Non-interest income was up £7 million. In US dollar terms non-interest income was down $10 million, or 1%, reflecting a decline in debit card fees as a result of the Durbin Amendment legislation and lower securities gains and deposit fees. This was largely offset by strong mortgage banking fees of £69 million ($109 million), up 71%, and the £47 million ($75 million) gross gain on the sale of Visa B shares.
Customer deposits decreased by 1% as a result of movements in foreign exchange rates partially offset by strong growth achieved in checking balances. Consumer checking balances fell by 1% while small business checking balances grew by 4% over the year.
Impairment losses were down £235 million ($379 million), or 72%, reflecting an improved credit environment and lower impairments on securities. Loan impairments improved by £168 million ($266 million) driven primarily by commercial loan impairments. Impairments as a percentage of loans and advances fell to 20 basis points.
Total income ongoing businesses 3,695 4,754 4,270 Inter-divisional revenue share (612) (708) (828) Run-off and recovery businesses 239 437 973
Capital and balance sheet Loans and advances to customers (gross) 25.4 29.8 31.5 Loan impairment provisions (0.2) (0.2) (0.2) Net loans and advances to customers 25.2 29.6 31.3 Net loans and advances to banks 12.5 16.6 29.9
Customer deposits (excluding repos) 21.5 26.3 36.8 Bank deposits (excluding repos) 23.8 45.4 48.2
2013 compared with 2012 Operating profit fell by £889 million with income falling by 26%, partly offset by significant cost reductions. The de-risking of Markets resulted in a 36% reduction in risk-weighted assets.
Credit Markets reflected the previous year’s de-risking of credit trading and witnessed a modest reduction in Debt Capital Markets income, although the business executed a number of significant transactions and retained its leading position in corporate GBP issuance.
Costs fell by 11%, reflecting a reduction in headcount of 1,000 – split evenly between the front and back-office - and tightly controlled discretionary expenses, although this was offset by a higher level of legal costs, primarily related to legacy issues in the US Asset Backed Products business.
Reducing risk and refocusing the division on core fixed income and currencies products drove a substantial reduction in both balance sheet and risk capital. Third party assets were £72 billion lower than 31 December 2012 and risk-weighted assets, at £65 billion, were down £37 billion.
Rates benefited from a strong trading performance, while losses incurred in managing counterparty exposures during the third quarter of 2011 were not repeated during 2012. Revenues for the year were up 32% to £1.9 billion.
Currencies volumes were weak across the industry, although the Spot FX business minimised the impact on revenue. Options income was limited by further Eurozone uncertainty.
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 8% from a strong performance of £1.22 billion in 2011.
A 59% increase in Credit Markets revenue to £735 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 division reduced risk-weighted assets, successfully focusing on lowering risk and enhancing models whilst managing the requirement for greater prudence in the regulatory environment.
Residual unallocated items relate to volatile corporate items that do not naturally reside within a division.
2013 compared with 2012 Central items not allocated, represented a debit of £89 million in 2013 compared with a credit of £84 million in 2012, a reduction of £173 million.
2012 compared with 2011 Central items not allocated represented a credit of £84 million compared with a debit of £34 million in 2011.
Offsetting these costs, profits on Group Treasury available-for-sale bond disposals totalled £880 million compared with £516 million in 2011, as active management of the liquid assets portfolio as well as favourable market conditions enabled the Group to crystallise gains on some holdings.
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) (4) Banking & portfolios 12.9% 4.2% 4.9%
Capital and balance sheet Loans and advances to customers (gross) (1) 35.6 55.4 79.4 Loan impairment provisions (13.8) (11.2) (11.5) Net loans and advances to customers 21.8 44.2 67.9
Gross customer loans and advances Banking & portfolios 35.4 54.5 77.3
Non-Core continued 31 December Disposals/ Drawings/ Foreign 31 December 2012 Run-off restructuring roll overs Impairments exchange 2013
International Banking Manufacturing and infrastructure (42) 3 57 Property and construction 835 623 752
UK Retail Mortgages — — 1.4 Personal — — 0.1 Total UK Retail — — 1.5
Other EMEA — 0.3 0.4 Total Ulster Bank 11.6 12.9 14.4
Markets Manufacturing and infrastructure 1.4 3.9 6.6 Property and construction 7.5 12.3 15.3
Telecoms, media and technology 0.8 0.4 0.7 Banking and financial institutions 2.9 4.7 5.6
Third party assets were reduced by £29 billion, or 51%, during the year. Approximately £3.1 billion of the reduction was due to increased impairments as a result of the change in the future run-down/disposal plan for the remaining Non-Core assets under the transition to RCR.
Operating loss of £5,527 million was £2,648 million higher than 2012, principally due to a £2,353 million increase in impairments. This was predominantly due to £3,118 million of 2013 impairments related to the creation of RCR, most significantly with £2,299 million in Ulster Bank and £742 million in International Banking, driven by the new RCR strategy to exit these assets over a shorter timeframe than previous plans, which has led to increased impairment losses on the non-performing assets.
Operating loss before impairment losses was £295 million higher with a reduction in net interest income of £407 million, £207 million additional disposal losses and £104 million further fair value writedowns offset by £506 million lower losses from trading activities.
Headcount declined by 1,700, or 55% to 1,400 of which 1,000 relates to operations in India and Romania, reflecting divestment activity and runoff.
2012 compared with 2011 Third party assets declined by £35 billion, or 38%, 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 £1,340 million lower than 2011, principally due to lower impairments and expenses, partially offset by lower net interest income following run-off and disposals.
Impairment losses fell by £1,694 million to £2,223 million, with £1,366 million of this reduction from the Ulster Bank portfolio and £269 million from the real estate portfolio.
Income declined by £686 million as continued divestment and run-off reduced net interest income. Rental income was lower following the disposal of RBS Aviation Capital in Q2 2012.
Expenses were £332 million lower, driven by reduced headcount and lower operating lease depreciation, principally following the disposal of RBS Aviation Capital.
HMT published its report on 1 November 2013. The review concluded that the effort, risk and expense involved in the creation of an external bad bank could not be justified. It also concluded that “RBS’s existing provisions and levels of capital deducted suggested that projected future losses are appropriately covered”.
As a result, and in line with its new strategic direction set out on 1 November 2013, RBS announced the creation of RBS Capital Resolution (‘RCR’) to separate and wind down RBS’s high capital intensive assets. RCR will bring assets under common management and was established with the following principles: • removing risk from the balance sheet in an efficient, expedient and economic manner; • reducing the volatile outcomes in stressed environments; and
The RCR division created with effect from 1 January 2014 is of a similar size to the ex Non-Core division, but the assets were selected on a different basis and no direct comparisons should be drawn. RCR assets were selected on the basis of long term capital intensity whereas the Non-Core assets were selected based on five strategic tests.
The RCR pool of assets was forecast to be c.£38 billion and c.£116 billion RWAe at its inception on 1 January 2014 based on 30 June 2013 data. Since this forecast was made: • £4.6 billion of impairments and other adjustments were recorded in respect of non-performing and other assets as a result of the change in realisation strategy noted above, with capital impact of £37 billion RWAe. The increased impairments relate to certain of the impaired or non-performing assets transferred to RCR, and reflect the revised holding strategy which has led to adverse changes in our estimates of future cash flows.
In aggregate, these two factors reduced the opening funded assets by £9 billion to £29 billion and RWAe by £51 billion to £65 billion. This reduction is funded assets in the second half of the year, particularly the disposals, has also resulted in a corresponding decrease in the Group’s funding requirements.
£12 billion of assets with RWAe of £11 billion managed by Non-Core have been returned to the relevant Core divisions because they did not meet the risk and capital criteria for RCR.
RCR commenced on 1 January 2014 and its first results will be reported separately in the Group’s first quarter 2014 results.
Capital deductions comprised expected losses less impairment provisions (31 December 2013 - £1,774 million; 30 June 2013 - £6,047 million) and allocation of defined pension fund deficit (31 December 2013 - £58 million; 30 June 2013 - £38 million).
RBS Capital Resolution continued The impact of the revised strategy on key metrics of the Group are set out below. Group RCR Rest of the Group £bn £bn £bn
Consolidated balance sheet at 31 December 2013 2013 2012* 2011* £m £m £m
Prepayments, accrued income and other assets 7,614 7,820 10,976 Assets of disposal groups 3,017 14,013 25,450
Commentary on consolidated balance sheet 2013 compared with 2012 Total assets of £1,027.9 billion at 31 December 2013 were down £284.4 billion, 22%, compared with 31 December 2012. This was driven by the downsizing of the Markets business, primarily reflected in decreases in loans to banks and customers, debt securities and derivatives balances, and a further decrease in loans and advances to banks and customers due to Non-Core disposals and run off.
Loans and advances to banks decreased by £9.9 billion, 15%, to £54.1 billion. Excluding reverse repurchase agreements and stock borrowing (‘reverse repos’), down £8.3 billion, 24%, to £26.5 billion, bank placings declined £1.6 billion, 6%, to £27.6 billion.
Loans and advances to customers declined £59.4 billion, 12%, to £440.7 billion. Within this, reverse repurchase agreements were down £20.1 billion, 29%, to £49.9 billion. Customer lending decreased by £39.3 billion, 9%, to £390.8 billion, or £35.2 billion to £416.0 billion before impairments. This reflected reductions in Non-Core of £19.9 billion, along with declines in International Banking, £6.2 billion, UK Corporate, £4.5 billion, Markets, £4.3 billion, Ulster Bank, £1.9 billion, UK Retail, £0.4 billion, Wealth, £0.3 billion, and US Retail & Commercial, £0.2 billion which included the impact of £0.7 billion of customer loans being transferred to assets of disposal groups at 31 December 2013. These decreases were partially offset by the effect of exchange rate and other movements, £2.5 billion.
Equity shares decreased by £6.4 billion, 42%, to £8.8 billion due to the targeted run-down of Markets’ equities business.
Intangible assets decreased by £1.2 billion, 9%, to £12.4 billion primarily as a result of the write-down of goodwill relating to the International Banking division at 31 December 2013.
Customer accounts decreased £50.4 billion, 10%, to £470.9 billion. Within this, repos decreased £31.6 billion, 36%, to £56.5 billion. Excluding repos, customer deposits were down £18.8 billion, 4%, at £414.4 billion, primarily reflecting decreases in International Banking, £6.9 billion, Markets, £4.8 billion, UK Corporate, £2.4 billion, Wealth, £1.7 billion, Ulster Bank, £0.7 billion, US Retail & Commercial, £5.9 billion, which included the impact of £3.2 billion of customer deposits being transferred to liabilities of disposal groups at 31 December 2013, and the effect of exchange rate and other movements of £3.4 billion. These decreases were partially offset by increases in UK Retail, £7.3 billion.
Retirement benefit liabilities decreased by £0.7 billion, 17%, to £3.2 billion with net actuarial gains of £0.5 billion arising from improved asset returns and higher discount rates partly offset by an increase in the assumed inflation rate. Additional employer contributions of £0.4 billion to the Group’s Main scheme also reduced retirement benefit liabilities.
Minority interests decreased by £1.3 billion, 73%, to £0.5 billion, predominantly due to the deconsolidation of Direct Line Group following the further sale of shares and ceding of control in 2013.
The decrease in assets and liabilities of disposal groups, down £11.4 billion, 45%, to £14.0 billion, and £13.8 billion, 58%, to £10.2 billion respectively, primarily reflects the removal of the UK branch-based businesses from disposal groups following Santander’s withdrawal from the purchase, together with the disposal of RBS Aviation Capital in the second quarter. These were partly offset by the transfer to disposal groups of Direct Line Group at 31 December 2012.
Deposits by banks decreased £7.4 billion, 7%, to £101.4 billion, with a decrease in inter-bank deposits, down £12.0 billion, 17%, to £57.1 billion. This was partly offset by an increase in repurchase agreements and stock lending (‘repos’), up £4.6 billion, 12%, to £44.3 billion, improving the Group’s mix of secured and unsecured funding.
Net cash flows from operating activities (30,631) (45,113) 3,325 Net cash flows from investing activities 21,183 27,175 14 Net cash flows from financing activities (2,728) 2,017 (1,741) Effects of exchange rate changes on cash and cash equivalents 512 (3,893) (1,473) Net (decrease)/increase in cash and cash equivalents (11,664) (19,814) 125 *Restated - see page 102.
Net interest income 10,992 (11) 10,981 Non-interest income 8,450 326 8,776
Net interest income 11,417 (15) 11,402 Non-interest income 10,668 (4,129) 6,539
Operating profit before impairment losses 8,231 (8,229) 2 Impairment losses (5,279) — (5,279) Operating profit/(loss) 2,952 (8,229) (5,277) Own credit adjustments (4,649) 4,649 — Payment Protection Insurance costs (1,110) 1,110 — Interest Rate Hedging Products redress and related costs (700) 700 — Regulatory and legal actions (381) 381 — Integration and restructuring costs (1,415) 1,415 — Gain on redemption of own debt 454 (454) — Write-down of goodwill (18) 18 — Asset Protection Scheme (44) 44 — Amortisation of purchased intangible assets (178) 178 — Strategic disposals 113 (113) — Bank levy (175) 175 — Write-down of other intangible assets (106) 106 — RFS Holdings minority interest (20) 20 — Operating loss before tax (5,277) — (5,277) Tax charge (441) — (441) Loss from continuing operations (5,718) — (5,718) (Loss)/profit from discontinued operations, net of tax - Direct Line Group (184) — (184)
Loss from discontinued operations, net of tax (172) — (172) Loss for the year (5,890) — (5,890) Non-controlling interests 136 — 136 Preference share and other dividends (301) — (301) Loss attributable to ordinary and B shareholders (6,055) — (6,055)
Net interest income 12,313 (10) 12,303 Non-interest income 11,111 1,237 12,348
Operating profit/(loss) 1,141 (2,537) (1,396) Own credit adjustments 1,914 (1,914) — Payment Protection Insurance costs (850) 850 — Sovereign debt impairment and related interest rate hedge adjustments (1,268) 1,268 — Integration and restructuring costs (1,021) 1,021 — Gain on redemption of own debt 255 (255) — Asset Protection Scheme (906) 906 — Amortisation of purchased intangible assets (222) 222 — Strategic disposals (105) 105 — Bank levy (300) 300 — Bonus Tax (27) 27 — RFS Holdings minority interest (7) 7 — Operating loss before tax (1,396) — (1,396) Tax charge (1,075) — (1,075) Loss from continuing operations (2,471) — (2,471) Profit from discontinued operations, net of tax - Direct Line Group 301 — 301
Profit from discontinued operations, net of tax 348 — 348 Loss for the year (2,123) — (2,123) Non-controlling interests (28) — (28) Loss attributable to ordinary and B shareholders (2,151) — (2,151)
Liabilities Bank deposits 35,329 — 35,329 57,073 1 57,074 69,113 1 69,114 Repos 28,650 — 28,650 44,332 — 44,332 39,691 — 39,691 Deposits by banks 63,979 — 63,979 101,405 1 101,406 108,804 1 108,805 Customer deposits 414,396 3,273 417,669 433,239 753 433,992 414,143 22,610 436,753 Repos 56,484 — 56,484 88,040 — 88,040 88,812 — 88,812 Customer accounts 470,880 3,273 474,153 521,279 753 522,032 502,955 22,610 525,565 Debt securities in issue 67,819 — 67,819 94,592 — 94,592 162,621 — 162,621 Settlement balances 5,313 — 5,313 5,878 — 5,878 7,477 8 7,485 Short positions 28,022 — 28,022 27,591 — 27,591 41,039 — 41,039 Derivatives 285,526 1 285,527 434,333 7 434,340 523,983 126 524,109 Accruals, deferred income and other liabilities 16,017 101 16,118 14,801 2,679 17,480 23,204 1,233 24,437 Retirement benefit liabilities 3,210 1 3,211 3,884 — 3,884 2,239 — 2,239 Deferred tax 507 — 507 1,141 — 1,141 1,945 — 1,945 Insurance liabilities — — — — 6,193 6,193 6,233 — 6,233 Subordinated liabilities 24,012 — 24,012 26,773 529 27,302 26,319 — 26,319 Liabilities of disposal groups 3,378 (3,376) 2 10,170 (10,162) 8 23,995 (23,978) 17 Total liabilities 968,663 — 968,663 1,241,847 — 1,241,847 1,430,814 — 1,430,814
Customer REIL 39,322 — 39,322 40,993 13 41,006 40,708 1,549 42,257 Bank REIL 70 — 70 134 — 134 137 — 137 REIL 39,392 — 39,392 41,127 13 41,140 40,845 1,549 42,394
The day-to-day management of risk in the Group is carried out through two independent risk management functions: RBS Risk Management and Group Conduct and Regulatory Affairs, which manage risk through independent oversight and challenge of both the customer-facing businesses and the support functions. These risk management functions provide an overarching risk control framework linked to the risk appetite of the Group. For further detail on risk appetite, refer to page 183.
Group Executive Committee - Operates under delegated authority from the Group Board and considers emerging issues material to both the Group’s strategy and risk exposures. The Group Executive Committee also oversees control frameworks.
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. It monitors the Group’s processes for internal audit and external audit and relationships with regulatory authorities. It operates under delegated authority from the Group Board.
RBS Risk Management is designed to align as closely as possible with the customer-facing businesses and support functions while maintaining an appropriate level of independence. This underpins the Group’s approach to risk management and is reinforced through the Group by reporting lines from divisions to RBS Risk Management and from RBS Risk Management to senior executives, Boards and Committees.
Risk management in divisions focuses on all material risks including credit, market, operational, regulatory, country and business risk (refer to pages 188 to 191 for further detail of these risks). Liquidity risk and the day-to-day management of liquidity and funding of the Group’s assets is Group Treasury’s responsibility (refer to page 210). Oversight of risk in divisions is the responsibility of the relevant divisional Chief Risk Officer (CRO), with input from the relevant Group risk function heads.
• Operation of Group-wide risk processes such as the Group Policy Framework and the New Product Risk Assessment Process are effective.
The Group Chief Risk Officer has direct involvement in the selection, appointment or removal of divisional CROs and Group risk function heads and also has responsibility for their ongoing performance assessment and management.
Conduct and Regulatory Affairs Created in August 2013, by amalgamating Group Compliance (previously part of RBS Risk Management) and RBS Regulatory Affairs (formerly part of RBS Legal), Group Conduct and Regulatory Affairs is led by the Group Head of Conduct and Regulatory Affairs, who reports directly to the Group Chief Executive and the Board Risk Committee, with right of access to the Chairman of the Board.
*unaudited 1st line of defence - Business units including all business areas and functions are accountable for owning and managing the risks which exist in their area within a defined risk appetite and framework.
2nd line of defence - Independent monitoring and control functions, as well as Group Policy Standard owners, are accountable for owning and developing the risk and control frameworks and tools which the 1st line of defence uses to discharge its responsibilities. The 2nd line of defence must be appropriately independent from the business and accountable for overseeing and challenging the 1st line of defence on the effective management of its risks.
3rd line of defence - Group Internal Audit provides independent assurance on the appropriateness of the design and operational effectiveness of risk management and internal control processes that mitigate the Group’s key risks.
Business model The Group is a bank serving approximately 24 million retail and corporate customers worldwide. UK Retail offers individuals a wide range of traditional retail banking and insurance products, including residential mortgages and credit cards, while UK Corporate provides both small businesses and large corporations with an extensive range of loan products and transactional services. Most of the customers of both divisions are located in the UK. Wealth provides both banking and investment services to high-net-worth individuals in the UK and overseas, while International Banking offers loan products and transactional services to corporations and financial institutions across a wide range of countries. Markets provides corporations and financial institutions in both the UK and overseas with investment banking products and services, helping them to hedge exposures to interest rate and foreign exchange risk. Markets also helps customers structure securitisation transactions and issue debt.
The Group’s activities expose it to a number of risks. The Group is pursuing a strategy of reducing the risks it takes while focusing on the delivery of products and services to a domestic customer base, giving rise to strategic risk. The delivery of all of its products and services exposes the Group to conduct risk, which has recently materialised in the form of fines and reputational damage, resulting from a failure to treat customers in line with their and other stakeholders’ expectations.
Finally, through the activities of all its divisions, the Group is exposed to a range of other risks, including pension, business, regulatory and reputational.
UK Retail and the wider Group are engaged in a wide-ranging conduct risk programme designed to ensure the focus of our culture is always on the customer and delivering good customer outcomes. While this is a long-term project, the Group is confident that it has already resulted in material changes to the way it conducts business.
For more information on PPI refer to page 479. For information on other litigation, investigations and reviews, refer to pages 474 to 482.
Further information on these and other risks facing the Group is detailed in Risk factors on pages 523 to 536.
(i) Increased impairments arising from defaults in sectors to which the Group has concentrated exposures, particularly commercial real estate and shipping The Group has material exposure to borrowers in a number of sectors, particularly shipping. This sector has experienced falling revenues and declining asset values. If global economic growth remains subdued, losses in these sectors may increase unexpectedly. Any such losses may be exacerbated by issues related to controls.
Impact on the Group A slower than expected recovery would likely result in lower revenues and income, and higher impairments. It could also result in higher operational losses. If such a downturn were prolonged, capital might also be negatively affected.
(iii) An increase in the Group’s obligations to support pension schemes The Group has established various pension schemes for its employees as a result of which it has incurred certain obligations as sponsor of these schemes. If economic growth stagnates and interest rates remain low as a result, the value of pension scheme assets may not be adequate to fund the pension schemes’ liabilities. All of the Group’s businesses are exposed to this risk.
Risk governance* continued Top and emerging risk scenarios continued In addition, the Group may be required to increase its cash contributions to the schemes. Similarly, the amount of additional cash contributions that may be required depends on the size of the shortfall when the assets are valued. If interest rates fall further, the value of the schemes’ assets may decline while the value of their liabilities increases, leading to a need to increase cash contributions.
(i) Increased conduct costs and reputational damage arising from a failure to achieve fair customer outcomes. In order to achieve its strategic objectives, the Group must put the customer at the heart of its business.
Impact on the Group Failure to do so would cause the Group to fail to achieve its strategic objectives, which would affect earnings, liquidity, capital and shareholder confidence adversely. The risk of failure affects all divisions.
Impact on the Group As a result of litigation, the Group may incur fines, be ordered to pay damages or other compensation, suffer reputational damage, or face limitations on its ability to operate. For example, in the case of LIBOR, the Group agreed to pay settlement penalties to resolve investigations by the European Commission into Yen LIBOR competition infringements and EURIBOR competition infringements.
Mitigants Although more work needs to be done to mitigate this risk, the Group has simplified some products and stopped offering others. Where appropriate, it has compensated purchasers of some products and services, such as payment protection insurance and certain interest rate hedging products. Future payments of such compensation would give rise to additional costs.
(i) Increased losses arising from cyber attacks The Group has experienced cyber attacks, which are increasing in frequency and severity across the industry. This risk affects all divisions.
Impact on the Group A successful cyber attack could lead to fraudulent activity or the loss of customer data. The Group could experience significant losses as a result of the need to reimburse customers, pay fines or both. Furthermore, a successful cyber attack could cause significant damage to the Group’s reputation.
(ii) Increased losses arising from the failure of information technology systems The Group’s information technology systems are vulnerable to failure. Because they are complex, recovering from failure is very challenging.
Impact on the Group A failure of information technology systems could lead to the Group’s inability to process transactions or provide services to its customers. Should a failure not be rectified promptly, the Group might lose customers, be subject to fines, incur remediation costs or face legal action. Its reputation might also suffer.
Mitigants The Group has launched a major investment programme to improve resilience, which has already had an impact. The Group has also enhanced its back up systems and created a ‘shadow bank’ capable of providing basic services in the event of need. Finally, the Group is improving the documentation of critical business functions.
(iii) Increased costs arising from a failure to execute successfully major projects The Group has a number of major projects underway, the successful conclusion of which is essential if it is to meet new regulatory and strategic requirements. These new requirements affect its organisational structure, its business strategies, its information technology systems, its operational processes and its product offerings. Given the number, scale and complexity of these projects, the Group may not complete them successfully, or at all. This affects all divisions.
Mitigants The Group is working to implement change in line with its project plans while assessing the risks to implementation and taking steps to mitigate those risks where possible.
(iv) Increased costs due to an inability to recruit or retain suitable staff The Group is undergoing significant organisational change, the result of a need to implement new business strategies and respond to a changing external environment. The pace of change, coupled with the associated uncertainty may cause experienced staff members to leave the Group and prospective staff members not to join. Although these risks concern all divisions, they particularly affect Markets and US Retail & Commercial.
Mitigants The Group has communicated expected changes in its organisational structure to members of staff, implementing plans aimed at minimising unexpected staff losses. The Group is also working to develop and implement an enhanced recruitment strategy.
The occurrence of any of the impacts above could significantly impact the Group’s costs and would have a material adverse effect on the Group’s business, financial condition, results of operations, and prospects.
The Executive Risk Forum (refer to Risk governance on page 176 for further information) 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 may also request additional stress tests as it deems necessary. Stress testing forms part of the Group's risk and capital management framework and is a major component of the Basel III requirements. It highlights to senior management potential unexpected adverse outcomes related to a mixture of risks and provides an indication of how much capital might be required to absorb losses should adverse scenarios materialise.
Scenario selection Stress test scenarios target both firm-wide vulnerabilities and negative global impacts. They consider a five year horizon and include stress projections for macroeconomic variables such as gross domestic product, unemployment rates, property prices, stock price indices, interest rates and inflation. The tests include a variety of scenarios, including some featuring an intensification of the eurozone’s sovereign debt problems.
As part of the financial planning and strategy cycle, stress tests are conducted by divisions and aggregated to produce firm-wide results. These stress tests are also used for monitoring divisional and Group risk appetite.
Portfolios subject to review Portfolio specific stress tests assess the reaction of key-focus portfolios to systemic shocks and individual risk factors to identify potential vulnerabilities, including risks that have not yet matured or are not yet visible. They assess the potential for outsized losses and the impact of rebalancing portfolios.
External stress tests The Group also takes part in a number of external stress tests. In 2014 the Group will take part in the Bank of England’s concurrent stress test of the UK banking system, as well as an industry-wide external stress test conducted by the European Banking Authority on the European Union banking system.
Risk appetite* Risk appetite is both a key business tool and an integral part of the Group’s enterprise-wide approach to risk management. It is aligned with the Group’s strategic objectives, aiming to strike an optimal balance between building a sustainable risk profile and creating long-term value for the Group’s customers, investors and wider stakeholders. The risk appetite framework seeks to ensure that each business can withstand significant deteriorations in economic and market conditions.
• Wider obligations to stakeholders - a bank that is safe and sound and puts serving customers at the heart of its thinking will also perform well for its owners, employees, regulators and communities.
Risk appetite is cascaded and embedded across the Group. The risk appetite framework provides each business with a greater understanding of acceptable risk levels, aligning commercial strategies with the most effective use of financial resources, such as capital, funding and risk capacity. Risk appetite provides a solid platform that allows the Group to focus on its key business strengths and competitive advantages over the long term.
Strategic risk objectives Risk management plays an integral role in the delivery of the Group’s strategic goal. The implementation of a stronger and more effective culture of risk management and control provides the platform necessary to address vulnerabilities, rebuild on core strengths and position the Group on a sustainable and profitable path for future growth.
• Maintain capital adequacy. To ensure that the Group has sufficient capital resources to meet regulatory requirements and to cover the potential for unexpected losses in its asset portfolio.
Risk appetite measures Risk appetite starts with the strategic goals and risk philosophy set by the Group Board and is cascaded through key targets, limits and risk tolerances that influence decision making, from the enterprise-wide to the transactional level.
The risk appetite framework is based on four main pillars: • Risk envelope metrics - The Group has set sustainable business goals over a medium-term horizon, including a target for the capital ratio, leverage ratio, loan:deposit ratio, liquidity portfolio and use of wholesale funding. These are the broad boundaries within which the Group operates. Non-Core division also acts as a primary driver for reducing risk and the size of the balance sheet.
• Qualitative risk appetite targets - The fourth 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 and reputational risk).
Risk appetite supports value creation in a safe 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. customer franchises, income and profit generation, synergies) and whether they fit within agreed risk appetite boundaries. A range of different but complementary tools have been developed to measure whether strategic plans are consistent with risk appetite, to test broader ‘what if’ questions and to assess the impact of changes in key assumptions: • Integrated stress testing - assesses how earnings, capital and funding positions change under an unfavourable, yet plausible, scenario. Stress scenarios can differ by theme, geographical location or severity.
• Economic capital - provides complementary insights, with a breadth of understanding of risk profile changes and ‘tail risks’ generated by stimulating millions of different scenarios.
• Ensures that commercial strategies are aligned with the use of available financial resources.
By setting a clear risk appetite and embedding a strong risk culture throughout its businesses, the Group can identify, measure and control risk exposures and respond effectively to shocks. Each division is responsible for ensuring its strategic plans are consistent with its approved risk appetite.
The embedding of the Group’s values into a strong risk culture is supported by a revised and more focused Code of Conduct. The Code provides guidance on expected behaviour and sets out the standards of conduct that support the Group’s values. It explains the effect of decisions that are taken and describes the principles that must be followed.
These business principles cover conduct related issues as well as wider business activities. They focus on desired outcomes, with practical guidelines to align the Group’s values with its commercial strategy and actions. The embedding of business principles facilitates sound decision making and a clear focus on good customer outcomes in ‘the moments that matter’. It is aligned with the people management and remuneration processes to support a positive and strong risk culture through appropriate incentive structures.
Training Across the risk management function, a series of events and activities have been undertaken to ‘bring alive’ the Group’s values and culture for employees. This is supported by performance management processes that hold individuals to account for poor behaviour and reward the behaviour that supports our purpose, visions and values.
• In five years time would others see this as a good way to work?
Each question is a prompt to think about the situation and how it fits with the Group’s values. It ensures that employees can think through decisions that don’t have a clear answer, guiding the judgements behind their decisions and actions.
Awards to employees under the Group's long-term incentive plan are subject to financial and operational measures and an underlying requirement for effective risk management during the performance period.
The Group Performance and Remuneration Committee has put in place a Group-wide remuneration policy which is explicitly aligned with effective risk management. Performance is a key input into the determining of remuneration levels. Group and divisional plans and targets are aligned with the risk appetite and the long-term interests of the Group, as determined by the Board. These targets are the basis of Group Executive members’ objectives, which are approved by the Group Performance and Remuneration Committee. These objectives are then cascaded through the divisions and functions.
Risk type Definition Features How the Group manages risk and the focus in 2013
It has the potential to disrupt the business if there is insufficient capital to support business activities. It also has the potential to cause the Group to fail to meet regulatory requirements. Group capital and earnings may be affected, impairing the activities of all divisions.
Risk type Definition Features How the Group manages risk and the focus in 2013 Credit risk The risk of financial loss due to the failure of a customer, or counterparty, to meet its obligation to settle outstanding amounts.
Refer to the Credit risk and Balance sheet analysis sections on pages 227 to 317 for further information.
Market risk The risk of loss arising from fluctuations in interest rates, credit spreads, foreign currency rates, equity prices, commodity prices and other risk-related factors such as market volatilities that may lead to a reduction in earnings, economic value or both.
Character and impact: Characterised by frequent small losses, which are material in aggregate, and infrequent large material losses due to stress events.
During 2013, the Group continued to reduce its risk exposures. Average trading value-at-risk (VaR) decreased significantly from £97 million to £79 million, reflecting risk reduction and capital management focus. De-risking within the rates business and improvements in the capture of valuation adjustment risks within the counterparty exposure management desk in Markets helped reduce VaR in the first half of 2013. Ongoing reductions in the asset-backed securities inventory drove down the risk even further in the second half of 2013.
Country risk The risk of losses occurring as a result of either a country event or unfavourable country operating conditions.
Arises from: Sovereign events, economic events, political events, natural disasters or conflicts.
Character and impact: Primarily present in credit portfolios of Markets, International Banking, Ulster Bank (Ireland), Group Centre (mainly Treasury), US Retail & Commercial and Non-Core.
Refer to the Country risk section on pages 341 to 353 for further information.
Arises from: Breaches of regulatory rules or laws, resulting from the Group’s retail or wholesale conduct; or from failing to meet customers’ or regulators’ expectations of the Group.
It has the potential to affect earnings (through loss of customer confidence and sales), as well as capital and liquidity (including regulator imposed fines for inappropriate conduct). It also affects the confidence of other key Group stakeholders, such as private and institutional shareholders, regulators and governments.
The focus in 2013 was on placing conduct risk at the centre of the Group’s philosophy and on completing the development of the risk framework. Promoting understanding of conduct issues and ensuring compliance with regulations and rules are priorities for the Group.
Character and impact: Pension schemes’ funding positions can be volatile due to the uncertainty of future investment returns and the projected value of schemes’ liabilities. The Group might have to make financial contributions to, or with respect to, its pension schemes.
It has the potential to adversely affect the Group’s funding and capital requirements.
The Group’s Pension Risk Committee considers the Group’s view of pension risk, mechanisms that could be used for managing pension risk and the financial strategy implications of the pension schemes as well as reviewing fund performance. The Committee reports to the Group Asset and Liability Committee on the material pension schemes that the Group is obliged to support.
Refer to the Pension risk section on pages 356 and 357 for further information.
Character and impact: May be financial in nature (characterised by either frequent small losses or infrequent material losses), or may lead to direct customer and/or reputational impact (for example, a major IT systems failure or fraudulent activity).
It has the potential to affect the Group’s profitability and capital requirements directly, as well as stakeholder confidence.
In 2013, the focus was on continued implementation and embedding of risk assessments across the Group, including the strengthening of links between risk assessments and other elements of the Group operational risk framework. In addition, risk assessments were increasingly used to identify single points of failure.
Refer to the Operational risk section on pages 358 to 360 for further information.
Character and impact: The crystallisation of regulatory risk can result in adverse impacts on the Group’s customers, strategy, business, financial condition or reputation, for instance, through the failure to provide appropriate protections to customers, or from regulatory enforcement or other interventions.
It has the potential to adversely impact the Group’s customers, strategy, business, financial condition or reputation.
The Group’s existing Compliance and Regulatory Affairs teams were brought together in the second half of 2013, following the creation of the role of Group Head of Conduct and Regulatory Affairs. The Conduct and Regulatory Affairs function has responsibility for setting Group-wide policy and standards, providing advice to the business and ensuring controls are effective for managing regulatory affairs, compliance and financial crime risks across all businesses.
Reputational risk The risk of brand damage and/or financial loss due to a failure to meet stakeholders’ expectations of the Group.
Character and impact: Can result in an inability to build or sustain customer relationships, in low staff morale, in regulatory censure, or in reduced access to funding.
The reputational risk framework is aligned with the Group’s focus on serving customers well, strategic objectives and the risk appetite goal of maintaining stakeholder confidence.
In 2013, the environmental, social and ethical risk management function was set up to address the reputational risk associated with the clients the Group chooses to do business with. It sets policy and provides guidance to avoid reputational risk relating to business engagements and lending to clients in sensitive industry sectors.
Character and impact: Can lead to adverse changes in revenues and/or costs.
The Group Board has ultimate responsibility for business risk through the achievement of the Group’s business plan. The primary responsibility for divisional financial performance rests with the divisional CEO supported by divisional Executive Committee and functions.
Strategic risk The risk that the Group will make inappropriate strategic choices, or that there will be changes in the external environment to which the Group fails to adapt its strategies.
Character and impact: Varied losses affecting earnings, capital, liquidity and customer and stakeholder confidence. Can affect all divisions.
The successful execution of this strategy is set against a background of increasing regulatory demands and scrutiny as well as a challenging macroeconomic environment. Successful and timely execution of the strategy will be key to the future success of the Group.
Political risk The risk to the Group’s business and operations of the referendum on Scottish independence.
During 2013 the focus on the question of potential Scottish independence from the UK heightened, and the Scottish government will be holding a referendum in September 2014. A vote in favour of Scottish independence would be likely to impact the Group’s costs and could also impact the fiscal, legal and regulatory landscape to which the Group is subject. Were Scotland to become independent, it may also affect Scotland’s status in the European Union.
Capital management 193 Definition 193 2013 overview 193 Regulatory developments 193 Governance 194 Economic capital 195 Capital resources 200 Estimated leverage ratio 202 Risk-weighted assets 205 Reconciliation between accounting and regulatory consolidation 206 Balance sheet to exposure at default bridge 207 RWA density
2013 overview The Group reported a Core Tier 1 ratio of 10.9% as at 31 December 2013. On a fully loaded Basel III basis, the Group’s equivalent Common Equity Tier 1 (CET1) ratio was 8.6%.
The Group’s Core Tier 1 ratio is higher than at the end of 2012 despite absorbing changes to credit model parameters 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 with the Group announcing in November 2013 management actions to accelerate the building of its capital strength. The measures include creation of an internal 'bad bank' to accelerate the rundown of high risk assets of £29 billion funded assets at the end of 2013.
Faster run-down of high risk assets entails accelerated and increased impairments and other adjustments in the fourth quarter of 2013, but the capital impact of this is significantly reduced by a commensurate reduction in expected loss capital deductions. The management strategy will result in a strengthening of the Group's capital ratios in the medium term.
The Group continues to target a fully loaded Basel III CET1 ratio of c.11% by the end of 2015 and 12% or above by the end of 2016.
The Group has announced plans to accelerate the divestment of RBS Citizens. Preparations for a partial initial public offering in 2014 are on track and the Group intends to fully divest the business by the end of 2016, benefiting CET1.
Focus for the Group remains on active de-risking of the balance sheet to meet strategic objectives, demonstrated in the leverage exposure measure by Non-Core asset disposal and run-off, and the downsizing of Markets business.
CRD IV and Basel III will impose a minimum CET1 ratio of 4.5% of RWAs. There are three buffers which will affect the Group: the capital conservation buffer set at 2.5%; the counter-cyclical capital buffer (up to 2.5% of RWAs), to be applied when macroeconomic conditions indicate areas of the economy are over-heating; and the Global-Systemically Important Bank buffer currently set at 1.5% for the Group. The regulatory target capital requirements will be phased in and are expected to apply in full from 1 January 2019, in the meantime using national discretion the PRA can apply a top-up. As set out in the PRA’s Supervisory Statement SS3/13, the Group and other major UK banks and building societies are required to meet a CET1 ratio of 7% after taking into account certain adjustments set by the PRA.
PRA guidance indicates that from 1 January 2015, the Group must meet at least 56% of its Pillar 2A capital requirement with CET1 capital and the balance with Additional Tier 1 capital. The Pillar 2A capital requirement is the additional capital that the Group must hold, in addition to meeting its Pillar 1 requirements in order to comply with the PRA’s overall financial adequacy rule.
Subordinated debt instruments which do not meet the new eligibility criteria will be grandfathered on a reducing basis over ten years.
Governance Governance and approach The Group Asset and Liability Management Committee (GALCO) is responsible for ensuring the Group maintains adequate capital at all times. The Capital and Stress Testing Committee (CAST) is a crossfunctional body driving and directing integrated risk capital activities including determination of the amount of capital the Group should hold, how and where capital is allocated and planning for actions that would ensure that an adequate capital position would be maintained in a stressed environment. These activities have linkages to capital planning, risk appetite and regulatory change. CAST reports through GALCO and comprises senior representatives from Risk Management, Group Finance and Group Treasury. Target capital ratios are set and monitored by the PRA for the Group. Management of capital is achieved by supervision of forecast capital and RWA over a five year time horizon.
Pillar 3 The Group’s Pillar 3 disclosures provide additional analysis of exposure at default and credit risk measures such as credit risk mitigation, counterparty credit risk and provisions and their associated RWAs under the various Basel II approaches.
Capital management* continued Governance continued Determining appropriate capital The Group’s own determination of sufficient capital is derived from the desired credit rating, risk appetite and reflects the current and emerging regulatory requirements of the Group. It is evaluated through both internally and externally defined stress testing to identify potential changes in capital ratios in a range of scenarios.
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 divisions use return on capital metrics when making pricing decisions on products and transactions, to ensure customer activity is appropriately aligned with Group and divisional targets and allocations.
The PRA 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).
Economic capital Economic capital is an internal measure of the risks to which the Group is exposed and is used as a supplement to other risk and capital tools, such as stress testing and regulatory capital. The measure includes risk exposures for credit, market, business, operational, pension, fixed asset and interest rate risk in the banking book. These models capture risks not fully addressed within the Pillar 1 regulatory framework e.g. concentration, pension, interest rate, business risk and diversification.
Capital resources The Group’s capital, RWAs and risk asset ratios, on the basis of current rules (Basel 2.5) and CRR or fully loaded Basel III (FLB3), calculated in accordance with PRA definitions, are set out below.
Core Tier 1 (excluding Asset Protection Scheme (APS) in 2011) 42.2 47.3 49.1
Key points • Core Tier 1 capital ratios, under current rules and the fully loaded
Although the CRR text has been finalised, many of the Regulatory Technical Standards (RTS) are still draft. The finalisation of these could have a material impact in a number of areas such as the scope of the deduction for insignificant financial holdings. Further guidance is provided by the European Banking Authority through published Q&A.
In the first year of transition, the regulatory adjustments will be calculated under the new rules. The CRR deductions are determined by applying the transitional percentage (20% in year 1)(1). The residual balance will be deducted according to the current rules, except where the PRA has specified a different treatment.
The Group’s CET1 ratio on a fully loaded basis at 31 December 2013, based on its interpretation of the rules is estimated at 8.6%(1).
Shareholders’ equity (excluding non-controlling interests) Shareholders' equity 58,742 58,742 58,742 68,678 68,678 68,168 75,367
Regulatory adjustments and deductions Own credit 726 601 601 691 691 493 (2,634) Defined benefit pension fund adjustment 362 (172) (172) 913 (144) (144) — Net unrealised AFS losses 308 — — 346 346 — 957
Qualifying deductions exceeding Additional Tier 1 (AT1) capital — — — — (8,420) — — Goodwill and other intangible assets (12,368) (12,368) (12,368) (13,545) — (13,956) (14,858) 50% of expected losses less impairment provisions (19) (1,731) (1,731) (1,904) — (6,154) (2,536)
Other Tier 1 capital Preference shares - equity 4,313 — — 4,313 — — 4,313
Tier 1 deductions 50% of material holdings (1) (976) — — (295) — — (340) Tax on expected losses less impairment provisions 6 — — 618 — — 915 Other regulatory adjustments — — — — (17,033) — —
Qualifying deductions exceeding AT1 capital — — — — 8,420 — —
Capital management* continued Capital resources continued 2013 2012 2011 Current Transitional Full Current Transitional Full Current basis basis basis basis basis basis basis (Basel 2.5) (PRA) (final CRR) (Basel 2.5) (draft CRR) (draft CRR) (Basel 2.5)
Qualifying Tier 2 capital Undated subordinated debt 2,109 — — 2,194 — — 1,838 Dated subordinated debt - net of amortisation 12,436 — — 13,420 — — 14,527 Qualifying items and related share premium — 4,431 3,582 — 2,774 7,292 — Qualifying own funds instruments issued by subsidiaries and held by third parties — 9,374 5,151 — 12,605 5,185 — Unrealised gains on AFS equity shares 114 — — 63 — — 108
The table below analyses the movement in Core Tier 1, Other Tier 1 and Tier 2 capital on a Basel 2.5 basis during the year ended 31 December 2013. Supervisory
Core Tier 1 Other Tier 1 Tier 2 deductions Total £m £m £m £m £m
The table below analyses the movement in CET1 and Tier 2 capital on a FLB3 basis during the year ended 31 December 2013.
At 1 January 2013 37,908 12,876 50,784 Attributable loss net of movements in fair value of own credit (8,887) — (8,887) Share capital and reserve movements in respect of employee share schemes 200 — 200 Ordinary shares issued 264 — 264 Nominal value of B shares 510 — 510 Foreign exchange reserve (217) — (217) Foreign exchange movements — (106) (106) Actuarial gains recognised in retirement benefit schemes (net of tax) 200 — 200 Termination of contingent capital facility 320 — 320 Decrease in goodwill and intangibles 1,588 — 1,588 Defined benefit pension fund (28) — (28) Deferred tax assets 971 — 971 Excess of expected loss over impairment provisions 4,423 — 4,423 Grandfathered instruments — (3,121) (3,121) Dated subordinated debt issues — 1,862 1,862 Dated subordinated debt maturities, redemptions and amortisation — (2,666) (2,666) Prudential valuation adjustments (PVA) (471) — (471)
Capital base: (1) Includes the nominal value of B shares (£0.5 billion) on the assumption that RBS will be privatised in the future and that they will count as permanent equity in some form by the end of 2017. (2) The PVA, arising from the application of the prudent valuation requirements to all assets measured at fair value, has been included in full in line with the guidance from the PRA and uses methodology discussed with the PRA pending the issue of the final RTS by the European Banking Authority. The full amount of the applicable PVA has been included in provisions in the determination of the deduction for expected losses.
The transitional period for the introduction of this ratio started with a supervisory monitoring period in 2011, with a parallel run period from January 2013 to December 2017. A minimum ratio of 3% is applied initially. The requirement is expected to be included in Pillar 1 from January 2018.
The Basel III leverage percentages are lower than those currently reported, primarily due to changes in methodology relating to the inclusion of potential future exposure on derivatives and undrawn commitments. In addition, inclusion or exclusion of grandfathered capital instruments can result in material differences.
Basel III basis: Transitional measure 1,093.5 44.3 25x 4.1 1,225.8 54.0 23x 4.4
Basel III texts, as well as the recently issued BCBS proposal are above 3%.
• Estimated leverage ratios on all full end point measure bases improved during the year reflecting downsizing in Markets and NonCore as well as risk reduction and portfolio focus ahead of CRR implementation.
CRR Basel III BCBS CRR Basel III BCBS basis basis basis basis basis basis
Cash and balances at central banks 82.7 82.7 82.7 79.3 79.3 79.3
(4) Undrawn commitments represent regulatory add-ons relating to off-balance sheet undrawn commitments based on a 10% credit conversion factor for unconditionally cancellable commitments and 100% for other commitments. The CRR basis uses the credit conversion factor (CCF) as per risk measure for medium to low risk trade finance and officially supported export credits. For the BCBS measure, commitments other than securitisation liquidity facilities with an original maturity up to one year and commitments with an original maturity over one year will receive a CCF of 20% and 50%, respectively. Refer to page 202 for further analysis.
Interest rate 10,582 16,212 8,795 35,589 Exchange rate 3,261 814 480 4,555 Equity 43 35 1 79 Commodities — 1 1 2 Credit risk 189 64 253 Total 13,886 17,062 9,277 189 64 40,478
Notes: (1) Relates to changes in credit quality metrics of customers and counterparties such as probability of default and loss given default. (2) Relates to internal treatment of exposures or calibration of models and regulatory prescribed changes. (3) Refers to implementation of a new model or modification of an existing model following approval by the PRA and includes: o exposure at default treatment (£4.8 billion) in the second quarter of 2013; o continuation of commercial real estate slotting (£4.4 billion) throughout 2013; and o loss given default changes to the shipping portfolio (£3.7 billion) in the second half of 2013.
US UK Retail UK Corporate Wealth IB (1) Ulster Bank R&C (1) Markets Other Core Non-Core RFS MI Total
Total RWAs £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
• Credit risk RWAs were down £57.8 billion or 16% to £313.4 billion despite absorbing £13.8 billion of higher RWAs due to model updates.
° Non-counterparty RWAs were down £32.1 billion or 10% to £291.1 billion: in Non-Core (£24.1 billion) due to run-off and disposals in commercial real estate, shipping and leveraged finance portfolios; and in Retail & Commercial (£10.0 billion) due to loans migrating into default, risk parameter changes and balance sheet reduction.
For additional analyses on RWAs by sector and related density see pages 207 and 208.
Non-Core 34.2 29.2 Group before RFS Holdings minority interest 425.2 381.6 RFS Holdings minority interest 3.9 3.9
Key points • Estimated FLB3 RWAs were £43.6 billion or 11% higher than under current rules principally reflecting: ° Treatment of securitisations as risk-weighted at 1,250% instead of as capital deductions, £18.7 billion.
° Credit valuation adjustments, £16.7 billion and financial institution asset valuation correlation, £5.6 billion.
° Reduced risk-weighting for small and medium-sized enterprises, £4.6 billion, mainly in UK Corporate.
Cash and balances at central banks 82,659 — 430 83,089 79,290 — 544 79,834 Loans and advances to banks 54,071 (66) 113 54,118 63,951 (30) 48 63,969 Loans and advances to customers 440,722 1,257 3,459 445,438 500,135 1,438 2,883 504,456
Debt securities in issue 67,819 — — 67,819 94,592 — — 94,592
Notes: (1) The Group can 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 associates for regulatory purposes where they are classified as credit institutions or financial institutions. These will generally have been equity accounted for financial reporting purposes.
Capital management* continued Balance sheet to exposure at default bridge The table below provides a bridge between the balance sheet and credit exposure at default (EAD) by balance sheet caption.
Other regulatory adjustments Methodology Within the differences Total Undrawn and Balance Consolidation Regulatory scope of Credit Netting and Capital and drawn off-balance Total sheet differences (1) consolidation market risk (2) provisions (3) collateral (4) deduction (5) reclassifications (6) EAD sheet EAD EAD 2013 £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
(5) Capital deductions are excluded as EAD only captures exposures for credit RWAs. (6) Comprises: - Cash and balances at central banks: notice balances with central banks included in loans and advances, reclassified as central bank balances for EAD. - Loans and advances: includes offset related to cash management pooling arrangements not allowed under IFRS, standardised approach credit risk mitigation and reclassification of central bank balances. This is partially offset by the reclassification of disposal groups and prepayments, accrued income and other assets as customer balances. - Debt securities: gross up of banking book securities that are matched by trading book short positions that cannot be offset under regulatory rules. - Derivatives: reflects difference between netting arrangements and netting within regulatory model sets as well as EAD valuation adjustments. - Property, plant and equipment: includes residual value of operating leases. - Prepayments, accrued income and other assets: includes amounts reclassified to loans and advances. - Assets of disposal groups: amounts reclassified to relevant balance sheet lines for EAD.
(7) Includes documentary credits (commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents), classified as commitments for financial reporting, and amounts related to entities proportionally consolidated for regulatory reporting.
Central banks 82,015 12,145 94,160 92,727 94,073 75,537 3 — 84 1,469 1,468 — 1 2 2 Central government 25,394 947 26,341 25,551 26,238 594 102 3 1 2,448 2,439 9 — 9 9 Other sovereign 9,560 1,288 10,848 11,788 10,405 1,759 401 47 42 1,600 1,535 59 6 15 15 Total sovereign 116,969 14,380 131,349 130,066 130,716 77,890 506 50 127 5,517 5,442 68 7 4 4 Financial institutions (FI) Banks 23,744 16,743 40,487 45,878 33,948 20,787 1,147 5,419 5,392 12,611 10,574 357 1,680 31 31 Other FI 37,679 19,814 57,493 47,640 49,158 19,865 5,056 3,510 3,279 24,331 20,803 2,140 1,388 42 42 SPVs (4) 20,416 3,671 24,087 22,127 21,661 2,584 2,419 7 7 8,016 7,209 805 2 33 33 Total FI 81,839 40,228 122,067 115,645 104,767 43,236 8,622 8,936 8,678 44,958 38,586 3,302 3,070 37 37 Corporates Property - Western Europe - UK 50,675 2,346 53,021 49,644 47,222 10,587 5,057 870 742 27,792 24,752 2,651 389 52 52 - Ireland 10,295 150 10,445 10,903 10,184 435 228 71 33 5,796 5,652 126 18 55 55 - Other 7,913 994 8,907 8,705 7,706 3,433 730 1,032 471 5,067 4,384 415 268 57 57 - US 7,469 184 7,653 5,797 5,839 3,790 1,468 466 346 6,872 5,243 1,318 311 90 90 - RoW 3,291 605 3,896 3,199 3,320 1,281 268 575 308 3,070 2,617 211 242 79 79 Total property 79,643 4,279 83,922 78,248 74,271 19,526 7,751 3,014 1,900 48,597 42,648 4,721 1,228 58 57 Natural resources 28,242 3,987 32,229 21,150 19,599 37,292 8,750 5,014 3,880 18,021 10,960 4,892 2,169 56 56 Transport 32,017 2,684 34,701 28,773 27,893 14,837 4,680 3,328 2,128 24,387 19,603 3,289 1,495 70 70 Manufacturing 31,426 998 32,424 24,029 21,256 31,132 8,700 3,785 2,468 21,206 13,902 5,690 1,614 65 65 Retail and leisure 30,473 1,245 31,718 28,429 25,301 17,161 4,923 1,786 1,494 25,893 20,655 4,018 1,220 82 82 Services 30,168 1,305 31,473 28,548 26,291 9,722 3,866 1,553 1,316 24,354 20,345 2,991 1,018 77 77 TMT (5) 14,911 861 15,772 15,811 10,127 15,933 4,609 1,578 1,036 10,668 6,849 3,118 701 68 68 Total corporates 246,880 15,359 262,239 224,988 204,738 145,603 43,729 20,058 14,222 173,126 134,962 28,719 9,445 66 66 Personal Mortgages - Western Europe - UK 118,311 — 118,311 108,690 108,700 9,796 9,570 41 41 17,679 16,243 1,430 6 15 15 - Ireland 17,181 — 17,181 16,841 16,841 62 340 — — 16,120 15,800 320 — 94 94 - Other 709 — 709 687 688 20 21 — — 227 220 7 — 32 32 - US 19,838 — 19,838 19,753 19,782 9,913 56 — — 9,771 9,744 27 — 49 49 - RoW 638 — 638 599 599 46 39 — — 157 147 10 — 25 25 Total mortgages 156,677 — 156,677 146,570 146,610 19,837 10,026 41 41 43,954 42,154 1,794 6 28 29 Other personal 47,826 53 47,879 30,030 29,187 40,829 18,135 634 557 25,989 15,843 9,844 302 54 54 Total personal 204,503 53 204,556 176,600 175,797 60,666 28,161 675 598 69,943 57,997 11,638 308 34 33 Other items 23,872 73 23,945 21,945 2,000 19,859 18,200 1,659 83 83 Total 674,063 70,093 744,156 647,299 637,963 327,395 80,568 29,719 25,625 313,403 255,187 43,727 14,489 42 40
Capital management* continued RWA density continued EAD Off- EAD post EAD post CRM (1) Drawn balance CRM RWA Non-CCR CCR (2) Total balance Undrawn sheet RWAs density (3) 2012 £m £m £m £m £m £m £m %
Corporates Property - Western Europe - UK 57,017 5,460 62,477 57,168 10,953 867 40,366 65
Personal Mortgages - Western Europe - UK 117,709 — 117,709 108,581 9,423 — 18,206 15
Liquidity and funding risk Definition Liquidity and funding 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.
The risk arises through the maturity transformation role that banks perform. It is dependent on company specific factors such as maturity profile, composition of sources and uses of funding, the quality and size of the liquidity portfolio as well as broader market factors, such as wholesale market conditions alongside depositor and investor behaviour.
• Continued enablement of new unencumbered assets as prepositioned collateral for various central bank liquidity facilities.
Liquidity risk Policy, framework and governance The Group’s liquidity policy reflects internal appetite, best market practice and complies with prevailing regulatory structures. These policies are designed to address four broad issues which ensure that: • The Group’s main legal entities maintain adequate liquid resources at all times to meet liabilities as they fall due.
In setting risk limits the Board takes into account the nature of the Group’s various activities, the Group’s overall risk appetite, market best practice and regulatory compliance.
The Group Asset and Liability Management Committee (GALCO) sets and reviews the liquidity risk management framework and limits within the risk appetite set by the Group Board. GALCO oversees the implementation of liquidity management across the Group. Each significant legal entity has a nominated Legal Entity Liquidity Risk Owner who is responsible for managing the liquidity risk for their legal entity. Group Treasury conducts the review, challenge and reporting of the Group’s liquidity performance, while GALCO’s management of liquidity risk is overseen by the Executive Risk Forum, Executive Committee and the Group Board.
Regulatory oversight* The Group operates in multiple jurisdictions and is subject to a number of regulatory regimes.
The Group’s principal regulator, the PRA, has a comprehensive set of liquidity policies, the cornerstone of which is Policy Statement (PS) 09/16. In order to comply with the PRA regulatory process, the Group: • At least annually, completes and keeps updated an ILAA; • Undertakes the Focused Liquidity Review process which is a comprehensive review of the Group’s ILAA, liquidity policies and operational capacity and capability. This in turn leads to the Group and the PRA agreeing the parameters of Group’s Individual Liquidity Guidance (ILG) which influences the overall size of the Group’s liquidity portfolio.
In January 2013, the Basel Committee on Banking Supervision (BCBS) issued its revised draft guidance for calculating the liquidity coverage ratio (LCR), which is currently expected to come into force from 1 January 2015 on a phased basis. Pending the finalisation of the definitions, the Group monitors the LCR and the net stable funding ratio (NSFR) in its internal reporting framework based on its interpretation and expectation of the final rules. On this basis, as of 31 December 2013, the Group’s LCR was 102% and the NSFR 122%.
At present there is a broad range of interpretations on how to calculate both the NSFR and the LCR due to the lack of commonly agreed technical standards. The Group continues to assess the impact of these consultations and actively communicates with regulators and industry groups. Assumptions will be refined as regulatory interpretations evolve.
The Board’s determination and quantification of the appetite for liquidity risk is primarily determined by reference to the ILAA which includes a comparison of the size of liquidity portfolio to an assessment of stressed outflows. The ILAA also informs the Board and PRA of the Group’s liquidity risks, their mitigation and about the current and future liquidity profile.
In determining what assets should be held within the liquidity portfolio, the liquidity risk management framework dictates minimum internal quality criteria, level of currency diversification and maturity mix. The liquidity value of an asset is generally determined by reference to the haircut that would be applied by a central bank operation or in a private repurchase agreement.
The Group actively monitors a range of market-wide and firm-specific early warning indicators of emerging liquidity stresses. Indicators include such areas as customer deposit outflows, market funding costs and movements in the Group’s credit default swap premiums. Early warning indicators and regulatory metrics are reported daily to senior management, including the CFO and Group Treasurer.
Liquidity risks are reviewed daily at a significant legal entity level and performance reported at least monthly to legal entity, divisional and Group Asset and Liability Management Committees. Any breach of internal metric limits will set in motion a series of actions and escalations that could lead to activation of the Group’s Contingency Funding Plan.
In November 2013, the Group’s credit rating was downgraded by Standard & Poor’s. Prior to this event, the Group undertook an intensive internal review of the magnitude of a rating downgrade on customer and counterparty behaviours and these included stress testing and scenario modelling. This analysis was also shared with the PRA. Following the downgrade by Standard & Poor’s, there was minimal impact on customer or counterparty behaviour, the primary reason for deposit withdrawals was due to contractual downgrade triggers or the rating no longer meeting the customer or counterparty’s investment requirements.
Liquidity risk continued Stress testing and contingency planning* Liquidity stress tests apply scenario-based behavioural and contractual assumptions to cash inflows and outflows to assess the level of liquidity reserves required under a particular scenario.
• Retail and commercial bank deposits - Substantial outflows as the
• 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.
The Group has a Contingency Funding Plan (CFP), which is updated at least annually and as the balance sheet evolves and forms the basis of analysis and actions to remediate adverse events as and if they arise. The CFP provides a detailed description of the availability, size and timing of all sources of contingent liquidity available to the Group in a stress event. These are ranked in order of economic impact and effectiveness to meet the anticipated stress requirement. The CFP includes documented processes for actions that may be required to meet the outflows and specifies roles and responsibilities for the effective implementation of the CFP.
The majority of the portfolio is centrally managed by Group Treasury, ring-fenced from the Markets trading book, and is the ultimate responsibility of the Group Treasurer. This portfolio is held in the PRA 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 & Company and Adam & Company.
The UK DLG liquidity portfolio accounted for c.88% of the Group’s total liquidity portfolio, this portion is available to meet liquidity needs as they arise across the Group. The remaining liquidity reserves are held locally within non-UK bank subsidiaries, the majority of this portion is restricted by regulatory requirements and therefore assumed to be restricted and only be available for use locally.
Separately from the liquidity portfolio, the Group holds high quality assets to meet payment systems collateral requirements, these assets are not freely available to other areas of the Group.
Secondary liquid assets comprise other assets that are eligible as collateral for local central bank liquidity facilities but do not meet the core local regulatory definition. These assets include own-issued securitisations or whole loans that are retained on balance sheet and prepositioned with a central bank so that they may be converted into additional sources of liquidity at very short notice.
Stressed outflow coverage (1) 145 128 Liquidity coverage ratio (LCR) (2) 102 >100 Net stable funding ratio (NSFR) (2) 122 117
(2) In January 2013, the Basel Committee on Banking Supervision issued its revised draft guidance for calculating LCR which is currently expected to come into effect from January 2015 on a phased basis. Pending the finalisation of the technical standards, the Group monitors the LCR and NSFR based on its interpretations of the expected final rules.
Liquidity risk continued Liquidity portfolio The table below analyses the Group’s liquidity portfolio by product, liquidity value and carrying value. Liquidity value is lower than carrying value as it is stated after the discounts applied by the Bank of England and other central banks to instruments, within the secondary liquidity portfolio, eligible for discounting.
Cash and balances at central banks 71,121 824 2,417 74,362 80,933 70,109 81,768 69,932 74,711 Central and local government bonds AAA rated governments 3,320 — — 3,320 5,149 9,885 18,832 29,632 37,947 AA- to AA+ rated governments and US agencies 5,822 6,369 96 12,287 12,423 9,621 9,300 14,102 3,074 governments rated below AA — — — — 151 206 596 955 925 local government — — — — 148 979 2,244 4,302 4,779 9,142 6,369 96 15,607 17,871 20,691 30,972 48,991 46,725 Treasury bills — — — — 395 750 202 — 5,937 Primary liquidity 80,263 7,193 2,513 89,969 99,199 91,550 112,942 118,923 127,373 Secondary liquidity (2) 48,718 4,968 2,411 56,097 56,589 55,619 41,978 36,407 34,075 Total liquidity portfolio 128,981 12,161 4,924 146,066 155,788 147,169 154,920 155,330 161,448
Company and Adam & Company plc. In addition, certain of the Group's significant operating subsidiaries - RBS N.V., RBS Citizens Financial Group, Inc. (CFG) and Ulster Bank Ireland Limited - hold locally managed portfolios of liquid assets that comply with local regulations that may differ from PRA rules.
Net stable funding ratio (NSFR)* The table below shows the composition of the Group’s NSFR, based on the current interpretation of the expected final rules. The Group’s NSFR may change over time in line with regulatory developments and related interpretations.
2013 2012 2011 ASF/RSF (1) ASF/RSF (1) ASF/RSF (1) Weighting £bn £bn £bn £bn £bn £bn %
Equity 59 59 70 70 76 76 100 Wholesale funding > 1 year 76 76 109 109 124 124 100 Wholesale funding < 1 year 51 — 70 — 134 — — Derivatives 286 — 434 — 524 — — Repurchase agreements 85 — 132 — 129 — — Deposits - retail and SME - more stable 196 176 203 183 227 204 90 - retail and SME - less stable 66 53 66 53 31 25 80 - other 156 78 164 82 179 89 50 Other (2) 53 — 64 — 83 — — Total liabilities and equity 1,028 442 1,312 497 1,507 518
Key point • The NSFR has improved by 500 basis points to 122% in the year. The required stable funding fell by £63 billion mainly due to the £31 billion decrease in customer lending reflecting balance sheet reduction, business disposals and a £24 billion reduction in other assets, principally equity shares reduction in Markets and lower disposal groups. This was mostly offset by a £55 billion reduction in available stable funding primarily due to a £33 billion planned reduction in term wholesale funding and £11 billion in customer deposit outflow.
Funding risk Funding sources The Group’s primary funding source is its customer deposit base, primarily built through its retail and commercial franchises in the UK, Ireland and the US. These deposits form a stable base which fully funds the Group’s customer lending activities.
Complementary to its deposit funding, the Group also accesses various wholesale markets for funding, on both a public and private basis. These include long-term secured and unsecured debt, short-term money markets and repurchase agreements. The Group has set policies for the prudent use of wholesale funding, as part of its wider liquidity policies.
Analysis Funding sources 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 the normal business environment, while ensuring adequate coverage of all cash requirements under extreme stress conditions.
The table below shows the Group’s sources and uses of funding.
Excluding Including Excluding Including Net derivative derivative derivative derivative inter-bank collateral collateral collateral collateral Deposits Loans (3) funding £bn £bn £bn £bn £bn £bn £bn
Customer deposits derivative cash collateral 7,082 — 7,082 7,949 — 7,949 9,242 — 9,242
2012 Wholesale funding 22,688 41,563 93,700 21,017 178,968 % of wholesale funding 13% 23% 52% 12% 100% Total funding 297,274 136,490 146,203 32,993 612,960 % of total funding 49% 22% 24% 5% 100%
Key point • The proportion of funding held in euros decreased in the year from 24% to 20% reflecting the reduction in euro denominated assets in Non-Core and Markets.
Debt securities in issue Conduit Other CP Covered Subordinated Total Total notes
Less than 1 year — 3,795 10,385 1,853 514 16,547 1,350 17,897 19 1-3 years — 61 14,920 3,621 — 18,602 3,944 22,546 25 3-5 years — — 6,497 867 — 7,364 4,209 11,573 13 More than 5 years — 4 15,362 2,700 7,240 25,306 14,509 39,815 43 — 3,860 47,164 9,041 7,754 67,819 24,012 91,831 100 2012 Less than 1 year — 5,478 13,019 1,038 761 20,296 2,351 22,647 18 1-3 years — 385 20,267 2,948 540 24,140 7,252 31,392 26 3-5 years — 1 13,374 2,380 — 15,755 756 16,511 14 More than 5 years — 5 19,943 3,773 10,680 34,401 16,943 51,344 42 — 5,869 66,603 10,139 11,981 94,592 27,302 121,894 100 2011 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
Firm financing* The Group has access to the short-term money markets to supplement deposit and wholesale funding. The Group’s reverse repos, mainly within Markets, are generally used to fund repos or to cover short positions. In addition, repos are used to fund a small proportion of Markets’ trading assets and by Group Treasury as part of the liquidity portfolio management.
The liquidity risk the Group is exposed to through security financing transactions is significantly lower than in relation to unsecured funding. The Group limits any exposure by setting limits and monitoring any mismatch of quality, maturity or currency. The exposure is also monitored in the context of the available liquid assets.
Less than More than 1 month 1 month Total 2013 £bn £bn £bn
Funding risk continued Divisional loan:deposit ratios and funding surplus The table below shows divisional loans, deposits, loan:deposit ratios and customer funding surplus.
Non-Core 22,880 2,188 nm (20,692) nm (41,846) nm (64,235) Direct Line Group — — — — — (881) — (893)
Notes: (1) Excludes reverse repurchase agreements and net of impairment provisions. (2) Excludes repurchase agreements. (3) 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.
Key point • The loan:deposit ratio improved by 600 basis points to 94% with the funding surplus increasing to £25.1 billion from £2.0 billion at 31 December 2012. The improvement in Retail & Commercial funding surplus was £6.6 billion and Non-Core run-off resulted in £21.2 billion contraction of its funding gap.
Maturity analysis The contractual maturity of balance sheet assets and liabilities reflects the maturity transformation role banks perform, lending long-term but obtaining funding predominantly through short-term liabilities such as customer deposits. 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, despite being repayable on demand or at short notice, have demonstrated stable characteristics even in periods of acute stress such as those experienced in 2008.
Less than 6 months More than excluding 1 month 1-3 months 3-6 months -1 year Subtotal 1-3 years 3-5 years 5 years HFT HFT Total 2012 £m £m £m £m £m £m £m £m £m £m £m
Cash and balances at central banks 79,308 — — — 79,308 — — — 79,308 — 79,308
• not currently encumbered. In this category, the Group has in place an enablement programme which seeks to identify assets which are capable of being encumbered and to identify the actions to facilitate such encumbrance whilst not impacting customer relationships or servicing.
Encumbered assets relating to: Encumbered Unencumbered Debt securities in issue Other secured liabilities Total assets Readily realisable (2)
Cash and balances at central banks — — — — — — — 74.3 8.4 — — 82.7 Loans and advances to banks 5.8 0.5 10.3 — — 16.6 60 0.1 10.9 — — 27.6 Loans and advances to customers - UK residential mortgages 14.6 16.2 — — — 30.8 28 60.8 18.6 — — 110.2 - Irish residential mortgages 9.3 — — — 1.2 10.5 70 0.7 3.8 — 0.1 15.1 - US residential mortgages — — — — 3.5 3.5 18 9.5 6.7 — — 19.7 - UK credit cards 3.4 — — — — 3.4 52 — 3.1 — — 6.5 - UK personal loans 3.4 — — — — 3.4 38 — 5.5 — — 8.9 - other 13.5 — 18.1 — 0.8 32.4 14 4.4 9.6 175.6 10.2 232.2 Reverse repurchase agreements and stock borrowing — — — — — — — — — — 76.5 76.5 Debt securities 0.9 — 5.5 55.6 2.7 64.7 57 17.0 31.9 — — 113.6 Equity shares — — 0.5 5.3 — 5.8 66 — 3.0 — — 8.8 Settlement balances — — — — — — — — — — 5.5 5.5 Derivatives — — — — — — — — — — 288.0 288.0 Intangible assets — — — — — — — — — — 12.4 12.4 Property, plant and equipment — — — — 0.4 0.4 5 — — 7.5 — 7.9 Deferred tax — — — — — — — — — — 3.5 3.5 Prepayments, accrued income and other assets — — — — — — — — — — 8.6 8.6 Assets of disposal groups — — — — — — — — — — 0.2 0.2 50.9 16.7 34.4 60.9 8.6 171.5 166.8 101.5 183.1 405.0 1,027.9
Liabilities secured Intra-Group - used for secondary liquidity (19.1) — — — — (19.1) Intra-Group - other (18.4) — — — — (18.4) Third-party (5) (7.8) (9.0) (42.7) (85.1) (6.0) (150.6) (45.3) (9.0) (42.7) (85.1) (6.0) (188.1)
(4) Assets that cannot be encumbered comprise: (a) derivatives, reverse repurchase agreements and trading related settlement balances. (b) non-financial assets such as intangibles, prepayments and deferred tax. (c) assets in disposal groups. (d) loans that cannot be pre-positioned with central banks based on criteria set by the central banks, primarily US, including date of origination and level of documentation. (e) non-recourse invoice financing balances and certain shipping loans whose terms and structure prohibit their use as collateral.
(5) In accordance with market practice the Group employs its own assets and securities received under reverse repo transactions as collateral for repos.
Encumbered assets relating to: Debt securities in issue Other secured liabilities Total Encumbered Unencumbered Securitisations Covered Secured encumbered assets as a Liquidity and conduits bonds Derivatives Repos deposits assets % of related portfolio Other Total 2012 £bn £bn £bn £bn £bn £bn assets £bn £bn £bn
For information on collateral received and used relating to securities financing transactions (SFT) and derivatives refer to the following page.
Funding risk continued Summary of assets available as collateral (on and off-balance sheet)* The table below summarises total on and off-balance sheet assets that are available to support funding and collateral requirements.
Total on-balance sheet assets 1,027.9 Less: - Reverse repos and derivatives (364.5) - Other assets not available to be pledged (40.5) Total on-balance sheet assets available 622.9 Add: - Fair value of securities received as collateral from reverse repo and derivative transactions 124.2 Total assets available 747.1 Less: - On-balance sheet assets pledged (171.5) - Reverse repo and derivative securities collateral that have been rehypothicated (111.5) Assets available to be pledged 464.1
The Group offers a number of lending products where it has an irrevocable obligation to provide credit facilities to a customer. Security may be obtained to mitigate the risk of loss in the form of physical collateral, such as commercial real estate assets and residential property, or financial collateral such as cash or bonds. Also included in the Group’s lending are exposures arising from leasing activities.
The Group holds debt securities with the intention of selling them and so is exposed to market risk. However, it also holds some debt securities generally for liquidity management purposes, and is exposed to credit risk as a result.
The Group Chief Credit Officer (GCCO), through the Group Credit Risk (GCR) function, is responsible for the development of, and ensuring compliance with, Group-wide policies and credit risk frameworks as well as Group-wide assessment of provision adequacy. The risk management functions, located in the Group’s business divisions, are responsible for the execution of these policies.
The divisional credit risk management functions work together with GCR to ensure that the risk appetite set by the Group Board is met. The credit risk function in each division is managed by a Chief Credit Officer, who reports jointly to a divisional Chief Risk Officer and to the GCCO. Divisional credit risk management activities include transaction analysis, credit approval, ongoing credit risk stewardship, and early problem identification and management.
Key trends in the credit risk profile of the Group, performance against limits and emerging risks are set out in the RBS Risk Management Monthly Report provided to the Executive Committee, the Board Risk Committee and the Group Board.
Risk management* Product/asset class concentration framework The Group manages certain lines of business where the nature of credit risk assumed could result in a concentration or a heightened risk in some other form. This includes specific credit risk types such as settlement or wrong-way risk and products such as long-dated derivatives or securitisations. These product and asset classes may require formal policies and expertise as well as tailored monitoring and reporting measures. In some cases specific limits and thresholds are deployed to ensure that the credit risk inherent in these lines of business and products is adequately controlled. Product and asset classes are reviewed regularly. The reviews consider the risks inherent in each product or asset class, the risk controls applied, monitoring and reporting of the risk, the client base, and any emerging risks to ensure risk appetite remains appropriate.
Sector concentration Exposures are assigned to, and reviewed in the context of, a defined set of industry sectors. Risk appetite and portfolio strategies are set at either the sector or sub-sector level, depending on where exposures may result in excessive concentration, or where trends in both external factors and internal portfolio performance give cause for concern. Regular formal reviews are undertaken at Group or divisional level depending on materiality. Reviews may include an assessment of the Group’s franchise in a particular sector, an analysis of the outlook, identification of key vulnerabilities or stress testing.
Several credit risk mitigation techniques are available to reduce single name concentrations. If the Group decides that its exposure is too high, it may decide to sell excess exposures. Alternatively, it may decide to take additional security or guarantees such as cash, bank or government guarantees or enter into credit default swaps. Credit risk mitigants must be effective in terms of legal certainty and enforceability. In addition, maturity or expiry dates must be the same, or later, than the underlying obligations.
Retail A product and asset class framework exists to control credit risk for retail businesses. It sets limits that measure and control the asset quality of each key business area, the portfolios in that business and the new business being originated. The actual performance of each portfolio is tracked relative to these limits and action taken where necessary.
Credit risk continued Risk management* continued Retail Retail lending entails making a large number of small value loans. To ensure that it makes these lending decisions consistently, the Group analyses the historical debt servicing behaviour of customers, including their behaviour with respect to their other lenders. The Group then uses the results of these analyses to set its lending rules, developing different rules for different products. The resulting credit decision making process is then largely automated, with customers receiving a credit score that reflects the outcome of a comparison of their credit profile with the rule set. However, in the case of relatively high value, complex personal or small business loans, including some residential mortgage lending, specialist credit managers make the final lending decisions.
Controls and assurance The Group’s credit control and assurance framework has three key components: credit policy; policy compliance assurance; and independent assurance. These apply to both wholesale and retail credit risk at both portfolio and individual customer level.
The second component is a policy assurance activity that GCR undertakes to provide the GCCO with evidence of the effectiveness of credit risk management controls in place across the Group. The results of these reviews are presented to the Group Credit Risk Committee on a regular basis in support of the self-certification that GCR must complete from time to time.
Risk measurement* The Group uses a range of measures for credit risk exposures. The internal measure used, unless otherwise stated, is credit risk assets (CRA) consisting of: • Lending exposure - measured using drawn balances and includes cash balances at central banks and loans and advances to banks and customers (including overdraft facilities, instalment credit and finance leases).
• Wholesale models - A number of credit grading models are in place that consider risk characteristics relevant to different customer types. These models use a combination of quantitative inputs, such as recent financial performance, and qualitative inputs such as management performance or sector outlook. As part of the credit assessment process, the Group assigns each customer an internal credit grade based on its PD.
Exposure at default (EAD) EAD models provide estimates of the level of use of a credit facility at the time of a customer's default, recognising that customers may make further drawings on unused credit facilities prior to default. Regulatory requirements determine that EAD is always equal to or higher than current utilisation. Exposure can be reduced by a netting agreement, subject to meeting standards of legal enforceability.
As in 2012, the impact of the model changes implemented in 2013 largely affected the lower risk segments of the Group’s portfolios, mostly to customers bearing the equivalent of investment-grade ratings.
The model takes into account migration risk (risk that credit assets will deteriorate in credit quality across multiple years), factor correlation (the assumption that groups of obligors share a common factor) and contagion risk (for example, the risk that the weakening of the sovereign’s creditworthiness has a significant impact on the creditworthiness of a business operating in that country).
Key points • Overall, CRA fell by 8% during the year. 59% of the £52.8 billion reduction was in the Core divisions.
Treasury’s exposure to central banks in the UK and US and was a function of the Group’s liquidity requirements and cash positions. Exposures to central banks in Western Europe decreased by 76% year-on-year and at the year end represented 7% of ‘other’ exposure (2012 - 32%).
UK (excl. UK) America Pacific America Other (1) Total Core Non-Core 2013 £m £m £m £m £m £m £m £m £m
Credit risk continued Credit risk assets* continued Key points Financial markets and the Group’s focus on risk appetite and sector concentration had a direct impact on the portfolio during the year with the following key trends observed: • Total CRA fell 8%, with the only notable increase being in the sovereign sector, including exposures to central banks (increased 3%). Excluding sovereign exposures, CRA decreased by 10%.
• At the year end, the portfolio comprised 31% personal exposure
• CRA fell in all geographic regions. The largest decrease, in Western
• Exposure to sovereigns fluctuates according to Group liquidity requirements and cash positions. These are driven by inflows and outflows of deposits which determine the level of cash placed with central banks and have contributed to higher exposures at the Bank of England and lower exposures at European central banks. The Group’s sovereign portfolio comprises exposures to central governments, central banks and sub-sovereigns such as local authorities, primarily in the Group’s key markets of the UK, Western Europe and the US. The asset quality is high because exposures are largely short-term cash balances placed with central banks such as the Bank of England, the Federal Reserve and the Eurosystem (including the European Central Bank and central banks in the eurozone). Information on the Group’s exposure to governments, including peripheral eurozone sovereigns, can be found in the Country risk section.
• The Group continued to manage down its exposures to financial guarantors - credit derivative products companies (CDPCs) and monolines with a view to exiting these portfolios. Exposure to financial guarantors declined by 69% and represented less than 1% of the other financial institutions portfolio (2012 - 2%). Exposures have decreased materially over time as trades are commuted and exposures reduced due to the tightening credit spread of the assets protected by CDPCs and monolines. At the year end, exposures to CDPCs and monolines totalled £274 million (2012 - £874 million).
Credit risk continued Credit risk assets* continued Asset quality (AQ) Internal reporting and oversight of CRA is principally differentiated by credit grades. Customers are assigned credit grades based on various credit grading models that reflect the key drivers of default for each customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures, used for internal management reporting across portfolios. Accordingly, measures of risk exposure may be readily aggregated and reported at increasing levels of granularity depending on stakeholder or business need. Performing loans are defined as AQ1-AQ9 (where the PD is less than 100%) and nonperforming loans as AQ10 (where the PD is 100%).
• The increase in the proportion of the Group’s Core exposures in the
• The increase in AQ4 was due to a positive shift in the asset quality band distribution of UK Retail and reflected improvements in the underlying credit quality of the UK Retail mortgage portfolio over the last three years.
• Property continued to be the largest sector in non-performing assets
• Non-performing assets in the Ulster Bank portfolio continued to grow, driven by exposures in the wholesale property sector. Refer to Key loan portfolios: Ulster Bank Group (Core and Non-Core) on pages 265 to 267 for more details.
AQ10 exposure. AQ10 exposure in this sector decreased during the year for all divisions except Ulster Bank.
Risk mitigation Risk mitigation techniques are used in the management of credit portfolios across the Group, typically to mitigate credit concentrations in relation to an individual customer, a borrower group or a collection of related borrowers. Where possible, the Group nets customer credit balances against obligations.
The Group’s business and credit teams are supported by specialist inhouse documentation teams. The Group uses industry-standard loan and security documentation wherever possible. However, when the Group uses non-standard documentation, external lawyers are employed on a case-by-case basis.
• Physical assets - These may include stock, plant, equipment, machinery, vehicles, ships and aircraft. Such assets are suitable collateral only if the Group can identify, locate, and segregate them from other assets on which it does not have a claim. The Group values physical assets in a variety of different ways, depending on the type of asset concerned and may rely on balance sheet valuations in certain cases. In the US, the Group also takes collateral in the form of motor vehicles to mitigate the credit risk arising from automobile lending. The Group values new vehicles at cost and used ones at the relevant average trade-in value.
Average LTV on new originations during the year (3) 67% 73% 68% 52%
The Group mitigates counterparty credit risk by netting amounts it owes to a counterparty against amounts the same counterparty owes to it, in accordance with relevant regulatory and internal policies. It generally does so only if it has a netting agreement in place as well as a legal opinion to the effect that the agreement is enforceable in the relevant jurisdictions.
Collateral generally takes the form of cash. In the case of repurchase agreements, collateral usually takes the form of debt and equity securities at the outset but if the value of collateral falls relative to that of the obligation, the Group may require additional collateral in the form of cash (variation margin). Industry standard documentation, such as master repurchase agreements and credit support annexes accompanied by legal opinion, is used for financial collateral taken as part of trading activities.
The Group limits counterparty credit exposures by setting limits which take into account the potential adverse movement of a counterparty credit exposure after adjusting the impact of netting and collateral where applicable.
Cash collateral held (24.3) (34.1) (37.2) Securities received as collateral (6.0) (5.6) (5.3)
Credit risk continued Early problem identification and problem debt management Wholesale Early problem identification Each division has defined early warning indicators (EWIs) to identify customers experiencing financial difficulty, and to increase monitoring if needed. EWIs may be internal, such as a customer’s bank account activity, or external, such as a publicly-listed customer’s share price. If EWIs show a customer is experiencing potential or actual difficulty, divisional credit officers may decide to place it on the Watchlist.
Remediation strategies available in the divisions include granting a customer various types of concessions. Any decision to approve a concession will be a function of the division’s specific country and sector appetite, the key metrics of the customer, the market environment and the loan structure and security. For further information, refer to the Wholesale forbearance section below.
Other potential outcomes of the relationship review are to: take the customer off the Watchlist; offer additional lending and continue monitoring; transfer the relationship to GRG if appropriate; or exit the relationship altogether.
Property 3,178 1,841 5,019 5,605 4,377 9,982 6,561 6,011 12,572 Transport 1,791 456 2,247 2,238 478 2,716 1,159 2,252 3,411 Retail and leisure 1,092 237 1,329 1,542 432 1,974 1,528 669 2,197 Services 955 40 995 870 84 954 808 141 949 Other 2,312 804 3,116 3,087 1,177 4,264 1,952 916 2,868 Total 9,328 3,378 12,706 13,342 6,548 19,890 12,008 9,989 21,997
The factor common to all customers managed by GRG is that the Group’s exposure is outside risk appetite. Customers transferred to GRG typically show symptoms of significant financial difficulty, such as cash flow pressures, or show evidence that the management team has limited experience of managing a business in difficulty. In addition, a customer may be transferred to GRG if the Group is not provided with sufficient or reliable information on which to make decisions.
GRG relationship managers use their skill, experience and judgement to support customers through these difficulties while seeking to minimise losses to protect the Group’s capital.
When the relationship is transferred, GRG conducts a detailed assessment of the viability of the business as well as the ability of management to deal with the causes of financial difficulty. Following GRG’s initial file assessment and, if appropriate, wider due diligence with input from independent experts (sector experts, accountants and surveyors), various options are presented to the customer. A strategy is then agreed with the customer for dealing with the distressed loan.
Wholesale forbearance Definition Forbearance takes place when a concession is made on the contractual terms of a loan in response to a customer’s financial difficulties.
A number of options are available to the Group. Such actions are tailored to the customer’s individual circumstances. The aim of such actions is to restore the customer to financial health and to minimise risk to the Group. To ensure that forbearance is appropriate for the needs and financial profile of the customer, the Group applies minimum standards when assessing, recording, monitoring and reporting forbearance.
The contractual margin may be amended to bolster the customer’s dayto -day liquidity to help sustain the customer’s business as a going concern. This would normally be a short-term solution. As set out above, the Group would seek to obtain a return commensurate to the risk that it is required to take and this can be structured in the same ways set out above.
The data presented in the tables below include loans forborne during 2011, 2012 and 2013 which individually exceeded thresholds set at divisional level. The Group continues to refine its reporting processes for forborne loans and, as a result, in 2013, thresholds were reduced to range from nil to £3 million. During 2011 and 2012, these thresholds ranged from nil to £10 million. The proportion of the Watch and GRG population covered by these thresholds has changed over time as the thresholds have been reduced. In 2013, this was 90% (2012 - 84%).
Credit risk continued Early problem identification and problem debt management continued The table below shows the value of loans (excluding loans where the Group has initiated recovery procedures) where forbearance was completed during the year, by sector and types. 2013 2012 2011
Provision Provision Provision Performing Non-performing coverage (1) Performing Non-performing Coverage (1) Performing Non-performing Coverage (1)Wholesale forbearance during the year by sector £m £m % £m £m % £m £m %
• Core bank customers were granted forbearance by GRG on loan facilities totalling £6.9 billion during 2012 and 2013, which equates to 23% of loans managed by GRG (excluding loans to customers managed by recovery units). Of these loans, 15% by value had been returned to performing portfolios managed within the originating divisions by 31 December 2013. There are also loans that are not forborne which have been returned from GRG to performing portfolios managed within the originating divisions. 79% by value of the performing Core loans granted forbearance during 2012 remained performing as at 31 December 2013.*
• Provision coverage for forborne loans increased during the year. This was primarily the result of provisions in Ulster Bank, specifically in the property sector, and driven by the Group’s RCR strategy. For further information regarding Ulster Bank refer to the Ulster Bank Group (Core and Non-Core) section on pages 265 to 267.
If collections strategies are unsuccessful the relationship is transferred to the recoveries team. For further details on recoveries, refer to page 250.
Retail forbearance Definition Forbearance takes place when a concession is made on the contractual terms of a loan in response to a customer's financial difficulties. In UK Retail and Ulster Bank, a broader definition of forbearance is used that includes mortgages where a customer has made a change to contractual terms, when their payments status is up-to-date and they are not necessarily evidencing signs of financial difficulty. Forbearance is granted on a permanent, or temporary, basis following an assessment of the customer's individual circumstances and ability to pay. For UK Retail and Ulster Bank, the disclosure covers changes in contractual terms dating back to January 2008 and early 2009 respectively.
In response to the economic difficulties in the Republic of Ireland, Ulster Bank has developed additional forbearance options. These payment concessions support customers over an extended period of time and include instances where some interest is forgiven by granting interest rate discounts for a 3-5 year period.
Similarly RBS Citizens participates in the US government mandated Home Affordable Modification Program as well as its own proprietary programme. Both feature a combination of term extensions, capitalisations of arrears, interest rate reductions and conversions from interest only to amortising. These tend to be permanent changes to contractual terms. In order to qualify for either of the programmes, customers must meet government-specified or internal criteria designed to evidence financial difficulty but demonstrate a willingness to pay.
Credit risk continued Early problem identification and problem debt management continued Unsecured portfolios For unsecured portfolios in UK Retail and Ulster Bank, forbearance entails reduced or deferred payments. Arrangements to facilitate the repayment of overdraft excesses or loan arrears can be agreed dependent on affordability. Where repayment arrangements are not affordable debt consolidation loans can be provided to customers in collections.
In RBS Citizens, granting of forbearance is predominantly restricted to short-term (1-3 months) loan extensions to alleviate the financial burden caused by temporary hardship. Such extensions are offered only if a customer has demonstrated a capacity and willingness to pay. The number and frequency of extensions granted to a customer are limited. Additionally, for loans secured by vehicles and credit cards, RBS Citizens may offer temporary interest rate modifications, but no principal reductions. Forbearance may also be offered to student loan customers consistent with the policy guidelines of the US Office of the Comptroller of the Currency.
• For unsecured portfolios in Ulster Bank, £16 million (3.8% by value)
• For unsecured portfolios in RBS Citizens, £135 million (1.7% of the unsecured balances) were subject to forbearance at 2013 year end (includes auto and recreational vehicle marine portfolios and excludes small business loans as these are included as part of wholesale reporting).
Monitoring of forbearance Forbearance loans may be performing or non-performing. The granting of forbearance does not change the delinquency status of the loan unless the arrangement involves a capitalisation of all existing arrears of principal and interest, in which case the loan becomes up-to-date.
Loans granted forbearance are included in the non-performing book: when 90 days past due; or if the forbearance arrangement is a payment concession that involves a reduction in contractually required cash flows i.e. the forgiveness of interest. Such loans are classified as impaired. In RBS Citizens, all loans subject to forbearance are included in the nonperforming book.
No missed payments 1-3 months in arrears >3 months in arrears Total Forborne
Notes: (1) As a percentage of mortgage loans. (2) Forbearance in UK Retail and Ulster Bank capture all instances where a change has been made to the contractual payment terms including those where the customer is up-to-date on payments and there is no obvious evidence of financial difficulty. (3) Includes the current stock position of forbearance deals agreed since early 2008 for UK Retail and early 2009 for Ulster Bank.
Interest only conversions - temporary and permanent (2) 1,784 512 — — 2,296 Term extensions - capital repayment and interest only 2,478 325 35 29 2,867 Payment concessions (3) 241 1,567 246 12 2,066 Capitalisation of arrears 907 494 — — 1,401 Other 366 — 92 86 544 5,776 2,898 373 127 9,174 2012 Interest only conversions - temporary and permanent 1,220 924 — 6 2,150 Term extensions - capital repayment and interest only 2,271 183 — 27 2,481 Payment concessions (3) 215 762 339 9 1,325 Capitalisation of arrears 932 119 — — 1,051 Other 452 — — 3 455 5,090 1,988 339 45 7,462 2011 Interest only conversions - temporary and permanent 1,269 795 — 3 2,067 Term extensions - capital repayment and interest only 1,805 58 — 97 1,960 Payment concessions 198 876 180 — 1,254 Capitalisation of arrears 864 101 — — 965 Other 517 — — 23 540 4,653 1,830 180 123 6,786
Notes: (1) As an individual case can include more than one type of arrangement, the analysis in the table on forbearance arrangements exceeds the total value of cases subject to forbearance. (2) The year-on-year increase for UK Retail was driven by an extension of the reporting definition to include legacy conversions to interest only repayment in cases where customers were previously on a combination of repayment types. (3) Includes £365 million of Ulster Bank loans (2012 - £10 million) and £62 million of RBS Citizens loans (2012 - £31 million) where an interest rate discount has been agreed resulting in a reduction of contractual cash flows through forgiveness of interest.
UK Retail Ulster Bank RBS Citizens Wealth Total 2013 £m £m £m £m £m
• The flow of new forbearance of £380 million in the fourth quarter of 2013 continued on a downward trend compared with an average of £456 million in the preceding four quarters. The full year flow for 2013 was £1.7 billion, a 15% reduction on the 2012 flow.
• The majority (90%) of UK Retail forbearance is permanent in nature
• The most frequently occurring forbearance types were term extensions (43% of forbearance loans at 31 December 2013), interest only conversions (31%) and capitalisations of arrears (16%). The growth of interest only stock reflected the extended definition referred to above. The underlying level of transfers was negligible and the remaining stock was the result of legacy policy. Conversions to interest only have only been permitted on a very exceptional basis since the fourth quarter of 2012 and have not been permitted for customers in financial difficulty since 2009.
• Temporary interest only arrangements decreased during 2013 to 18% of forbearance loans at 31 December 2013 (2012 - 46%). This reflected Ulster Bank’s strategy to transition customers in financial difficulty to long-term arrangements.
• Payment concessions represented the remaining 54%, comprising: deals where payments amortised the outstanding balance (41%); a diminishing portfolio of deals that negatively amortised (10%); and payment holidays (3%).
Group impairment loss provisioning Impaired definition A financial asset is impaired if there is objective evidence that an event or events since initial recognition of the asset, has adversely affected the amount or timing of future cash flows from it. The loss is measured as the difference between the carrying value of the loan and the present value of estimated future cash flows discounted at the loan’s original effective interest rate.
Individually assessed provisions Loans and securities above a defined threshold deemed to be individually significant are assessed on a case-by-case basis. Assessments of future cash flows take into account the impact of any guarantees or collateral held. Projections of cash flow receipts are based on the Group’s judgement and facts available at the time. Projected cash flows are reviewed on subsequent assessment dates as new information becomes available.
Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as coupon period and repayment terms, and the duration of the administrative process required to report and identify an impaired loan as such. Emergence periods vary across different portfolios from 2 to 225 days. They are based on actual experience within the particular portfolio and are reviewed regularly.
Impact of forbearance on provisioning Wholesale Forbearance may result in the value of the outstanding debt exceeding the present value of the estimated future cash flows. This may result in the recognition of an impairment loss or a write-off.
In the case of non-performing loans that are forborne, the loan impairment provision assessment almost invariably takes place prior to forbearance being granted. The quantum of the loan impairment provision may change once the terms of the forbearance are known, resulting in an additional provision charge or a release of the provision in the period the forbearance is granted.
Impairment provisions in respect of loans subject to forbearance are evaluated as follows: In UK Retail performing loans are subject to a latent loss provision but form a separate risk pool for 24 months. The higher of the observed default rates and PDs are used in the latent provisioning calculations for these loans to ensure that appropriate provision is held. Furthermore, for these portfolios the latent provision incorporates extended emergence periods. Once such loans are no longer separately identified, the use of account level PDs refreshed monthly in the latent provision methodology captures the underlying credit risk without a material time lag.
There is no reassessment of the PD at the time forbearance is granted but the loan will be the subject to the latent provisioning methodology described above. Non-performing loans are subject to a collectively assessed provision methodology.
In Ulster Bank performing loans are subject to a latent loss provision but form a separate risk pool for the period of forbearance. The performance of forbearance arrangements is analysed and breakage (a single missed payment) rates computed. The higher of the breakage rate and the modelled PD for this separate risk pool is used when calculating the latent provision. Furthermore, for this portfolio the latent provision incorporates an extended emergence period. Once such loans are no longer separately identified, the use of account level PDs refreshed monthly in the latent provision methodology captures the underlying credit risk without a material time lag. There is no reassessment of the PD at the time forbearance is granted but the loan will be the subject to the latent provisioning methodology described above. Non-performing loans are subject to a collectively assessed provision methodology. However, loans not 90 days past due that are subject to forbearance arrangements involving a reduction in contractually required cash flows i.e. the forgiveness of interest and where arrears have not been capitalised are classified as non-performing. They form a separate risk pool for the period of forbearance and the related loan loss provision is computed using Ulster Bank’s latent loss provision methodology.
Non-performing loans are grouped into homogeneous portfolios sharing similar credit characteristics according to the asset type. Further characteristics such as LTVs, arrears status and default vintage are also considered when assessing recoverable amount and calculating the related provision requirement. While non-performing forbearance retail loans do not form a separate risk pool, the LGD models used to calculate the collective impairment provision are affected by agreements made under forbearance arrangements.
In RBS Citizens, retail loans subject to forbearance are segmented from the rest of the non-forborne population and assessed individually for impairment loss throughout their lives until the loans are repaid or fully written off. The amount of recorded impairment depends on whether the loan is collateral dependent. If the loans are considered collateral dependent, the excess of the loan’s carrying amount over the fair value of the collateral is the impairment amount. If the loan is not deemed collateral dependent, the excess of the loans’ carrying amount over the present value of expected future cash flows is the impairment amount. Any confirmed losses are charged off immediately.
Write-offs The Group normally writes-off loans when it has exhausted all its collection strategies and has no realistic chance of recovering the money it is owed. Refer to pages 382 and 383 for further information on the Group’s write-off policies and practices.
2013 2012 2011 Investment Development Total Investment Development Total Investment Development Total Commercial real estate by division (1) £m £m £m £m £m £m £m £m £m
UK Corporate 20,547 3,467 24,014 22,504 4,091 26,595 25,101 5,023 30,124 Ulster Bank 3,419 718 4,137 3,575 729 4,304 3,882 881 4,763 US Retail & Commercial 4,018 — 4,018 3,857 3 3,860 4,235 70 4,305 International Banking 762 182 944 849 315 1,164 872 299 1,171 Markets 136 1 137 630 57 687 141 61 202 28,882 4,368 33,250 31,415 5,195 36,610 34,231 6,334 40,565
Investment Development Investment Development Commercial Residential Commercial Residential Total Core Non-Core Core Non-Core TotalCommercial real estate by geography (1) £m £m £m £m £m £m £m £m £m £m
For the notes to these tables refer to the following page.
UK Ireland Western (excl NI (2)) (ROI and NI (2)) Europe US RoW (2) Total Commercial real estate by sub-sector (1) £m £m £m £m £m £m
Notes: (1) Excludes commercial real estate lending in Wealth as these loans are generally supported by personal guarantees in addition to collateral. This portfolio, which totalled £1.4 billion at 31 December 2013 (2012 - £1.4 billion; 2011 - £1.3 billion) continued to perform in line with expectations and required minimal provision. (2) ROI: Republic of Ireland; NI: Northern Ireland; RoW: Rest of World.
• A significant proportion of the decrease was in Non-Core and was due to repayments, asset sales and write-offs. The Non-Core portfolio totalled £19.3 billion (37% of the portfolio) at 31 December 2013 (2012 - £26.4 billion or 42% of the portfolio).
Commercial real estate maturity profile of portfolio £m £m £m £m £m £m 2013
Non-Core < 1 year (1) 1,432 8,479 85 4,864 — 14,860 1-2 years 77 1,276 31 507 — 1,891 2-3 years 36 185 33 220 — 474 > 3 years 295 186 83 1,404 — 1,968 Not classified (2) 135 — — — — 135 1,975 10,126 232 6,995 — 19,328 2012 Core < 1 year (1) 8,639 3,000 797 216 59 12,711 1-2 years 3,999 284 801 283 130 5,497 2-3 years 3,817 215 667 505 — 5,204 > 3 years 9,597 805 1,595 160 498 12,655 Not classified (2) 543 — — — — 543 26,595 4,304 3,860 1,164 687 36,610
Non-Core < 1 year (1) 2,071 9,498 138 4,628 — 16,335 1-2 years 192 1,240 79 3,714 — 5,225 2-3 years 99 38 43 1,137 — 1,317 > 3 years 1,058 214 132 1,935 — 3,339 Not classified (2) 214 — — — — 214 3,634 10,990 392 11,414 — 26,430 2011 Core < 1 year (1) 8,268 3,030 1,056 142 — 12,496 1-2 years 5,187 391 638 218 60 6,494 2-3 years 3,587 117 765 230 133 4,832 > 3 years 10,871 1,225 1,846 581 9 14,532 Not classified (2) 2,211 — — — — 2,211 30,124 4,763 4,305 1,171 202 40,565
Non-Core < 1 year (1) 3,224 11,089 293 7,093 — 21,699 1-2 years 508 692 163 3,064 — 4,427 2-3 years 312 177 152 1,738 — 2,379 > 3 years 1,636 392 321 3,126 — 5,475 Not classified (2) 297 — — 4 — 301 5,977 12,350 929 15,025 — 34,281 Notes: (1) Includes on demand and past due assets. (2) Predominantly comprises overdrafts and multi-option facilities for which there is no single maturity date.
• The majority of Ulster Bank’s commercial real estate portfolio was categorised as under one year, owing to the high level of nonperforming assets in the portfolio.
Key points • There was an overall decrease in AQ10 during the year with reductions in Non-Core partially offset by increases in Ulster Bank. The high proportion of the portfolio in AQ10 was driven by exposure in Non-Core (Ulster Bank and International Banking) and Core (Ulster Bank).
• Of the total portfolio of £52.6 billion at 31 December 2013, £24.9 billion (2012 - £28.1 billion) was managed within the Group’s standard credit processes. Another £2.9 billion (2012 - £5.1 billion) received varying degrees of heightened credit management under the Watchlist process. The decrease in the portfolio managed in the Group’s Watchlist process occurred mainly in Non-Core and UK Corporate. The remaining £24.7 billion (2012 - £29.8 billion) was managed in GRG and included Watchlist and non-performing exposures.
Notes: (1) In 2012, the Group reclassified loans with limited (defined as LTV>1,000%) or non-physical security as minimal security, of which a majority were commercial real estate development loans in Ulster
Refer to pages 262 to 264 for further information on interest only loans.
Performing performing Total Performing performing Total Performing performing Total Performing performing Total Loan-to-value ratio £m £m £m £m £m £m £m £m £m £m £m £m
Average LTV on new originations during the year (3) 65% 74% 64%
Non- Non- Non- Performing performing Total Performing performing Total Performing performing Total
• Gross new mortgage lending amounted to £14.4 billion and the average LTV by volume was 62.7% compared to 61.3% at 31 December 2012. The average LTV calculated by weighted LTV of lending was 66.6% (2012 - 65.2%).
Credit risk continued Key loan portfolios* continued Ulster Bank • Ulster Bank’s residential mortgage portfolio was £19.0 billion at 31
The interest rate product mix was approximately 68% on tracker rate products, 23% on variable rate products and 9% on fixed rate. Interest only represented 11% of the total portfolio.
• The average individual LTV on new originations was 73% in 2013,
• The portfolio average indexed LTV fell 4% during 2013 and reflected positive house price index trends over the last 12 months.
• RBS Citizens continued to focus on its ‘footprint states’ of New
• Of the total real estate portfolio of £1.8 billion in Non-Core, the serviced-by-others (SBO) element was the largest component (76%). The SBO book decreased from £1.8 billion at 31 December 2012 to £1.4 billion at 31 December 2013 and was closed to new purchases in the third quarter of 2007. The arrears rate of the SBO portfolio decreased from 1.9% at 31 December 2012 to 1.6% at 31 December 2013 reflecting portfolio liquidation as well as more effective account servicing and collections. The charge-off rate also continued to decrease (4.4% annualised at the fourth quarter of 2013 compared to 7.4% in 2012).
Personal lending The Group’s personal lending portfolio includes credit cards, unsecured loans, auto finance and overdrafts. The majority of personal lending exposures exist in the UK and the US. Impairment charge as a proportion of average loans and receivables is shown in the following table.
• The impairment charge on unsecured lending was £291 million for the year, down 34% on 2012. The decline reflected the effect of prior risk appetite tightening.
• The Group continued to perform favourably relative to industry benchmarks for cards arrears.
2013 2012 Mortgages Other loans Mortgages Other loans (1) £bn £bn £bn £bn
Notes: (1) The other loans category for 2012 has been restated to exclude non-personal interest only loans within Wealth division. (2) Mortgages with partial interest only and partial capital repayments.
The Group reduced its exposure to interest only mortgages. UK Retail ceased offering interest only mortgages to residential owner occupied customers with effect from 1 December 2012. Interest only repayment remains an option for buy-to-let mortgages. Ulster Bank withdrew interest only as a standard mortgage offering for new lending in the Republic of Ireland in 2010 and in Northern Ireland in 2012. Interest only mortgages are now granted on a very limited basis to high net worth customers or as part of its forbearance programme. RBS Citizens offers its customers interest only mortgages and conventional HELOC that enter an amortising repayment period after the interest only period. Wealth offers interest only mortgages to its high net worth customers.
The Group recognises impairment provisions in respect of loans in its interest only portfolios (UK Retail - 2 years; RBS Citizens - 1 year) that are approaching their contractual maturity based on historical analysis and customer behaviour. These impairment provisions are refreshed as new trends and data become available.
2013 £bn £bn £bn £bn £bn £bn £bn £bn 2012 £bn £bn £bn £bn £bn £bn £bn £bn
2013 2012 Bullet principal Conversion Proportion of Bullet principal Conversion Proportion of repayment to amortising Total mortgage lending repayment to amortising Total mortgage lending £bn £bn £bn % £bn £bn £bn %
UK Retail (1) 25.4 — 25.4 25.6 28.1 — 28.1 28.4 Ulster Bank 0.7 1.4 2.1 11.0 1.4 1.8 3.2 16.7 RBS Citizens 0.4 8.9 9.3 47.5 0.5 9.0 9.5 44.1 Wealth 6.0 — 6.0 69.0 5.7 0.1 5.8 66.0 Total 32.5 10.3 42.8 35.7 10.9 46.6
Note: (1) UK Retail also has exposure of £7.7 billion to customers who have a combination of repayment types, capital repayments and interest only.
UK Retail UK Retail’s interest only mortgages require full principal repayment (bullet) at the time of maturity. Typically such loans have remaining terms of between 15 and 20 years. Customers are reminded of the need to have an adequate repayment vehicle in place during the mortgage term.
Of the bullet mortgages that matured in the six months to 30 June 2013 (£1.2 million), 20% had fully repaid by 31 December 2013 leaving residual balances of £0.9 million, 78% of which were meeting the terms of a revised repayment schedule. Of the amortising loans that matured in the six months to 30 June 2013 (£65 million), 69% were either fully repaid or meeting the terms of a revised repayment schedule.
Ulster Bank also offers temporary interest only periods to customers as part of its forbearance programme. An interest only period of up to two years is permitted after which the customer enters an amortising repayment period following further assessment of the customer’s circumstances. The affordability assessment conducted at the end of the forbearance period takes into consideration the repayment of the arrears that have accumulated based on original terms during the forbearance period. The customer’s delinquency status does not deteriorate further while forbearance repayments are maintained. Term extensions in respect of existing interest only mortgages are offered only under a forbearance arrangement.
RBS Citizens RBS Citizens has a book of interest only bullet repayment HELOC loans (£0.4 billion at 31 December 2013) for which repayment of principal is due at maturity, and an interest only portfolio that comprises loans that convert to amortising after an interest only period that is typically 10 years (£8.9 billion at December 2013 of which £8.0 billion are HELOCs). The majority of the bullet loans are due to mature between 2014 and 2015. Of the bullet loans that matured in the six months to 30 June 2013, 50% had fully repaid or are current as of 31 December 2013. The residual balances (modified, delinquent, and charged-off) made up £21 million. For those loans that convert to amortising, the typical uplift in payments is currently 210% (average uplift calculated at £132 per month). Delinquency rates have shown a modest increase in the over 30 days arrears rate.
Bullet principal Conversion to repayment amortising Other Total 2013 £bn £bn £bn £bn
Gross as a % of as a % of as a % of Impairment Amounts loans REIL Provisions gross loans REIL gross loans charge (1) written-off
Mortgages 19,034 3,235 1,725 17.0 53 9.1 235 34 Commercial real estate - investment 3,419 2,288 1,151 66.9 50 33.7 593 51 - development 718 472 331 65.7 70 46.1 153 4 Other corporate 7,039 2,277 1,984 32.3 87 28.2 771 149 Other lending 1,236 194 187 15.7 96 15.1 22 39 31,446 8,466 5,378 26.9 64 17.1 1,774 277
Non-Core Commercial real estate - investment 3,211 3,006 2,162 93.6 72 67.3 837 53 - development 6,915 6,757 6,158 97.7 91 89.1 1,837 370 Other corporate 1,479 1,209 1,069 81.7 88 72.3 345 6 11,605 10,972 9,389 94.5 86 80.9 3,019 429
Non-Core Commercial real estate - investment 3,383 2,800 1,433 82.8 51 42.4 288 15
Non-Core Commercial real estate - investment 3,860 2,916 1,364 75.5 47 35.3 609 1 *unaudited
• Provisions covered CRE REIL by 78%, up from 58% at the end of 2012, with the investment portfolio being covered 80% and the development portfolio 95%.
ROI 3,227 806 1,402 3,684 9,119 NI 1,083 223 517 1,848 3,671 UK (excluding NI) 1,232 50 56 112 1,450 RoW 9 — 8 6 23 5,551 1,079 1,983 5,650 14,263 2012 ROI 3,546 779 1,603 3,653 9,581 NI 1,083 210 631 2,059 3,983 UK (excluding NI) 1,239 86 82 290 1,697 RoW 14 1 8 10 33 5,882 1,076 2,324 6,012 15,294 2011 ROI 3,775 853 1,911 4,095 10,634 NI 1,322 279 680 2,222 4,503 UK (excluding NI) 1,371 111 95 336 1,913 RoW 27 4 — 32 63 6,495 1,247 2,686 6,685 17,113
• Ulster Bank experienced further migration of commercial real estate exposures to its problem management framework, where various measures may be agreed to assist customers whose loans are performing, but who are experiencing temporary financial difficulties.
Financial assets Exposure summary The table below analyses the Group’s financial assets exposures, both gross and net of offset arrangements as well as credit mitigation and enhancement.
Securities Clearing Corporation. (2) Carrying value on the balance sheet represents the exposure to credit risk by class of financial instrument. (3) Balance sheet offset reflects the amounts by which the Group’s credit risk is reduced through master netting and cash management pooling arrangements. Derivative master netting agreements include cash pledged with counterparties in respect of net derivative liability positions and are included in lending in the table above. (4) Includes cash collateral pledged by counterparties based on daily mark-to-market movements of net derivative positions with the counterparty. (5) Securities collateral represent the fair value of securities received from counterparties, mainly relating to reverse repo transactions as part of netting arrangements. (6) Property valuations are limited to the loan value and reflect the application of haircuts and capping in line with regulatory rules to indexed valuations. Commercial collateral includes shipping vessels and plant and equipment collateral. (7) Credit enhancement comprises credit derivatives (bought protection) and guarantees and reflect notional amounts less fair value and notional amounts respectively.
2012 Central and local government 441 9,853 97,339 — 5,791 591 114,015 (5,151) 108,864 Financial institutions - banks 34,783 31,394 11,555 1,643 335,521 79,308 494,204 (341,103) 153,101 - other (2) 69,256 42,198 50,104 2,672 80,817 5,591 250,638 (97,589) 153,049 Personal - mortgages — 149,625 — — — — 149,625 — 149,625 - unsecured — 32,212 — — — 4 32,216 — 32,216 Property — 72,219 774 318 4,118 — 77,429 (1,333) 76,096 Construction — 8,049 17 264 820 — 9,150 (1,687) 7,463 Manufacturing 326 23,787 836 1,639 1,759 144 28,491 (3,775) 24,716 Finance leases and instalment credit — 13,609 82 1 13 — 13,705 — 13,705 Retail, wholesale and repairs — 21,936 461 1,807 914 41 25,159 (1,785) 23,374 Transport and storage — 18,341 659 382 3,397 2 22,781 (3,240) 19,541 Health, education and leisure — 16,705 314 554 904 59 18,536 (964) 17,572 Hotels and restaurants — 7,877 144 51 493 11 8,576 (348) 8,228 Utilities — 6,631 1,311 638 3,170 50 11,800 (2,766) 9,034 Other 24 30,057 1,886 5,380 4,201 172 41,720 (2,403) 39,317 Total gross of provisions 104,830 484,493 165,482 15,349 441,918 85,973 1,298,045 (462,144) 835,901 Provisions — (21,262) (858) (112) — — (22,232) n/a (22,232)
Central and local government 2,247 9,742 125,543 — 5,541 641 143,714 (1,098) 142,616 Financial institutions - banks 39,345 44,080 16,940 2,218 400,261 79,396 582,240 (407,457) 174,783 - other (2) 58,478 51,870 60,628 2,501 98,255 7,451 279,183 (119,717) 159,466 Personal - mortgages — 149,273 — — — — 149,273 — 149,273 - unsecured — 34,424 — — — 52 34,476 (7) 34,469 Property — 81,058 573 175 4,599 1 86,406 (1,274) 85,132 Construction — 9,869 50 53 946 — 10,918 (1,139) 9,779 Manufacturing 254 28,639 664 1,938 3,786 306 35,587 (2,214) 33,373 Finance leases and instalment credit — 14,499 145 2 75 — 14,721 (16) 14,705 Retail, wholesale and repairs — 24,378 645 2,652 1,134 18 28,827 (1,671) 27,156 Transport and storage 436 22,058 539 74 3,759 — 26,866 (241) 26,625 Health, education and leisure — 17,492 310 21 885 — 18,708 (973) 17,735 Hotels and restaurants — 8,870 116 5 671 — 9,662 (184) 9,478 Utilities — 8,406 1,530 554 3,708 30 14,228 (450) 13,778 Other 174 33,490 3,785 5,136 6,437 595 49,617 (1,003) 48,614 Total gross of provisions 100,934 538,148 211,468 15,329 530,057 88,490 1,484,426 (537,444) 946,982 Provisions — (20,674) (2,388) (141) — — (23,203) n/a (23,203)
Key points • Financial asset exposures after offset decreased by £129.4 billion or 16% to £684.3 billion in the year, reflecting the Group’s focus on reducing its funded balance sheet primarily through ongoing sales in Non-Core and downsizing of Markets.
• Reductions across securities (debt - £51.0 billion; equity - £6.4 billion), lending (£43.1 billion) reverse repos (£28.4 billion) and derivatives (£153.9 billion) were partially offset by higher cash holdings (£3.4 billion). Conditions in the financial markets and the Group’s continued focus on risk appetite and sector concentrations resulted in the trends seen.
• Exposures to central and local government decreased by £29.5 billion principally in debt securities. This was driven by Markets derisking its balance sheet, management of the Group Treasury liquidity portfolio as well as some risk reduction in respect of Eurozone exposures.
• Exposure to financial institutions was £59.4 billion lower across reverse repos, lending, securities and derivatives. This was driven by economy-wide subdued activity being partially offset marginally by increased cash holdings.
• The Group’s exposure to property and construction sector decreased by £13.1 billion, principally in commercial real estate lending. The majority of the Group’s Core property exposure is within UK Corporate (72%).
• Transport and storage exposure decreased by £1.1 billion. The sector includes asset-backed exposures to ocean-going vessels. Conditions remain poor across the major shipping market segments in 2013 with low charter rates and vessel values. At 31 December 2013, £1.1 billion (2012 - £0.7 billion) of loans were included in risk elements in lending with an associated provision of £0.4 billion and impairment charge of £0.4 billion for 2013.
Europe Central and local government — 778 21,465 — 53 — 22,296 — 22,296 Financial institutions - banks 658 2,331 3,727 1 50 7,133 13,900 — 13,900 - other (2) — 1,434 3,975 93 46 4 5,552 — 5,552 Personal - mortgages — 17,540 — — — — 17,540 — 17,540 - unsecured — 1,267 — — — 3 1,270 — 1,270 Property — 13,177 — 31 25 — 13,233 (5) 13,228 Construction — 979 — — — — 979 (20) 959 Manufacturing — 3,618 25 3 26 22 3,694 (9) 3,685 Finance leases and instalment credit — 378 — — — — 378 — 378 Retail, wholesale and repairs — 2,840 — — 27 — 2,867 (21) 2,846 Transport and storage — 5,269 — — 16 — 5,285 (5) 5,280 Health, education and leisure — 1,080 9 1 2 — 1,092 (6) 1,086 Hotels and restaurants — 1,180 — — — — 1,180 (4) 1,176 Utilities — 1,670 6 — 40 — 1,716 — 1,716 Other — 4,373 136 47 31 — 4,587 (52) 4,535 Total gross of provisions 658 57,914 29,343 176 316 7,162 95,569 (122) 95,447 Provisions — (13,109) (30) (5) — — (13,144) n/a (13,144)
Reverse Securities Other Balance Exposure repos Lending Debt Equity Derivatives financial assets sheet value Offset (1) post offset 2012 £m £m £m £m £m £m £m £m £m
UK Central and local government 441 8,087 62,722 — 5,582 47 76,879 (5,028) 71,851 Financial institutions - banks 24,856 22,651 6,110 1,175 193,892 40,851 289,535 (202,189) 87,346 - other (2) 42,203 33,955 16,834 2,069 62,810 2,946 160,817 (78,976) 81,841 Personal - mortgages — 109,530 — — — — 109,530 — 109,530 - unsecured — 20,498 — — — 4 20,502 — 20,502 Property — 53,730 547 282 3,954 — 58,513 (1,328) 57,185 Construction — 6,507 14 248 789 — 7,558 (1,666) 5,892 Manufacturing 326 10,058 579 1,553 1,286 111 13,913 (3,542) 10,371 Finance leases and instalment credit — 10,532 81 1 — — 10,614 — 10,614 Retail, wholesale and repairs — 11,531 397 1,634 701 41 14,304 (1,590) 12,714 Transport and storage — 10,577 527 361 2,049 2 13,516 (2,279) 11,237 Health, education and leisure — 11,901 144 548 818 59 13,470 (888) 12,582 Hotels and restaurants — 5,989 121 51 493 11 6,665 (344) 6,321 Utilities — 3,556 1,178 492 2,654 30 7,910 (2,515) 5,395 Other 19 15,843 1,085 4,757 2,647 140 24,491 (1,885) 22,606 Total gross of provisions 67,845 334,945 90,339 13,171 277,675 44,242 828,217 (302,230) 525,987 Provisions — (9,761) (420) (112) — — (10,293) n/a (10,293)
Reverse Securities Other Balance Exposure repos Lending Debt Equity Derivatives financial assets sheet value Offset (1) post offset 2011 £m £m £m £m £m £m £m £m £m
Europe Central and local government — 831 13,362 — 60 — 14,253 — 14,253 Financial institutions - banks 247 8,611 10,859 78 — 6,725 26,520 — 26,520 - other (2) — 3,008 4,521 165 289 90 8,073 (1) 8,072 Personal - mortgages — 18,946 — — — — 18,946 — 18,946 - unsecured — 2,464 — — — 28 2,492 — 2,492 Property — 16,384 — — 168 — 16,552 (9) 16,543 Construction — 1,754 — 22 18 — 1,794 (24) 1,770 Manufacturing — 8,115 57 5 23 — 8,200 (9) 8,191 Finance leases and instalment credit — 695 — — — — 695 — 695 Retail, wholesale and repairs — 4,764 16 2 23 — 4,805 (24) 4,781 Transport and storage — 6,529 143 — 15 — 6,687 (6) 6,681 Health, education and leisure — 1,584 164 5 2 — 1,755 (8) 1,747 Hotels and restaurants — 1,427 — — 6 — 1,433 (6) 1,427 Utilities — 2,099 124 3 85 — 2,311 — 2,311 Other 7 5,445 568 70 35 — 6,125 (56) 6,069 Total gross of provisions 254 82,656 29,814 350 724 6,843 120,641 (143) 120,498 Provisions — (8,898) (1,218) — — — (10,116) n/a (10,116)
Asset quality The asset quality analysis presented below is based on the Group’s internal asset quality ratings which have ranges for the probability of default, as set out below. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures used for internal management reporting across portfolios. Debt securities are analysed by external ratings and are therefore excluded from the following tables. These are set out on pages 285 to 287.
Loans and advances Banks (1) Customers Settlement Cash and Derivative Derivative balances and balances at Reverse cash Reverse cash other financial Contingent central banks repos collateral Other Total repos collateral Other Total assets Derivatives Commitments liabilities Total 2013 £m £m £m £m £m £m £m £m £m £m £m £m £m £m
AQ1 80,266 5,885 2,043 5,986 13,914 30,233 10,042 31,712 71,987 2,706 71,101 64,149 6,688 310,811 AQ2 — 4,744 4,930 653 10,327 996 1,899 17,253 20,148 192 69,821 28,643 2,917 132,048 AQ3 1,873 2,164 1,502 2,176 5,842 1,857 3,796 28,480 34,133 746 94,319 23,008 7,039 166,960 AQ4 420 9,864 1,451 6,924 18,239 10,642 1,894 95,546 108,082 446 38,683 40,737 4,215 210,822 AQ5 — 1,776 416 659 2,851 5,403 297 75,211 80,911 717 8,113 33,313 1,989 127,894 AQ6 — 1,823 1 147 1,971 82 38 37,269 37,389 59 1,191 13,787 1,399 55,796 AQ7 — 301 — 204 505 677 50 29,417 30,144 22 756 7,160 747 39,334 AQ8 3 — — 25 25 — 10 8,000 8,010 58 95 1,086 115 9,392 AQ9 — — — 23 23 — 41 12,492 12,533 — 481 697 283 14,017 AQ10 — — — — — — — 687 687 — 305 979 64 2,035 Past due — — — — — — — 8,536 8,536 583 — — — 9,119 Impaired — — — 69 69 — — 18,364 18,364 — — — — 18,433 Impairment provision — — — (62) (62) — — (11,324) (11,324) — — — — (11,386)
Loans and advances Banks (1) Customers Settlement Cash and Derivative Derivative balances and balances at Reverse cash Reverse cash other financial Contingent central banks repos collateral Other Total repos collateral Other Total assets Derivatives Commitments liabilities Total 2012 (2) £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Cash and Settlement balances at Loans and advances balances and other Contingent central banks Banks (1) Customers financial assets Derivatives Commitments liabilities Total
Notes: (1) Excludes items in the course of collection from other banks of £1,454 million (2012 - £1,531 million; 2011 - £1,470 million). (2) Excludes balances in relation to Direct Line Group (loans to banks: 2012 - £2,036 million; 2011 - £2,579 million and loans to customers: 2012 - £881 million; 2011 - £893 million). (3) Exposures are allocated to asset quality bands on the basis of statistically driven models which produce an estimate of default rate. The variables included in the models vary by product and geography. For portfolios secured on residential property these models typically include measures of delinquency and loan-to-value as well as other differentiating characteristics such as bureau score, product features or associated account performance information.
• Within cash and balances at central banks there has been an increase in AQ1 of £2.3 billion due to additional funds deposited with the Bank of England and the Federal Reserve. Additionally, increases of £1.1 billion in AQ3 and AQ4 are due to deposits with other central banks as part of the Group’s overall liquidity management.
• Reverse repo balances decreased £28.4 billion due to reduced trading volumes within Markets. However, AQ2 and AQ4-AQ7 have increased £7.2 billion in bank reverse repurchase agreements as a small number of counterparties moved bands, in addition to the implementation of a strategy to develop relationships with newer, lower-rated counterparties.
• Core customer lending in AQ1-AQ3 increased to 22% from 18% at 31 December 2012 as recalibration of the UK Retail models using updated data trends from the last three years resulted in £9.8 billion moving from AQ5 to higher bands. In addition, mid corporate model updates in UK Corporate and data quality improvements in Wealth also led to improving trends.
Balance sheet analysis continued Debt securities IFRS measurement classification and issuer The table below analyses debt securities by issuer and IFRS measurement classifications. US central and local government includes US federal agencies; financial institutions includes US government sponsored agencies and securitisation entities, the latter principally relating to asset-backed securities (ABS).
Held-for-trading (HFT) 6,764 10,951 22,818 1,720 12,406 1,947 56,606 10,674 Designated as at fair value — — 104 — 17 1 122 15 Available-for-sale 6,436 12,880 10,303 5,974 17,330 184 53,107 24,174 Loans and receivables 10 1 — 175 3,466 136 3,788 3,423 Long positions 13,210 23,832 33,225 7,869 33,219 2,268 113,623 38,286
2011 Held-for-trading 9,004 19,636 36,928 3,400 23,160 2,948 95,076 20,816 Designated as at fair value 1 — 127 53 457 9 647 558 Available-for-sale 13,436 20,848 25,552 13,175 31,752 2,535 107,298 40,735 Loans and receivables 10 — 1 312 5,259 477 6,059 5,200 Long positions 22,451 40,484 62,608 16,940 60,628 5,969 209,080 67,309
AFS • Government securities, primarily US, German and UK, decreased by £15.4 billion reflecting Group Treasury’s disposals. Holdings in bank issuances fell by £2.9 billion due to maturities and amortisations. The decrease in securities issued by other financial institutions of £6.6 billion primarily related to ABS (£1.6 billion collateralised loan obligations in Non-Core and £3.4 billion residential mortgage-backed securities), due to disposals, maturities and buy backs by issuers. This was partially offset by a build up of securities (£0.9 billion), primarily US agency securities in US Retail & Commercial. The reduction includes £7.2 billion related to Direct Line Group, not included at 31 December 2013 as it is now an associate.
AFS gross unrealised gains and losses • The UK government net decrease of £0.9 billion reflects exposure reductions. The US government decrease of £0.7 billion reflects exposure reduction as well as the impact of expectations of tapering of the liquidity programme by the US Federal Reserve. The reductions in bank, other financial institutions and ABS reflected maturities, disposals and market movements.
Ratings The table below analyses debt securities by issuer and external ratings. Ratings are based on the lowest of Standard and Poor’s, Moody’s and Fitch.
Total AAA — 18 13,106 1,434 8,155 162 22,875 20 6,796 AA to AA+ 13,210 23,812 7,847 446 16,825 138 62,278 55 21,054 A to AA- — — 4,200 1,657 1,521 290 7,668 7 1,470 BBB- to A- — — 7,572 3,761 2,627 854 14,814 13 4,941 Non-investment grade — — 494 341 2,444 427 3,706 3 2,571 Unrated — 2 6 230 1,647 397 2,282 2 1,454 13,210 23,832 33,225 7,869 33,219 2,268 113,623 100 38,286
Non-Core AAA — — — — 433 — 433 21 405 AA to AA+ — — — — 307 — 307 15 307 A to AA- — — — — 390 — 390 19 390 BBB- to A- — — — — 65 — 65 3 65 Non-investment grade — — 88 — 429 87 604 29 494 Unrated — — — — 240 25 265 13 209 — — 88 — 1,864 112 2,064 100 1,870
Central and local government Other financial Of which UK US Other Banks institutions Corporate Total Total ABS
• The decrease in holdings of debt securities rated A to AA- was primarily driven by reductions in Japanese and Belgian bonds.
Debt securities include residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralised debt obligations (CDOs), collateralised loan obligations (CLOs) and other ABS. In many cases, the risk associated with these assets is hedged by credit derivatives. The counterparties to some of these hedge transactions are monoline insurers.
The Group RMBS classifications, including prime, non-conforming and sub-prime, reflect the characteristics of the underlying mortgage portfolios. RMBS are classified as prime RMBS where the loans have low default risk and are made to borrowers with good credit records and reliable payment histories and there is full documentation. Nonconforming RMBS include US Alt-A RMBS together with RMBS, in jurisdictions other than the US, where the underlying mortgages are not classified as either prime or sub-prime. Classification of RMBS as subprime or Alt-A is based on Fair Isaac Corporation scores (FICO), level of documentation and loan-to-value ratios of the underlying mortgage loans. US RMBS are classified as sub-prime if the mortgage portfolio comprises loans with FICO scores between 500 and 650 with full or limited documentation. Mortgages in Alt-A RMBS portfolios have FICO scores of 640 to 720, limited documentation and an original LTV of 70% to 100%. In other jurisdictions, RMBS are classified as sub-prime if the mortgage portfolio comprises loans with one or more high risk characteristics such as: unreliable or poor payment histories; high loan-to-value ratios; high debt-to-income ratio; the loan is not secured on the borrower's primary residence; or a history of delinquencies or late payments on the loan.
RMBS: government sponsored or similar 14,886 — 2,491 — 17,377 7,088 — 10,289 —
Carrying value RMBS: government sponsored or similar 14,870 — 2,403 — 17,273 7,031 — 10,242 —
ABS covered bond — — 48 — 48 — — 48 —
RMBS: government sponsored or similar 22,162 — 5,366 18 27,546 13,961 — 13,585 — RMBS: prime 819 2,821 1,181 403 5,224 753 509 3,876 86 RMBS: non-conforming 595 2,077 58 — 2,730 202 — 1,235 1,293 RMBS: sub-prime 968 99 66 5 1,138 1,027 — 5 106 MBS: covered bond 46 172 6,129 — 6,347 — — 6,347 — CMBS 3,352 1,121 671 3 5,147 1,992 — 2,327 828 CDOs 4,002 42 404 — 4,448 3,111 — 1,307 30 CLOs 2,705 44 787 — 3,536 1,049 — 2,422 65 ABS covered bond — 132 374 16 522 — — 522 — Other ABS 1,632 1,873 1,111 306 4,922 1,667 7 1,774 1,474 36,281 8,381 16,147 751 61,560 23,762 516 33,400 3,882
Carrying value RMBS: government sponsored or similar 22,460 — 4,879 18 27,357 13,959 — 13,398 — RMBS: prime 717 2,552 912 390 4,571 569 509 3,420 73 RMBS: non-conforming 477 1,918 58 — 2,453 150 — 1,009 1,294 RMBS: sub-prime 660 73 46 5 784 682 — — 102 MBS: covered bond 48 204 5,478 — 5,730 — — 5,730 — CMBS 3,274 821 425 3 4,523 1,489 — 2,284 750 CDOs 480 22 218 — 720 104 — 589 27 CLOs 2,550 12 464 — 3,026 697 — 2,266 63 ABS covered bond — 137 380 16 533 — — 533 — Other ABS 1,401 1,263 929 295 3,888 969 7 1,514 1,398 32,067 7,002 13,789 727 53,585 18,619 516 30,743 3,707
Net exposure RMBS: government sponsored or similar 22,460 — 4,879 18 27,357 13,959 — 13,398 — RMBS: prime 513 2,549 911 383 4,356 554 509 3,221 72 RMBS: non-conforming 277 1,908 58 — 2,243 110 — 839 1,294 RMBS: sub-prime 417 73 46 4 540 439 — — 101 MBS: covered bond 48 204 5,478 — 5,730 — — 5,730 — CMBS 2,535 821 425 3 3,784 750 — 2,284 750 CDOs 162 22 212 1 397 79 — 290 28 CLOs 879 12 459 — 1,350 639 — 648 63 ABS covered bond — 137 380 16 533 — — 533 — Other ABS 1,257 1,170 929 163 3,519 601 7 1,513 1,398 28,548 6,896 13,777 588 49,809 17,131 516 28,456 3,706
Net exposure RMBS: government sponsored or similar 28,022 — 5,549 2 33,573 15,132 — 18,441 — RMBS: prime 825 3,456 1,005 458 5,744 447 557 4,668 72 RMBS: non-conforming 677 2,225 74 — 2,976 284 — 1,320 1,372 RMBS: sub-prime 385 138 67 2 592 434 — — 158 MBS: covered bond 136 209 7,175 — 7,520 — — 7,520 — CMBS 860 1,253 543 1 2,657 777 — 718 1,162 CDOs 1,030 31 294 — 1,355 304 — 964 87 CLOs 1,367 98 712 — 2,177 827 — 1,171 179 ABS covered bond 19 70 952 4 1,045 — — 1,045 — Other ABS 1,456 843 1,527 804 4,630 617 — 1,941 2,071 34,777 8,323 17,898 1,271 62,269 18,822 557 37,788 5,101
sponsored Non- covered covered Other or similar (1) Prime conforming Sub-prime bond CMBS CDOs CLOs bond ABS Total 2013 £m £m £m £m £m £m £m £m £m £m £m
Notes: (1) Includes US agency and Dutch government guaranteed securities. (2) Comprises HFT £1,275 million (2012 - £1,177 million; 2011 - £1,682 million), DFV nil (2012 - £7 million; 2011 - nil), AFS £1,138 million (2012 - £1,173 million; 2011 - £2,056 million) and LAR £158 million (2012 - £317 million; 2011 - £754 million). (3) Comprises HFT £504 million (2012 - £808 million; 2011 - £804 million), AFS £26 million (2012 - £149 million; 2011 - £249 million) and LAR £924 million (2012 - £130 million; 2011 - £182 million).
US 20 433 1,088 1,541 (31) 165 607 36 808 2,349 12 UK 135 154 1,362 1,651 (97) — 222 198 420 2,071 79 Japan 9 295 686 990 (8) — 1 — 1 991 — China 148 45 163 356 — — — — — 356 — Australia 75 50 83 208 — — 1 4 5 213 — Switzerland 10 11 78 99 (8) — 47 — 47 146 40 Hong Kong 2 56 73 131 — — — 7 7 138 5 Russia 13 3 88 104 — — — — — 104 — Other 68 83 445 596 (37) — — 45 45 641 6 Total 515 1,645 5,039 7,199 (259) 173 893 546 1,612 8,811 149
Balance sheet analysis continued Equity shares continued 2012 HFT AFS/DFV (1)
Ireland — 126 47 173 (3) — 17 — 17 190 — Italy 7 1 33 41 (15) — 5 — 5 46 — Portugal — — 5 5 — — — — — 5 — Greece — — 6 6 — — — — — 6 — Eurozone periphery 25 127 142 294 (18) — 22 92 114 408 (41)
France 10 75 103 188 (10) — 1 143 144 332 23 Luxembourg 14 196 46 256 (1) — 6 34 40 296 1 Germany 33 1 106 140 (54) — — — — 140 — Other 18 26 116 160 (15) — 3 — 3 163 1 Total eurozone 120 582 978 1,680 (119) — 72 425 497 2,177 (35)
Other financial HFT short Other financial AFS Banks institutions (2) Corporate Total positions Banks institutions Corporate Total Total reserves
Ireland — 7 208 215 (4) — 6 — 6 221 — Italy 11 1 51 63 (4) — 5 — 5 68 — Portugal — — — — (1) — — 5 5 5 — Greece — 1 1 2 (22) — — 1 1 3 — Eurozone periphery 66 11 271 348 (47) — 11 142 153 501 (4)
US 120 97 1,391 1,608 (544) 323 575 103 1,001 2,609 128 UK 420 207 2,582 3,209 (145) 33 225 267 525 3,734 40 Japan 43 82 1,289 1,414 (3) — 1 — 1 1,415 — China 510 228 637 1,375 (6) — 13 — 13 1,388 4 Australia 95 82 405 582 (219) — 8 15 23 605 2 Switzerland 10 8 234 252 (44) — — 15 15 267 14 Hong Kong 10 45 100 155 (2) — — 3 3 158 (2)
Balance sheet analysis continued Derivatives Summary The table below analyses the Group’s derivatives by type of contract. Master netting arrangements and collateral shown below do not result in a net presentation in the Group’s balance sheet under IFRS.
Interest rate (2) 5,401 10,583 13,695 5,910 35,589 218,041 208,698 33,483 363,454 345,565 38,727 422,553 406,784 Exchange rate 362 1,982 628 1,583 4,555 61,923 65,749 4,698 63,067 70,481 4,482 74,526 81,022 Credit 2 166 66 19 253 5,306 5,388 553 11,005 10,353 1,054 26,836 26,743 Equity and commodity 29 27 17 8 81 2,770 5,692 111 4,392 7,941 123 6,142 9,560 288,040 285,527 441,918 434,340 530,057 524,109 of which:
Notes: (1) Includes exchange traded contracts were £2,298 billion (2012 - £2,497 billion; 2011 - £2,765 billion) principally interest rate. Trades are margined daily hence carrying values were insignificant: assets - £69 million (2012 - £41 million; 2011 - £119 million) and liabilities - £299 million (2012 - £255 million; 2011 - £428 million). (2) Interest rate notional includes £22,563 billion (2012 - £15,864 billion; 2011 - £16,377 billion) in respect of contracts with central clearing counterparties to the extent related assets and liabilities are offset.
• Exchange rate contracts’ fair value decreased due to strengthening of sterling against the US dollar and decrease in trade volumes.
• The decrease in credit derivatives notional and fair values was driven by increased use of trade compression cycles and novation of certain trades in Markets in line with the Group’s risk reduction strategy, primarily in the first half of the year. Tightening of credit spreads also contributed to the decrease in fair value.
• Sales and reduction in trade volumes contributed to reduction in equity contracts.
(bank and non-bank) in certain jurisdictions, or due to other legal reasons, are not deemed to be enforceable and are therefore reported as uncollateralised above.
Traded on Not settled Traded on Traded Traded on Traded recognised Settled by central by central recognised over the recognised over the exchanges counterparties counterparties Total exchanges counter exchanges counter 2013 £bn £bn £bn £bn £m £m £m £m
Balance sheet analysis continued Derivatives continued Credit derivatives The Group trades credit derivatives as part of its client-led business and to mitigate credit risk. The Group’s credit derivative exposures relating to proprietary trading are minimal. The table below analyses the Group’s bought and sold protection.
2013 2012 2011 Notional Fair value Notional Fair value Notional Fair value
Bought Sold Bought Sold Bought Sold Bought Sold Bought Sold Bought Sold Group £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Credit hedging - trading book - rates 4.4 3.5 0.1 0.1 7.8 4.6 0.1 0.1 19.9 16.2 0.9 1.7
Credit hedging - trading book - rates 0.7 0.5 — — 1.6 1.2 — — 1.3 0.9 — —
Divisional analysis The tables below analyse gross loans and advances (excluding reverse repos) and the related credit metrics by division.
Gross loans to of gross loans as a % Of which Amounts Banks Customers REIL Provisions to customers of REIL Total RCR (1) written-off
UK Retail 760 113,152 3,566 2,106 3.2 59 319 — 815 UK Corporate 701 102,547 6,226 2,833 6.1 46 1,188 410 772 Wealth 1,531 16,764 277 120 1.7 43 29 — 15 International Banking 7,971 35,993 470 325 1.3 69 219 52 281 Ulster Bank 591 31,446 8,466 5,378 26.9 64 1,774 892 277 US Retail & Commercial 406 50,551 1,034 272 2.0 26 151 — 284 Retail & Commercial 11,960 350,453 20,039 11,034 5.7 55 3,680 1,354 2,444 Markets 12,579 25,455 338 286 1.3 85 21 18 46 Other 2,670 5,126 1 66 — nm 65 — — Core 27,209 381,034 20,378 11,386 5.3 56 3,766 1,372 2,490 Non-Core 431 36,718 19,014 13,839 51.8 73 4,646 3,118 1,856 Group 27,640 417,752 39,392 25,225 9.4 64 8,412 4,490 4,346 nm = not meaningful
UK Retail 628 110,659 4,599 2,679 4.2 58 788 823 UK Corporate 806 110,729 5,001 2,061 4.5 41 790 658 Wealth 2,422 16,913 211 81 1.2 38 25 11 International Banking 3,411 57,729 1,632 851 2.8 52 168 125 Ulster Bank 2,079 34,052 5,523 2,749 16.2 50 1,384 124 US Retail & Commercial 208 51,562 1,007 455 2.0 45 248 373 Retail & Commercial 9,554 381,644 17,973 8,876 4.7 49 3,403 2,114 Markets 29,991 31,490 414 311 1.3 75 — 23 Other 1,270 56 — — — — — — Core 40,815 413,190 18,387 9,187 4.5 50 3,403 2,137 Non-Core 706 80,005 24,007 11,487 30.0 48 3,838 2,390 Direct Line Group 2,559 873 — — — — — — Group 44,080 494,068 42,394 20,674 8.6 49 7,241 4,527
(£3.1 billion) to £8.4 billion from £5.3 billion in 2012. The Core charge increased 26% (£0.8 billion) to £3.8 billion and the Non-Core charge increased by 100% (£2.3 billion) to £4.6 billion. £4.5 billion of the impairment increase was in relation to the creation of RCR and the related strategy, £1.4 billion in Core and £3.1 billion in Non-Core. The underlying provision charge decreased £1.4 billion mainly in UK Retail (£0.2 billion), Ulster Bank residential mortgages (£0.4 billion) and Non-Core (£0.8 billion), largely due to run down and lower single name charges in Non-Core.*
• REIL decreased by £1.7 billion to £39.4 billion during the year mainly in Non-Core (£2.4 billion) and UK Retail (£1.0 billion) offset by increases in UK Corporate (£0.8 billion) and Ulster Bank (£0.9 billion). REIL reductions in Non-Core primarily related to repayments and write-offs in UK corporate and International Banking donated portfolios.
• The RCR provision charge mainly related to loans already within
• REIL in UK Corporate increased 14% mainly driven by individual cases in the commercial real estate and shipping portfolios as credit conditions remained difficult in these sectors. The impact of the RCR related strategy resulted in a £0.4 billion provision increase in Q4 2013.*
December 2012. The increase in REIL was largely in relation to commercial real estate investment loans. RCR and related provisioning in 2013 contributed £0.9 billion to the Core Ulster Bank provision and has resulted in the provision coverage increasing from 52% to 64% in the year and in the fourth quarter.*
Finance leases and instalment credit 13,609 442 294 3.2 67 2.2 44 263 of which: UK - residential mortgages 109,530 2,440 457 2.2 19 0.4 122 32
Finance leases and instalment credit 14,499 794 508 5.5 64 3.5 112 170 of which: UK - residential mortgages 106,388 2,262 431 2.1 19 0.4 180 25
Central and local government 8,485 — — — — — — —
Balance sheet analysis continued REIL, provisions and AFS reserves continued Sector and geographical regional analyses: Core continued Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Central and local government 1,153 — — — — — — —
Finance leases and instalment credit 3,232 124 101 3.8 81 3.1 (7) 90 of which: UK - residential mortgages — — — — — — 1 1 nm = not meaningful
Balance sheet analysis continued REIL, provisions and AFS reserves continued Sector and geographical regional analyses: Non-Core continued Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Finance leases and instalment credit 6,059 622 398 10.3 64 6.6 81 102 of which: UK - residential mortgages 1,423 52 11 3.7 21 0.8 6 1
RoW - residential mortgages 200 — — — — — — — - personal lending 1 — — — — — — —
UK UK International Ulster US Retail & Central Retail Corporate Wealth Banking Bank Commercial Markets items Core Non-Core Total £m £m £m £m £m £m £m £m £m £m £m
Non-Core (by donating divisions) UK International Ulster US Retail & Corporate Banking Bank Commercial Other Total £m £m £m £m £m £m
At 1 January 2012 4,599 5,001 211 1,632 5,523 1,007 414 18,387 24,007 42,394 Currency translation and other adjustments 53 (6) (1) (227) (115) (47) 184 (159) (487) (646)
At 1 January 2012 3,685 8,051 11,675 486 110 24,007 Currency translation and other adjustments (57) (104) (231) (20) (75) (487) Additions 1,542 2,210 1,713 323 12 5,800 Transfers (1) 11 59 — — — 70 Transfer to performing book (171) (863) — — (1) (1,035)
REIL and PPLs summary The table below analyses REIL between UK and overseas, based on the location of the lending office.
Past due 1-29 days 4,587 178 4,765 5,349 250 5,599 5,722 724 6,446 Past due 30-59 days 1,212 48 1,260 1,062 55 1,117 1,556 171 1,727 Past due 60-89 days 792 30 822 1,151 26 1,177 975 107 1,082 Past due 90 days or more 1,945 276 2,221 2,215 426 2,641 1,794 542 2,336 8,536 532 9,068 9,777 757 10,534 10,047 1,544 11,591
Past due analysis by sector* Personal 4,982 190 5,172 5,198 303 5,501 6,819 741 7,560 Property and construction 1,075 298 1,373 1,475 388 1,863 1,126 651 1,777 Financial institution 366 2 368 92 11 103 83 6 89 Other corporate 2,113 42 2,155 3,012 55 3,067 2,019 146 2,165 8,536 532 9,068 9,777 757 10,534 10,047 1,544 11,591
Recoveries of amounts previously written-off 46 15 — 15 1 89 166 2 — 168 88 256 Charged to income statement - continuing operations 319 1,188 29 219 1,774 151 3,680 21 65 3,766 4,646 8,412 Unwind of discount (2) (74) (38) (3) (4) (81) — (200) (1) — (201) (190) (391)
Individually assessed - banks — — — 1 — — 1 61 — 62 1 63 - customers — 1,462 109 207 2,078 60 3,916 214 66 4,196 12,650 16,846 Collectively assessed 1,929 1,096 — — 2,596 118 5,739 — — 5,739 565 6,304 Latent 177 275 11 117 704 94 1,378 11 — 1,389 623 2,012
Currency translation and other adjustments (12) 26 60 (43) (3) 28 Disposal of subsidiaries — — (77) — — (77)
Currency translation and other adjustments (100) (58) (107) (89) (15) (369) Disposal of subsidiaries — — — (1) — (1)
Individually assessed - banks — — 2 44 — — 46 76 122 1 — 123 - customers — 838 70 637 991 73 2,609 224 2,833 9,965 — 12,798 Collectively assessed 2,474 894 — 2 1,282 162 4,814 — 4,814 874 — 5,688 Latent 205 329 9 168 476 220 1,407 11 1,418 647 — 2,065
UK UK International Ulster US Total Central Total Retail Corporate Wealth Banking Bank R&C R&C Markets items Core Non-Core Group 2013 £m £m £m £m £m £m £m £m £m £m £m £m
Corporate Banking Bank R&C Other Total 2013 £m £m £m £m £m £m
Note: (1) Includes eurozone countries as detailed in the Country risk section on pages 341 to 353.
Market risk 319 Definition 319 Sources of risk 321 Governance structure 322 Traded market risk 334 Non-traded market risk
Market risk Definition Market risk is the risk of losses arising from fluctuations in interest rates, credit spreads, foreign currency rates, equity prices, commodity prices and other factors, such as market volatilities, that may lead to a reduction in earnings, economic value or both.
Traded market risk The majority of the Group’s traded market risk exposure arises in Markets and Non-Core.
Over-the-counter transactions with standard terms are cleared through central counterparties, while complex transactions are settled directly with the counterparty. These range from commoditised transactions in derivative markets to trades tailored to meet specific customer requirements. Such transactions also give rise to counterparty credit risk, which the Group manages actively (for more information on how the Group manages counterparty credit risk, refer to the Credit Risk section, page 241).
Interest rate risk NTIRR arises from the provision to customers of a range of banking products that have differing interest rate characteristics. Therefore, when aggregated, these products form portfolios of assets and liabilities with varying degrees of sensitivity to changes in market interest rates. Mismatches in these characteristics can give rise to volatility in net interest income as interest rates rise and fall.
NTIRR comprises four primary risk factors: repricing risk, yield curve risk, basis risk and optionality risk. For more information, see page 334.
Foreign exchange risk Non-traded foreign exchange risk exposures for the Group arise from two main sources: • the capital deployed in foreign subsidiaries, branches and associates and related currency funding where it differs from sterling (these exposures are known as structural foreign exchange exposures); and
Equity risk Non-traded equity risk is the potential variation in the Group’s income and reserves arising from changes in the values of non-trading book equity positions. Equity exposures arise through strategic acquisitions, venture capital investments and GRG restructuring arrangements.
Pension risk The Group’s pension-related activities also give rise to market risk. Refer to page 356 and 357 for more information on risk related to pensions.
Assets Cash and balances at central banks 82.7 — 82.7 Interest rate, foreign exchange Net loans and advances to banks 27.6 9.3 18.3 Interest rate Net loans and advances to customers 390.8 19.4 371.4 Interest rate Reverse repurchase agreements and stock borrowing 76.4 75.7 0.7 Interest rate Debt securities 113.6 56.7 56.9 Interest rate Equity shares 8.8 7.2 1.6 Equity Derivatives 288.0 284.9 3.1 Interest rate, foreign exchange Settlement balances 5.6 5.6 — Other assets 34.4 — 34.4 Interest rate Total assets 1,027.9 458.8 569.1
Notes: (1) Trading businesses are entities that primarily have exposures that are classified as trading book under regulatory rules. For these exposures, the main methods used by the Group to measure market risk are discussed under Traded market risk - Risk measurement on page 323. (2) Non-trading businesses are entities that primarily have exposures that are not classified as trading book. For these exposures, with the exception of pension-related activities, the main measurement methods are sensitivity analysis of net interest income, internal non-traded VaR and fair value calculations; for more information, refer to pages 334 to 340.
Group market risk limits that express its market risk appetite in quantitative terms for trading and non-trading activities are proposed by, respectively, the heads of traded and non-traded market risk. Once approved by the ERF, these limits establish a set of comprehensive boundaries within which business activities are conducted and monitored. The heads of traded and non-traded market risk cascade the Group market risk limits down to the legal entities and divisions. The divisional market risk functions are responsible for cascading legal entity and divisional market risk limits to lower levels as appropriate.
The limit framework at the Group level comprises Value at Risk (VaR), Stressed Value at Risk (SVaR), sensitivity and stress limits (for more details on VaR and SVaR, see pages 323 and 328). The limit framework at the divisional, legal entity and lower levels also comprises additional metrics that are specific to the market risk exposures within its scope. These additional metrics aim to control various risk dimensions such as product type, exposure size, aged inventory, currency and tenor.
Business unit controllers are responsible for ensuring that independent price verification processes are in place covering all trading book positions held by their business. Independent price verification is the key control over front office marking of positions.
Model validation This sub-section discusses the independent model validation framework governing both pricing models and risk models (including Value-at-Risk).
Pricing models* Pricing models are developed by a dedicated front office team, in conjunction with the trading desk. They are used for the valuation of positions for which prices are not directly observable and for the risk management of the portfolio.
Risk models* All new risk models are subject to GRA review and sign-off.
All model changes are approved through model governance at the divisional level. Changes to existing models that have an impact on VaR exceeding 5% at legal entity level or 15% at a major business level are also subject to GRA review and sign-off as are all model changes that require regulator approval before implementation.
The traded market risk team in Markets also performs regular VaR model testing, which is discussed in more detail under Risk measurement - Value at Risk on page 323.
GRA’s independent review comprises some or all of the following steps, as appropriate: • Testing and challenging the logical and conceptual soundness of the methodology; • Testing the assumptions underlying the model, where feasible, against actual behaviour. In its validation report, GRA will opine on the reasonableness and stability of the assumptions and specify which assumptions, if any, should be routinely monitored in production; • Testing whether all key market risks have been sufficiently captured; • Re-applying the Group's proposed approach to verify that the same outcome is achieved; • Comparing outputs with results from alternative methods; • Testing parameter selection and calibration; *unaudited
Identification and assessment Identification and assessment of traded market risk is achieved through gathering, analysing, monitoring and reporting market risk information by business line or at a consolidated level. Industry expertise, continued system developments and techniques such as stress testing are also used to enhance the effectiveness of the identification of all material market risks.
Reporting and monitoring The Group’s traded market risk exposures are monitored against limits and analysed daily by market risk reporting and control functions. A daily report that summarises the Group’s market risk exposures against the limits set by the ERF is sent to the Group CRO, divisional CROs and market risk managers across the divisions.
Finally, a market risk update is included in the monthly risk management report sent to Group Board. The update covers the key risks and trends, together with a discussion of relevant issues and market topics.
Risk measurement The Group uses a comprehensive and complementary set of methodologies and techniques to measure traded market risk that collectively ensure a complete approach to the measurement of material market risks.
These methods have been designed to capture correlation effects and allow the Group to form an aggregated view of its traded market risk across risk types, markets and business lines while also taking into account the characteristics of each risk type.
Value at-risk VaR is a statistical estimate of the potential change in the market value of a portfolio (and, thus, the impact on the income statement) over a specified time horizon at a given confidence level.
For internal risk management purposes, the Group’s VaR assumes a time horizon of one trading day and a confidence level of 99%. The Group's VaR model is based on a historical simulation, utilising data from the previous 500 days on an equally weighted basis.
The RBS internal VaR model captures the impact on the income statement of the following risk factors: • Interest rate risk, which arises from the impact of changes in interest rates and volatilities on cash instruments and derivatives. This includes interest rate tenor basis risk and cross-currency basis risk.
• Credit spread risk, which arises from the impact of changes in the credit spreads of sovereign bonds, corporate bonds, securitised products and credit derivatives.
Market risk continued Traded market risk continued VaR limitations* Historical VaR and the Group’s implementation of this risk measurement methodology have a number of known limitations, as summarised below, and the Group’s VaR should be interpreted in light of these. The Group’s approach is to supplement VaR with other risk metrics that address these limitations to ensure appropriate coverage of all material market risks.
• The use of a one-day time horizon will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day. This may not fully reflect market risk at times of severe illiquidity in the market when a one-day period may be insufficient to liquidate or hedge positions fully. Thus, the regulatory VaR that is used for modelled market risk capital uses a ten-day time horizon.
1-day 99% traded internal VaR table The table below analyses the internal VaR for the Group’s trading portfolios, segregated by type of market risk exposure, and split between Core, NonCore and CEM.
Interest rate 37.2 44.1 78.2 19.1 62.6 75.6 95.7 40.8 53.4 68.1 79.2 27.5 Credit spread 60.0 37.3 86.8 33.3 69.2 74.1 94.9 44.9 82.7 74.3 151.1 47.4 Currency 8.6 6.5 20.6 3.6 10.3 7.6 21.3 2.6 10.3 16.2 19.2 5.2 Equity 5.8 4.1 12.8 3.2 6.0 3.9 12.5 1.7 9.4 8.0 17.3 4.6 Commodity 0.9 0.5 3.7 0.3 2.0 1.5 6.0 0.9 1.4 2.3 7.0 — Diversification (1) (23.7) (55.4) (52.3)
Key points • The Group’s period end and average interest rate VaR declined in 2013 compared with 2012. The reduction was mainly seen in Q1 2013, when the rates desk significantly de-risked its exposures and repositioned itself to manage concentrations. In addition, CEM’s contribution to VaR decreased due to improvements in the capture of valuation adjustment risk within VaR metrics. The volatility seen in the second half was also due to rate volatility reflecting Bank of England and European Central Bank rate announcements and a US Federal Reserve announcement regarding tapering of its quantitative easing programme.
• During H2 2013, some positions from businesses were migrated to the newly created Run-off and Recovery (ROR) unit in Markets. At 31 December 2013, the VaR on the ROR business was £6.0 million.
• Apply in-house models to perform advanced internal back-testing to complement the regulatory back-testing.
• Ensure that tests capture the effect of using external data proxies where these are used.
• Identify any model weaknesses or scope limitations and their impact.
There are two types of profit and loss (P&L) used in back-testing comparisons: Clean P&L and Hypothetical (Hypo) P&L.
The Royal Bank of Scotland plc — — Green National Westminster Bank Plc 1 1 Green RBS Securities Inc — — Green RBS Financial Products Inc — — Green The Royal Bank of Scotland N.V. 1 1 Green
Key points • Statistically the Group would expect to see back-testing exceptions 1% of the time over a one-year period. From a capital requirement perspective, the PRA categorises a firm’s VaR model as green, amber or red. A green model status is consistent with a satisfactory VaR model and is achieved for models that have four or fewer exceptions in a continuous 12 month period. The Group’s VaR model has maintained a green status for its regulated legal entities and hence has considered that no action is required to rectify or adapt its VaR models.
The table below shows internal back-testing exceptions for a period of 250 days for 1-day 99% traded internal VaR vs. Clean and Hypo P&L for major Markets businesses.
Key points • As mentioned above, statistically the Group would expect to see back-testing exceptions 1% of the time over a one-year period. At Group level, there were no exceptions during 2013, confirming that the model was satisfactory.
• The businesses presented in the table above are subject to quarterly governance by the PRA. For some of these businesses, exceptions were noted during 2013 and analysis conducted as explained below.
Flow occurred in the normal course of business and were mainly related to volatile currencies and rates following a Bank of England announcement on interest rates, a US Federal Reserve announcement regarding tapering of its quantitative easing programme and a statistical release indicating slow growth in the Chinese economy.
• The exceptions in Currencies were mainly due to currency fluctuations, driven primarily by increased volatility in the Australian dollar, Singapore dollar and Japanese yen. Investigation into the number of exceptions confirmed that the VaR model used for this business was satisfactory.
The risk system simulates 99% VaR on the current portfolio for each 260day period from 1 January 2005 to the current VaR date, moving forward one day at a time. The SVaR is the worst VaR outcome of the simulated results.
This is in contrast with VaR, which is based on a rolling 500-day historical data set. For the purposes of both internal risk management and regulatory SVaR calculation, a time horizon of ten trading days is assumed with a confidence level of 99%.
Total Group 309 396 Core Markets 298 372 Non-Core 51 69
The RNIVs provide a capital estimate of risks not captured in the VaR model and are regularly reported and discussed with senior management and the regulator. The methodology used in the RNIV calculation is internally reviewed by the model-testing team. Where appropriate, risk managers set sensitivity limits to control specific risk factors giving rise to the RNIV. RNIVs form an integral part of the Group’s ongoing model and data improvement efforts to capture all market risks in scope for model approval in VaR and SVaR. Since the introduction of the RNIV framework, the Group has made significant progress in transitioning RNIVs into the VaR model.
In 2013, for each legal entity covered by the PRA VaR model waiver, RNIVs above a regulatory defined threshold were aggregated to obtain the following three measures: (i) Total VaR RNIV; (ii) Total SVaR RNIV; and (iii) Total stressed RNIV. In each of these categories, potential diversification benefits between RNIVs are ignored.
Group’s VaR model is based on a P&L approximation function rather than full repricing of deals.
The most material of these are proxy or basis risks, followed by higherorder sensitivity risks.
Key points • The decreases in the VaR RNIV and SVaR RNIV were driven by progress in obtaining reliable sources of equity market data and by an improvement in the VaR model for asset-backed products.
• The decrease in the Stressed RNIV primarily reflected a reduction in
Stress testing* The Group undertakes daily market risk stress testing to identify vulnerabilities and potential losses in excess of or not captured in VaR. The calculated stresses measure the impact of changes in risk factors on the fair values of the Group’s trading and available-for-sale portfolios.
The Group conducts scenario-based sensitivity analysis and historical, macroeconomic and bottom-up stress testing.
Historical stress testing is a measure that is used for internal management. Using a similar technical framework to VaR, the current portfolio is stressed using historical data since 1 January 2005. The methodology simulates the impact of the worst loss that would be incurred by historical risk factor movements over the period, assuming a holding period specific to the risk factors and the businesses. At present, a holding period of 60 business days is applied for credit risk factors (including in the case of ABS) and for the AFS portfolios that are held by Markets Treasury and generally a period of 10 business days for other risk factors. The Group reviews the holding periods annually and is considering introducing greater distinction between the liquidity assumptions associated with each risk factor.
The main strength of this methodology is that it is founded on objective data and the potential loss is directly informed by real-life examples. As with all historically based methodologies, an obvious limitation is that the approach it is not forward-looking. However, this weakness is materially addressed by the other stress testing approaches that constitute the RBS stress testing framework.
Macroeconomic stress tests are carried out periodically as part of the firm-wide, cross-risk capital planning process. The scenario narratives are translated into risk factor shocks using historical events and insights by economists, risk managers and the front office. Market risk stress results are combined with those for other risks into the capital plan that is presented to the Board. The cross-risk capital planning process is conducted twice a year, in April/May and October/November, with a planning horizon of five years. The scenario narratives cover both regulatory scenarios such as the PRA Anchor and Fed Stress comprehensive capital assessment review (CCAR) and macroeconomic scenarios identified by the firm such as a Euro Break-Up and the US Fiscal Cliff.
Sensitivity measures refer to the changes in deal or portfolio value that result from small changes in market parameters that are subject to the Group market risk limit framework.
Firms can choose from two broad methodologies to calculate their market risk capital charge: (i) the standard rules, whereby regulator-prescribed rules must be applied, and (ii) the internal model approach, where, subject to regulatory approval, a model such as VaR is used to calculate the capital charge.
• The All Price Risk (APR) model covers the generally lower-liquidity correlation trades and their liquid hedges (such as first-to-default basket trades).
RWAs by legal entity and by regulatory approach* Market risk RWAs of £30.3 billion and minimum capital requirement of £2.4 billion are analysed below.
The RNIV framework does not include tail event risks; these risks are covered indirectly by the regulatory multiplier applied to VaR and directly by relevant charges, e.g. IRC, APR and gap risk discussed below.
Gap risk* Certain traded products are structured with buffers so that losses below a certain level are borne by the Group’s counterparties. These products may, however, exhibit large sudden market movements in excess of their buffer, which may result in losses for the Group. The VaR model does not fully capture the risk to the Group presented by these products. The gap risk model takes into account the liquidity of the products and the likely effectiveness of the buffer and produces an additional capital requirement for the relevant products.
This risk is concentrated in the equities business in Markets. Markets’ exposure to gap risk was not material in 2013 as the portfolios considered under this framework have been significantly reduced.
The model has different parameters for sovereign and corporate exposures. The model reflects the overall liquidity of each position referencing an entity, arising from product type, product maturity and product concentration characteristics.
All price risk (APR)* The APR model determines the capital that should be held against all material price risks, including those arising from defaults and credit rating changes affecting securities in the hedged portfolio, using a 99.9% confidence level over a one year time horizon.
The most significant risks are credit spread risk, credit (base) correlation risk, index basis risk, default risk and recovery rate risk. In addition, losses due to both hedging costs and hedge slippage are modelled. The overall APR capital charge is floored at 8% of the corresponding standard rules charge for the same portfolio.
RBS no longer has market risk exposure to corporate CDOs in the trading book. It has residual exposure to nth-to-default basket swaps, many of which have matured. As a consequence, the APR charge for RBS is small.
Notes: (1) The average, maximum and minimum positions are based on the monthly Pillar 1 model based capital requirements. (2) All items are expressed in capital requirement terms.
• The interest rate position risk requirement decreased, primarily due to the migration to VaR of certain trades, the maturity or closing of other trades and a reduction in unmatched positions.
• The option position risk requirement fell, driven by an increased impact of netting for some types of options. This was partially offset by the inclusion of some emerging market trades in the calculation as part of the migration of portfolios from RBS NV to RBS plc.
• The IRC contribution to the Pillar 1 model based position risk requirement was broadly unchanged. This differs from the figures presented in the IRC table on page 333 for the reasons explained in the note to that table. For more commentary on the IRC, see that table.
• The decrease in the APR charge was due to the maturing of trades, with significant reductions in the final quarter.
• For details on the drivers of the decline in the RNIV charge, see the commentary on page 329.
Notes: (1) Based on assessment of S&P, Moody’s and Fitch ratings, where available, or on the Group’s internal master grading scale. (2) The figures presented are based on the spot IRC charge at 31 December 2013 and will therefore not agree with the IRC position risk requirement, as this is based on the 60-day average. The figures presented above are in capital terms.
• By product category, the largest rise was in interest rate derivatives, notably increased positions in BBB-rated Italian floating rate notes. This was partly offset by a decrease in BB and BBB-rated credit derivative products, principally CDS and Index CDS.
Securitisation positions in the trading book The following table shows the capital requirement for trading book securitisation positions by rating.
Key point • The charge decreased in 2013, due to the disposal of assets, primarily in the AAA and BB rating categories, during the year.
The Group manages non-traded market risk, separately for the three key categories: non-traded interest rate risk; non-traded foreign exchange risk; and non-traded equity risk.
• Yield curve risk, which arises from unanticipated changes in the shape of the yield curve, such that rates at different maturity points may move differently. Such movements may give rise to interest income and economic value volatility.
• Optionality risk, which arises when customers have the right to terminate, prepay or otherwise alter a transaction without penalty, resulting in a change in the timing or magnitude of the cash flows of an asset, liability or off-balance sheet instrument. This risk primarily arises in the US mortgage business in Citizens Financial Group where long-term fixed-rate loans are the norm and prepayment penalties are rare.
Due to the long-term nature of many non-trading book portfolios and their varied interest rate repricing characteristics and maturities, it is likely that net interest income will vary from period to period, even if interest rates remain the same. New business originated in any period will alter the interest rate sensitivity of the Group if the resulting portfolio differs from portfolios originated in prior periods, depending on the extent to which exposure has been hedged.
In order to manage exposures within these limits, the Group aggregates its interest rate positions and hedges them externally using cash and derivatives - primarily interest rate swaps.
Foreign exchange risk The Group’s only material non-traded open currency positions are the structural foreign exchange exposures arising from its investments in foreign subsidiaries and associates and their related currency funding. These exposures are assessed and managed by Group Treasury under delegated authority from GALCO. Group Treasury seeks to limit the potential volatility impact on the Group’s Core Tier 1 ratio from exchange rate movements to pre-defined risk appetite levels set by GALCO. The sensitivity of the Group’s Core Tier 1 capital to exchange rates is updated and reported to GALCO quarterly.
Investments, acquisitions or disposals of a strategic nature are referred to the Group Acquisitions and Disposals Committee (ADCo). Once approved by ADCo for execution, such transactions are referred for approval to the Group Board, Group Executive Committee (ExCo), Group Finance Director or as otherwise required. Decisions to acquire or hold equity positions in the non-trading book that are not of a strategic nature, such as customer restructurings, are taken by authorised persons with delegated authority under the Group credit approval framework.
The Group uses both approaches to quantify its interest rate risk: VaR as its value-based approach and sensitivity of net interest income (NII) as its earnings-based approach.
The table below shows the NTIRR VaR for the Group’s retail and commercial banking activities at a 99% confidence level together with a currency analysis of period end VaR.
Key points • Period end interest rate VaR was higher at 31 December 2013 than at 31 December 2012. Average VaR was relatively unchanged.
• The overall year-on-year increase in VaR mainly reflected an increase in the duration of the Group’s balance sheet - that is, greater economic exposure to longer-term interest rates - as described in more detail below.
Commercial to reduce earnings sensitivity to movements in short term dollar interest rates.
Sensitivity of net interest income* To analyse earnings sensitivities, forecasts are generated using implied forward rates, projected new business volumes, mix and pricing generated using business assumptions. Based on the balance sheet at the most recent month end, two NII forecasts are calculated each month: (i) a forecast for the current full year, which incorporates actuals on a monthly basis as the year progresses; and (ii) a base-case 12 month rolling forecast.
Market risk continued Non-traded market risk continued The following table shows the sensitivity of net interest income, over the next 12 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 (bear steepener) and a gradual 300 basis point flattening (bull flattener) of the yield curve for tenors greater than a year.
The scenarios represent annualised interest rate stresses of a scale deemed sufficient to trigger a modification in customer behaviour. The asymmetry in the steepening and flattening scenarios reflects the difference in the expected behaviour of interest rates as they approach zero.
2011 + 100 basis point shift in yield curves (19) 190 59 14 244 − 100 basis point shift in yield curves 25 (188) (4) (16) (183) Bear steepener 443 Bull flattener (146)
Key points • The Group's interest rate exposure remains asset sensitive, such that rising rates will have a positive impact on its net interest income.
• The Group’s increased sensitivity to parallel shifts in the yield curve over a 12 month horizon primarily reflects the higher volume of structural hedges maturing in 2014 relative to 2013. This reflects the maturity profile of legacy hedges. If rates were to rise, these would be reinvested at higher rates, with an upward impact on net interest income. This increased sensitivity also reflects changes in underlying pricing assumptions for customer loans and deposits.
Structural hedging* Banks generally have the benefit of a significant pool of stable, non and low interest bearing liabilities, principally comprising equity and money transmission accounts. These balances are usually hedged, either by investing directly in longer-term fixed rate assets or by the use of interest rate swaps, in order to provide a consistent and predictable revenue stream.
The table below shows the element of net interest income associated with product hedges managed by Group Treasury, relating to the main UK banking divisions, except Wealth. The amount represents the incremental contribution of the hedge relative to LIBOR cash rates.
Foreign exchange risk The table below shows the Group’s structural foreign currency exposures.
Note: (1) 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.
Market risk continued Non-traded market risk continued Key points • The Group’s structural foreign currency exposure at 31 December 2013 was £21.7 billion and £15.6 billion before and after economic hedges, respectively, both £2.3 billion lower than at 31 December 2012. Movements in structural foreign currency exposure are significantly driven by movements in net assets of overseas operations.
• Net investment hedges were reduced broadly in line with the reduction in net investments.
Equity risk Equity positions are carried at fair value on the balance sheet based on available market prices where possible. In the event that market prices are not available, fair value is based on appropriate valuation techniques or management estimates.
Refer to the table below for the balance sheet carrying value of the Group’s non-traded book equity positions.
Exchange-traded equity 368 472 576 Private equity 621 632 674 Other 623 799 1,094 1,612 1,903 2,344
The exposures may take the form of listed and unlisted equity shares, linked equity fund investments, private equity and venture capital investments, preference shares classified as equity or Federal Home Loan Bank stock. Refer to the table below for the net realised and unrealised gains from these positions: Net realised gains arising from disposals 48 89 150 Unrealised gains included in Tier 1 or 2 capital 232 168 235
2013 2012 2011 Average Period end Maximum Minimum Average Period end Maximum Minimum Average Period end Maximum Minimum £m £m £m £m £m £m £m £m £m £m £m £m
Interest rate 2.7 2.4 4.8 1.9 6.9 4.5 10.7 4.1 8.8 9.9 11.1 5.7 Credit spread 8.5 4.4 13.3 4.4 10.5 8.8 15.4 7.3 18.2 13.6 39.3 12.1 Currency 1.3 1.0 2.8 1.0 3.0 1.3 4.5 1.3 2.1 4.0 5.9 0.1 Equity 0.2 0.1 0.3 — 1.7 0.3 1.9 0.3 2.1 1.9 3.1 1.6 Diversification (1) (2.9) (5.4) (13.6)
Notes: (1) The Group benefits from diversification as it reduces risk by allocating positions across various financial instrument types, currencies and markets. The extent of the diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. (2) The table above excludes the structured credit portfolio and loans and receivables.
Key point • The total, Core and credit spread period end VaR were lower in 2013 than in 2012. VaR initially increased in Q1 2013 reflecting changes to the call assumptions on some Dutch residential mortgage-backed securities, thereby extending their weighted average life. This increase was offset during Q3 as the issuer bought back some of these securities, resulting in a net decrease in VaR for the year as a whole. The Non-Core period end and average VaR were lower in 2013 than in 2012. VaR steadily declined during 2013, due to de-risking and divestment within Non-Core.
Market risk continued Non-traded market risk continued Structured credit portfolio The structured credit portfolio is held in Non-Core. The risk in this portfolio is not managed using VaR because the Group believes this is not an appropriate tool for a non-trading book portfolio comprising illiquid debt securities. These assets are reported on a drawn notional and fair value basis, and managed on a third-party asset and risk-weighted assets basis. Drawn notional represents the amount of cash granted against debt securities received as part of a structured credit transaction. The table below shows the open market risk in the structured credit portfolio.
The Group’s non-traded equity risk is captured in credit risk RWAs.
In the second half of the year, investor concerns were heightened by the risk that the US federal debt ceiling increase would not be passed on time and that the government might delay debt payments. Short-term political solutions to these issues were found, though with further progress needed in 2014.