sale reserves, £0.6 billion, and cash flow hedging reserves, £0.8 billion, share capital and reserve movements in respect of employee share schemes, £0.8 billion and other share issuances of £1.0 billion.
Loans and advances to banks decreased by £17.2 billion, 17%, to £83.3 billion. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were down £3.2 billion, 7%, to £39.4 billion and bank placings declined £14.0 billion, 24%, to £43.9 billion, primarily as a result of the reduction in exposure to eurozone banks and lower cash collateral requirements.
Loans and advances to customers were down £39.7 billion, 7%, to £515.6 billion. Within this, reverse repurchase agreements were up £9.0 billion, 17%, to £61.5 billion. Customer lending decreased by £48.7 billion, 10%, to £454.1 billion or £46.9 billion, 9%, to £473.9 billion before impairment provisions. This reflected the transfer to disposal groups of £19.5 billion of customer balances relating to the UK branch-based businesses. There were also planned reductions in Non-Core of £28.1 billion, together with declines in International Banking, £4.7 billion, UK Corporate, £3.0 billion and Ulster Bank, £2.0 billion, together with the effect of exchange rate and other movements, £1.9 billion. These were partially offset by growth in Markets, £6.4 billion, Wealth, £0.8 billion, UK Retail, £2.3 billion and US Retail & Commercial, £2.8 billion.
Settlement balances declined £3.8 billion, 33% to £7.8 billion as a result of decreased customer activity.
Customer accounts fell £7.7 billion, 2%, to £503.0 billion. Within this, repos increased £6.7 billion, 8%, to £88.8 billion. Excluding repos, customer deposits were down £14.4 billion, 3%, to £414.1 billion, reflecting the transfer to disposal groups of £21.8 billion of customer accounts relating to the UK branch-based businesses. This was partly offset by the net effect of growth in International Banking, £1.7 billion, UK Corporate, £1.8 billion, UK Retail, £5.8 billion, US Retail & Commercial, £0.5 billion and Wealth, £1.8 billion, together with exchange rate and other movements of £0.5 billion and declines in Markets, £1.1 billion, Ulster Bank, £0.8 billion and Non-Core, £2.9 billion.
Debt securities in issue were down £55.8billion, 26% to £162.6 billion driven by reductions in the level of certificates of deposit and commercial paper in Markets and Group Treasury.
Owners’ equity decreased by £0.3 billion to £74.8 billion. This was driven by the attributable loss for the year, £2.0 billion, together with the recognition of actuarial losses in respect of the Group’s defined benefit pension schemes, net of tax, £0.5 billion and exchange rate and other movements of £0.3 billion. Offsetting these reductions were gains in available-for-sale reserves, £1.1 billion and cashflow hedging reserves, £1.0 billion and the issue of shares under employee share schemes, £0.4 billion.
Net cash flows from operating activities (45,113) 3,325 19,291 Net cash flows from investing activities 27,175 14 3,351 Net cash flows from financing activities 2,017 (1,741) (14,380) Effects of exchange rate changes on cash and cash equivalents (3,893) (1,473) 82 Net (decrease)/increase in cash and cash equivalents (19,814) 125 8,344 2012 The major factors contributing to the net cash outflow from operating activities of £45,113 million were the decrease of £48,736 million in operating assets and liabilities, the net operating loss before tax of £5,276 million from continuing and discontinued operations, loans and advances written off net of recoveries of £3,925 million and other noncash items of £1,491 million. These were partially offset by the elimination of foreign exchange differences of £7,140 million, provisions for impairment losses of £5,283 million and depreciation and amortisation of £1,854 million.
Net cash inflows from financing activities of £2,017 million relate primarily to the issue of subordinated liabilities of £2,093 million and proceeds of non-controlling interests issued of £889 million partly offset by interest paid on subordinated liabilities of £746 million and dividends paid of £301 million.
2010 The major factors contributing to the net cash inflow from operating activities of £19,291 million were the increase of £17,095 million in operating assets less operating liabilities, depreciation and amortisation of £2,220 million and income taxes received of £565 million, partly offset by the net operating loss before tax of £940 million from continuing and discontinued operations.
Capital base Tier 1 capital 57,135 56,990 60,124 76,421 69,847 Tier 2 capital 12,152 8,546 9,897 15,389 32,223 Tier 3 capital — — — — 260 69,287 65,536 70,021 91,810 102,330 Less: Supervisory deductions (2,487) (4,828) (4,732) (4,565) (4,155)
Risk-weighted assets Credit risk 323,200 344,300 385,900 513,200 551,300 Counterparty risk 48,000 61,900 68,100 56,500 61,100 Market risk 42,600 64,000 80,000 65,000 46,500 Operational risk 45,800 37,900 37,100 33,900 36,900 459,600 508,100 571,100 668,600 695,800 Asset Protection Scheme relief — (69,100) (105,600) (127,600) n/a 459,600 439,000 465,500 541,000 695,800
Reconciliations of managed to statutory income statements Basis of preparation of 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 which are listed on page 38. This information is provided to give a better understanding of the results of the Group’s operations.
Net interest income 11,695 (15) (278) 11,402 Non-interest income (excluding insurance net premium income) 10,374 (4,129) 294 6,539 Insurance net premium income 3,718 — (3,718) — Non-interest income 14,092 (4,129) (3,424) 6,539 Total income 25,787 (4,144) (3,702) 17,941 Operating expenses (14,619) (4,220) 1,012 (17,827) Profit before insurance net claims and impairment losses 11,168 (8,364) (2,690) 114 Insurance net claims (2,427) — 2,427 — Operating profit before impairment losses 8,741 (8,364) (263) 114 Impairment losses (5,279) — — (5,279)
Own credit adjustments (4,649) 4,649 — — Asset Protection Scheme (44) 44 — — Payment Protection Insurance costs (1,110) 1,110 — — Interest Rate Hedging Products redress and related costs (700) 700 — — Regulatory fines (381) 381 — — Amortisation of purchased intangible assets (178) 178 — — Integration and restructuring costs (1,550) 1,550 — — Gain on redemption of own debt 454 (454) — — Strategic disposals 113 (113) — — Bank levy (175) 175 — — Write-down of goodwill and other intangible assets (518) 518 — — RFS Holdings minority interest (20) 20 — — Operating loss including the results of Direct Line Group discontinued operations (5,296) 394 (263) (5,165) Direct Line Group discontinued operations (1) 131 (394) 263 — Operating loss before tax (5,165) — — (5,165) Tax charge (469) — — (469) Loss from continuing operations (5,634) — — (5,634) (Loss)/profit from discontinued operations, net of tax - Direct Line Group (184) — — (184) - Other 12 — — 12 Loss from discontinued operations, net of tax (172) — — (177) Loss for the year (5,806) — — (5,806) Non-controlling interests 123 — — 123 Preference share and other dividends (288) — — (288) Loss attributable to ordinary and B shareholders (5,971) — — (5,971)
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 related one-off and other items including write-down of goodwill, integration and restructuring costs and strategic disposals.
Own credit adjustments 242 (242) — — Asset Protection Scheme (1,550) 1,550 — — Amortisation of purchased intangible assets (369) 369 — — Integration and restructuring costs (1,032) 1,032 — — Gain on redemption of own debt 553 (553) — — Strategic disposals 171 (171) — — Bonus tax (99) 99 — — Write-down of goodwill and other intangible assets (10) 10 — — RFS Holdings minority interest (150) 150 — — Operating loss including the results of Direct Line Group discontinued operations (399) — 245 (154) Direct Line Group discontinued operations (1) 245 — (245) — Operating loss before tax (154) — — (154) Tax charge (703) — — (703) Loss from continuing operations (857) — — (857) Loss from discontinued operations, net of tax - Direct Line Group (176) — — (176)
Gross of disposal groups £m £m £m £m £m £m £m £m £m
Liabilities Bank deposits 57,073 1 57,074 69,113 1 69,114 66,051 266 66,317 Repurchase agreements and stock lending 44,332 — 44,332 39,691 — 39,691 32,739 — 32,739 Deposits by banks 101,405 1 101,406 108,804 1 108,805 98,790 266 99,056 Customer deposits 433,239 753 433,992 414,143 22,610 436,753 428,599 2,267 430,866 Repurchase agreements and stock lending 88,040 — 88,040 88,812 — 88,812 82,094 — 82,094 Customer accounts 521,279 753 522,032 502,955 22,610 525,565 510,693 2,267 512,960 Debt securities in issue 94,592 — 94,592 162,621 — 162,621 218,372 — 218,372 Settlement balances 5,878 — 5,878 7,477 8 7,485 10,991 907 11,898 Short positions 27,591 — 27,591 41,039 — 41,039 43,118 — 43,118 Derivatives 434,333 7 434,340 523,983 126 524,109 423,967 5,042 429,009 Accruals, deferred income and other liabilities 14,801 2,679 17,480 23,125 1,233 24,358 23,089 925 24,014 Retirement benefit liabilities 3,884 — 3,884 2,239 — 2,239 2,288 — 2,288 Deferred tax 1,141 — 1,141 1,945 — 1,945 2,142 — 2,142 Insurance liabilities — 6,193 6,193 6,312 — 6,312 6,794 — 6,794 Subordinated liabilities 26,773 529 27,302 26,319 — 26,319 27,053 — 27,053 Liabilities of disposal groups 10,170 (10,162) 8 23,995 (23,978) 17 9,428 (9,407) 21 Total liabilities 1,241,847 — 1,241,847 1,430,814 — 1,430,814 1,376,725 — 1,376,725
Gross loans and advances to banks 29,282 2,112 31,394 43,993 87 44,080 58,038 651 58,689 Bank loan impairment provisions (114) — (114) (123) — (123) (127) — (127) Net loans and advances to banks 29,168 2,112 31,280 43,870 87 43,957 57,911 651 58,562
Customer REIL 40,993 13 41,006 40,708 1,549 42,257 38,453 53 38,506 Bank REIL 134 — 134 137 — 137 145 — 145 REIL 41,127 13 41,140 40,845 1,549 42,394 38,598 53 38,651
Gross unrealised gains on debt securities 3,946 230 4,176 4,978 — 4,978 2,595 — 2,595 Gross unrealised losses on debt securities (1,832) (15) (1,847) (3,408) — (3,408) (4,097) — (4,097)
Our business and our strategy Our approach to risk management Except as otherwise indicated by an asterisk (*), the information in the Risk and balance sheet management section (pages 107 to 293) is within the scope of the Independent auditor’s report.
In the balance sheet, all assets and liabilities of disposal groups are presented as a single line. In the risk and balance sheet management section, balances and exposures relating to disposal groups are included within risk measures for all periods presented. Refer to pages 105 and 106 for analysis of balance sheet pre and post disposal groups.
Strategic risk objectives* Risk management plays an integral role in the delivery of the Group’s strategic goal to be a safe and secure banking group. The implementation of a stronger and more effective culture of risk management and control provides the platform necessary to address historical vulnerabilities, rebuild upon the Group’s core strengths and position it on a sustainable and profitable path for future growth.
This is how the Group brings the Strategic Plan to life in the management of risk.
Although management is concerned with a range of risk scenarios, a relatively small number attracted particular attention from senior management during the past year. These can be grouped into three broad categories: Macro-economic risks.
In addition, further information on these and other risks facing the Group appears in the discussion of Risk Factors on pages 503 to 515.
Descriptions of top and emerging risks are provided below: Macro-economics risks
(i) Increased defaults in sectors to which the Group has concentrated exposure, particularly commercial real estate The Group has concentrated lending exposure to several sectors, most notably commercial real estate, giving rise to the risk of losses and reputational damage from unexpectedly high defaults. Another sector to which the Group has concentrated lending exposure is shipping. Several of the Group’s businesses are exposed to these sectors, principally NonCore, Ulster Bank and UK Corporate.
If one or more sovereigns exit the eurozone, credit ratings for eurozone borrowers more broadly may be downgraded, resulting in increases in credit spreads and decreases in security values, giving rise to market value losses.
To mitigate the impact of a eurozone sovereign default, the Group has reduced its exposures to peripheral eurozone countries. To mitigate the impact of the exit from the eurozone of one or more countries, and the sovereign ratings downgrade that would likely result, the Group has extended its limit control framework to include all eurozone countries.
Impact on the Group If the UK experiences an unexpectedly severe economic downturn, the Group is exposed to the risk of losses largely as a result of increased impairments in its retail and commercial businesses in the UK. Its investment banking activities in the UK could also be adversely affected.
Mitigants To mitigate the risk, the Group actively monitors its risk positions with respect to country, sector, counterparty and product relative to risk appetite, placing exposures on Watch and subjecting them to greater scrutiny. In addition, the Group reduces exposures when appropriate and practicable.
(iv) An increase in the Group’s obligations to support pension schemes The Group has established various pension schemes, thereby incurring certain obligations as sponsor of these schemes. All of the Group’s businesses are exposed to this risk.
Impact on the Group If the Group sells unsuitable products and services to customers or if the sales process is flawed, it may incur regulatory censure, including fines. In addition, it may suffer serious reputational damage.
Mitigants In order to mitigate these risks, the Group has taken a number of steps: In order to mitigate the risk of mis-selling, affected divisions are exiting some businesses and improving staff training and controls in others.
In order to improve the handling of customer complaints, divisions have detailed action plans in place to meet or exceed customer and regulatory requirements and address known shortcomings.
Impact on the Group If the Group sells products and services to sanctioned individuals or groups, it may expose itself to the risk of litigation as well as regulatory censure. Its reputation would also suffer materially.
The Group has also established and is implementing a plan to enhance the resilience of information technology and payment processing systems.
(iii) Losses or reputational damage arising from litigation Given its diverse operations, the Group is exposed to the risk of litigation. For example, during the course of 2012, it was the subject of investigations into its activities in respect of LIBOR as well as securitisation. This risk affects all of the Group’s divisions.
Impact on the Group As a result of litigation, the Group may incur fines, suffer reputational damage, or face limitations on its ability to operate. In the case of LIBOR, the Group reached settlements with the Financial Services Authority, the Commodity Futures Trading Association and the US Department of Justice. It continues to cooperate with other governmental and regulatory authorities in relation to LIBOR investigations; the probable outcome is that the Group will incur additional financial penalties at the conclusion of these investigations.
Impact on the Group Compliance with the regulation will require substantial changes in the Group’s systems. As a result, the Group may not be able to meet the deadline for implementation, giving rise to the risk of regulatory fines and censure. In addition, as such a failure would affect customers, it could also have a material negative impact on the Group’s reputation.
(i) A failure of information technology systems The Group relies on information technology systems to service its customers, giving rise to the risk of losses and significant reputational damage should one or more of these systems fail. The risks of an information technology system failure affects all of the Group’s businesses.
Impact on the Group A failure could prevent the Group from making or receiving payments, processing vouchers or providing other types of services to its customers.
A lack of management information could lead to an inadvertent breach of regulations governing capital or liquidity.
Group is also exposed to this risk indirectly, through outsourcing arrangements with third parties.
Mitigants The Group has developed a risk appetite framework to manage these risks and is implementing a plan to bring its risk position within risk appetite by improving batch processing through process redesign and simplification. The Group expects these investments to result in improvements over the course of 2013 and 2014.
(ii) A failure of operational controls The Group is exposed to the risk of losses arising from a failure of supervisory controls to prevent a deviation from procedures. An example of such a deviation is an unauthorised trading event. Should existing controls prove inadequate, one or more individuals may expose the Group to risks far in excess of its approved risk appetite. While all divisions are exposed to this risk to some degree, Markets is particularly at risk.
Qualitative risk appetite targets - The third strategic risk objective of maintaining stakeholder confidence covers qualitative aspects relating to the culture of risk management and controls and meeting stakeholder expectations. Risk appetite is based around identified expectations across a range of stakeholders (e.g. customers, employees, investors and the general public) and is closely aligned with key risk policies and controls (e.g. the Group Policy Framework, conduct risk, reputational risk).
Risk control frameworks and limits - Risk control frameworks set granular tolerances and limits for material risk types (e.g. credit risk, market risk, conduct risk and operational risk) that are used to manage risk on a day-to-day basis. These limits support and are required to be consistent with the high-level risk appetite targets.
The framework is supported by a programme of communication, engagement and training rolled out across the Group to engender a wide understanding of the purpose and value of an effective risk appetite.
The Group Policy Framework (see following section) directly supports the qualitative aspects of risk appetite, helping to rebuild and maintain stakeholder confidence in the Group’s risk control and governance. This integrated approach ensures that an appropriate standard of control is set for each of the material risks the Group faces, with an effective assurance process put in place to monitor and report on performance.
Risk appetite has its own policy standard within the Group Policy Framework that sets out clear roles and responsibilities to measure, cascade and report performance against risk appetite, and to provide assurances that business is being conducted within approved risk limits and tolerances.
Granular tolerances and limits, consistent with the high-level targets, are set and used to manage risk on a day-to-day basis
Creating sustainable value within risk appetite Risk appetite supports value creation delivered in a safe and sustainable way. It is embedded within the annual planning and budgeting process. Business strategies are designed on the basis of key value drivers (e.g. regulatory framework, customer franchises, internal control framework, incentives) and whether they fit within agreed risk appetite boundaries.
Economic capital - provides complementary insights, with a breadth of understanding of risk profile changes and ‘tail risks’ across millions of different modelled scenarios.
Sensitivity analysis - provides ‘ready reckoners’ around changes in key variables. It offers a high-level view on questions such as ‘what if GDP worsened by a further 1%?’, identifying certain tipping points where the Group’s risk profile moves outside its risk appetite.
Effective processes for reporting the results have also been developed, presenting the Board and senior management with a holistic and dynamic view of key risk exposures.
Group Policy Framework* Achieving and sustaining a robust control framework comparable to those of the Group’s strongest international peers is critical to achieving the successful delivery of the Group’s risk objectives.
The Group Policy Framework (GPF), introduced in 2009, supports this goal by providing a consistent and structured overarching framework for conduct, control and governance. It provides clear guidance and controls on how the Group does business, linked to its risk appetite, its business conduct and compliance responsibilities, and its focus on delivering a control environment consistent with best practice against relevant external benchmarks.
The GPF and related initiatives aim to ensure that: The Group has ethical principals and clear control standards to identify the risks it faces to support effective risk management and meet regulatory and legal requirements; Policies are followed across the Group and compliance can be clearly evidenced, assessed and reported by line management; The control environment is monitored and overseen through good governance.
A conduct risk framework was agreed and is being progressively established. Grouped under four policy standards - employee conduct, corporate conduct, market conduct; and conduct towards our customers - each is designed to provide high level direction to the Group and is supported by the Group's Code of Conduct (refer to page 347 for more detail).
Certain procedural-related policy standards were removed from the framework to reduce bureaucracy and simplify the structure.
The GPF continues to be improved. The results of assurance activity, monitoring and analysis of the internal and external environment are used to reassess the policy standards on a regular basis.
Risk appetite and risk governance continued Risk organisation* The Group has an independent risk management function (‘RBS Risk Management’) which manages risk through independent challenge and oversight of the customer-facing businesses and support functions. It provides an overarching risk control framework linked to the risk appetite of the Group.
The Head of Restructuring and Risk is the Group Chief Risk Officer, who leads this function through the strategic setting and execution of its responsibilities. The Head of Restructuring and Risk reports to the Group Chief Executive and the Board Risk Committee, with a right of access to the Chairman.
Oversight of risk within divisions is the responsibility of the relevant divisional Chief Risk Officer (CRO), with input from the relevant Group heads of function. This involves ensuring that: All activities undertaken by the individual divisions are consistent with the Group’s risk appetite targets; Group policies and resulting operating frameworks, including delegated authorities and limits, are complied with through effective monitoring and exception reporting; and
There is the effective operation of Group-wide risk processes such as the Group Policy Framework and the New Product Risk Assessment Process.
Divisional CROs have a direct functional reporting line to the Deputy Group CRO.
The Head of Restructuring and Risk and the Deputy Group CRO have a direct involvement in the selection, appointment or removal of divisional CROs and Group functional heads and also have responsibility for their ongoing performance assessment and management.
For more information on risk governance and a presentation of the Group’s risk committees, refer to pages 117 to 120. For a summary of the main risk types faced by the Group and how it manages each of them, refer to pages 122 to 126.
Risk appetite and risk governance: Risk governance* continued The key risk responsibilities of each of these committees as well as their membership are set out in the table below. Further information on the Group Board and Board Committees is available on page 297.
The Board Risk Committee provides oversight and advice to the Group Board on current and potential future risk exposure of the Group and risk strategy. It reviews the Group’s performance on risk appetite, oversees the operation of the Group Policy Framework and provides a risk review of remuneration arrangements. It operates under delegated authority from the Group Board.
Group Audit Committee The Group Audit Committee reviews accounting policies, financial reporting and regulatory compliance practices of the Group, as well as its systems and standards of internal controls and monitors the Group’s processes for internal audit and external audit. It has responsibility for monitoring relationships with regulatory authorities. It operates under delegated authority from the Group Board.
Group Chief Executive Group Finance Director Chief Administration Officer Chief Executive Officers of divisions Head of Restructuring and Risk Deputy Group Chief Risk Officer
Conduct Risk Committee The Conduct Risk Committee is responsible for the governance, leadership and strategic oversight of the Group’s conduct risk agenda, as well as escalating and reporting any material or strategically significant issues or matters to the Executive Risk Forum. It operates under delegated authority from the Executive Risk Forum.
Pension Risk Committee The Pension Risk Committee considers the Group-wide view of pension risk appetite, mechanisms that could potentially be used for managing risk within the funds, and implications of the pension schemes’ financial strategy. It also reviews actuarial funding assumptions from a Group perspective as appropriate. The Pension Risk Committee consults with the Trustee’s Investment Executive where necessary. The Pension Risk Committee operates under delegated authority from the Group Asset and Liability Management Committee.
Group A members (1) Head of Restructuring and Risk Deputy Chief Risk Officer Group Chief Credit Officer/Chief Credit Officer N.V. Head of Global Restructuring Group Chief Risk Officer, Corporate Banking
(1) Decisions require input from at least one member from each of
Divisional Risk and Audit Committees report to the Board Risk Committee and the Group Audit Committee on a quarterly basis. Their main responsibilities are to: monitor the performance of the divisions relative to divisional and Group risk appetite; and review accounting policies, internal control, financial reporting functions, internal audit, external audit and regulatory compliance.
Members: at least three non-executive members who are executives of the Group who do not have executive responsibility in the relevant division.
Internal stress tests The Group’s stress testing framework is designed to embed stress testing as a key risk management technique into mainstream risk reporting, capital planning and business processes at divisional, legal entity and Group levels.
The Executive Risk Forum (see Risk governance on page 119) is the main body overseeing the Group's stress testing approach, processes and results. The forum is primarily responsible for reviewing and challenging the results of any Group-wide stress test and ensuring that, where necessary, appropriate management actions are undertaken. The Board Risk Committee receives reports detailing stress tests undertaken as part of the financial planning process. It reviews and challenges the stress scenarios and considers their impact on the Group's financial position. These reports outline relevant management actions as well as the extent to which such actions mitigate the effects of the stress scenario on the Group’s capital adequacy. The Board Risk Committee may also request additional stress tests as it deems necessary.
Stress testing is performed centrally by Group functions both to meet regulatory requirements and for ad-hoc business analysis and decision-making. These stress tests also include reverse stress tests, which identify scenarios and circumstances that could render RBS’s business model unviable.
Stress test scenarios specifically target both firm-wide vulnerabilities and negative global impacts. They consider a five-year horizon and include stress projections for macroeconomic variables such as GDP, unemployment rates, property prices, stock price indices, interest rates and inflation.
Risk appetite and risk governance continued Risk coverage* The main risk types faced by the Group are presented below, together with a summary of the key areas of focus and how the Group managed these risks in 2012.
Core Tier 1 ratio was 10.3%, a sixty basis point improvement on 2011 (excluding the effect of APS). This largely reflected reduction in risk profile with risk-weighted assets (RWAs) down by nearly 10%, principally in Non-Core due to disposals and runoff and in Markets.
Credit risk The risk that the Group will incur losses owing to the failure of a customer or counterparty to meet its obligation to settle outstanding amounts.
The Group manages credit risk based on a suite of credit approval, risk concentration, early warning and problem management frameworks and associated risk management systems and tools.
With a view to strengthening its credit risk management framework and ensuring consistent application across the Group, during 2012 the Group Credit Risk function launched a set of credit control standards with which divisions must comply, to supplement the existing policy suite. These standards comprise not only governance and policy but also behavioural, organisational and management norms that determine how the Group manages credit from origination to repayment.
Risk type Definition Features How the Group managed risk and the focus in 2012
Under the Group's country risk framework, all countries except the UK and the US are currently under limit control. All countries with material exposures are monitored continually using the Group’s country risk watchlist process to identify emerging issues and facilitate the development of mitigation strategies. Detailed portfolio reviews are undertaken on a regular basis to ensure that country portfolio compositions remain aligned to the Group’s country risk appetite in light of evolving economic and political developments.
The majority of the Group’s market risk exposure is in the Markets, International Banking and Non-Core divisions and Group Treasury. The Group is also exposed to market risk through interest rate risk and foreign exchange risk on its non-trading activities in the retail and commercial businesses.
A comprehensive structure is in place aimed at ensuring the Group does not exceed its qualitative and quantitative tolerance for market risk.
Operational risk data have been enriched by the outputs from these enhancements, resulting in a more complete view of the Group’s operational risk profile and more informed risk appetite decisions.
Regulatory risk The risk arising from noncompliance with regulatory requirements, regulatory change or regulator expectations.
Adverse impacts on strategy, capital structure, business models and operational effectiveness.
Management of regulatory risk entails early identification and effective management of changes in legislative and regulatory requirements that may affect the Group.
Within the Group Policy Framework, specific policies define the minimum standards for regulatory engagement, upstream risk management and registration and licensing of individuals. These set minimum standards within their respective areas, applicable across the Group.
During 2012, the Group, along with the rest of the banking industry, continued to experience unprecedented levels of prospective changes to laws and regulations from national and supranational regulators. Particular areas of focus were: conduct regulation; prudential regulation (capital, liquidity, governance and risk management); treatment of systemically important entities (systemic capital surcharges and recovery and resolution planning); and structural reforms, with the UK’s Independent Commission on Banking proposals, the European Union’s Liikanen Group recommendations and the DoddFrank /Volcker Rule agenda in the US.
Arises from breaches of regulatory rules or laws by individual employees, or as a result of the Group’s retail or wholesale market conduct.
Non-compliance may result in regulator enforcement, adverse publicity and financial penalties.
Reputational risk The risk of brand damage and/or financial loss due to the failure to meet stakeholders’ expectations of the Group.
Can arise from a range of actions taken (or, in some cases, not taken) by the Group, as well as its wider policies and practices.
Can be detrimental to the business in a number of ways, including an inability to build or sustain customer relationships, low staff morale, regulatory censure, or reduced access to funding sources.
The Group Board has ultimate responsibility for managing the Group's reputation, although all parts of the Group have responsibility for any reputational impact arising from their operations. The Board's oversight is supported by executive risk committees (including a new Conduct Risk Committee) and by the Group Sustainability Committee.
In 2012, the Group strengthened the alignment of reputational risk management with its strategic objective of serving customers well and with the management of a range of risk types that have a reputational sensitivity. There are still legacy reputational issues to work through, but dealing with them in an open and direct manner is a necessary prerequisite to rebuilding a strong reputation for the Group.
The Group seeks to minimise its exposure to business risk, subject to its wider strategic objectives. Business risk is identified, measured and managed through the Group’s planning cycles and performance management processes.
The management of business risk lies primarily with divisions, with oversight at the Group level led by Finance.
In 2012, the Group focused on enhancing its pension risk management and modelling systems and implementing a Group pension risk policy standard.
Looking forward 135 Basel III 135 Model changes 136 Other regulatory capital changes 136 European Banking Authority (EBA) recommendation 136
Capital management Introduction* The Group aims to maintain an appropriate level of capital to meet its business needs and regulatory requirements, and the Group operates within an agreed risk appetite.
2012 achievements* The Group’s Core Tier 1 ratio of 10.3% is higher than at the end of 2011 (after adjusting for Asset Protection Scheme effects) despite absorbing regulatory changes equivalent to 109 basis points and in the face of challenging economic headwinds and continuing costs of de-risking. This has been achieved through a continued focus on reshaping the Group’s use of capital.
The capital allocation approaches used in the Group will be developed to become increasingly risk sensitive and align risk management and resource allocation more fully.
Monitoring and maintenance* Based on these determinations, which are continually reassessed, the Group aims to maintain capital adequacy, both at Group level and in each regulated entity.
The Group operates a rigorous capital planning process aimed at ensuring the capital position is controlled within the agreed parameters. This incorporates regular re-forecasts of the capital positions of the regulated entities and the overall Group. In the event that the projected position might deteriorate beyond acceptable levels, the Group would issue further capital and/or revise business plans accordingly.
Stress testing approaches are used to determine the level of capital required to ensure the Group expects to remain adequately capitalised.
The Group aims to deliver sustainable returns across the portfolio of businesses with projected business returns stressed to test key vulnerabilities.
The Financial Services Authority (FSA) uses the risk asset ratio as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its RWAs (the assets and off-balance sheet exposures are weighted to reflect the inherent credit and other risks). By international agreement, the risk asset ratios should not be less than 8% with a Tier 1 component of not less than 4%.
Refer to page 135 for details on regulatory changes due to Basel III and Capital Requirement Directive IV and commentary on related projections for the Group.
Supervisory deductions At 1 January 2012 (4,828) Decrease in deductions 2,341 At 31 December 2012 (2,487)
Reconciliation between accounting and regulatory consolidation* The table below provides a reconciliation between accounting and regulatory consolidation.
Notes: (1) The Group must only include particular types of subsidiary undertaking in the regulatory consolidation. Insurance undertakings and non-financial undertakings are excluded from the regulatory consolidation, although they are included in the consolidation for financial reporting. (2) The Group must proportionally consolidate its associated undertakings where they are classified as credit institutions or financial institutions for regulatory purposes. These will generally have been equity accounted for financial reporting purposes.
Shareholders’ equity (excluding non-controlling interests) Called-up share capital 6,582 15,318 15,125 Paid-in equity 431 431 431 Share premium 24,361 24,001 23,922 Retained earnings 10,596 18,929 21,239 AFS reserve - debt securities (409) (1,065) (2,061) AFS reserve - equity shares 63 108 25 Cash flow hedging reserve 1,666 879 (140)
Less: innovative securities transferred to other Tier 1 capital (431) (431) (431) Less: preference shares transferred to other Tier 1 capital (4,313) (4,313) (4,313)
Non-controlling interests 2,318 1,234 1,719 Less: innovative securities transferred to other Tier 1 capital (548) (548) (548) Less: minority interest deconsolidated (1,367) (259) (259)
Regulatory adjustments and deductions Own credit 691 (2,634) (1,182) Defined benefit pension adjustment 913 — — Unrealised losses on AFS debt securities 409 1,065 2,061 Unrealised gains on AFS equity shares (63) (108) (25) Cash flow hedging reserve (1,666) (879) 140 Other adjustments for regulatory purposes (197) 571 204 Goodwill and other intangible assets (13,545) (14,858) (14,448)
Qualifying Tier 2 capital Subordinated debt 26,773 26,319 27,053 Less: transferred to other Tier 1 capital (4,200) (4,782) (4,780)
Tier 2 deductions 50% of securitisation positions (1,107) (2,019) (2,321) 50% excess of expected losses over impairment provisions (2,522) (3,451) (2,658)
Attributable loss, net of fair value of own credit, of £2.6 billion was partially offset by lower Core Tier 1 deduction for securitisation positions of £1.1 billion, primarily relating to restructuring of monolines within Non-Core.
Capital management continued Risk-weighted assets* Divisional analysis Risk-weighted assets by risk category and division were as follows: Credit risk Non-counterparty Counterparty
At 1 January 2012 344.3 61.9 64.0 37.9 508.1 Business and market movements (1) (46.0) (20.4) (16.3) 7.9 (74.8)
The increase in operational risk follows the recalibration based on the average of the previous three years financial results. The substantial losses recorded in 2008 no longer feature in the calculation.
Model changes of £44 billion reflect: - Changes to credit metrics applying to corporate, bank and sovereign exposures as models were updated to reflect more recent experience, £30 billion; and - Application, of slotting approach to UK commercial real estate exposures, £12 billion.
Looking forward Basel III* The rules issued by the Basel Committee on Banking Supervision (BCBS), commonly referred to as Basel III, are a comprehensive set of reforms designed to strengthen the regulation, supervision, risk and liquidity management of the banking sector.
CRD IV and Basel III will impose a minimum common equity Tier 1 (CET1) ratio of 4.5% of RWAs. There are three buffers which will affect the Group: the capital conservation buffer(1); the counter-cyclical capital buffer(2) (up to 2.5% of RWAs), to be applied when macro-economic conditions indicate areas of the economy are over-heating; and the Global-Systemically Important Bank (G-SIB) buffer(3), leading to an additional common equity Tier 1 requirement of 4% and a total common equity Tier 1 ratio of 8.5%. The regulatory target capital requirements will be phased in and are expected to apply in full from 1 January 2019.
The actual impact of CRD IV on capital ratios may be materially different as the requirements and related technical standards have not yet been finalised and will ultimately be subject to application by local regulators. The actual impact will also be dependent on required regulatory approvals and the extent to which further management action is taken prior to implementation.
Models changes The Group, in conjunction with the FSA, regularly evaluates its models for the assessment of RWAs ascribed to credit risk (including counterparty risk) across various classes. This includes implementing changes to the RWA requirements for commercial real estate portfolios consistent with revised industry guidance from the FSA. The changes to RWA resulting from model changes during 2012 have increased RWA requirements by £44 billion of which £12 billion relates to property guidance. Further uplifts are expected in 2013 totalling c.£10 billion to £15 billion.
Other regulatory capital changes* The Group is managing the changes to capital requirements from new regulation and model changes and the resulting impact on the common equity Tier 1 ratio, focusing on risk reduction and deleveraging. This is principally being achieved through the continued run-off and disposal of Non-Core assets and deleveraging in Markets, as the business focuses on the most productive returns on capital. Markets RWAs decreased by £19 billion in 2012 which also lessens the increases driven by the counterparty risk changes in CRD IV.
European Banking Authority (EBA) recommendation The EBA issued a recommendation in 2011 that the national regulators should ensure that credit institutions build up a temporary capital buffer to reach a 9% Core Tier 1 ratio by 30 June 2012 (‘the recapitalisation of EU banks’). In its final report on the recapitalisation exercise in October 2012, the EBA stated that once the CRD IV is finally adopted, the 2011 recommendation would be replaced with a new recommendation. The new recommendation will include the requirement for banks to maintain a nominal amount of Core Tier 1 capital as defined by the EBA for the 2011 stress test and recapitalisation recommendation) corresponding to the amount of 9% of the RWAs at 30 June 2012. The Group does not expect the potential floor to become a limiting factor.
Note: (1) Based on the following principal assumptions: (i) divestment of Direct Line Group (ii) deductions for financial holdings of less than 10% of common equity Tier 1 capital have been excluded pending the finalisation of CRD IV rules (iii) RWA uplifts assume approval of all regulatory models and completion of planned management actions (iv) RWA uplifts include the impact of credit valuation adjustments (CVA) and asset valuation correlation on banks and central clearing counterparties (v) EU corporates, pension funds and sovereigns are assumed to be exempt from CVA volatility charge in calculating RWA impacts.
Funding risk 143 Funding sources 143 Central bank funding 143 Balance sheet composition 143
Liquidity and funding risk: Analyses 144 Funding sources 144 – Notes issued 144 – Deposit and repo funding 145 – Divisional loan:deposit ratios and funding gaps 145 – Long-term debt issuance 146 Liquidity 147 – Liquidity portfolio 147 – Net stable funding ratio 149 Maturity analysis 150 Encumbrance 151 Non-traded interest rate risk 153 – Introduction and methodology 153 – Analyses 153
Currency risk 155 – Structural foreign currency exposures 155 Non-traded equity risk 156
Liquidity, funding and related risks Introduction Liquidity risk is the risk that the Group is unable to meet its financial obligations, including financing wholesale maturities or customer deposit withdrawals, as and when they fall due. Liquidity risk is highly dependent on company specific characteristics such as the maturity profile and composition of the Group’s assets and liabilities, the quality and marketable value of its liquidity buffer and broader market factors, such as wholesale market conditions alongside depositor and investor behaviour.
2012 achievements and looking forward* The Group continued to make solid progress in pursuit of its safety and soundness agenda throughout 2012, with the majority of its medium-term balance sheet targets now met or exceeded. This is despite particularly volatile wholesale market conditions during most of the year due to ongoing stresses emanating from the eurozone.
The Group has actively reduced short-term wholesale funding and has a lower wholesale funding need compared to earlier years. Progress has largely been due to the continued success in executing the Group’s restructuring efforts, as well as by attracting deposits and continuing to deleverage via the run down of Non-Core and risk reductions in Markets. The Group has a smaller balance sheet that is funded by a diverse and stable deposit base.
The Group repaid all the remaining emergency UK Government funding and liquidity support that was provided to it during 20082009 under the Credit Guarantee Scheme and Special Liquidity Scheme.
The Group resumed coupon payments on hybrid capital securities following the end of the two year coupon payment ban imposed by the European Commission as part of its 2009 State Aid ruling. Coupons remain suspended on Tier 1 instruments issued by RBS Holdings N.V. until the end of April 2013.
The overall size of the liquidity buffer reduced modestly to £147.2 billion from £155.3 billion reflecting the lower levels of short-term wholesale funding and a smaller balance sheet. This also allowed the Group to alter the ratio of primary to secondary liquid assets within the liquidity buffer to 62%:38% from 77%:23%. This reweighting, by reducing the holdings of the lowest yielding liquid assets, benefited the Group’s net interest margin, whilst maintaining a higher quality buffer.
RBS Group plc, RBS plc, RBS Citizens Financial Group Inc. and
Direct Line Insurance Group plc in aggregate issued £4.8 billion of subordinated liabilities in 2012.
These policies are designed to address three broad issues which ensure that: the Group’s main legal entities maintain adequate liquidity resources at all times to meet liabilities as and when they fall due; the Group maintains an adequate liquidity buffer appropriate to the business activities of the Group and its risk profile; and the Group has in place robust strategies, policies, systems and procedures for identifying, measuring, monitoring and managing liquidity risk.
At its simplest, these policies and the governance and actions they mandate, determine the sources of liquidity risk and the steps the Group can take when these risks exceed certain tolerances which are actively monitored. These include not only when and how to use the Group’s liquidity buffer but also what other adjustments to the Group’s balance sheet could be undertaken to manage these risks within Group appetite.
During 2012, the Group’s liquidity risk management was tested by two different events, the lowering of the Group’s credit rating and the technology incident. These two events highlight the variety of circumstances and events through which liquidity risk can materialise.
Conversely, the technology event could not be foreseen and whilst similar steps to understand the full impact needed to be taken, the process was performed under a vastly compacted timeframe. Both events have demonstrated the considerable progress the Group has made in addressing the sources of liquidity risk and mitigating any impacts, real or reputational.
Policy, framework and governance Governance The Group has in place a robust and comprehensive set of policies and procedures for assessing, measuring and controlling the liquidity risk within the Group. This ensures that the Group always maintain sufficient eligible and appropriate financial resources to meet its forward looking financial commitments as they fall due.
In setting risk limits the Board takes into account the nature of the Group’s various activities, the Groups overall risk appetite, market best practice and regulatory compliance.
Analogous provisions and requirements exist for each member of the Group, who must comply with both internal standards and local regulatory frameworks for the different jurisdictions in which they operate.
This in turn leads to the Group and the FSA agreeing the parameters of Group’s Individual Liquidity Guidance (ILG). Which influences the overall size of the Group’s liquidity buffer.
The Group has identified ten specific liquidity risk factors which range from the risk associated with both behavioural and contractual customer deposit outflows, through to firm-specific reputational factors that could impact the Group’s liquidity position from time to time.
In addition, the Group follows the broader market developments in respect of the ongoing evolution of industry and regulatory liquidity risk policies that are currently being debated at an international level and adjusts its policies and processes where appropriate.
The majority of this work is conducted under the auspices of the Basel Committee on Bank Supervision and includes discussion on important measures such as the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR). The Group will always look to proactively adopt such measures into its reporting capabilities provided that there is an alignment and agreement between domestic and international regulators on these issues and specific country regulatory rules are updated to reflect these agreements.
At present there is a broad range of interpretations on how to calculate the NSFR and, especially, the LCR due to the lack of a commonly agreed market standard. There are also inconsistencies between the current regulatory approach of the FSA and that being proposed in the LCR with respect to the treatment of unencumbered assets that could be pledged to central banks via a discount window facility. This makes meaningful comparisons of the LCR between institutions difficult. The Group will continue to work with regulators and industry groups to measure and report the impact of the rules as they are finalised. Assumptions will be refined as regulatory interpretations evolve.
Liquidity measurement and monitoring Liquidity risk is measured and assessed on a daily basis at Group level. The Group uses a set of internal and regulatory metrics and analysis to assess liquidity risk.
The Group uses limits to manage and control the overall extent of liquidity risk within the balance sheet. Limits focus on the aggregate risk, the amount and composition of particular sources of liabilities, asset liability mismatches and third party counterparty concentrations. Reported balance sheet metrics such as loan:deposit ratio targets or the percentage of short-term wholesale funding are examples of these limits.
Stress and scenario testing is used to help inform a broader understanding of liquidity risk as well as to model specific liquidity risks events, for example the secession of a country from the euro.
Stress testing* The strength of any bank’s liquidity risk management can only be evaluated on the Group’s ability to survive under stress.
Simulated liquidity stress testing is regularly performed for each business as well as the major operating subsidiaries. Stress tests are designed to look at the impact of a variety of firm-specific and market-related scenarios on the future adequacy of the Group’s liquidity resources. Stress tests can be run at any time in response to the emergence of one of these risks.
Scenarios include assumptions about significant changes in key funding sources, external credit ratings, contingent uses of funding, and political and economic conditions or events in particular countries. For example, during 2012 the Group undertook a specific series of stress tests to assess the likely worst case impact associated with a one notch downgrade to the Group’s credit rating by Moody’s. Stress scenarios are applied to both on-balance sheet instruments and off-balance sheet activities, to provide a comprehensive view of potential cash flows.
In determining the adequacy of the Group’s liquidity resources the Group focuses on the stressed outflows it could be anticipated to experience as a result of any stress scenario occurring. These outflows are measured as occurring over certain time periods which extend from any given day out to two weeks, to as long as three months. The Group is expected to be able to withstand these stressed outflows through its own resources (principally the use of the liquidity buffer) over these time horizons without having to revert to extraordinary central bank or governmental assistance.
The Group’s liquidity risk appetite is measured by reference to the liquidity buffer as a percentage of stressed contractual and behavioural outflows under the worst of three severe stress scenarios as envisaged under the FSA regime. Liquidity risk is expressed as a surplus of liquid assets over three months’ stressed outflows under the worst of a marketwide stress, an idiosyncratic stress and a combination of both. At 31 December 2012, the Group’s holding of liquid assets was 128% of the worst case stress requirements.
Intra-group commitments and support - Risk of cash within subsidiaries becoming unavailable to the wider Group and contingent calls for funding on Group Treasury from subsidiaries and affiliates.
Off-balance sheet activities - Collateral outflows due to market movements, and all collateral owed by the Group to counterparties but not yet called; anticipated increase in firm’s derivative initial margin requirement in stress scenarios; collateral outflows contingent upon a multi-notch credit rating downgrade of Group firms; drawdown on committed facilities provided to corporates, based on counterparty type, creditworthiness and facility type; and drawdown on retail commitments.
Liquidity reserves Liquidity risks are mitigated by the Group’s centrally managed liquidity buffer. The size of the reserve is an output from internal modelling and the FSA’s ILG. The majority of the portfolio is held in the FSA regulated UK Defined Liquidity Group (UK DLG) comprising the Group’s five UK banks: The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co and Adam & Company.
The Group‘s liquidity buffer is managed by Group Treasury and is the responsibility of the Group Treasurer. The liquidity buffer is ring-fenced from the trading book within the Markets division. The liquidity buffer is actively managed so as to balance its liquidity value relative to the margin impact of maintaining a large and high quality investment portfolio. This is in line with internal liquidity risk policy and appetite and regulatory guidance. The portfolio is accounted for on an available-for-sale basis. The value of the portfolio can move up and down based on a variety of market movements. Gains can and will be taken through sales of portfolios. Such sales and gains are part of normal portfolio management and these gains can be used to offset costs in other parts of the Group.
The Group in consultation with the FSA and subject to the requirements of the FSA’s ILG can change the composition of its liquidity buffer. The change in composition may relate to market specific factors, changes in internal liquidity risk mix or regulatory guidance. This occurred in 2012 when the FSA agreed to recognise an increase in the amount of secondary liquidity assets and a reduction in primary assets. Such a change was made possible in conjunction with the introduction of the Funding for Lending Scheme. The reduction in the balance of primary assets was also beneficial to the Group’s margin.
The Group’s lead regulator is the UK Financial Services Authority (FSA). The FSA implemented a new liquidity regime as documented in PS 09/16, on 1 June 2010. The new rules provide a standardised approach applied to all UK banks and all building societies as well as branches and subsidiaries of foreign financial firms. The rules focus on the UK DLG and cover adequacy of liquidity resources, controls, stress testing and the Individual Liquidity Adequacy Assessment.
In addition, in the US, the Group’s operations must meet liquidity requirements set out by the US Federal Reserve Bank, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Financial Industry Regulatory Authority. In the Netherlands, RBS N.V. is subject to the De Nederlandsche Bank liquidity oversight regime.
Funding sources The Group has access to a variety of wholesale funding sources across the globe, including short-term money markets and term debt investors through its secured and unsecured funding programmes. These sources of funding are complementary to the Group’s customer deposit gathering activities.
The Group accesses the market directly or through one of its main operating subsidiaries through established funding programmes. The use of different entities to access the market from time to time allows the Group to further diversify its funding profile, take advantage of different benefits offered by using these entities, and in certain limited circumstances demonstrate to regulators that specific operating subsidiaries enjoy market access in their own right. This flexibility will become increasingly important in the future as the Group moves towards complying with the Independent Commission on Banking recommendations.
Central bank funding* The Group may access various funding facilities offered by central banks from time to time. The use of such facilities can be both part of a wider strategic objective to support initiatives to help stimulate economic growth or as part of the Group’s broader liquidity management and funding strategy. Overall usage and repayment of available central bank facilities will fit within the Group’s overall liquidity risk appetite and concentration limits contained therein so as not to create outsized maturity exposures.
Balance sheet composition The Group’s balance sheet composition is a function of the broad array of product offerings and diverse markets served by its Core divisions. The structural composition of the balance sheet is augmented as needed through active management of both asset and liability portfolios. The objective of these activities is to optimise the liquidity profile in normal business environments, while ensuring adequate coverage of all cash requirements under extreme stress conditions.
Less than 1 year 11,164 21,396 36,302 — 27 68,889 624 69,513 37 1-3 years — 278 26,595 2,760 479 30,112 3,338 33,450 18 3-5 years — 2 16,627 3,673 — 20,302 7,232 27,534 14 More than 5 years — 1 26,185 2,674 14,458 43,318 15,125 58,443 31 11,164 21,677 105,709 9,107 14,964 162,621 26,319 188,940 100
Deposit and repo funding The table below shows the composition of the Group’s deposits excluding repos and repo funding.
UK Corporate 104,593 127,070 82 22,477 Wealth 16,965 38,910 44 21,945 International Banking (4) 39,500 46,172 86 6,672 Ulster Bank 28,742 22,059 130 (6,683)
UK Corporate 108,668 126,309 86 17,641 Wealth 16,834 38,164 44 21,330 International Banking (4) 46,417 45,051 103 (1,366)
Notes: (1) Excludes reverse repurchase agreements and stock borrowing and net of impairment provisions. (2) Excludes repurchase agreements and stock lending. (3) Based on loans and advances to customers net of provisions and customer deposits as shown. (4) All conduits relate to International Banking and have been extracted and shown separately as they were funded by commercial paper issuance until the end of the third quarter of 2012.
Long-term debt issuance The table below shows debt securities issued by the Group during the year with an original maturity of one year or more. The Group also executes other long-term funding arrangements (predominantly term repurchase agreements) which are not reflected in the following table.
UK DLG (1) CFG Other Total Average* 2012 £m £m £m £m £m
Cash and balances at central banks 43,804 2,314 7,543 53,661 Central and local government bonds AAA rated governments and US agencies 32,337 4,830 4,268 41,435 AA- to AA+ rated governments (2) 2,404 — 1,340 3,744 governments rated below AA — — 1,029 1,029 local government — — 5,672 5,672 34,741 4,830 12,309 51,880 Treasury bills 14,529 — — 14,529 Primary liquidity 93,074 7,144 19,852 120,070 Other assets (3) AAA rated 7,787 — 10,049 17,836 below AAA rated and other high quality assets 8,313 4,601 3,779 16,693 Secondary liquidity 16,100 4,601 13,828 34,529 Total liquidity portfolio 109,174 11,745 33,680 154,599
Notes: (1) The FSA regulated UK Defined Liquidity Group (UK DLG) comprises the Group’s five UK banks: The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co and Adam & Company. In addition, certain of the Group's significant operating subsidiaries - RBS N.V., RBS Citizens Financial Group Inc. (CFG) and Ulster Bank Ireland Limited (UBIL) - hold locally managed portfolios of liquid assets that comply with local regulations that may differ from FSA rules.
(2) Includes US government guaranteed and US government sponsored agencies. (3) Includes assets eligible for discounting at the Bank of England and other central banks.
Equity 70 70 76 76 77 77 100 Wholesale funding > 1 year 109 109 124 124 154 154 100 Wholesale funding < 1 year 70 — 134 — 157 — — Derivatives 434 — 524 — 424 — — Repurchase agreements 132 — 129 — 115 — — Deposits - retail and SME - more stable 203 183 227 204 172 155 90 - retail and SME - less stable 66 53 31 25 51 41 80 - other 164 82 179 89 206 103 50 Other (2) 64 — 83 — 98 — — Total liabilities and equity 1,312 497 1,507 518 1,454 530
Cash 79 — 79 — 57 — — Inter-bank lending 29 — 44 — 58 — — Debt securities > 1 year - governments AAA to AA- 64 3 77 4 89 4 5 - other eligible bonds 48 10 73 15 75 15 20 - other bonds 19 19 14 14 10 10 100 Debt securities < 1 year 26 — 45 — 43 — — Derivatives 442 — 530 — 427 — — Reverse repurchase agreements 105 — 101 — 95 — — Customer loans and advances > 1 year - residential mortgages 145 94 145 94 145 94 65 - other 136 136 173 173 211 211 100 Customer loans and advances < 1 year - retail loans 18 15 19 16 22 19 85 - other 131 66 137 69 125 63 50 Other (3) 70 70 70 70 97 97 100 Total assets 1,312 413 1,507 455 1,454 513 Undrawn commitments 216 11 240 12 267 13 5 Total assets and undrawn commitments 1,528 424 1,747 467 1,721 526
Notes: (1) Available stable funding. (2) Deferred tax, insurance liabilities and other liabilities. (3) Prepayments, accrued income, deferred tax, settlement balances and other assets.
Markets' strategy, and funding requirement relating to long-term lending decreased by £37 billion, reflecting de-risking, sales and repayments in Non-Core.
Liquidity and funding risk: Analyses continued Maturity analysis The contractual maturity of balance sheet assets and liabilities highlights the maturity transformation which underpins the role of banks to lend longterm, but to fund themselves predominantly through short-term liabilities such as customer deposits. This is achieved through the diversified funding franchise of the Group across an extensive customer base, and across a wide geographic network. In practice, the behavioural profiles of many liabilities exhibit greater stability and longer maturity than the contractual maturity. This is particularly true of many types of retail and corporate deposits which whilst may be repayable on demand or at short notice, have demonstrated very stable characteristics even in periods of acute stress such as those experienced in 2008.
Retail & Commercial* The table below illustrates the contractual and behavioural maturity analysis of Retail & Commercial customer deposits.
Contractual maturity The following table shows the residual maturity of financial instruments, based on contractual date of maturity. Held-for-trading (HFT) assets and liabilities have been excluded from the maturity analysis in view of their short-term nature and are shown in total in the table below. Hedging derivatives are included within the relevant maturity bands.
HFT HFT Total 2012 £m £m £m £m £m £m £m £m £m £m
Bank repos 3,551 3,261 — — 1,150 — — 7,962 36,370 44,332 Customer repos 2,733 3,083 — — — — — 5,816 82,224 88,040 Deposits by banks 15,046 1,409 564 489 7,127 336 1,532 26,503 30,571 57,074 Customer accounts 359,157 14,773 8,933 15,662 18,932 3,660 798 421,915 12,077 433,992 Debt securities in issue 2,248 2,639 7,996 6,263 21,220 12,038 31,309 83,713 10,879 94,592 Settlement balances 5,875 — — — 3 — — 5,878 — 5,878 Short positions — — — — — — — — 27,591 27,591 Derivatives — 310 251 501 1,790 1,262 1,682 5,796 428,544 434,340 Subordinated liabilities 231 184 1,352 620 7,070 862 16,983 27,302 — 27,302 Other liabilities 1,684 — — — 8 1 3 1,696 — 1,696 Total financial liabilities 390,525 25,659 19,096 23,535 57,300 18,159 52,307 586,581 628,256 1,214,837
not currently encumbered but can for instance be used to access funding from market counterparties or central bank facilities as part of the Group’s contingency funding.
Covered bond programme Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards associated with these loans, the partnerships are consolidated, the loans retained on the Group’s balance sheet and the related covered bonds in issue included within debt securities in issue. The following table shows the asset categories and the carrying amounts of those assets and of the covered bonds issued.
Securities repurchase agreements and lending transactions The Group enters into securities repurchase agreements and securities lending transactions (repos) under which it transfers securities in accordance with normal market practice. Generally, the agreements require additional collateral to be provided if the value of the securities falls below a predetermined level. Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction. Securities sold under repurchase transactions are not derecognised if the Group retains substantially all the risks and rewards of ownership. The fair value (which is equivalent to the carrying value) of securities transferred under such repurchase transactions included within debt securities on the balance sheet are set out below. All of these securities could be sold or repledged by the holder.
Encumbered assets relating to: Debt securities in issue Other secured liabilities
Total encumbered assets Liquidity portfolio Other Total £bn £bn £bn £bn £bn £bn
Encumbered assets as a % of related total assets £bn £bn £bn
Cash and balances at central banks 5.3 0.5 — — — 5.8 7 70.2 3.3 79.3 Loans and advances to banks (1) — — 12.8 — — 12.8 41 — 18.5 31.3 Loans and advances to customers (1) - UK residential mortgages 16.4 16.0 — — — 32.4 30 58.7 18.0 109.1 - Irish residential mortgages 10.6 — — — 1.8 12.4 81 — 2.9 15.3 - US residential mortgages — — — — — — — 7.6 14.1 21.7 - UK credit cards 3.0 — — — — 3.0 44 — 3.8 6.8 - UK personal loans 4.7 — — — — 4.7 41 — 6.8 11.5 - other 20.7 — 22.5 — 0.8 44.0 16 6.5 217.1 267.6 Debt securities 1.0 — 8.3 91.2 15.2 115.7 70 22.3 26.6 164.6 Equity shares — — 0.7 6.8 — 7.5 49 — 7.7 15.2 61.7 16.5 44.3 98.0 17.8 238.3 165.3 318.8 722.4
Liabilities secured Intra-Group - used for secondary liquidity (22.6) — — — — (22.6) Intra-Group - other (23.9) — — — — (23.9) Third-party (2) (12.0) (10.1) (60.4) (132.4) (15.3) (230.2) (58.5) (10.1) (60.4) (132.4) (15.3) (276.7)
Notes: (1) Excludes reverse repos. (2) In accordance with market practice the Group employs its own assets and securities received under reverse repo transactions as collateral for repos.
Key points The Group’s encumbrance ratio dropped marginally from 19% to 30% of the Group’s residential mortgage portfolio was encumbered
Non-traded interest rate risk Introduction and methodology Non-traded interest rate risk impacts earnings arising from the Group’s banking activities. This excludes positions in financial instruments which are classified as held-for-trading, or hedging items.
The Group provides a range of financial products to meet a variety of customer requirements. These products differ with regard to repricing frequency, tenor, indexation, prepayments, optionality and other features. When aggregated, they form portfolios of assets and liabilities with varying degrees of sensitivity to changes in market rates.
The Group policy is to manage interest rate sensitivity in banking book portfolios within defined risk limits. With the exception of CFG and Markets, interest rate risk is transferred from the divisions to Group Treasury. Aggregate positions are then hedged externally using cash and derivative instruments, primarily interest rate swaps, to manage exposures within Group Asset and Liability Management Committee (GALCO) approved limits.
Key measures used to evaluate IRRBB are subject to approval by divisional Asset and Liability Management Committees (ALCOs) and GALCO. Limits on IRRBB are proposed by the Group Treasurer for approval by the Executive Risk Forum annually. Residual risk positions are reported on a regular basis to divisional ALCOs and monthly to the Group Balance Sheet Management Committee, GALCO, the Executive Risk Forum and the Group Board.
The Group uses a variety of approaches to quantify its interest rate risk encompassing both earnings and value metrics. IRRBB is measured using a version of the same value-at-risk (VaR) methodology that is used for the Group’s trading portfolios. Net interest income exposures are measured in terms of earnings sensitivity over time against movements in interest rates.
Analyses Value-at-risk VaR metrics are based on interest rate repricing gap reports as at the reporting date. These incorporate customer products and associated funding and hedging transactions as well as non-financial assets and liabilities such as property, plant and equipment, capital and reserves. Behavioural assumptions are applied as appropriate.
The reduction in VaR seen across all currencies reflects closer matching of the Group’s structural interest rate hedges to the behavioural maturity profile of the hedged liabilities as well as changes to the VaR methodology (refer to page 244 for more details on VaR methodology improvement).
The following table shows the sensitivity of net interest income, over the next twelve months, to an immediate upward or downward change of 100 basis points to all interest rates. In addition, the table includes the impact of a gradual 400 basis point steepening and a gradual 300 basis point flattening of the yield curve at tenors greater than a year.
+ 100 basis points shift in yield curves (19) 190 59 14 244 100 basis points shift in yield curves 25 (188) (4) (16) (183)
The primary contributors to the increased sensitivity to a 100 basis points parallel shift in the yield curve are changes to underlying business pricing assumptions and assumptions in respect of the risk of early repayment of consumer loans and deposits. The latter incorporates revisions to pricing strategies and consumer behaviour.
The impact of the steepening and flattening scenarios is largely driven by the reinvestment of structural hedges. The year on year change reflected a change to a longer term hedging programme implemented in 2010.
Currency risk Structural foreign currency exposures The Group does not maintain material non-traded open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding.
US dollar 17,137 2 17,135 (1,820) 15,315 (4,058) 11,257 Euro 8,443 33 8,410 (578) 7,832 (2,305) 5,527 Other non-sterling 5,320 244 5,076 (4,135) 941 — 941 30,900 279 30,621 (6,533) 24,088 (6,363) 17,725
Note: (1) The economic hedges represent US dollar and euro preference shares in issue that are treated as equity under IFRS and do not qualify as hedges for accounting purposes.
Key points The Group’s structural foreign currency exposure at 31 December 2012 was £24.0 billion and £17.9 billion before and after economic hedges respectively, broadly unchanged from the end of 2011.
Objective Equity positions in the non-traded book are held to support strategic objectives and venture capital transactions, or in respect of customer restructuring arrangements.
Risk control framework The commercial decision to take or hold equity positions in the nontrading book, including customer restructurings, is taken by authorised persons with delegated authority under the Group credit approval framework. Investments or disposals of a strategic nature are referred to the Group Acquisitions and Disposals Committee (ADCo), Group Executive Committee (ExCo), and where appropriate the Board for approval. Those involving the purchase or sale by the Group of subsidiary companies require Board approval, after consideration by ExCo and/or ADCo.
Exchange-traded equity 472 472 576 576 Private equity 632 632 674 674 Other 799 799 1,094 1,094 1,903 1,903 2,344 2,344
Refer to additional analysis of equity shares in Balance sheet analysis on page 218.
Introduction 158 Top and emerging credit risks 158 Objectives, organisation and governance 159
Credit risk assets 163 – Divisional analysis 163 – Sector and geographical regional analyses 164 – Asset quality 166
Credit risk mitigation 168 – Approaches and methodologies 168 – Secured portfolios 168
Early problem identification and problem debt management 172 – Wholesale customers 172
– Wholesale renegotiations 173 Wholesale renegotiations during the year by sector 174 Renegotiation arrangements 174 Provisioning for wholesale renegotiated customers 175 Recoveries and active insolvency management 175
– Retail customers 176 Collections and recoveries 176 Retail forbearance 176 Identification of forbearance 176 Types of retail forbearance 176 Arrears status and provisions 177 Forbearance arrangements 177 Unsecured portfolios 179 Provisioning for retail customers 179
Key credit portfolios 181 – Commercial real estate 181 – Residential mortgages 186 – Personal lending 189 – Ulster Bank Group (Core and Non-Core) 190
Credit risk Introduction Credit risk is the risk of financial loss due to the failure of a customer or counterparty to meet its obligation to settle outstanding amounts. The credit risk that the Group faces arises mainly from wholesale and retail lending, provision of contingent obligations (such as letters of credit and guarantees) and counterparty credit risk arising from derivative contracts and securities financing transactions entered into with customers. Other material risks covered by the Group’s credit risk management framework are: Concentration risk - the risk of an outsized loss due to the concentration of credit risk to a specific asset class or product, industry sector, customer or counterparty, or country.
Wrong way risk - the risk of loss that arises when the risk factors driving the exposure to a counterparty are positively correlated with the probability of default for that counterparty.
Top and emerging credit risks* The quantum and nature of credit risk assumed across the Group’s different businesses vary considerably, while the overall credit risk outcome usually exhibits a high degree of correlation with the macroeconomic environment. The Group therefore remains sensitive to the economic conditions within the geographies in which it operates, in particular the UK, Ireland, the US and the eurozone.
The following credit risks continue to be the focus of management attention.
Irish property market The continuing challenging economic climate within Ireland has resulted in impairment levels for Irish portfolios remaining at elevated levels. In particular, high unemployment, austerity measures and general economic uncertainty have reduced real estate lease rentals. This, together with limited liquidity, has depressed asset values and reduced consumer spending with a consequent downward impact on the commercial real estate portfolio as well as broader impacts on Ulster Bank Group’s mortgage and small and medium enterprise (SME) lending portfolios. Further details on Ulster Bank Group’s credit risk profile can be found on pages 190 to 193.
Refinancing risk remains a focus of management attention and is assessed throughout the credit risk management life cycle. In particular, it is considered as part of the early problem recognition and impairment assessment processes.
Eurozone troubles The ongoing impact of the troubles in the eurozone continued to be felt most significantly in the banking sector, where widening credit spreads and regulatory demand for increases in Tier 1 capital and liquidity exacerbated the risk management challenges already posed by the sector’s continued weakness, as provisions and write-downs remain elevated.
A material percentage of global banking activity in risk mitigation now passes through the balance sheets of the top global players, increasing the systemic risks to the banking sector. The Group’s exposures to these banks continue to be closely managed. In particular, the Group has intensified its management of settlement risk through ongoing review of the level of risk and the operational controls in place to manage it, together with proactive actions to reduce limits. The weaker banks in the eurozone also remained subject to heightened scrutiny and the Group’s risk appetite for these banks was adjusted throughout 2012.
The Group has continued to focus on operational preparations for possible sovereign defaults and/or eurozone exits. The Group has also considered initiatives to determine and reduce redenomination risk. Further actions to mitigate risks and strengthen control in the eurozone typically included taking guarantees or insurance, updating collateral agreements, and tightening certain credit pre-approval processes.
Further details on the Group’s approach to managing country risk and the risks faced within the eurozone can be found on pages 252 to 280.
Shipping The downturn observed in the shipping sector since 2008 has continued, with an oversupply of vessels leading to lower asset prices and charter rates. The Group has continued to manage exposures within this portfolio intensively, with an increasing number of customers managed under the Group’s Watchlist process (see page 172 for a description of this process). The financed fleet comprises modern vessels with experienced operators and despite the difficult market conditions impairments to date have remained low. However, impairment levels remain vulnerable to a continuing underperforming market.
Central counterparties (CCPs) New regulation requiring greater use of CCPs for clearing over-thecounter derivatives across the industry is aimed at reducing systemic risk in the banking sector. RBS welcomes this move but recognises that the Group’s concentration risk to CCPs will rise; thus exchanging concentration risk to individual counterparties for concentration risk to CCPs. CCPs are vulnerable to a significant member default, fraud and increased operational risk if their infrastructure and collateral management approaches are not developed commensurate with increased activity they undertake.
Responsibility for development of, and compliance with, Group-wide policies and credit risk frameworks and Group-wide assessment of provision adequacy resides with the Group Credit Risk (GCR) function under the management of the Group Chief Credit Officer. Execution of these policies and frameworks is the responsibility of the risk management functions, located within the Group’s business divisions.
The Group Credit Risk Committee is chaired by the Group Chief Credit Officer and has representation from each of the Group’s divisional credit risk functions. Monthly updates are provided to the Group Risk Committee on key matters approved under delegated authority by the Group Credit Risk Committee, performance against limits, and emerging issues, to enable it to fulfil its role as an oversight committee.
Credit risk management framework The Group has established an appropriate and comprehensive framework for the management of credit risk that includes governance structures, risk appetite and concentration frameworks, policies, measurement and reporting tools and independent assurance.
Wholesale - Formal policies, specialised tools and expertise, tailored monitoring and reporting and, in certain cases, specific limits and thresholds are deployed to address certain lines of business across the Group, where the nature of credit risk incurred could represent a concentration or a specific/heightened risk in some other form. Those portfolios identified as potentially representing a concentration or heightened risk are subject to formal governance, including periodic review, at either Group or divisional level, depending on materiality.
Sector concentration Across wholesale portfolios, exposures are assigned to, and reviewed in the context of, a defined set of industry sectors. Through this sector framework, risk appetite and portfolio strategies are agreed and set at aggregate and more granular levels, where exposures have the potential to represent excessive concentration or where trends in both external factors and internal portfolio performance give cause for concern. Formal periodic reviews are undertaken at Group or divisional level depending on materiality. These may include an assessment of the Group’s franchise in a particular sector, an analysis of the outlook (including downside outcomes), identification of key vulnerabilities and stress/scenario tests.
The focus during 2012 was on embedding sector and sub-sector specific appetite within divisional policies and processes and on setting appropriate controls. This includes strengthening portfolio controls on key metrics and lending parameters, and the ongoing development of sectorspecific lending policies.
As a result of the reviews carried out in 2012, the Group has reduced its risk appetite in the most material corporate sectors of commercial real estate and retail. For further details on sector-specific strategies, exposure reduction and key credit risks, refer to pages 181 to 193.
Single-name concentration* Within wholesale portfolios, much of the activity undertaken by the credit risk function is organised around the assessment, approval and management of the credit risk associated with a borrower or group of related borrowers.