UK Central and local government 2,130 8,012 25 8,037 78,892 8 78,900 5,282 548 94,897 1,098 93,799 Finance - banks 25,204 29,575 207 29,782 1,950 — 1,950 — 40,365 97,301 18,653 78,648 - other (3) 39,154 30,874 2,361 33,235 25,779 4,462 30,241 301,125 3,259 407,014 312,007 95,007 Residential mortgages — 99,303 1,423 100,726 — — — 48 — 100,774 — 100,774 Personal lending — 20,080 127 20,207 — — — 51 24 20,282 7 20,275 Property — 31,141 24,610 55,751 278 137 415 4,332 — 60,498 1,265 59,233 Construction — 5,291 1,882 7,173 20 26 46 895 — 8,114 1,115 6,999 Manufacturing 254 9,641 835 10,476 499 1,908 2,407 2,259 — 15,396 2,205 13,191 Service industries and business activities - retail, wholesale and repairs — 11,071 1,441 12,512 574 2,616 3,190 952 18 16,672 1,647 15,025 - transport and storage 436 8,589 3,439 12,028 145 67 212 2,217 — 14,893 200 14,693 - health, education and recreation — 8,734 757 9,491 72 8 80 756 — 10,327 965 9,362 - hotels and restaurants — 5,599 569 6,168 23 — 23 664 — 6,855 178 6,677 - utilities — 2,462 922 3,384 1,150 513 1,663 3,207 30 8,284 450 7,834 - other — 13,963 1,644 15,607 1,017 3,459 4,476 3,988 593 24,664 830 23,834 Agriculture, forestry and fishing — 2,660 76 2,736 18 10 28 111 — 2,875 117 2,758 Finance lease and instalment credit — 5,618 5,598 11,216 1 2 3 73 — 11,292 16 11,276 Interest accruals 126 375 — 375 474 — 474 — — 975 — 975 Group 67,304 292,988 45,916 338,904 110,892 13,216 124,108 325,960 44,837 901,113 340,753 560,360
UK Central and local government 611 5,728 173 5,901 72,427 1 72,428 7,300 173 86,413 3,916 82,497 Finance - banks 28,370 41,541 481 42,022 5,381 — 5,381 — 28,097 103,870 24,489 79,381 - other (3) 33,186 27,995 6,023 34,018 27,737 18,645 46,382 249,324 5,390 368,300 232,460 135,840 Residential mortgages — 99,928 1,665 101,593 — — — 6 — 101,599 14 101,585 Personal lending — 23,035 585 23,620 1 — 1 9 23 23,653 11 23,642 Property — 34,970 30,492 65,462 2,302 175 2,477 3,739 28 71,706 1,041 70,665 Construction — 7,041 2,310 9,351 39 — 39 741 — 10,131 1,392 8,739 Manufacturing 389 12,300 1,510 13,810 354 — 354 2,159 — 16,712 2,150 14,562 Service industries and business activities - retail, wholesale and repairs — 12,554 1,853 14,407 343 11 354 874 — 15,635 2,452 13,183 - transport and storage — 8,105 5,015 13,120 241 3 244 1,573 — 14,937 219 14,718 - health, education and recreation — 13,502 1,039 14,541 160 22 182 877 — 15,600 1,047 14,553 - hotels and restaurants — 6,558 808 7,366 172 — 172 518 — 8,056 249 7,807 - utilities — 3,101 1,035 4,136 1,040 5 1,045 2,112 2 7,295 985 6,310 - other 1 14,445 1,991 16,436 549 447 996 1,986 335 19,754 1,354 18,400 Agriculture, forestry and fishing — 2,872 67 2,939 — — — 35 — 2,974 94 2,880 Finance lease and instalment credit — 5,589 7,785 13,374 13 2 15 14 — 13,403 134 13,269 Interest accruals 56 415 98 513 501 — 501 — — 1,070 — 1,070 Group 62,613 319,679 62,930 382,609 111,260 19,311 130,571 271,267 34,048 881,108 272,007 609,101
UK Central and local government 129 4,353 276 4,629 79,662 1 79,663 6,752 4 91,177 1,725 89,452 Finance - banks 21,955 36,741 424 37,165 2,355 — 2,355 — 20,693 82,168 2,483 79,685 - other (3) 29,240 29,278 6,004 35,282 38,135 5,676 43,811 257,109 5,492 370,934 236,443 134,491 Residential mortgages — 90,688 1,896 92,584 — — — 11 — 92,595 7 92,588 Personal lending — 24,613 1,137 25,750 1 — 1 9 22 25,782 21 25,761 Property — 36,407 35,387 71,794 3,303 458 3,761 4,086 104 79,745 1,114 78,631 Construction — 6,964 3,640 10,604 48 306 354 849 62 11,869 1,450 10,419 Manufacturing 182 14,462 3,255 17,717 640 1,003 1,643 4,222 102 23,866 3,184 20,682 Service industries and business activities - retail, wholesale and repairs — 13,412 2,672 16,084 445 263 708 819 29 17,640 2,549 15,091 - transport and storage — 10,066 5,319 15,385 369 163 532 988 15 16,920 201 16,719 - health, education and recreation 22 15,551 1,225 16,776 303 164 467 1,005 — 18,270 1,057 17,213 - hotels and restaurants — 7,575 1,033 8,608 320 573 893 824 86 10,411 284 10,127 - utilities — 2,626 1,652 4,278 1,142 2,308 3,450 2,321 259 10,308 445 9,863 - other — 13,516 3,964 17,480 1,608 2,621 4,229 1,892 353 23,954 1,274 22,680 Agriculture, forestry and fishing — 2,946 138 3,084 43 209 252 39 9 3,384 76 3,308 Finance lease and instalment credit — 5,343 10,843 16,186 291 3 294 16 — 16,496 39 16,457 Interest accruals 321 713 178 891 457 — 457 — — 1,669 — 1,669 Group before RFS MI 51,849 315,254 79,043 394,297 129,122 13,748 142,870 280,942 27,230 897,188 252,352 644,836 RFS MI — — — 444 49 1 50 494 — 988 — 988 Group 51,849 315,254 79,043 394,741 129,171 13,749 142,920 281,436 27,230 898,176 252,352 645,824
US Central and local government — 196 64 260 23,841 779 24,620 9 141 25,030 — 25,030 Finance - banks 7,466 982 76 1,058 1,473 — 1,473 — 7,533 17,530 63 17,467 - other (3) 9,912 9,524 1,771 11,295 25,592 85 25,677 125,599 5,779 178,262 113,607 64,655 Residential mortgages — 21,842 4,317 26,159 — — — — — 26,159 — 26,159 Personal lending — 7,373 3,599 10,972 — — — — — 10,972 — 10,972 Property — 1,498 3,788 5,286 56 — 56 30 — 5,372 — 5,372 Construction — 490 132 622 71 1 72 50 — 744 — 744 Manufacturing — 5,895 1,200 7,095 218 25 243 580 — 7,918 — 7,918 Service industries and business activities - retail, wholesale and repairs — 3,897 422 4,319 142 — 142 108 — 4,569 — 4,569 - transport and storage — 1,679 1,525 3,204 108 1 109 738 — 4,051 — 4,051 - health, education and recreation — 1,595 1,356 2,951 1,698 — 1,698 272 — 4,921 — 4,921 - hotels and restaurants — 772 88 860 98 — 98 7 — 965 — 965 - utilities — 1,178 46 1,224 113 — 113 204 — 1,541 — 1,541 - other 280 4,957 1,068 6,025 944 216 1,160 1,157 — 8,622 — 8,622 Agriculture, forestry and fishing — 27 — 27 1 — 1 2 — 30 — 30 Finance lease and instalment credit — 2,417 — 2,417 — — — — — 2,417 — 2,417 Interest accruals 16 204 94 298 334 — 334 — — 648 — 648 Group before RFS MI 17,674 64,526 19,546 84,072 54,689 1,107 55,796 128,756 13,453 299,751 113,670 186,081 RFS MI — — — 360 — — — — — 360 — 360 Group 17,674 64,526 19,546 84,432 54,689 1,107 55,796 128,756 13,453 300,111 113,670 186,441
Europe Central and local government — 334 1,164 1,498 25,328 — 25,328 68 24 26,918 — 26,918 Finance - banks — 4,905 529 5,434 17,390 — 17,390 — 22,792 45,616 — 45,616 - other (3) 189 4,095 905 5,000 5,097 426 5,523 1,699 43 12,454 — 12,454 Residential mortgages — 15,055 6,718 21,773 — — — — — 21,773 — 21,773 Personal lending — 1,877 1,009 2,886 — — — — 17 2,903 — 2,903 Property — 10,812 9,417 20,229 — 1 1 17 4 20,251 — 20,251 Construction — 1,946 1,167 3,113 — 1 1 1 1 3,116 — 3,116 Manufacturing — 7,311 8,609 15,920 19 23 42 123 — 16,085 — 16,085 Service industries and business activities - retail, wholesale and repairs — 5,464 1,661 7,125 15 1 16 7 — 7,148 — 7,148 - transport and storage — 4,385 1,463 5,848 15 4 19 — 2 5,869 — 5,869 - health, education and recreation — 1,419 1,121 2,540 54 9 63 — — 2,603 — 2,603 - hotels and restaurants — 1,221 568 1,789 — 19 19 — 4 1,812 — 1,812 - utilities — 1,816 786 2,602 4 30 34 6 37 2,679 — 2,679 - other 12 4,783 4,284 9,067 156 24 180 75 8 9,342 — 9,342 Agriculture, forestry and fishing — 737 356 1,093 — 1 1 — — 1,094 — 1,094 Finance lease and instalment credit — 379 1,094 1,473 — 12 12 — — 1,485 — 1,485 Interest accruals 102 168 245 413 706 — 706 — — 1,221 — 1,221 Group before RFS MI 303 66,707 41,096 107,803 48,784 551 49,335 1,996 22,932 182,369 — 182,369 RFS MI — — — 140,098 21,681 3,232 24,913 165,020 — 330,031 — 330,031 Group 303 66,707 41,096 247,901 70,465 3,783 74,248 167,016 22,932 512,400 — 512,400
United States 20,932 7,300 38,721 66,953 13,329 53,624 Germany 34,615 5,952 9,787 50,354 2,946 47,408 France 11,633 14,800 8,189 34,622 5,903 28,719 Japan 8,350 7,505 3,375 19,230 3,141 16,089 Netherlands 4,466 2,210 10,711 17,387 982 16,405 Spain 340 3,656 10,282 14,278 973 13,305 Italy 5,190 548 1,489 7,227 4,826 2,401 Republic of Ireland 665 3,287 2,759 6,711 68 6,643 Switzerland 1,335 3,282 1,492 6,109 25 6,084 China 1,589 2,669 1,849 6,107 — 6,107 Cayman Islands — 15 4,194 4,209 2 4,207 Belgium 1,662 1,285 1,222 4,169 726 3,443
United States 21,201 14,382 36,813 72,396 14,240 58,156 Germany 22,962 6,276 10,467 39,705 4,685 35,020 France 17,293 16,007 6,756 40,056 4,285 35,771 Japan 7,983 6,962 7,542 22,487 409 22,078 Netherlands 2,900 3,055 10,824 16,779 951 15,828 Spain 1,401 4,248 11,589 17,238 1,357 15,881 Italy 6,409 1,083 2,188 9,680 3,183 6,497 Republic of Ireland 199 3,789 3,101 7,089 131 6,958 Switzerland 4 1,714 2,944 4,662 12 4,650 China 553 1,775 1,561 3,889 5 3,884 Cayman Islands 2 94 7,330 7,426 44 7,382 Belgium 1,461 752 2,806 5,019 606 4,413
Asset quality band Probability of default range AQ1 0% - 0.034% AQ2 0.034% - 0.048% AQ3 0.048% - 0.095% AQ4 0.095% - 0.381% AQ5 0.381% - 1.076% AQ6 1.076% - 2.153% AQ7 2.153% - 6.089% AQ8 6.089% - 17.222% AQ9 17.222% - 100% AQ10 100%
Other financial instruments Commitments Contingent liabilities Total 2009 £m £m £m £m £m £m £m £m £m
AQ1 51,521 72,384 106,062 6,582 389,019 754 62,085 9,446 697,853 AQ2 — 1,725 10,780 306 11,550 9 27,598 4,526 56,494 AQ3 1 2,175 29,958 199 10,791 — 28,364 6,088 77,576 AQ4 23 1,357 102,922 605 8,296 — 52,496 14,948 180,647 AQ5 2 2,497 124,724 149 8,270 37 43,239 7,387 186,305 AQ6 1 424 94,513 40 2,548 — 30,847 2,448 130,821 AQ7 — 110 46,928 33 2,181 98 26,724 2,352 78,426 AQ8 — 137 23,593 — 1,448 — 12,507 1,008 38,693 AQ9 — 184 16,025 — 2,030 — 5,141 1,279 24,659 AQ10 — 277 9,142 3 2,026 — 3,618 507 15,573 Accruing past due — 36 14,475 3,910 40 — — — 18,461 Impaired — 206 31,588 197 — — — — 31,991 Impairment provision — (157) (15,016) — — — — — (15,173) Group before RFS MI 51,548 81,355 595,694 12,024 438,199 898 292,619 49,989 1,522,326 RFS MI 713 7,865 132,699 9 3,255 — 5,022 4,031 153,594 Group 52,261 89,220 728,393 12,033 441,454 898 297,641 54,020 1,675,920
For the note relating to this table refer to page 174.
Non-Core AQ1 58 503 18,733 16 3,876 88 6,136 829 30,239 AQ2 — 4 1,652 2 677 — 865 32 3,232 AQ3 140 14 2,748 — 459 — 1,152 73 4,586 AQ4 1 55 6,616 1 946 — 1,263 192 9,074 AQ5 — 5 7,145 — 1,429 — 1,367 209 10,155 AQ6 — 48 6,416 — 234 — 1,035 28 7,761 AQ7 — — 4,265 — 1,597 — 1,649 88 7,599 AQ8 — 10 2,014 — 586 — 91 40 2,741 AQ9 — — 4,491 — 558 48 517 45 5,659 AQ10 — — 306 — 708 — 1,080 41 2,135 Accruing past due — — 1,544 — — — — — 1,544 Impaired — 1 23,440 — — 1 — — 23,442 Impairment provision — (1) (11,468) — — (1) — — (11,470)
Debt securities The table below analyses debt securities by issuer and external ratings. Ratings are based on the lower of S&P, Moody’s and Fitch.
Total AAA 22,451 45 32,522 5,155 15,908 452 76,533 37 17,156 AA to AA+ — 40,435 2,000 2,497 30,403 639 75,974 36 33,615 A to AA- — 1 24,966 6,387 4,979 1,746 38,079 18 6,331 BBB- to A- — — 2,194 2,287 2,916 1,446 8,843 4 4,480 Non-investment grade — — 924 575 5,042 1,275 7,816 4 4,492 Unrated — 3 2 39 1,380 411 1,835 1 1,235 22,451 40,484 62,608 16,940 60,628 5,969 209,080 100 67,309
Core AAA 22,112 45 32,489 4,601 13,245 448 72,940 37 14,534 AA to AA+ — 40,435 1,995 2,434 28,125 565 73,554 38 31,323 A to AA- — 1 24,964 6,302 3,348 1,614 36,229 18 4,731 BBB- to A- — — 2,194 2,272 1,727 1,232 7,425 4 3,188 Non-investment grade — — 723 559 2,542 1,048 4,872 2 2,552 Unrated — 3 1 25 821 260 1,110 1 785 22,112 40,484 62,366 16,193 49,808 5,167 196,130 100 57,113
Non-Core AAA 339 — 33 554 2,663 4 3,593 28 2,622 AA to AA+ — — 5 63 2,278 74 2,420 19 2,292 A to AA- — — 2 85 1,631 132 1,850 14 1,600 BBB- to A- — — — 15 1,189 214 1,418 11 1,292 Non-investment grade — — 201 16 2,500 227 2,944 23 1,940 Unrated — — 1 14 559 151 725 5 450 339 — 242 747 10,820 802 12,950 100 10,196
Non-Core AAA 376 311 22 172 3,793 39 4,713 30 3,794 AA to AA+ — — — 26 2,781 4 2,811 18 2,679 A to AA- — — — 506 1,051 66 1,623 11 1,365 BBB- to A- — — — 274 2,000 102 2,376 15 2,277 Non-investment grade — — 306 84 1,864 411 2,665 17 1,871 Unrated — — 1 60 1,177 157 1,395 9 725 376 311 329 1,122 12,666 779 15,583 100 12,711 2009 AAA 26,601 28,210 44,155 13,208 49,363 4,021 165,558 66 65,067 AA to AA+ — — 22,003 4,225 9,602 1,474 37,304 15 8,942 A to AA- — — 13,161 3,425 4,563 1,526 22,675 9 3,886 BBB- to A- — — 3,847 788 4,727 1,738 11,100 5 4,243 Non-investment grade — — 353 159 3,937 1,630 6,079 2 3,515 Unrated — — 509 232 3,586 2,052 6,379 3 1,949 Group before RFS MI 26,601 28,210 84,028 22,037 75,778 12,441 249,095 100 87,602
Key points The decrease in AAA rated debt securities relates to the downgrading of US government and agencies to AA+ by S&P during the year.
Non-investment grade and unrated debt securities accounted for 5% of the debt securities portfolio at 31 December 2011, down from 7% in the prior year.
Key points Held-for-trading debt securities decreased by £3.8 billion during the year due to a reduction in trading volumes. The reduction in sovereign exposures in the eurozone and other countries, in response to the current economic environment, was offset by an increase in US and UK government bonds.
The following tables summarise the gross and net exposures and carrying values of these securities by the location of the underlying assets at 31 December 2011, 2010 and 2009. Gross exposures represent the principal amounts relating to ABS. Government sponsored or similar RMBS comprises securities that are: (a) guaranteed or effectively guaranteed by the US government, by way of its support for US federal agencies and government sponsored enterprises or (b) guaranteed by the Dutch government. Net exposures represent the carrying value after taking account of protection purchased from monoline insurers and other counterparties, but exclude the effect of counterparty credit valuation adjustments. The hedge provides credit protection of both principal and interest cash flows in the event of default by the counterparty. The value of this protection is based on the underlying instrument being protected.
FVTPL (1) US UK Europe RoW Total HFT (2) DFV (3) AFS (4) LAR (5)
Gross exposure RMBS: government sponsored or similar 26,644 17 7,016 94 33,771 13,536 — 20,235 — RMBS: prime 2,965 5,276 4,567 222 13,030 6,274 147 5,761 848 RMBS: non-conforming 1,341 2,138 128 — 3,607 635 — 1,498 1,474 RMBS: sub-prime 1,668 724 195 561 3,148 1,632 17 1,020 479 MBS: covered bond 49 297 9,019 — 9,365 — — 9,365 — CMBS 3,422 1,781 1,420 75 6,698 2,936 209 1,842 1,711 CDOs 12,382 329 571 27 13,309 9,080 1 3,923 305 CLOs 9,092 166 2,169 1,173 12,600 5,346 — 6,581 673 ABS covered bond — — 2,206 — 2,206 — — 2,206 — Other ABS 3,587 1,980 2,825 1,569 9,961 2,912 18 3,046 3,985 61,150 12,708 30,116 3,721 107,695 42,351 392 55,477 9,475
Carrying value RMBS: government sponsored or similar 26,984 17 6,870 33 33,904 13,397 — 20,507 — RMBS: prime 2,696 4,583 4,009 212 11,500 5,133 141 5,643 583 RMBS: non-conforming 958 1,957 128 — 3,043 389 — 1,180 1,474 RMBS: sub-prime 977 314 146 387 1,824 779 17 704 324 MBS: covered bond 50 288 8,734 — 9,072 — — 9,072 — CMBS 3,237 1,305 924 43 5,509 2,279 216 1,637 1,377 CDOs 3,275 166 400 27 3,868 2,064 1 1,600 203 CLOs 6,736 112 1,469 999 9,316 3,296 — 5,500 520 ABS covered bond — — 2,200 — 2,200 — — 2,200 — Other ABS 2,886 1,124 2,169 1,187 7,366 1,483 19 2,421 3,443 47,799 9,866 27,049 2,888 87,602 28,820 394 50,464 7,924
Net exposure RMBS: government sponsored or similar 26,984 17 6,870 33 33,904 13,397 — 20,507 — RMBS: prime 2,436 3,747 3,018 172 9,373 3,167 142 5,480 584 RMBS: non-conforming 948 1,957 128 — 3,033 379 — 1,180 1,474 RMBS: sub-prime 565 305 137 290 1,297 529 17 427 324 MBS: covered bond 50 288 8,734 — 9,072 — — 9,072 — CMBS 2,245 1,228 595 399 4,467 1,331 203 1,556 1,377 CDOs 743 124 382 26 1,275 521 1 550 203 CLOs 1,636 86 1,104 39 2,865 673 — 1,672 520 ABS covered bond — — 2,200 — 2,200 — — 2,200 — Other ABS 2,117 839 2,131 1,145 6,232 483 19 2,421 3,309 37,724 8,591 25,299 2,104 73,718 20,480 382 45,065 7,791
AAA 4,169 3,599 1,488 105 2,595 647 135 2,171 625 1,622 17,156 AA to AA+ 29,252 669 106 60 379 710 35 1,533 321 550 33,615 A to AA- 131 506 110 104 2,567 1,230 161 697 100 725 6,331 BBB- to A- — 39 288 93 1,979 333 86 341 — 1,321 4,480 Non-investment grade 21 784 658 396 — 415 1,370 176 — 672 4,492 Unrated — 148 29 146 — 56 170 423 — 263 1,235 33,573 5,745 2,679 904 7,520 3,391 1,957 5,341 1,046 5,153 67,309 2010 AAA 28,835 4,355 1,754 317 7,107 2,789 444 2,490 988 2,156 51,235 AA to AA+ 1,529 147 144 116 357 392 567 1,786 681 616 6,335 A to AA- — 67 60 212 408 973 296 343 192 693 3,244 BBB- to A- — 82 316 39 — 500 203 527 — 1,718 3,385 Non-investment grade — 900 809 458 — 296 1,863 332 — 265 4,923 Unrated — 196 52 76 — — 85 596 — 698 1,703 30,364 5,747 3,135 1,218 7,872 4,950 3,458 6,074 1,861 6,146 70,825
AAA 33,779 9,211 1,981 578 8,645 3,441 615 2,718 1,933 2,166 65,067 AA to AA+ 125 676 197 121 360 599 944 4,365 267 1,288 8,942 A to AA- — 507 109 306 67 1,022 254 607 — 1,014 3,886 BBB- to A- — 547 160 87 — 298 944 260 — 1,947 4,243 Non-investment grade — 558 594 579 — 147 849 636 — 152 3,515 Unrated — 1 2 153 — 2 262 730 — 799 1,949 33,904 11,500 3,043 1,824 9,072 5,509 3,868 9,316 2,200 7,366 87,602
Notes: (1) Residential mortgage-backed securities. (2) Includes US agency and Dutch government guaranteed securities. (3) Commercial mortgage-backed securities. (4) Collateralised debt obligations. (5) Collateralised loan obligations.
The decrease in CMBS of £1.6 billion, primarily reflecting restructuring of certain monoline exposures.
The average mark of total ABS was 83%, broadly the same as 2010 and 2009.
Non-investment grade and unrated ABS The table below summarises the carrying values by accounting classification of non-investment grade or not publicly rated ABS.
Non-investment grade Unrated HFT AFS LAR Total HFT AFS LAR Total
RMBS: G10 governments — 21 — 21 — — — — RMBS: prime 312 417 54 783 148 — — 148 RMBS: non-conforming 279 372 7 658 28 — — 28 RMBS: sub-prime 387 9 — 396 146 — — 146 CMBS 307 10 98 415 56 — — 56 CDOs 116 1,215 40 1,371 130 40 — 170 CLOs 131 — 44 175 284 139 — 423 Other ABS 150 12 511 673 12 70 182 264 1,682 2,056 754 4,492 804 249 182 1,235 2010 RMBS: prime 354 535 11 900 196 — — 196 RMBS: non-conforming 389 414 6 809 52 — — 52 RMBS: sub-prime 437 21 — 458 76 — — 76 CMBS 198 17 81 296 — — — — CDOs 691 1,151 21 1,863 85 — — 85 CLOs 239 5 88 332 267 329 — 596 Other ABS 148 17 100 265 191 162 345 698 2,456 2,160 307 4,923 867 491 345 1,703
RMBS: prime 120 430 8 558 — 1 — 1 RMBS: non-conforming 253 341 — 594 — 2 — 2 RMBS: sub-prime 339 240 — 579 153 — — 153 CMBS 89 3 55 147 1 — 1 2 CDOs 487 300 62 849 143 119 — 262 CLOs 269 359 8 636 207 523 — 730 Other ABS 78 63 11 152 270 134 395 799 1,635 1,736 144 3,515 774 779 396 1,949
Residential mortgage-backed securities RMBS are securities that represent an interest in a portfolio of residential mortgages. Repayments made on the underlying mortgages are used to make payments to holders of the RMBS. The risk of the RMBS will vary primarily depending on the quality and geographic region in which the underlying mortgage assets are located and the credit enhancement of the securitisation structure. Several tranches of notes are issued, each secured against the same portfolio of mortgages, but providing differing levels of seniority to match the risk appetite of investors. The most junior (or equity) notes will suffer early capital and interest losses experienced by the referenced mortgage collateral, with each more senior note benefiting from the protection provided by the subordinated notes below. Additional credit enhancements may be provided to the holder of senior RMBS notes, including provided by monoline insurers.
The main categories of mortgages that serve as collateral to RMBS held by the Group with related vintages are set out below and described in the Glossary on pages 476 to 483. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for the Group's RMBS categorisation.
AQ1 24,580 10,957 17,180 126,105 302,800 481,622 30,840 10,755 17,554 135,311 214,029 408,489 389,019 AQ2 326 236 431 2,046 5,138 8,177 319 105 212 1,561 462 2,659 11,550 AQ3 975 390 459 2,811 6,184 10,819 1,284 391 626 610 406 3,317 10,791 AQ4 1,465 782 713 4,093 7,368 14,421 989 155 240 1,726 281 3,391 8,296 AQ5 890 93 219 1,787 3,527 6,516 1,016 81 201 1,447 2,115 4,860 8,270 AQ6 121 30 81 803 1,186 2,221 134 46 71 653 166 1,070 2,548 AQ7 101 29 56 1,674 533 2,393 150 29 44 375 259 857 2,181 AQ8 16 21 11 143 1,061 1,252 2 1 10 118 272 403 1,448 AQ9 5 8 7 254 876 1,150 104 8 39 110 189 450 2,030 AQ10 13 20 35 658 321 1,047 170 11 52 353 995 1,581 2,026 Accruing past due — — — — — — — — — — — — 40 28,492 12,566 19,192 140,374 328,994 529,618 35,008 11,582 19,049 142,264 219,174 427,077 438,199 RFS MI — — 3,255 Group 529,618 427,077 441,454 Counterparty mtm netting (441,626) (330,397) (358,917) Cash collateral held against derivative exposures (1) (37,222) (31,096) (33,667)
At 31 December 2011 the Group also held collateral in the form of securities of £5.3 billion (2010 - £2.9 billion; 2009 - £3.6 billion).
Risk management: Credit risk continued Balance sheet analysis: Derivatives continued The tables below analyse the Group’s derivative assets by contract type and residual maturity and the effect of position netting and collateral.
Exchange rate 28,938 7,820 9,360 23,174 13,961 83,253 (69,509) 13,744 Interest rate 4,822 3,533 7,927 104,026 191,423 311,731 (236,513) 75,218 Credit derivatives 497 99 313 12,374 13,589 26,872 (22,728) 4,144 Equity and commodity 751 130 1,449 2,690 201 5,221 (1,647) 3,574 35,008 11,582 19,049 142,264 219,174 427,077 (330,397) 96,680
The table below analyses the Group’s credit derivative bought and sold, by counterparty
Counterparty Central and local government - APS 131.8 — (0.2) — 195.8 — 0.6 — Monoline insurers 8.6 — 0.6 — 14.9 — 1.5 — CDPCs 24.5 — 0.9 — 25.0 — 0.8 — Banks 204.1 202.1 8.5 10.2 370.7 370.6 5.0 5.7 Other financial institutions 234.8 231.6 10.5 9.5 176.6 195.0 4.4 4.3 Corporates 9.6 7.1 (0.2) 0.3 6.5 1.9 (0.7) 0.1 613.4 440.8 20.1 20.0 789.5 567.5 11.6 10.1
Credit valuation adjustment as a % of gross exposure 63% 61% 62%
The net income statement effect relating to monoline exposures is detailed below.
Note: (1) Comprises the following elements: - a loss of £670 million (2010 - £5 million; 2009 - £2,387 million) in income from trading activities; - impairment (losses)/reversals of £(1) million (2010 - £71 million; 2009 - £(239) million); and - other income of £235 million (2010 - £138 million; 2009 - £60 million) relating to reclassified debt securities.
A number of debt instruments with monoline protection were reclassified from HFT to AFS in 2008. Changes in the fair value of these securities since the reclassification are recognised in the income statement to the extent that they are considered to be impaired. Changes in the fair value of the related monoline CDSs continue to be recorded in the income statement.
Risk management: Credit risk continued Balance sheet analysis continued The Group also has indirect exposures to monoline insurers through wrapped securities and other assets with credit enhancement from monoline insurers. These securities are traded with the benefit of this credit enhancement. Any deterioration in the credit rating of the monoline is reflected in the fair value of these assets.
AAA 213 212 1 — 1 A to AA- 646 632 14 3 11 Non-investment grade 19,671 18,151 1,520 788 732 Unrated 3,974 3,613 361 243 118 24,504 22,608 1,896 1,034 862 2010 AAA 213 212 1 — 1 A to AA- 644 629 15 4 11 Non-investment grade 20,066 19,050 1,016 401 615 Unrated 4,165 3,953 212 85 127 25,088 23,844 1,244 490 754 2009 AAA 1,658 1,637 21 5 16 BBB- to A- 1,070 1,043 27 9 18 Non-investment grade 17,696 16,742 954 377 577 Unrated 3,926 3,653 273 108 165 24,350 23,075 1,275 499 776
Credit valuation adjustment at 1 January (490) (499) (1,311) Credit valuation adjustment at 31 December (1,034) (490) (499) (Increase)/decrease in credit valuation adjustment (544) 9 812 Net credit/(debit) relating to realisations, hedges, foreign exchange and other movements 459 (150) (1,769) Loss from trading activities (85) (141) (957)
Key points The exposure to CDPCs has increased during the year. This was primarily driven by wider credit spreads of the underlying reference loans and bonds.
Counterparty and credit RWAs increased in line with the increase in the exposure.*
Loans are classified as accruing loans past due 90 days or more where they are past due 90 days but where no impairment provision is recognised. This category is used for fully collateralised non revolving credit facilities.
Note: (1) Includes assets of disposal groups and loans excluding reverse repos.
Risk management: Credit risk continued Balance sheet analysis: REIL, provisions and reserves continued
REIL by division The tables below analyse loans and advances (excluding reverse repos and disposal groups) and related REIL, provisions, impairments, amounts written-off and coverage ratios by division.
Impaired loans Other loans (1) REIL Core Non-Core Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m
Note: (1) Accruing loans past due 90 days or more (also see table below).
Ulster Bank Group’s non-performing loans increased significantly by £3.5 billion (Core - £1.9 billion; Non-Core - £1.6 billion). This principally related to residential mortgages (£0.6 billion, 39% increase) and commercial real estate (£2.4 billion, 25% increase), reflecting the continued deterioration in the property sectors in Ireland. The Non-Core REIL increase related to Ulster Bank was partially offset by run off in other Non-Core donating divisions in the year.
Past due 1-29 days 5,518 724 6,242 6,401 822 7,223 6,587 7,796 Past due 30-59 days 1,472 171 1,643 1,725 392 2,117 2,300 2,724 Past due 60-89 days 907 107 1,014 922 271 1,193 2,410 2,587 Past due 90 days or more 1,556 542 2,098 1,696 1,201 2,897 3,178 3,224 9,453 1,544 10,997 10,744 2,686 13,430 14,475 16,331
Central and local government 9,742 — — — — — — — Finance - banks 43,993 137 123 0.3 90 0.3 — — - other 49,681 1,049 719 2.1 69 1.4 89 87 Residential mortgages 143,611 5,084 1,362 3.5 27 0.9 1,076 516 Personal lending 32,623 2,737 2,172 8.4 79 6.7 782 1,286 Property 76,768 21,655 8,862 28.2 41 11.5 3,670 1,171 Construction 9,453 1,762 703 18.6 40 7.4 139 244 Manufacturing 28,132 881 504 3.1 57 1.8 227 215 Service industries and business activities - retail, wholesale and repairs 23,653 1,007 516 4.3 51 2.2 180 172 - transport and storage 21,931 589 146 2.7 25 0.7 78 43 - health, education and recreation 14,692 1,077 458 7.3 43 3.1 304 98 - hotels and restaurants 8,304 1,437 643 17.3 45 7.7 334 131 - utilities 8,392 88 23 1.0 26 0.3 3 3 - other 28,000 2,403 1,095 8.6 46 3.9 799 373 Agriculture, forestry and fishing 3,600 145 63 4.0 43 1.8 (7) 18 Finance leases and instalment credit 14,499 794 508 5.5 64 3.5 112 170 Interest accruals 791 — — — — — — — Latent — — 1,986 — — — (545) — 517,865 40,845 19,883 7.9 49 3.8 7,241 4,527 of which: UK
- residential mortgages 23,237 770 240 3.3 31 1.0 426 481 - personal lending 8,441 143 66 1.7 46 0.8 112 153 - property 3,783 329 92 8.7 28 2.4 (2) 138 - other 38,158 656 913 1.7 139 2.4 (166) 197 RoW
Central and local government 8,452 — — — — — — — Finance - banks 58,036 145 127 0.2 88 0.2 (13) 12 - other 54,561 1,129 595 2.1 53 1.1 198 141 Residential mortgages 146,501 4,276 877 2.9 21 0.6 1,014 669 Personal lending 37,472 3,544 2,894 9.5 82 7.7 1,370 1,577 Property 90,106 19,584 6,736 21.7 34 7.5 4,682 1,009 Construction 12,032 2,464 875 20.5 36 7.3 530 146 Manufacturing 32,317 1,199 503 3.7 42 1.6 (92) 1,547 Service industries and business activities - retail, wholesale and repairs 25,165 1,157 572 4.6 49 2.3 334 161 - transport and storage 24,141 248 118 1.0 48 0.5 87 39 - health, education and recreation 19,321 1,055 319 5.5 30 1.7 159 199 - hotels and restaurants 9,681 1,269 504 13.1 40 5.2 321 106 - utilities 9,208 91 23 1.0 25 0.2 14 7 - other 29,994 1,438 749 4.8 52 2.5 378 310 Agriculture, forestry and fishing 3,893 152 86 3.9 57 2.2 31 6 Finance leases and instalment credit 16,850 847 554 5.0 65 3.3 252 113 Interest accruals 1,109 — — — — — — — Latent — — 2,650 — — — (121) — 578,839 38,598 18,182 6.7 47 3.1 9,144 6,042 of which: UK
- residential mortgages 24,201 640 253 2.6 40 1.0 615 645 - personal lending 9,520 55 55 0.6 100 0.6 160 271 - property 4,929 765 202 15.5 26 4.1 321 220 - other 36,780 870 1,133 2.4 130 3.1 (76) 524 RoW
- residential mortgages 613 23 9 3.8 39 1.5 9 1 - personal lending 1,462 5 5 0.3 100 0.3 98 129 - property 1,940 299 116 15.4 39 6.0 (13) 182 - other 22,666 722 508 3.2 70 2.2 194 136 Group before RFS MI 578,839 38,598 18,182 6.7 47 3.1 9,144 6,042 RFS MI 2 — — — — — 42 —
Central and local government 7,660 — — — — — — — Finance - banks 48,934 206 157 0.4 76 0.3 34 — - other 60,386 1,539 419 2.5 27 0.7 886 692 Residential mortgages 140,907 3,284 551 2.3 17 0.4 909 642 Personal lending 41,671 3,940 2,926 9.5 74 7.0 2,517 2,002 Property 99,426 14,318 3,422 14.4 24 3.4 3,296 650 Construction 14,760 2,232 519 15.1 23 3.5 479 287 Manufacturing 44,674 3,131 2,088 7.0 67 4.7 1,520 784 Service industries and business activities 134,076 5,308 1,860 4.0 35 1.4 1,964 1,281 Agriculture, forestry and fishing 4,279 137 73 3.2 53 1.7 30 5 Finance leases and instalment credit 20,103 894 418 4.4 47 2.1 271 135 Interest accruals 1,728 — — — — — — — Latent — — 2,740 — — — 1,184 — 618,604 34,989 15,173 5.7 43 2.5 13,090 6,478 of which: UK 394,297 16,104 6,922 4.1 43 1.8 5,593 2,924 Europe 107,803 13,390 5,449 12.4 41 5.1 3,270 427 US 84,072 4,115 2,020 4.9 49 2.4 3,273 2,656 RoW 32,432 1,380 782 4.3 57 2.4 954 471 Group before RFS MI 618,604 34,989 15,173 5.7 43 2.5 13,090 6,478 RFS MI 142,688 3,260 2,110 2.3 65 1.5 1,044 461 Group 761,292 38,249 17,283 5.0 45 2.3 14,134 6,939
Central and local government 8,359 — — — — — — — Finance - banks 43,374 136 122 0.3 90 0.3 — — - other 46,452 732 572 1.6 78 1.2 207 44 Residential mortgages 138,509 4,704 1,182 3.4 25 0.9 776 198 Personal lending 31,067 2,627 2,080 8.5 79 6.7 715 935 Property 38,704 3,686 1,001 9.5 27 2.6 470 167 Construction 6,781 660 228 9.7 35 3.4 178 143 Manufacturing 23,201 458 221 2.0 48 1.0 106 125 Service industries and business activities - retail, wholesale and repairs 21,314 619 312 2.9 50 1.5 208 119 - transport and storage 16,454 325 52 2.0 16 0.3 47 29 - health, education and recreation 13,273 576 213 4.3 37 1.6 170 55 - hotels and restaurants 7,143 952 354 13.3 37 5.0 209 60 - utilities 6,543 22 1 0.3 5 — — — - other 24,228 1,095 591 4.5 54 2.4 553 189 Agriculture, forestry and fishing 3,471 98 36 2.8 37 1.0 (15) 5 Finance leases and instalment credit 8,440 172 110 2.0 64 1.3 31 68 Interest accruals 675 — — — — — — — Latent — — 1,339 — — — (252) — 437,988 16,862 8,414 3.8 50 1.9 3,403 2,137 of which: UK
- residential mortgages 99,928 2,010 307 2.0 15 0.3 164 16 - personal lending 23,035 2,888 2,341 12.5 81 10.2 1,033 1,142 - property 34,970 2,454 500 7.0 20 1.4 394 43 - other 161,746 2,657 1,743 1.6 66 1.1 689 318 Europe - residential mortgages 19,473 1,506 280 7.7 19 1.4 184 6 - personal lending 2,270 203 164 8.9 81 7.2 43 19 - property 5,139 631 240 12.3 38 4.7 241 1 - other 38,992 1,565 1,343 4.0 86 3.4 468 85 US
- residential mortgages 20,548 460 97 2.2 21 0.5 225 221 - personal lending 6,816 35 35 0.5 100 0.5 81 110 - property 1,611 144 43 8.9 30 2.7 84 54 - other 33,110 388 649 1.2 167 2.0 35 171 RoW
- residential mortgages 410 23 9 5.6 39 2.2 5 — - personal lending 1,460 5 5 0.3 100 0.3 — — - property 735 58 35 7.9 60 4.8 20 — - other 19,390 180 75 0.9 42 0.4 71 38 Group before RFS MI 469,633 15,207 7,866 3.2 52 1.7 3,737 2,224
Central and local government 6,128 — — — — — — — Finance - banks 47,574 168 135 0.4 80 0.3 12 — - other 50,673 1,038 259 2.0 25 0.5 256 113 Residential mortgages 127,975 2,670 341 2.1 13 0.3 305 146 Personal lending 35,313 3,344 2,560 9.5 77 7.2 1,816 1,398 Property 49,054 1,766 468 3.6 27 1.0 417 37 Construction 9,502 457 131 4.8 29 1.4 58 30 Manufacturing 30,272 491 191 1.6 39 0.6 136 93 Service industries and business activities 100,438 1,762 669 1.8 38 0.7 500 365 Agriculture, forestry and fishing 3,726 90 46 2.4 51 1.2 24 4 Finance leases and instalment credit 8,147 303 116 3.7 38 1.4 52 100 Interest accruals 1,179 — — — — — — — Latent — — 2,005 — — — 991 — 469,981 12,089 6,921 2.6 57 1.5 4,567 2,286 of which: UK 315,254 7,704 4,209 2.4 55 1.3 2,884 1,645 Europe 66,707 2,607 1,709 3.9 66 2.6 750 46 US 64,526 1,497 876 2.3 59 1.4 813 576 RoW 23,494 281 127 1.2 45 0.5 120 19 Group before RFS MI 469,981 12,089 6,921 2.6 57 1.5 4,567 2,286
- residential mortgages 1,423 52 11 3.7 21 0.8 6 1 - personal lending 127 37 30 29.1 81 23.6 (12) 179 - property 24,610 5,405 2,291 22.0 42 9.3 1,034 377 - other 19,756 2,298 1,504 11.6 65 7.6 174 349 Europe - residential mortgages 553 84 49 15.2 58 8.9 30 — - personal lending 492 66 55 13.4 83 11.2 33 104 - property 11,538 12,035 5,384 104.3 45 46.7 2,134 497 - other 11,068 2,641 1,315 23.9 50 11.9 277 107 US
- residential mortgages 2,926 244 120 8.3 49 4.1 264 317 - personal lending 936 7 7 0.7 100 0.7 46 68 - property 1,370 218 68 15.9 31 5.0 (18) 95 - other 2,104 213 329 10.1 154 15.6 (192) 96 RoW
- residential mortgages 200 — — — — — — — - personal lending 1 — — — — — — — - property 546 311 118 57.0 38 21.6 50 35 - other 2,227 372 188 16.7 51 8.4 12 165 Group before RFS MI 79,877 23,983 11,469 30.0 48 14.4 3,838 2,390
- residential mortgages 1,665 52 7 3.1 13 0.4 5 1 - personal lending 585 195 177 33.3 91 30.3 13 11 - property 30,492 5,532 1,719 18.1 31 5.6 1,152 354 - other 30,188 2,995 1,837 9.9 61 6.1 508 386 Europe - residential mortgages 621 45 21 7.2 47 3.4 37 — - personal lending 600 198 152 33.0 77 25.3 23 5 - property 12,636 9,903 3,959 78.4 40 31.3 2,587 209 - other 14,388 2,385 1,111 16.6 47 7.7 295 1,338 US
- residential mortgages 3,653 180 156 4.9 87 4.3 390 424 - personal lending 2,704 20 20 0.7 100 0.7 79 161 - property 3,318 621 159 18.7 26 4.8 237 166 - other 3,670 482 484 13.1 100 13.2 (111) 353 RoW
Impairment loss provision methodology A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
For retail loans, which are segmented into collective, homogenous portfolios, time-based measures, such as days past due, are typically used as evidence of impairment. For these portfolios, the Group recognises an impairment at 90 days past due.
Individually assessed provisions: provisions required for individually significant impaired assets are assessed on a case-by-case basis. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the assets carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. Future cash flows are estimated through a case-by-case analysis of individually assessed assets.
This assessment takes into account the benefit of any guarantee or other collateral held. The value and timing of cash flow receipts are based on available estimates in conjunction with facts available at that time. Timings and amounts of cash flows are reviewed on subsequent assessment dates, as new information becomes available. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off.
The provision is determined based on a quantitative review of the relevant portfolio, taking account of the level of arrears, the value of any security, historical and projected cash recovery trends over the recovery period. The provision also incorporates any adjustments that may be deemed appropriate given current economic and credit conditions. Such adjustments may be determined based on: a review of the current cash collections profile performance against historical trends; updates to metric inputs - including model recalibrations; and monitoring of operational processes used in managing exposures - including the time taken to process nonperforming exposures.
Latent loss provisions: a separate approach is taken for provisions held against impairments in the performing portfolio that have been incurred as a result of events occurring before the balance sheet date but which have not been identified at the balance sheet date.
Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs and are subsequently measured at fair value with changes in fair value reported in owners’ equity until disposal, at which stage the cumulative gain or loss is recognised in profit or loss. When there is objective evidence that an available-for-sale financial asset is impaired, any decline in its fair value below original cost is removed from equity and recognised in profit or loss.
Analyses of AFS debt securities and related AFS reserves are set out on page 206.
Individually assessed - banks — — 2 7 — — 9 113 122 1 — 123 - customers — 679 70 193 991 73 2,006 668 2,674 9,960 — 12,634 Collectively assessed 2,157 662 — 17 1,282 161 4,279 — 4,279 861 — 5,140 Latent 186 267 9 17 476 217 1,172 167 1,339 647 — 1,986 2010 At 1 January 2,677 1,271 55 189 962 478 5,632 1,289 6,921 8,252 2,110 17,283 Intra-group transfers — — — — (351) — (351) (217) (568) 568 — — Transfers to disposal groups — — — — — — — — — (72) — (72) Currency translation and other adjustments — 71 4 (2) (22) 19 70 (86) (16) 59 — 43 Disposal of subsidiaries — — — — — — — — — (20) (2,152) (2,172)
Analysis of loan impairment charge The following table analyses impairment losses. 2011 £m
Ulster Bank Group’s provisions increased by £3.1 billion during the year (Core - £1.1 billion; Non-Core - £2.0 billion), with provision coverage increasing to 53% (Core - 50%; Non-Core - 54%) from 44% at the end of 2010, predominantly reflecting the deterioration in the value of the commercial real estate development portfolio.
Impairment losses on securities - debt securities 1,381 50 2 1,433 40 41 81 98 503 601
The Group’s customer loan impairment charge as a percentage of loans and advances was 1.5% compared with 1.7% for 2010.
2011 2010 US UK Other (1) Total US UK Other (1) Total £m £m £m £m £m £m £m £m
Central and local government 20,848 13,436 25,552 59,836 22,244 8,377 32,865 63,486 Banks 376 1,391 11,408 13,175 704 4,297 11,981 16,982 Other financial institutions 17,453 3,100 11,199 31,752 15,973 1,662 11,513 29,148 Corporate 131 1,105 1,299 2,535 65 438 1,011 1,514 Total 38,808 19,032 49,458 107,298 38,986 14,774 57,370 111,130
Note: (1) Includes eurozone countries as detailed on pages 211 to 228.
Available-for-sale debt securities: gross unrealised losses The table below shows the fair value of available-for-sale debt securities that were in an unrealised loss position at 31 December and the related gross unrealised losses.
Central and local government - Other 2,878 65 778 106 3,656 171 Banks 3,924 49 5,676 789 9,600 838 Other financial institutions 472 41 6,504 2,345 6,976 2,386 Corporate 204 11 78 2 282 13 Total 7,478 166 13,036 3,242 20,514 3,408 2010 Central and local government - UK 716 10 — — 716 10 - US 74 1 163 1 237 2 - Other 4,328 6 1,738 612 6,066 618 Banks 1,655 16 6,202 770 7,857 786 Other financial institutions 2,993 73 6,972 2,553 9,965 2,626 Corporate 163 32 114 23 277 55 Total 9,929 138 15,189 3,959 25,118 4,097
Eurozone risks Europe was at the centre of rising global risks, owing to a combination of slower growth among some of its major economies and a further deepening of the ongoing sovereign crisis, which in turn harmed financial sector health. Risks in Greece rose as a deeper than expected contraction in GDP impacted the fiscal adjustment programme and hit debt sustainability. Negotiations on a voluntary restructuring of public debt held by the private sector commenced in the first half and a deal was eventually reached in February 2012, with more punitive write-offs for private investors than previously envisaged. This in turn led to an agreement by eurozone leaders on a further borrowing programme for the Greek government.
Despite the announcement of significant new support proposals by eurozone leaders in July 2011, investor worries over risks to their implementation rose and market conditions worsened markedly as a result. Risk aversion towards Spanish and Italian assets picked up and despite a policy response by both countries, yields remained elevated, prompting the ECB to intervene to support their bonds in secondary markets for the first time. Contagion affected bank stocks and asset prices.
Eurozone leaders responded by stepping up anti-crisis efforts, focusing largely on agreeing fiscal reform, bolstering bank capital and strengthening capacity to offer financing support to sovereigns losing market access. The ECB continued to buy sovereign debt in the secondary market and increased liquidity support to banks with the introduction of an emergency three-year long-term refinancing operation in December. This helped ease interbank funding tensions somewhat and may have contributed to some relief in sovereign debt markets late in the year, as yields on new issuance by Spain and Italy dropped.
In emerging Europe, Russia experienced some contagion into asset markets from weaker commodity prospects and a challenging investment climate, but the sovereign balance sheet remained quite robust. Foreign exchange debts remained a risk factor in a number of Eastern European economies. Elsewhere, Turkey’s economy cooled in the second half of 2011, helping to narrow the current account deficit sharply, though external vulnerabilities persisted.
The Middle East and North Africa witnessed political instability in a number of the relatively lower-income countries. The path of any transition has yet to become fully clear in most cases. Excluding Bahrain, pressures for change were more contained in the Gulf Co-Operation Council countries.
Outlook Overall, the outlook for 2012 remains challenging with risks likely to remain elevated but divergent. Much will depend on the success of EU efforts to contain contagion from the sovereign crisis (where downside risks are high) and whether growth headwinds in larger advanced economies persist. Emerging market balance sheet risks remain lower, despite ongoing structural and political constraints, but these economies will continue to be affected by events elsewhere through financial markets and trade channels.
Governance* All country exposures are covered by the Group's country risk framework. In this framework, a limited number of advanced countries are under riskbased monitoring, with all other countries placed under limit control using the Group’s country risk watchlist process either when these have been identified as exhibiting signs of stress, or when it is considered appropriate. Detailed portfolio reviews are undertaken to align country risk profiles to the Group’s country risk appetite in light of evolving economic and political developments.
Total and medium-term exposure limits are set for individual countries based on a risk assessment taking into account the country’s economic situation and outlook as well as the Group’s franchise and business mix in that country. Additional limitations (for example, on foreign-currency exposure and product types with higher potential for loss in case of country events) may be established to address specific vulnerabilities in the context of a country's outlook and/or the Group's business strategy in a particular country.
The situation remains very uncertain and the results of stress tests are sensitive to input assumptions. As a result, estimates of the potential impact on the Group of various developments are wide-ranging. If a single country exits the eurozone, the impact could be limited. If several do, the impact is likely to be significant. Depending on the circumstances, the generally negative effect on the Group of devaluations could be offset by the impact of revaluations. Nonetheless, the extent of market disruption is very difficult to predict and could be substantial.
From mid-2011, the Group intensified its risk-mitigating actions at divisional level aimed at preparing the Group for a wide variety of potential eurozone stress scenarios, with a particular focus on counterparty credit risk, settlement risk and funding risk. It also carried out a detailed assessment of the potential impact of such scenarios on Group systems to ensure broad readiness.
In a few specific cases, management of the Group’s exposure was temporarily handed over to a cross-divisional country crisis team. Risk mitigation actions typically included taking guarantees or insurance, updating collateral agreements, credit documentation reviews and specified credit referral processes.
The Group’s regular, comprehensive and detailed country exposure reviews were further enhanced by intensified counterparty monitoring. Refer to pages 147 to 149 for discussion on banks, financial institutions and other sectors.
All of this, in combination with customers’ own efforts to reduce their debt levels, contributed to reductions in exposure to a range of countries including the vulnerable eurozone countries, Japan and countries in political transition in North Africa and the Middle East. Exposure reductions were implemented selectively, often retaining some credit lines for strategic clients and in cases of sufficient risk mitigation. Due to their nature, medium-term exposures cannot be adjusted as rapidly as short-term exposure.
Internal rating systems were also further developed, contributing to more accurate calculations of country-specific default probabilities and expected loss given default rates which are determinants in the calculation of risk-weighted assets and economic capital.
Other developments in country risk management in 2011 included the development of the regional and country risk view in the Group’s economic capital model and in integrated stress testing.
The terms of the Group’s CDS contracts are covered by standard ISDA documentation, which determines if a contract is triggered due to a credit event. Such events may include bankruptcy or restructuring of the reference entity or a failure of the reference entity to repay its debt or interest. Under the terms of a CDS contract, one of the regional ISDA Credit Derivatives Determinations Committees is empowered to decide whether or not a credit event has occurred.
Derivatives comprise the mark-to-market (mtm) value of such contracts after the effect of enforceable netting agreements, but gross of collateral. Reverse repurchase agreements (repos) comprise the mtm value of counterparty exposure arising from repo transactions net of collateral.
Contingent liabilities and commitments comprise contingent liabilities, including guarantees and committed undrawn facilities.
The column CDS notional less fair value represents the notional less fair value amounts arising from sold positions netted against those arising from bought positions, and represents the net change in exposure for a given reference entity should the CDS contract be triggered by a credit event, assuming there is a zero recovery rate. However, in most cases, the Group expects the recovery rate to be greater than zero and the exposure change to be less than this amount.
The Group used CDS contracts throughout 2011 to manage both eurozone country and counterparty exposures. As shown in the individual country tables, this resulted in increases in both gross notional bought and sold eurozone CDS contracts, mainly on Italy, France and the Netherlands. The magnitude of the fair value of bought and sold CDS contracts increased over 2011 in line with the widening of eurozone CDS spreads.
‘Other eurozone’ comprises Austria, Cyprus, Estonia, Finland, Malta, Slovakia and Slovenia.
Exposure to most countries shown in the table declined over 2011 as the Group maintained a cautious stance and many bank clients reduced debt levels. Decreases were seen in balance sheet and offbalance sheet exposures in many countries. Increases in derivatives and repos were in line with the Group’s strategy, driven partly by customer demand for hedging solutions and partly by market movements; risks are generally mitigated by active collateralisation.
China - lending to Chinese banks increased in the first three quarters of the year, supporting trade finance activities and on-shore regulatory needs, but by the end of 2011 exposure had decreased close to December 2010 levels. The Group reduced lending in the interbank money markets over the final quarter. This reduction in lending was offset by significant growth in repo trading with Chinese financial institutions helping to support the Group’s funding requirements, with highly liquid US Treasuries being the main underlying security. A reduction in off-balance sheet exposures, including guarantees and undrawn commitments, was in part due to the run-off of performance bonds in respect of shipping deliveries and also due to reduced appetite for trade finance assets.
South Korea - exposure decreased by £1.6 billion during 2011. This was partly due to a reduction in debt securities as the Group managed its wrong-way risk exposure. The Group maintained a cautious stance given the current global economic downturn.
Eurozone periphery (Ireland, Spain, Italy, Greece and Portugal) - exposure decreased across most of the periphery, with derivatives (gross of collateral) and repos being the only component that still saw some increases (partly an effect of market movements on existing positions). Most of the Group’s country risk exposure to the eurozone periphery countries arises from the activities of GBM and Ulster Bank (with respect to Ireland). The Group has some large holdings of Spanish bank and financial institution mortgage-backed security bonds and smaller quantities of Italian bonds and Greek sovereign debt. GTS provides trade finance facilities to clients across Europe including the eurozone periphery.
Banks 1,586 300 2 — — — — — 1,588 300 Other financial institutions 1,325 232 161 1 129 7 — — 1,615 240 Total 2,911 532 163 1 129 7 — — 3,203 540
Key points* The Group’s exposure to Ireland is driven by Ulster Bank Group (87% of the Group’s Irish exposure at 31 December 2011). The portfolio is predominantly personal lending of £18.9 billion (largely mortgages) and corporate lending of £19.0 billion (largely loans to the property sector). In addition, the Group has lending and derivatives exposure to the Central Bank of Ireland, financial institutions and large international clients with funding units based in Ireland.
Ireland Non-Core lending exposure was £10.2 billion at 31 December 2011, down by £0.6 billion or 6% since 31 December 2010. The remaining lending portfolio largely consists of exposures to real estate (79%), retail (7%) and leisure (4%).
Balance sheet exposures Bought Sold Bought Sold 2011 £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Banks 6,595 499 68 5 32 4 — — 6,695 508 Other financial institutions 7,238 736 162 3 269 50 — — 7,669 789 Total 13,833 1,235 230 8 301 54 — — 14,364 1,297
The Group maintains strong relationships with Spanish government entities, banks, other financial institutions and large corporate clients. The exposure to Spain is driven by corporate lending and a large MBS covered bond portfolio.
Exposure fell in most categories in 2011, particularly in corporate lending, as a result of steps to de-risk the portfolio.
Exposure to corporate clients declined during 2011, with reductions in lending of £1.2 billion and in off-balance sheet items of £0.4 billion, driven by reductions in exposure to property, transport and technology, media and telecommunications sectors. The majority of REIL relates to commercial real estate lending and decreased over the year, reflecting disposals and restructurings.
Key points* The Group maintains strong relationships with Italian government entities, banks, other financial institutions and large corporate clients. Since the start of 2011, the Group has taken steps to reduce its risks through strategic exits where appropriate, or to mitigate these risks through increased collateral requirements, in line with its evolving appetite for Italian risk. As a result, the Group reduced lending exposure to Italian counterparties by £0.6 billion over 2011 to £3.1 billion.
The Group is an active market-maker in Italian government bonds, resulting in large gross long and short positions in held-for-trading securities. Given this role, the Group left itself in a relatively modest long position at 31 December 2011 to avoid being temporarily over exposed as a result of its expected participation in the purchase of new government bonds being issued in January 2012.
Financial institutions The majority of the Group’s exposure to Italian financial institutions relates to the top five banks. The Group’s product offering consists largely of collateralised trading products and, to a lesser extent, short-term uncommitted lending lines for liquidity purposes.
Lending exposure fell slightly during 2011, with reductions in lending to the property industry offset by increased lending to manufacturing companies, particularly in the fourth quarter.
Non-Core lending exposure was £1.2 billion at 31 December 2011, a £0.7 billion (39%) reduction since 31 December 2010. The remaining lending exposure comprises mainly commercial real estate finance (22%), leisure (20%), unleveraged funds (16%), electricity (15%) and industrials (10%).
Corporate At the start of 2011, the Group reclassified the domicile of exposures to a number of defaulted clients, resulting in an increase in reported exposure to Greek corporate clients as well as increases in REIL and impairment provisions.
The Group’s focus is now on short-term trade facilities to the domestic subsidiaries of international clients, increasingly supported by parental guarantees.
The Non-Core division’s lending exposure to Greece was £0.1 billion at 31 December 2011, a reduction of 28% since 31 December 2010. The remaining lending portfolio primarily consists of the following sectors: financial intermediaries (33%), construction (20%), other services (16%) and electricity (14%).
During 2011, the Group’s exposure to the Portuguese government was reduced to a very small derivatives position, the result of decreases in contingent and lending exposures to public sector entities by way of facility maturities. The Group’s exposure to the government was negative at 31 December 2011, reflecting net short held-for-trading debt securities.
Non-Core (included above) Refer to tables on pages 211 and 212 for details.
The Non-Core division’s lending exposure to Portugal was £0.3 billion at 31 December 2011, an increase of 8% in the portfolio since 31 December 2010, due to an infrastructure project drawing committed facilities. The portfolio comprises lending exposure to the land transport and logistics (52%), electricity (30%) and commercial real estate (14%) sectors. There is no exposure to central or local government.
Banks 14,644 171 163 4 8 — — — 14,815 175 Other financial institutions 16,315 357 18 — 334 6 — — 16,667 363 Total 30,959 528 181 4 342 6 — — 31,482 538
Banks 13,353 453 162 13 79 8 — — 13,594 474 Other financial institutions 19,641 758 24 1 254 22 — — 19,919 781 Total 32,994 1,211 186 14 333 30 — — 33,513 1,255
Other banks 101 — — 10 — 7 — 17 546 664 — — — — Other financial institutions 1,779 — — 54 (7) 82 80 56 2,963 4,798 2,080 1,976 118 (108)
Central and local government 124 — — 324 (25) 268 283 309 697 1,130 1,975 2,190 (26) 34 Central banks 1 — — — — — — — 1 2 — — — — Other banks 142 — — 71 (1) 52 44 79 564 785 148 142 1 — Other financial institutions 119 — — 4 — — 5 (1) 29 147 — — — — Corporate 1,505 238 67 133 (1) 30 15 148 79 1,732 3,254 2,966 (63) 51 Personal 24 — — — — — — — — 24 — — — — 1,915 238 67 532 (27) 350 347 535 1,370 3,820 5,377 5,298 (88) 85
Banks 2,877 58 50 1 — — — — 2,927 59 Other financial institutions 3,464 67 4 — 30 — — — 3,498 67 Total 6,341 125 54 1 30 — — — 6,425 126
Note: (1) Comprises Austria, Cyprus, Estonia, Finland, Malta, Slovakia and Slovenia.
Due to credit risk and capital considerations, the Group increased exposure to central banks (particularly in Germany and the Netherlands) by depositing with them higher levels of surplus liquidity on a short-term basis, given the limited alternative investment opportunities.
During 2011, in anticipation of widening credit spreads and for reasons of general risk management, the Group reduced its holdings in French and Dutch AFS sovereign bonds. The Group concurrently increased its holdings of German AFS sovereign debt in line with internal liquidity and risk management strategies.
Non-Core Refer to tables on pages 211 and 212 for details.
Governance Business structure The primary focus of the Group’s trading activities is to provide an extensive range of debt and equity financing, risk management and investment services to its customers, including major corporations and financial institutions around the world. The Group undertakes these activities organised within the principal business lines: money markets, rates flow trading, currencies and commodities, equities, credit markets and portfolio management and origination.
Financial instruments held in the Group’s trading portfolios include, but are not limited to: debt securities, loans, deposits, equities, securities sale and repurchase agreements and derivative financial instruments.
Risk management Key principles The Group’s qualitative market risk appetite is set out in policy statements, which outline the governance, responsibilities and requirements surrounding the identification, measurement, analysis, management and communication of market risk arising from the trading and non-trading investment activities of the Group. All teams involved in the management and control of market risk are required to fully comply with the policy statements to ensure the Group is not exposed to market risk beyond the qualitative and quantitative risk appetite. The control framework covers the following principles: Clearly defined responsibilities and authorities for the primary groups involved in market risk management in the Group; An independent market risk management process; A market risk measurement methodology that captures correlation effects and allows aggregation of market risk across risk types, markets and business lines; Daily monitoring, analysis and reporting of market risk exposures against market risk limits; Clearly defined limit structure and escalation process in the event of a market risk limit excess; Use of VaR as a measure of the one-day market risk exposure of all trading positions; Use of non-VaR based limits and other controls; Use of stress testing and scenario analysis to support the market risk measurement and risk management process by assessing how portfolios and global business lines perform under extreme market conditions; Use of back-testing as a diagnostic tool to assess the accuracy of the VaR model and other risk management techniques; Adherence to the risks not in VaR (RNIV) framework to identify and quantify risks not captured within the VaR model; and
At the Group level, the risk appetite is expressed in the form of a combination of VaR, sensitivity and stress testing limits.
The FSA categorises a VaR model as green, amber or red. A green model status is consistent with a good working model and is achieved for models that have four or fewer back-testing exceptions in a 12-month period. For the Group’s trading book, a green model status was maintained throughout 2011.
The Group’s VaR should be interpreted in light of the limitations of the methodology used, as follows: Historical simulation VaR may not provide the best estimate of future market movements. It can only provide a prediction of the future based on events that occurred in the two-year time series. Therefore, events that are more severe than those in the historical data series cannot be predicted.
These limitations mean that the Group cannot guarantee that losses will not exceed the VaR.
The RNIV framework has been developed to quantify those market risks not adequately captured by the market standard VaR methodology. Where risks are not included in the model, various non-VaR controls (for example, portfolio size limits, sensitivity limits, triggers or stress limits) are in place.
Risk models are developed both within business units and by Group functions. Risk models are also subject to independent review and signoff to the same standard as pricing models. Meetings are held with the FSA every quarter to discuss the traded market risk, including changes in models, management, back-testing results, risks not included in the VaR framework and other model performance statistics.
Basel 2.5 (CRD III)* The aim of CRD III is to improve the financial strength of institutions by increasing the financial resources required against certain risks in the trading book.
The Group is required to calculate: (i) an additional capital charge based on a stressed calibration of the VaR model - stressed VaR; (ii) an incremental risk charge to capture the default and migration risk for credit risk positions in the trading book; and (iii) an all price risk measure for correlation trading positions, subject to a capital floor that is based on standardised securitisation charges.
The capital charges associated with these new models at 31 December 2011 are shown in the table below: Total £m
All other aspects of the CRD III rule changes have also been implemented.
In 2011, updated Group Standards for the development, testing and validation of derivative pricing models were agreed and implemented. Revisions to the model validation framework ensure that all new models and model changes are reviewed by Market Risk and Finance and, subject to materiality, independently validated by GRA. Model governance is through the ALMPRCs, which are newly established subcommittees of the overall GBM Modelled Product Review Committee (previously called the Group Model Product Review Committee).
Stress testing The Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from extreme market events. Stress testing measures the impact of exceptional changes in market rates and prices on the fair value of the Group’s trading portfolios. The Group calculates sensitivity analysis, historical stress tests and bottom-up stress testing.
Bottom-up stress testing is based on analysing the market risk exposures by risk factors and stressing each risk factor based on consultation with risk managers, economists and front office. The tests may be based on an economic scenario that is translated into risk factor shocks by an economist or by risk managers and front office as a means of assessing the vulnerabilities of their book.
GBM trading revenue was adversely affected by ongoing concerns around the European sovereign crisis and an overall uncertain macroeconomic environment. High volatility in the markets and increasingly risk-averse sentiment reduced levels of trading activity.
The average daily revenue earned by GBM’s trading activities in 2011 was £19 million, compared with £25 million in 2010. The standard deviation of the daily revenues for 2011 was £21 million, down from £22 million in 2010. The standard deviation measures the variation of daily revenues about the mean value of those revenues.
The number of days with negative revenue increased from 22 days in 2010 to 42 days in 2011, primarily due to the market and economic conditions referred to above.
Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 £m
Trading VaR The Group has disclosed separately the Counterparty Exposure Management (CEM) trading book exposure and the exposure of Core excluding CEM. The CEM desk manages the counterparty risk associated with over-the-counter derivatives on behalf of GBM. This risk is centrally controlled and actively managed to reduce excessive concentrations and unwanted counterparty exposures. The hedge positions are reported in the trading books and, thus, included in market risk VaR calculations for the Group, whereas the market value of the counterparty credit risk does not contribute to VaR for regulatory capital. The CEM VaR is disclosed separately, to allow a clear representation of the risk exposure of the trading book including and excluding these hedge activities.
Trading VaR Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m
Key points The Group’s market risk profile in 2010 was equally split across Non-Core and Core divisions, with a concentrated exposure to credit spread risk factors. The credit spread risk exposure significantly decreased in 2011, primarily due to the reduction in ABS trading inventory in Core and the restructuring of some monoline hedges for banking book exposures in Non-Core, in line with the overall business strategy to reduce risk exposures.
Overall the average interest rate trading VaR was relatively unchanged between 2011 and 2010.
Risk management: Market risk continued Non-trading portfolios The table below analyses the risk for the Group’s non-trading portfolios.
In order to better represent the risk of the non-traded portfolios, the table below analyses the VaR for the non-trading portfolios but excludes the
Non-trading VaR Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m
Interest rate 8.8 9.9 11.1 5.7 8.7 10.4 20.5 4.4 13.0 13.9 26.3 7.7 Credit spread 18.2 13.6 39.3 12.1 32.0 16.1 101.2 15.4 81.7 100.3 131.5 39.7 Currency 2.1 4.0 5.9 0.1 2.1 3.0 7.6 0.3 1.4 0.6 7.0 0.2 Equity 2.1 1.9 3.1 1.6 1.2 3.1 4.6 0.2 3.3 2.2 5.8 1.6 Diversification (1) (13.6) (15.9) (20.4)
Note: (1) Mortgage-backed securities (MBS) include sub-prime residential mortgage-backed securities (RMBS) with a drawn notional amount of £401 million (31 December 2010 - £471 million) and a fair value of £252 million (31 December 2010 - £329 million), all with residual maturities of greater than 10 years.
The structured credit portfolio is within Non-Core. The risk on this portfolio is not measured or disclosed using VaR, as the Group believes this is not an appropriate tool for the banking book portfolio, which comprises illiquid debt securities. These assets are reported on a drawn notional and fair value basis, and managed on a third party asset and RWA basis.
Key Points The increase in total and collateralised debt obligation (CDO) drawn notional year-on-year is due to the inclusion of banking book exposures that were previously hedged by monoline protection. As a result of the restructuring of some monoline protection, those previously protected assets are now reported on a drawn notional and fair value basis.
Governance and culture RBS Insurance has developed a robust governance structure to control the way it manages insurance risk. This structure includes various forums and committees with associated delegated authorities for the management of insurance risk.
Control and management The internal economic capital model is rigorously controlled, with robust validation processes applied to the inputs, the model and all outputs to ensure that such data may be used confidently by the business in its decision-making processes.
Monitoring and reporting A clear framework is in place for the monitoring and reporting of insurance risk within RBS Insurance, with well-defined processes and procedures for the escalation and management of risks and issues.
In addition, comprehensive reporting of pricing strength occurs on a monthly basis. Significant enhancements have also been made in the reporting and monitoring of claims management and reserving. Further enhancements are underway, including the launch of a risk management system in late 2011.
Operational risk* Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. It is an integral and unavoidable part of the Group’s business as it is inherent in the processes it operates to provide services to customers and meet strategic objectives.
Operational risk management The objective of operational risk management is not to remove operational risk altogether, but to manage it to an acceptable level, taking into account the cost of minimising the risk against the resultant reduction in exposure. Strategies to manage operational risk include avoidance, transfer, acceptance and mitigation by controls.
To ensure the Group operates within the set risk appetite, the high-level statements are supplemented by specific tolerances for different types of operational risk. The GPF sets out how to manage risk within acceptable limits, which in turn enables the Group to operate within the overall risk appetite and the specific tolerances. The Group has a zero tolerance for risks such as breaches of laws and regulations.
Group new product approval process The Group’s new product approval process ensures there is a consistent process to identify, assess and approve the risks associated with new products.
Following the conclusion of reviews conducted during 2011, enhancements will be made during 2012 to the product governance forums, to provide earlier engagement between the business, Group and divisional risk teams and subject matter experts when assessing whether the risks associated with new products are in line with appetite. The forums will be supported by an upgrade to the Group’s key tools used to manage and report on new product approval.
Scenario analysis Scenario analysis is used to assess the possible impact of extreme but plausible operational risk loss events. It provides a forward-looking basis for managing exposures beyond the Group's risk appetite. The methodology provides a structured and consistent approach to scenario scoping and measurement. A significant portfolio of scenarios was developed in 2011 across divisions, covering material risks to which the Group is exposed. Group-wide scenarios are centrally scoped and workshops are facilitated by Group Operational Risk in conjunction with functions and policy owners, before being assessed by divisions to derive specific impact estimates. This also allows the Group to review operational risk impacts as they arise from macroeconomic stresses (e.g. eurozone distress) in a time-efficient and effective manner.
Stress testing During the economic downturn, there has been an increase in large operational risk losses within the banking industry.
Unexpected levels of operational risk losses, by stressing its existing portfolio of operational risk scenarios.
Management, monitoring and reporting Issues management The objective of the operational risk issues management framework is the adoption of a consistent approach to the identification, capture, classification, monitoring, closure and acceptance of operational risk issues and associated actions across the Group, in accordance with the Group’s three lines of defence model.
Significant enhancements were made to the issues management process during 2010 including rollout of a single repository for capturing issues and actions; mapping issues to GPF; and a tightening of governance over issue management. These improvements were further embedded during 2011, through training and assurance reviews.
During 2011, an enhanced EDLM process was launched to promote consistency in the management of operational risk events and the collection of loss data across the Group. It included the introduction of a single repository to capture all events and loss data in the Group and the establishment of thresholds above which operational risk events will trigger a risk assessment.
The improvements in approach, and use of a single Group-wide database, have enhanced the completeness and accuracy of the Group’s internal loss data, and therefore better inform the Group’s operational risk profile.
Reporting and monitoring Reporting and monitoring forms an integral part of all of the Group’s operational risk management processes, which are designed to ensure that risks and issues are identified, escalated and managed on a timely basis. Exposures for each division are reported through monthly risk and control reports, which provide detail on the risk exposures and action plans. Enhancements made to reporting and monitoring during the year include analysing operational risk events, losses and issues against the GPF components; this has led to better identification of areas requiring management focus and remediation.
The regulatory environment remained highly challenging during 2011, as policymakers and regulators continued to strengthen regulation and supervision in response to the events of 2007/2008 and subsequent economic and financial stress.
These trends have posed multiple challenges for banking groups, including RBS, namely: tracking, analysing and engaging with policymakers on proposed changes; implementing change programmes to ensure compliance with new requirements; revisiting strategy, business and operating models in response to the new environment; and driving through cultural and other changes to minimise compliance and enforcement risks.
Below is an outline of some of the key developments in the regulatory environment that took place during 2011. An explanation of how the Group manages compliance risk begins on page 242.
Risk management: Compliance risk* continued A progress report on the action plan was issued at the Cannes summit. Key developments during 2011 included the following: Basel III Following publication by the Basel Committee on Banking Supervision in December 2010 of rules for the new Basel III capital and liquidity framework, work during 2011 focused on finalising the remaining elements of policy and preparing for implementation. Highlights were: The issuance of minimum requirements regarding the loss absorbency of capital instruments at the point of non-viability (January 2011); The finalisation of rules for the capital treatment of counterparty credit risk in bilateral trades (June 2011); Technical changes to Basel III relating to the treatment of trade finance, aimed at helping promote trade with low-income countries (October 2011); Further work on the capitalisation of bank exposures to central counterparties (November 2011); and
A Basel Committee paper proposing that debit valuation adjustments for over-the-counter derivatives and securities financing transactions should be fully deducted from Common Equity Tier 1 capital (December 2011). The Group is evaluating the potential impact of this proposal.
Systemic financial institutions The main focus of policy development at the global level during 2011 was delivering on the G20-mandated target of agreeing a framework by the end of 2011 for dealing with global systemically important financial institutions (G-SIFIs). This target was met, with the Cannes summit endorsing: A new Financial Stability Board (FSB) international standard, “The Key Attributes of Effective Resolution Regimes for Financial Institutions”, which amongst other things provides a benchmark for national resolution regimes, as well as mandatory requirements for resolvability assessments and recovery and resolution plans for each G-SIFI; and
Shadow banking In response to concerns, that heightened regulation of banks should not lead to risks being displaced into unregulated sectors, regulatory authorities started to pay growing attention to the “shadow banking” system during 2011. This term broadly refers to entities and financial transactions that fall outside the scope of existing financial (banking) regulation, such as hedge funds, money market funds and structured investment vehicles.
EU regulatory developments The EU regulatory agenda in 2011 continued to focus mainly on prudential and market structure measures; retail issues also started receiving more attention and are likely to come under increased focus in 2012. Key highlights were as follows: New regulatory architecture 2011 saw the implementation of a new EU regulatory architecture, with the start of operations of the ESRB and three supervisory authorities: the European Banking Authority (EBA), the European Securities and Markets Authority, and the European Insurance and Occupational Pensions Authority.
The new framework marks a significant transfer of power to the three supervisory authorities, particularly with respect to detailed rule-making, where over time they will be issuing “binding technical standards” across a range of policy areas that will replace national rules.
However, an early preoccupation of the new regulatory authorities was the eurozone crisis. In particular, the EBA was heavily engaged in overseeing the stress testing of EU banks, including UK groups.
Prudential and related reforms A key focus during 2011 was work on amending the EU’s Capital Requirements Directive (CRD): a key step in that process was the publication of draft legislative text in September 2011, the CRD IV package, which is expected to be finalised during 2012 and will implement Basel III in the EU.
Financial Transaction Tax (FTT) - the EU Commission published proposals for an FTT, which would see trades in bonds and shares taxed at 0.1% and complex derivatives taxed at 0.01%. However, the proposal requires approval from all 27 EU members, but is opposed by some, including notably the UK, which reduces the likelihood of it being imposed.
Other initiatives - these have included changes to the market abuse regime and prospectus requirements, initiatives on short-selling, further legislative developments impacting credit rating agencies and changes to depositor and investor protection.
EU retail market reforms Notwithstanding the focus on prudential and market reforms in response to the financial crisis, the EU Commission during 2011 also continued to work on a wide range of retail agenda initiatives. These included a draft legislative proposal for a mortgage credit directive, with a focus on responsible lending and borrowing; the development of proposals on collective redress; and ongoing discussions with the banking industry to improve the transparency and comparability of bank fees. The Group also continued to work on implementing the requirements coming into force at the end of 2011, contained in the EU Payment Services Directive.
UK regulatory developments UK regulatory developments during 2011 continued to be extensively determined by global and EU developments, with UK regulators working to implement requirements coming into force, such as the CRD III package of reforms, and actively participating in policy development at the EU and global levels. In addition, there were a number of developments specific to the UK.
Independent Commission on Banking (ICB) The ICB was appointed by the UK Government in June 2010 to review possible structural measures to reform the UK banking system in order to promote, amongst other things, stability and competition. It published its final report to the Cabinet Committee on Banking Reform on 12 September 2011 (the ‘Final Report’), which set out the ICB’s views on possible reforms to improve stability and competition in UK banking.
On 19 December 2011, the UK Government published its response to the Final Report and indicated its support and intention to implement the recommendations set out in the Final Report substantially as proposed. The Government indicated that it would work towards putting in place the necessary legislation by May 2015, requiring compliance as soon as practicable thereafter and a final deadline for full implementation of 2019.
Regulatory architecture reforms Work on the UK coalition government’s plans for reforming the UK’s regulatory structure continued during 2011, with major consultations from HM Treasury, a number of calls for evidence from parliamentary committees and the publication of a draft Bill for pre-legislative scrutiny purposes in June 2011. In addition, the FSA and Bank of England published policy documents setting out initial high-level policy thinking on the new regulatory bodies; and an interim version of the Financial Policy Committee started to meet in advance of legislation being enacted. However, the timescale for completing the legislative process and fully implementing the new framework has been delayed until 2013 (from the end of 2012).
Risk management: Compliance risk* continued Payment Protection Insurance (PPI) The Judicial Review requested by the British Bankers’ Association (BBA) in respect of the FSA’s policy statement on PPI complaints and guidance published by the Financial Ombudsman Service concluded in April 2011 with an adverse ruling. The BBA and the banks concerned decided not to appeal and the UK banks including the Group have moved towards settling claims in accordance with the FSA’s revised principles. Under the terms of a waiver granted by the FSA, the Group, along with the rest of the industry, has had to deal with the backlog of complaints within specified timescales.
Compliance risk management The Group manages its compliance risk through a regulatory affairs and compliance framework that seeks to ensure it complies with all banking, securities, insurance and anti-money laundering regulations, defined by over 120 different regulatory bodies and central banks, wherever the Group operates. This framework is managed by the Group’s Regulatory Affairs and Compliance functions and includes: the tracking and management of regulatory developments; regulatory relationship management; the implementation of global compliance risk policies; assurance and monitoring; training and awareness; and mitigation activity.
Management of regulatory change The early identification and effective management of changes in legislative, regulatory and other requirements that may impact the Group is critical to the successful mitigation of compliance risk.
Increased communications, such as the development of a fortnightly Regulatory Affairs Flash Report, circulated widely across the Group, which captures key regulatory developments and relationship topics.
Quarterly reporting to the Group Audit Committee captures all material regulatory reviews and investigations and upstream regulatory developments worldwide, as well as tracking the status and trends in key regulatory relationships.
Global compliance risk and compliance policies Within the Group Policy Framework, compliance risk and compliance policies define minimum standards to which all businesses must adhere. The policies are primarily driven by the rules and regulations set by the FSA, the Group’s lead regulator. However, these global minimum standards are supplemented, where appropriate, by divisional policies to meet local product or market requirements.
In compliance risk management, the term ‘conduct risk’ is used to refer to the risk of breaches of: (a) regulation or law; or (b) regulatory expectation. This is distinguished from ‘prudential risk’, i.e. compliance risks related to capital management, liquidity, credit risk, operational risk and market risk. A significantly enhanced compliance/conduct policy structure was outlined during 2011. It is aligned to a new Conduct Risk Appetite statement as well as the expected direction of the new Financial Conduct Authority, which will be one of the successors of the FSA. As a result, in future, it will be possible to assess the pan-Group risk profile for conduct risk against its risk appetite. In addition, it will be possible to provide more detailed policy direction to divisions on key areas of conduct risk.
During 2011, a ‘heatmap’ of the key inherent conduct risks across all the Group’s global businesses, reflecting both internal and external change and divisional priorities, was developed. This, in turn, drove a comprehensive programme of assurance reviews across the Group. These reviews introduced a global, end-to-end thematic approach, looking at customer outcomes as well as process adherence. In addition to immediate issues, for which action plans were developed, the reviews identified a number of wider themes that required a more strategic approach.
Risk management: Compliance risk* continued Anti-Money Laundering During 2011, RBS continued to enhance its Anti Money Laundering (AML) Change Programme across the Group. Key developments include: A new cohesive target operating model to support the capability required and reviewed divisional AML capabilities against the target operating model to identify and analyse gaps; A framework for understanding and managing compliance and conduct risk, including the introduction of a clear Group-level conduct risk appetite statement and the design of a new conduct risk policy framework; and
Reputational risk* Reputational risk is the risk of brand damage arising from financial and non-financial events due to a failure to meet stakeholders’ expectations of the Group’s performance and behaviour.
Such loss in reputation has the potential to put the entire business at risk. It could also lead to negative publicity, loss of revenue, costly litigation or a decline in the customer base.
The Board has ultimate responsibility for managing any impact on the reputation of the Group arising from its operations. The Group Sustainability Committee (established at the beginning of 2010) sets the overall strategy and approach for the management of Group sustainability. However, all parts of the Group take responsibility for reputation management.
Business risk* Business risk is the potential risk of revenues being lower than expected and/or operating costs being higher than expected. It is influenced by a variety of factors, including pricing, sales volumes, input costs, regulations and the prevailing market and economic environment.
The Group seeks to minimise its exposure to business risk, subject to its wider strategic objectives (e.g. return on equity). As a large financial services group, it recognises and values the potential diversification benefits associated with differences in the nature and timing of potential business risk across its portfolio of businesses.
Business risk is identified, measured and managed through the Group’s bi-annual strategic planning cycles. Expected profiles for revenues and costs are determined, on a bottom-up basis, through strategic plans and expectations of the external environment. These profiles are tested against a range of stress scenarios and factors to identify the key risk drivers behind any potential volatility, along with management actions to address and manage them.
The Group Board has ultimate responsibility for the impact of any volatility in revenues and costs on the Group’s performance. Business risk is incorporated within the Group’s risk appetite target for earnings volatility, with an assessment of volatility in revenues and costs a key component in determining whether the Group and its underlying businesses are within risk appetite.
The management of business risk lies primarily with divisional and business unit strategic teams, with oversight at the Group level from the Finance, Strategy and Risk functions. Elements of business risk (e.g. regulatory changes) also overlap with other areas and are managed by the appropriate risk functions.
Pension risk* The Group is exposed to risk from its defined benefit pension schemes to the extent that the assets of the schemes do not fully match the timing and amount of the schemes’ liabilities. Pension scheme liabilities vary with changes to long-term interest rates, inflation, pensionable salaries and the longevity of scheme members as well as changes in legislation. The Group is exposed to the risk that the market value of the schemes’ assets, together with future returns and any additional future contributions could be considered insufficient to meet the liabilities as they fall due. In such circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes.
The RBS Group Pension Fund (‘Main scheme’) is the largest of the schemes and the main source of pension risk. The Main scheme operates under a trust deed under which the corporate trustee, RBS Pension Trustees Limited, is a wholly owned subsidiary of The Royal Bank of Scotland plc and the trustee board comprises six directors selected by the Group and four directors nominated by members.
Risk management framework From a sponsor perspective, the Group manages this risk using a framework that encompasses risk reporting and monitoring, stress testing, modelling and an associated governance structure that helps ensure the Group is able to fulfil its obligation to support the defined benefit pension schemes to which it has exposure.
Improvements in 2011 and next steps As part of the continuing development of the pension risk management framework within RBS Group, key achievements in 2011 focused on improved stress testing and risk governance mechanisms. The framework will continue to be developed in 2012 with improvements in risk reporting and monitoring, modelling and stress testing capability along with the embedding of the pension risk governance structure implemented in 2011.
Main scheme The most recent funding valuation, at 31 March 2010, was agreed during 2011. It showed that the value of liabilities exceeded the value of assets by £3.5 billion at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the Group has agreed to pay additional contributions each year over the period 2011 to 2018. These contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. Further details are given in Note 4 of the consolidated accounts.
The Group has the right to terminate the Scheme at any time provided that the Financial Services Authority has confirmed in writing to HM Treasury that it has no objection. On termination, the Group is liable to pay HM Treasury a termination fee, which comprises the difference between £2.5 billion (or, if higher, a sum related to the economic benefit of regulatory capital relief obtained from the APS) and the aggregate fees paid. In addition, the Group would have to repay any amounts received from HM Treasury under the terms of the APS. The Group has paid APS premiums totalling £2,225 million (2011 - £125 million; 2010 - £700 million; 2009 - £1,400 million). From 31 December 2011 premiums of £125 million are payable quarterly until the earlier of 2099 and the date the Group leaves the Scheme.
Non-contractual early repayments (8.9) Maturities and amortisation (26.1) Rollovers and covered amount cap adjustments (1.7) Currency translation and other adjustments (11.8)
Maturities, amortisation and early repayments (28.7) Reclassified assets 3.1 Withdrawals (2.9) Currency translation and other adjustments 2.4 At 31 December 2010 194.7 Disposals (5.3) Maturities, amortisation and early repayments (42.4) Withdrawals (12.4) Currency translation and other adjustments (2.8)
The Group withdrew £12.4 billion of covered assets with a lower than average risk profile from the Scheme.
Credit impairments and write-downs The table below analyses the credit impairment provision (adjusted for write-downs) and adjustments to par value (including available-for-sale reserves) relating to covered assets.
Key points The increase in Non-Core impairments of £1.5 billion accounted for the majority of the increase in credit impairments and write-downs in 2011.
The increase in Core is largely accounted for by impairments offset by asset withdrawals.
First loss utilisation The Group has agreed with HM Treasury modifications to the Scheme rules, which affect most APS portfolios in Global Banking & Markets and an APS portfolio in UK Corporate that relates to larger clients. All other APS portfolios in the Group are unaffected. The overall economic aspects of the Scheme are unchanged, including value and term of cover, credit derivative valuation and capital effects.
The modified rules for recognition of triggered assets align more closely to the Group’s normal accounting and risk management procedures and will reduce the administrative burden of operating the Scheme. For the portfolios subject to these changes, the calculation of loss now takes into account expected recoveries in addition to those already received. This has resulted in a reduction in first loss utilisation. A comparison of losses arising under the original Scheme rules with those arising under the modified Scheme rules is set out below. This covers the period from the Scheme inception to 31 March 2011 (the last point at which the original rules applied for the affected assets).
Net triggered total £m £m £m £m £m £m £m £m
Key points The cumulative first loss is £32.2 billion however, the Group does not expect to claim under the Scheme, which has a first loss of £60 billion.
Risk-weighted assets The table below analyses risk-weighted assets (RWAs) covered by the APS. 2011 2010 2009 £bn £bn £bn
251 Letter from the Chairman 252 Our governance structure 253 Our Board 257 Executive Committee 258 Corporate governance 263 Report of the Group Audit Committee 268 Report of the Board Risk Committee 272 Directors’ remuneration report 294 Other remuneration disclosure 296 Compliance report 298 Report of the directors 303 Directors’ interests in shares 304 Statement of directors’ responsibilities
I am pleased to present our Corporate governance report for the 2011 financial year.
Further details on the role and principal activities of the Board are contained within the Corporate governance report on pages 252 to 295. Individual reports from the Group Audit Committee, Board Risk Committee and Group Remuneration Committee are also included.
Corporate governance in RBS The Group is working hard to achieve a very challenging and complex turnaround and good corporate governance is a key element of supporting delivery of our strategy and underpinning cultural change across the Group.
In May 2011, the Board introduced a new Corporate Governance Policy to demonstrate that we are committed to the highest standards of governance, integrity and professionalism throughout the Group. The policy comprises ten principles and related guidance that apply across the Group in all divisions and jurisdictions. The principles cover areas such as decision making, individual and collective responsibility, identifying and managing risks, risk and reward and escalation and transparency. We want to ensure we have the right structures and systems in place so that sound business decisions are made and it is important to us that we demonstrate high standards of governance in all of our activities. A clear corporate governance policy is helping us achieve this and we will be monitoring compliance with the policy on a continuing basis.
Our statement of compliance with the UK Corporate Governance Code issued by the Financial Reporting Council in May 2010 (the “Code”) is set out on page 296.
The Board During 2011, we were pleased to welcome three new independent nonexecutive directors to the Board: Alison Davis, Tony Di Iorio and Baroness Noakes. They have brought with them a wealth of relevant and diverse experience in both the public and private sectors, along with a strong global perspective and have made a significant contribution to the work of the Board since joining. Their appointments have also strengthened the membership of a number of Board committees with Alison Davis joining the Group Remuneration Committee, Tony Di Iorio joining the Group Audit Committee and Board Risk Committee, and Baroness Noakes joining the Group Audit Committee. In addition to our new Board members, Colin Buchan retired as a director in August 2011 following nine years on the Board and John McFarlane will step down from the Board on 31 March 2012. We have greatly appreciated the experience, commitment and knowledge they brought to the Board and Committees.
Leadership and Board effectiveness As Chairman, I am responsible for ensuring we have an effective Board and for leading the Board. I am supported by the Group Nominations Committee in reviewing Board composition and the recruitment of new directors and by the Group Secretary on induction, continuing professional development, Board process and evaluation.
A key part of my role in leading the Board is to ensure that directors develop a good understanding of the Group’s business so that the Board is able to provide input to help shape future strategy. This is achieved through site visits, in-depth board presentations and, for new directors, their induction programme. I believe it is important to encourage a culture and environment in the boardroom that facilitates debate and where nonexecutive directors are able to provide constructive challenge to the executive team.
I would like to thank both the executive and non-executive directors for their outstanding commitment and their contributions to the Board and Committees in 2011. This year is shaping up to be another challenging year for the Group and the Board but I am confident that we are on track to restore the performance of the Group in all material aspects.
Group Audit Committee assists the Group Board in discharging its responsibilities for the disclosure of the financial affairs of the Group. It reviews the accounting policies, financial reporting and regulatory compliance practices of the Group and the Group’s system and standards of internal controls, and monitors the Group’s processes for internal audit and external audit.
Board Risk Committee provides oversight and advice to the Group Board on current and potential future risk exposures of the Group and risk strategy. It reviews the Group’s performance on risk appetite and oversees the operation of the Group Policy Framework.
Group Remuneration Committee has oversight of the Group’s policy on remuneration. It also considers senior executive remuneration and makes recommendations to the Group Board on remuneration of executive directors.
Group Sustainability Committee is responsible for reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues.
Philip Hampton (age 58) Date of appointment: appointed to the Board on 19 January 2009 and to the position of Chairman on 3 February 2009
Former director of First Data Corporation and chair of the board of LECG Corporation. She previously worked at McKinsey & Company, AT Kearney, as chief financial officer at Barclays Global Investors (now BlackRock) and managing partner of Belvedere Capital, a private equity firm focused on buy-outs in the financial services sector.
Tony Di Iorio (age 68) Date of appointment: 1 September 2011
External appointments Senior independent director of Cable & Wireless Worldwide plc Non-executive director of Wm Morrison Supermarkets plc Trustee of the British Museum
Held a number of senior executive positions with J.P. Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region. Previously held non-executive roles at The Morgan Crucible Company plc and Brit Insurance Holdings plc. He is a fellow of the Institute of Chartered Accountants.
External appointments Trustee of MacMillan Cancer Support Chairman of Prytania Holdings LLP
Former chief executive officer of Australia and New Zealand Banking Group Limited. Previously he was a group executive director of Standard Chartered and head of Citicorp/Citibank in the UK and Ireland. Former president of the International Monetary Conference and a former chairman of the Australian Bankers Association and has previously served as a director of the London Stock Exchange and a member of the Auditing Practices Board.
External appointments Non-executive director of Westfield Holdings Limited Deputy chairman and chairman designate of Aviva plc
External appointments Non-executive director and chairman of the Audit Committee of BP plc Board member of Financial Skills Partnership Member of the Financial Reporting Review Panel Vice President of the Institute of Chartered Accountants of Scotland
Baroness Noakes, DBE (age 62) Date of appointment: 1 August 2011
External appointments Non-executive director and chairman of Audit Committee of Severn Trent plc Senior independent director and chairman of Audit and Nominations Committees of Carpetright plc Trustee of the Thomson Reuters Founders Share Company Ltd
Former chairman, chief executive officer and president of Prudential Financial Inc. Previously he held senior positions with Chase Manhattan Bank N.A. and was a founding member of the Financial Services Forum. He is a non-executive director of Citizens Financial Group, Inc.
External appointments Non-executive director and chairman of the Audit Committee of Diageo plc
Group Secretary Aileen Taylor (age 39) Date of appointment: 1 May 2010
She is a fellow of the Chartered Institute of Bankers in Scotland, a fellow of the Industry and Parliament Trust and a member of the European Corporate Governance Council.
Ellen Alemany (age 56) Chief Executive, Citizens and Head of Americas Ellen Alemany joined the RBS Group in June 2007 as Head of RBS Americas. She became Chief Executive Officer of Citizens Financial Group, Inc. in March 2008 and Chairman in March 2009. Prior to these appointments, Ellen was the chief executive officer for Global Transaction Services at Citigroup, one of Citi’s 12 publicly reported product lines. Ellen joined Citibank in 1987 and held various positions including executive vice-president for Commercial Business Group, chairman and chief executive officer for Citibank International plc and Citibank’s European bank. She also served on the Citibank, N.A., Board of Directors. Ellen was elected to serve on the Board of Directors of Automatic Data Processing, Inc., beginning in January 2012.
Chris Sullivan (age 54) Chief Executive, UK Corporate Chris Sullivan was appointed Chief Executive of the UK Corporate Banking Division (including Global Transaction Services) in August 2009. His previous role was Chief Executive of RBS Insurance. Prior to this, Chris was Chief Executive of Retail and Deputy Chief Executive of Retail Markets. Chris is a member of the CBI President’s Committee, vicechairman of the Global Banking Alliance for Women, a governor of the IFS and a governor of Ashridge Management College. Chris is also chairman of the Interalpha group of banks. He spent five years as chief executive of Lombard Asset Finance and under his leadership it attained a leading position in the UK and Europe. Chris Sullivan earned his Fellowship of the Chartered Institute of Bankers in Scotland for his services to Scottish Banking.
Ron Teerlink (age 51) Chief Administrative Officer Ron Teerlink joined the RBS Group in April 2008 as Chief Executive of Business Services, becoming the Group Chief Administrative Officer in February 2009. At the same time he was re-appointed to the Managing Board of ABN AMRO to oversee the integration programme. Ron started his career with ABN Bank in 1986 as an IT/Systems analyst and held various functional positions before becoming Chief Operating Officer of the Wholesale Clients Business in 2002. He was appointed Chief Executive Officer of Group Shared Services in 2004 and joined ABN AMRO’s Managing Board in January 2006, where he was responsible for Services and Market Infrastructure. Ron holds a Masters degree in Economics from Amsterdam’s Vrije Universiteit.
Management Committee The Management Committee, comprising our major business and functional leaders, meets regularly, up to four times annually, as a vehicle for strategy and business performance review.
The Board has overall responsibility for: establishment of Group strategy and consideration of strategic challenges; management of the business and affairs of the Group; ensuring the Group manages risk effectively through the approval and monitoring of the Group’s risk appetite; considering stress scenarios and agreed mitigants and identifying longer term strategic threats to the Group’s business operations; the allocation and raising of capital; and the preparation and approval of the Group’s annual report and accounts.
The Board’s terms of reference includes key aspects of the company’s affairs reserved for the Board’s decision and are reviewed bi-annually. The terms of reference are available on the Group’s website www.rbs.com.
There are a number of areas where the Board has delegated specific responsibility to management, including the Group Chief Executive and the Group Finance Director. These include responsibility for the operational management of the Group’s businesses as well as reviewing high level strategic issues and considering risk appetite, risk policies and risk management strategies in advance of these being considered by the Board and/or its Committees. Specific delegated authorities are also in place in relation to business commitments across the Group.
Membership of the Board The Board currently comprises the Chairman, two executive directors and ten independent non-executive directors, one of whom is the Senior Independent Director. The Board functions effectively and efficiently and is considered to be of an appropriate size. The directors provide the Group with the knowledge, mix of skills and experience required. The Board Committees comprise directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.
The Board considers that the Chairman was independent on appointment and that all non-executive directors are independent for the purposes of the Code. The standard terms and conditions of appointment of nonexecutive directors are available on the Group’s website www.rbs.com and copies are available on request from RBS Secretariat.
Board meetings In 2011, nine Board meetings were scheduled and individual attendance by directors at these meetings is shown in the following table. Two of the Board meetings took place overseas during Board visits to the Netherlands in May 2011 and the United States in September 2011.
In addition to the nine scheduled meetings, 24 additional meetings of the Board and Committees of the Board were held, including meetings to consider and approve financial statements. The Chairman and the nonexecutive directors meet at least once per year without executive directors present.
Sandy Crombie 9/9 Alison Davis (1) 4/4 Tony Di Iorio (2) 3/3 Philip Hampton 9/9 Stephen Hester 9/9 Penny Hughes 9/9 Joe MacHale 9/9 John McFarlane 8/9 Brendan Nelson 9/9 Baroness Noakes (1) 4/4 Art Ryan 9/9 Philip Scott 9/9 Bruce Van Saun 9/9
Principal activities of the Board during 2011 In advance of each Board meeting, the directors were supplied with comprehensive papers in hard copy and electronic form.
The directors also received reports on the Group’s financial performance, capital, funding and liquidity position, risk management and government lending commitments together with regular reports on strategy, risk appetite, litigation and treating customers fairly. Specific strategy sessions and updates were considered in June, August and December.
Board Committees In order to provide effective oversight and leadership, the Board has established a number of Board Committees with particular responsibilities. The Committee chairmanship and membership are reviewed on a regular basis. The names and biographies of all Board Committee members are set out on pages 253 to 256.
The Group Secretary also provides a comprehensive and ongoing professional development programme for directors. Directors are advised of appropriate external training and professional development opportunities and undertake the training and professional development they consider necessary to assist them to carry out their duties as directors. Internal training is also provided, tailored to the business of the Group. As part of their ongoing development in 2011, the directors received briefings on the UK Bribery Act 2010, the European Commission Green Paper on the EU Corporate Governance Framework, various Financial Reporting Council Consultations, amendments to the Code, the Capital Requirements Directive IV, a Group Treasury presentation on Balance Sheet Management and Capital Management & Term Funding and participated in a business visit to Group Technology.
Amongst the areas reviewed were Board role and composition, Group strategy, risk management, Board meetings and processes, external relationships, Board committees, directors’ support and information, and continuing professional development.
Findings of performance evaluation 2011 The Board has considered and discussed reports on the outcomes of the evaluation and is satisfied with the way in which the evaluation was conducted.
The Board should continue the focus on Group strategy in the short, medium and long term to ensure the strategy is appropriate and sustainable in the current environment.
Risk reporting should continue to be developed to ensure the Group Board has adequate oversight of risk management and risk appetite.
Group executives should be invited to the Group Board to discuss bench strength and succession planning in their respective functions.
Membership of the Group Nominations Committee All non-executive directors are members of the Group Nominations Committee which is chaired by the Chairman of the Group. The Group Chief Executive is invited to attend meetings. The Group Nominations Committee holds at least two scheduled meetings per year, and also meets on an ad hoc basis as required. In 2011, five meetings of the Group Nominations Committee were held. The Chairman and members of the Committee during 2011, together with their attendance at meetings in 2011, is shown below.
Principal activity of the Group Nominations Committee during 2011 Appointment of new non-executive directors During 2011, the Group Nominations Committee focussed on changes to the Board’s composition and succession planning for the executive directors.
The Group Nominations Committee reviewed the structure, size and composition of the Board and agreed that the composition of the Board could be enhanced with the recruitment of candidates with financial services expertise and experience of European and regulatory issues. It was also agreed that non-UK based candidates should be considered, ideally from the US or Europe. It was recognised that investment banking as well as governmental experience would be useful.
To ensure the Group had access to a wide pool of suitable candidates, the Chairman and Group Secretary contacted two executive search firms with a role profile and a description of the skills required to enhance the Board composition. The Chairman considered a number of candidates before submitting several shortlists to the Group Nominations Committee for consideration. Following discussion, it was agreed that the combination of skills, knowledge and experience of Alison Davis, Baroness Noakes and Tony Di Iorio would enhance the composition of the Board.
ec ut iv e di re ct or s 4+ years2-4 years0-2 years
Length of service Pe rc en ta ge of no nex
Diversity At its meeting in June 2011, the Group Nominations Committee considered a letter from Lord Davies recommending that a Board discussion be held prior to the announcement of aspirational diversity targets in September 2011. The statement released in September 2011 announced that the Group is supportive of Lord Davies’ recommendations and aspires to meet the target of 25 per cent female board representation in 2012 as set out in Lord Davies’ report and confirmed that the Group will continue to meet or exceed this standard. In December 2011, in accordance with the recommendations contained within Lord Davies’ report, the Board established a boardroom diversity policy including measurable objectives for implementing the policy.
The Group understands the importance of diversity and recognises the importance of women having greater representation at key decision making points in organisations. The search for Board candidates will continue to be conducted, and nominations/appointments made, with due regard to the benefits of diversity on the Board. However, all appointments to the Group Board are based on merit, measured against objective criteria, and the skills and experience the individual can bring to the Group Board.
The balance of skills, experience, independence, knowledge and diversity on the Board, and how the Board operates together as a unit is reviewed annually as part of the Board evaluation. Where appropriate, findings from the evaluation will be considered in the search, nomination and appointment process. If appropriate, additional targets on diversity will be developed in due course.
Further details on the Group’s approach to diversity can be found on page 299.
Relations with shareholders The Chairman is responsible for ensuring effective communication with shareholders. The company communicates with shareholders through the Annual Report and Accounts and by providing information in advance of the Annual General Meeting. Individual shareholders can raise matters relating to their shareholdings and the business of the Group at any time throughout the year by letter, telephone or email via the Group’s website www.rbs.com/ir.
Shareholders are given the opportunity to ask questions at the Annual General Meeting or can submit written questions in advance. Directors including the chairs of the Group Audit, Board Risk, Group Remuneration and Group Nominations Committees are available to answer questions at the Annual General Meeting. The Senior Independent Director is also available.
I am pleased to bring you this report following my first full year as Chairman of the Group Audit Committee.
I would like to begin by welcoming Baroness Noakes and Tony Di Iorio who joined the Committee in August and September 2011, respectively; coinciding with Colin Buchan’s retirement from the Group Board. They bring with them a wealth of experience and knowledge. I am grateful to Colin for his commitment to the Committee.
The oversight role of the Committee in these areas is explained in more detail in the Committee’s full report given below.
It is clear that 2012 will be as challenging as 2011. External conditions, internal change and the remediation of known and future issues, while managing the regulatory agenda, will make ‘business as usual’ extremely challenging. The Committee will continue to monitor compliance with the Group’s current regulatory requirements and monitor the implications of proposed future regulatory change, including the Independent Commission on Banking’s recommendations as they develop through 2012. Internal organisational change will also present challenges and the Committee will provide oversight of the revised control framework within the new Markets and International Banking division as it fully embeds.
Brendan Nelson Chairman of the Group Audit Committee 22 February 2012
Meetings and visits A total of seven meetings of the Group Audit Committee were held in 2011, including meetings held immediately before the submission of the annual and interim financial statements and the quarterly Interim Management Statements to the Board. Group Audit Committee meetings are attended by relevant executive directors, the Internal and External Auditors and Finance and Risk management executives. Other executives, subject matter experts and external advisers are also invited to attend the Group Audit Committee, as required, to present and advise on reports commissioned by the Committee. At least twice per annum the Group Audit Committee meets privately with the External Auditors. The Committee also meets privately with the Internal Audit function.
The members of the Group Audit Committee are selected with a view to the expertise and experience of the Group Audit Committee as a whole. The Board is satisfied that all Group Audit Committee members have recent and relevant financial experience, and that each member of the Group Audit Committee is an ‘Audit Committee Financial Expert' and is independent, each as defined in the SEC rules under the US Securities Exchange Act of 1934 (“Exchange Act”) and related guidance. Full biographical details are set out on pages 253 to 256.
The Committee reviewed the effectiveness of the Group New Product Approval Process, the Credit Quality Assurance Process and considered the operation of the Group Notifiable Event Process as it applies in specific circumstances.
Divisional Risk and Audit Committees have been established with responsibility for reviewing the business of each division and reporting to the Group Audit Committee and Board Risk Committee. Given the size and complexity of the Group, these committees are an essential component of the governance framework that supports the effective operation of the Group Audit Committee and Board Risk Committee across the organisation. The Committee has agreed changes to the Divisional Risk Reporting framework and these improvements will be implemented during 2012. Quarterly reports are received by the Group Audit Committee and Board Risk Committee from each Divisional Committee.
During 2011, the Committee sought to enhance further management responsiveness to Group Internal Audit findings and has developed a process to invite management to respond, either directly or in writing, to the Committee regarding identified deficiencies. The Group Audit Committee monitors these findings and management responses ensuring that issues raised are dealt with in a timely and appropriate manner.
The Group Audit Committee also considers Group Internal Audit’s annual plan and the adequacy of its resources and budget. During 2011, the Group Audit Committee actively supported the development of the Internal Audit vision and strategy and the transition to thematic reporting and the development of centres of excellence. It has supported increased resources for the function and has been directly involved in the process for the appointment of the new Head of Group Internal Audit.
An external review of the effectiveness of Group Internal Audit takes place every three to five years, in line with best practice, with internal reviews continuing in intervening years. In January 2012, the Group Audit Committee undertook an internal evaluation of Group Internal Audit. The evaluation concluded that Group Internal Audit had operated effectively throughout 2011.
The Group Audit Committee undertakes an annual evaluation to assess the independence and objectivity of the External Auditors and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The annual evaluation is carried out following completion of the annual accounts and audit. In assessing the effectiveness of the Group’s External Auditors, the Group Audit Committee has regard to: the experience and expertise of the senior members of the engagement team; the proposed scope of the audit work planned and executed; the quality of dialogue between the External Auditors, the Committee and senior management; the clarity, quality and robustness of written reports presented to the Committee setting out the External Auditors’ findings arising form the audit; the quality of observations provided to the company by the External Auditor on the Group’s systems of internal control; and the views of management on the performance of the External Auditors.
The Group Audit Committee reviews the policy annually and prospectively approves the provision of audit services and certain nonaudit services by the External Auditors. Annual audit services include all services detailed in the annual engagement letter including the annual audit and interim reviews (including US reporting requirements) and periodic profit verifications.
Annual audit services also include statutory or non-statutory audits required by any Group companies that are not incorporated in the UK. Terms of engagement for these audits are agreed separately with management, and are consistent with those set out in the audit engagement letter insofar as local regulations permit. During 2011, prospectively approved non-audit services included the following classes of service: capital raising, including consents, comfort letters and relevant reviews of registration statements; provision of accounting opinions relating to the financial statements of the Group; provision of reports that, according to law or regulation, must be rendered by the External Auditors; tax compliance services; permissible services relating to companies that will remain outside the Group; restructuring services relating to the Group's customers; and reports providing assurance to third parties over certain of the Group's internal controls prepared under US Statement of Auditing Standards 70 or similar auditing standards in other jurisdictions.
For all other permitted non-audit services, Group Audit Committee approval must be sought, on a case by case basis, before the provision of the service commences. The Group Audit Committee reviews and monitors the independence and objectivity of the External Auditors when it approves non-audit work, taking into consideration relevant legislation, ethical guidance and the level of non-audit services relative to audit services. The approval process is rigorously applied to prevent the External Auditors from functioning in the role of management, auditing their own work, or serving in an advocacy role.
During 2011, the Group Audit Committee approved changes to the Group’s non-audit services policy. Tax compliance services, permissible services to companies that will remain outwith the Group and restructuring services will require ad hoc approval of the Group Audit Committee in 2012. In addition, a competitive tender process will be required for all proposed engagements where the fees are expected to exceed £100,000. Engagements below £100,000 may be approved by the Chairman of the Group Audit Committee; as an additional governance control all engagements have to be approved by the Group Chief Accountant and Group Sourcing and Vendor Management. Ad hoc approvals of non-audit services are ratified by the Group Audit Committee each quarter. During 2011, the External Auditor was approved to undertake certain significant engagements which are categorised and explained more fully below: Summary of category of engagement Reason for selection of External Auditor
Assurance testing RBS, NatWest and Ulster Bank customer charters and the Group’s Corporate Governance Policy (three engagements)
The External Auditors prior experience and ability to make use of previous work made them a competitive choice for the assurance of the various customer charters.
A selective tender was undertaken to provide support and advice to the Group Secretary for the assurance of the Group Corporate Governance Policy. The External Auditor was judged to be both financially competitive and provided the clearest, and most comprehensive approach to supporting the Group Secretary in this assignment.
The External Auditor was experienced in this field and had performed three previous AUP reviews. Timing was also an issue for this request but a competitive tender process will be considered prior to the next review.
The External Auditor was appointed for one of the engagements following submission of a detailed proposal document, formal presentation and lengthy discussion with RBS management. Given the nature of the engagement it was determined that appointment of the External Auditor was appropriate.
The Group Board met with the Federal Reserve Bank of Boston collectively in this regard during 2011. The Chairman of the Group Audit Committee also met with the US regulator on an individual basis.
As one would expect, managing the risks presented by the challenging external market conditions that have continued throughout 2011 has been a key priority of the Committee. Market, credit and liquidity risk have featured prominently in the discussions of the members in the period. The regulatory agenda has continued to exert pressures on the organisation and the Committee has sought to understand the global implications of proposed regulation while managing and overseeing remediation of known issues. The Committee has continued to build upon existing relationships with the Group’s regulators globally, wherever possible.
Tony Di Iorio joined the Committee with effect from 1 September 2011. It is my pleasure to welcome Tony to the Committee. I am certain that his broad background in financial services and global investment banking will prove to be immensely useful to the Committee, particularly in managing the complex risks presented by the Group’s new Markets and International Banking Division. Colin Buchan retired from the Group Board in August 2011 and I would like to thank Colin for his contribution to the Committee during the first half of the year.
Report of the Board Risk Committee Role of the Board Risk Committee The Board Risk Committee is responsible for providing oversight and advice to the Board in relation to current and potential future risk exposures of the Group and future risk strategy, including determination of risk appetite and tolerance. The Committee reviews the performance of the Group relative to risk appetite and provides oversight of the effectiveness of key Group policies. The Board Risk Committee has responsibility for promoting a risk awareness culture within the Group.
Authority is delegated to the Board Risk Committee by the Group Board and the Committee will report and make recommendations to the Group Board as required. The terms of reference of the Board Risk Committee are available on the Group’s website www.rbs.com and these are considered annually by the Board Risk Committee and approved by the Board.
Philip Scott (chairman) Independent 6/6 Sandy Crombie Independent 5/6 Tony Di Iorio (1) Independent 1/1 Joe MacHale Independent 6/6 Brendan Nelson Independent 6/6
Philip Scott, Tony Di Iorio and Brendan Nelson are also members of the Group Audit Committee. This common membership ensures effective governance across all Finance and Risk issues, and that agendas are aligned and overlap is avoided.
Principal activity of the Board Risk Committee during 2011 Risk strategy and policy The Board Risk Committee is fully engaged in the risks deriving from the recently announced organisational changes to form the new Markets and International Banking division and consideration of the impact of the FSA’s Recovery and Resolution programme and where possible the ICB proposals on the wider Group, will be a priority of the Committee over the course of 2012 and beyond.
Development of the Group Policy Framework has been a major project for the Group in 2011 and the Board Risk Committee has provided oversight and direction to the project. Standards have now been developed, benchmarked and are now being implemented across the organisation. The Board Risk Committee will continue to ensure that the standards are properly embedded globally and will review the output of assurance testing to ensure that the standards are operating effectively. Risk governance across the Group, including the operation of the Board Risk Committee, will be reviewed pursuant to the Corporate Governance Policy standard and the Committee will take forward any recommendations from that review during the course of 2012.
The Committee has overseen the development of a conduct risk appetite statement and framework during 2011. The Committee regards conduct risk to be a fundamental tenet of risk and will receive reports in 2012 on the implementation of the standard and framework across the organisation, including how conduct risk is considered from the point of product inception to conclusion of a relationship with a customer. The terms of reference of the Committee have been extended to cover conduct risk specifically.
Risk profile The Committee receives a detailed report on key risks and metrics at each meeting and receives an oral report from the Chief Risk Officer at each meeting on the key risks to the organisation. This enables the Committee to identify the key risk areas where more focus should be directed. The Committee reported to the Board following each meeting on its consideration of the risk profile of the Group and any longer term macro or perceived strategic threats to the Group and made recommendations as appropriate.
The difficulties being experienced in Europe and the US necessitated a continued focus on market and sovereign risk over the course of 2011. The Committee received additional reports in this regard and will continue to closely monitor and manage these risks in 2012.
Risk appetite, framework and limits The Committee has kept the Group Board appraised of the considerable progress made in relation to development of a risk appetite framework and methodology during 2011 and it has made recommendations to the Board in this regard. The Committee will ensure this framework is fully aligned with the conduct risk framework and is rolled out and embedded across divisions in 2012.
Risk management operating model Culture is key to driving the correct behaviours from a risk perspective. In recognition of this, the Committee received regular updates during 2011 on the One Risk programme, including the risk management vision and values. The Committee has reviewed the calibre of senior risk personnel and succession planning arrangements. It has also reviewed the adequacy of that resource alongside its review of the scope and nature of work undertaken by the risk management function.
The Committee has monitored the standards of data quality across the Group and the programmes in place to improve management information and reporting. In particular, the Committee has tracked progress of the Finance and Risk Transformation Programme designed to develop a golden source of data for use in reporting across the Group.
My priority as Chair of the Group Remuneration Committee is to implement a remuneration policy that serves the long-term interests of our shareholders including, of course, the UK taxpayer. We recognise the duty of public accountability and therefore the need to be sensitive to the public’s views on pay, particularly for senior people. It is a difficult balance that we are trying to achieve in reconciling the, at times, conflicting objectives of our various stakeholders.
Financial Performance A key factor in the Committee’s deliberations is the financial performance of the Group. RBS is a unique recovery challenge and success must be measured by the progress we are making towards being a safer, stronger and more sustainable bank. Effectively we are asking our management team to do two jobs; to successfully compete with strong banking competitors across our ongoing businesses AND to recover RBS from its legacy risk profile, itself the largest corporate restructuring on record. In 2011 the Group put even greater priority on actions to strengthen its balance sheet and reduce risks in the face of difficult economic and financial market conditions, as it continued to work through the restructuring plan embarked upon in 2009. Key financial achievements for 2011 were: Core Bank Operating Profit of £6.1 billion represents a strong performance and compares well with other similar sized banks; Core Bank’s Return on Equity (ROE) was 10.5%, with Retail & Commercial ROE at 11.3%, or 16.6% excluding Ulster Bank. Our investment bank’s ROE was 7.7%, notwithstanding the challenging market conditions; The Group funded balance sheet decreased by £49 billion to £977 billion; The Core Tier 1 ratio of 10.6% and tangible net asset value per share of 50.1p were broadly stable over the year, in spite of derisking costs and regulatory impacts; Group operating profit was £1.9 billion, up 11% after adjusting for the disposal of Global Merchant Services at the end of 2010; Group expenses were 7% lower in 2011 than in 2010 at £15.5 billion; with staff costs down 9%; Impairment losses totalled £7.4 billion, which is down 20% from 2010; and
Targets for reducing Non-Core assets have been exceeded, reducing by £44 billion to £94 billion in 2011.
Whilst there is still much to do to deliver an overall profitable business as we pay for the costs of repair, we are already much better positioned as a safer, stronger bank.
Executive directors Events at the start of 2012 put the difficulty of balancing our stakeholders’ interests firmly into the public spotlight. The bonus for Stephen Hester in relation to the 2011 performance year attracted considerable attention from the media and politicians and I wanted to explain the reasons behind that decision.
Group-wide remuneration arrangements It is not only the executive directors’ interests that the Committee considers. It is also tasked with recognising the work of all our employees, whilst maintaining a balance and showing restraint. Examples of where we have shown such restraint are as follows: More than 10,000 of the Group’s most senior employees will not receive a pay increase for 2012; Average salary increases for 2012 will be less than 1%; 85% of employees eligible for a bonus will receive less than £10,000. The majority of employees eligible for a bonus will receive less than £2,000; The investment bank bonus pool is down by 58% over the last year. This follows a 33% reduction between 2009 and 2010; and
Another area of focus for the Group Remuneration Committee in 2011 has been how value is shared between investors and employees. Shareholders have rightly questioned whether banks, and in particular investment banks, have got this right in the past. We are working hard to get this right now and in the future. A balance is always required between minimising compensation costs, and so maximising profits in the year, and protecting the business from which future profits can flow.
We have sought to strike this balance fairly, while erring on the side of restraint, reflecting the nature of our ownership. In this context, I am pleased to report that the returns achieved in our investment bank, while below our targets, compare favourably to our competitors. Yet our compensation ratios are among the lowest and this has been the position for the last three years.
We do consider that pay at all investment banks became overheated during the exuberant period of growth pre-financial crisis. It is clear that the industry as a whole delivered results in 2011 below the cost of capital. This is an unsustainable position with further significant costs of regulation to come. We are committed to taking necessary action on pay alongside the other strategic business decisions we make around the reduced size and scope of our activities in order to build a sustainable business, capable of serving customers and delivering fair and adequate returns for shareholders and employees.
The remuneration process undertaken by the Group Remuneration Committee is thorough and robust. This year’s report contains more detail on the decision process to demonstrate to you how engaged and committed the Committee is to making the best decisions for the benefit of shareholders, employees and wider stakeholders.
Finally, let me thank my fellow Committee members for their extensive contributions and all those who supported the Committee to help us weigh up all the relevant factors and seek the right balance in our decision-making.
Report of the Group Remuneration Committee The role and responsibilities of the Group Remuneration Committee The Group Remuneration Committee is responsible for setting the Group’s policy on remuneration and overseeing its implementation. It considers and makes recommendations to the Group Board in respect of the remuneration arrangements of the executive directors of the Group. No director is included in decisions regarding his or her own remuneration.
The Group Remuneration Committee is also responsible for approving remuneration and severance arrangements for members of the Group’s Executive and Management Committees, as well as overseeing arrangements for employees who are ‘In-Scope’ under the Asset Protection Scheme (APS) or ‘Code Staff’ under the FSA Remuneration Code. Details of the FSA Remuneration Code can be found at www.fsa.gov.uk and a definition of Code Staff is provided on page 279.
Membership of the Group Remuneration Committee All members of the Committee are independent non-executive directors. The Committee held nine meetings in 2011. The Chair and members of the Committee, together with their attendance at meetings, are shown below: Attended / Scheduled
Notes: (1) Became a member of the Committee on 1 August 2011. (2) Will step down as a member of the Committee on 31 March 2012.
Third quarter half year performance reviews for executive directors, members of the Executive Committee and Management Committee; and outcome of Group Internal Audit review on how the FSA Remuneration Code has been implemented which showed management is aware of the key risks and are pro-active in identifying issues relating to remuneration.
In addition, the Committee received regular knowledge updates on global remuneration regulatory developments; pay consultations issued by the FSA, Department for Business, Innovation & Skills, HM Treasury and the High Pay Commission; guidelines from shareholders and investor bodies; and market trends reports.
Advisers to the Group Remuneration Committee The advisers to the Group Remuneration Committee are appointed independently by the Committee, which reviews its selection of advisers annually. The advisers are instructed by and report directly to the Committee. The Committee Chair oversees the fees for the advisers.
As well as receiving advice from PwC during 2011, the Committee took account at meetings of the views of the Group Chairman, Group Chief Executive, Group Finance Director, Group Human Resources Director, Group Head of Reward, Group Secretary and the Chief Risk Officer.
Key inputs to the Group Remuneration Committee to assist its decision-making The Group Remuneration Committee receives regular updates on regulatory developments and general remuneration issues, as well as market and benchmarking data to support its decisions. It also received information from a number of external and internal sources during 2011. The diagram below illustrates this: Directors’ remuneration report continued
Evaluates collective overall performance against agreed APS performance objectives and reports to the Committee. The APSPRC also makes recommendations on the proportion of incentive awards for In-Scope employees which are evaluated against APS objectives.
Supports the Group Remuneration Committee as they develop reward philosophy, strategy and policies across the RBS Group. Provides input on market trends and compensation structures for the executives and the broader population in the Group.
Provides independent review of the financial performance of the Divisions and Group and reports on the Group's capital position.
The importance of value sharing between investors and employees, retaining capital, and taking this into account in remuneration decisions were key themes from the shareholder consultation. As mentioned in the letter from the Committee Chair, value sharing between investors and employees and retention of capital have been key areas for the Remuneration Committee during 2011. In 2011 variable compensation was 11% of Core Bank operating profit, down from 16% in 2010. This proportion compares favourably with other banks.
The Committee has considered the LTIP award policy for 2012 in light of the Group’s current share price and has reduced potential awards to executive directors by capping them at 300% of salary.
The population receiving LTIP awards has also been reviewed, and for 2012, there will be a significant reduction as LTIP awards are targeted at the Group’s most senior management. All LTIP awards are subject to both group-wide and division/function specific performance conditions to ensure that the leadership team is focused on both value creation and other key objectives. Group performance targets will be aligned to the executive director LTIP performance targets to ensure a consistent view of performance.
How risk is reflected in our remuneration process Focus on risk is achieved through clear risk input into incentive plan design and target setting, as well as thorough risk review of performance, bonus pools and clawback. The Group Remuneration Committee is supported in this by the Board Risk Committee and the Group’s risk management function.
The outcomes from recent accountability reviews for the performance year 2011 have included: adjustment of current year bonus awards; dismissal; clawback of previously awarded deferred and LTIP awards; and suspended vesting pending further investigation.
HM Treasury published a consultation on 6 December 2011 with draft regulations on remuneration disclosure. This proposes that all large banks operating in the UK, publish the pay details of their eight highest paid senior executive officers who are not main board directors. The consultation follows the Project Merlin agreement in February 2011 that applied to the five major UK banks including RBS. Details are set out on page 294.
There is strong central governance and oversight of both bonus pools and individual awards. Across the Group, bonus awards for the 2011 performance year are significantly lower than those made last year. This is due to a combination of factors including financial performance, particularly in the investment bank division, but also recognising the need for moderation and the external climate. This year we have recorded substantial losses for two issues: PPI and Greek sovereign debt. Whilst current management inherited these issues, the Committee’s judgement is that reductions to shareholder value of this scale must be reflected in lower variable compensation across the Group and overall bonus pools have been reduced as a result.
Remuneration policy The remuneration policy supports the Group’s business strategy and is designed to: attract, retain, motivate and reward high calibre employees to deliver long term business performance within acceptable risk parameters; provide clear alignment between annual and long-term targets for individuals and Group/divisional strategic plans; and ensure that the Group’s metrics, reward structures and governance processes as a whole provide coverage of the key risks in an appropriate way.
In the Non-Core division and businesses we are exiting, appropriate arrangements are put in place to ensure that employees are motivated to reduce risk effectively, to minimise losses taken on value of businesses/ assets at the point of divestment.
The remuneration policy applies the same principles to all employees including Code Staff (1). The current key principles underpinning the Group-wide remuneration policy are set out below: Base salary Base salaries are reviewed annually. Base salaries should be competitive in the specific market for the business in which the individual works; reflect the talents, skills and competencies that the individual brings to the Group; and be sufficient so that inappropriate risktaking is not encouraged.
Guaranteed bonuses are only used in limited circumstances in accordance with the FSA Remuneration Code.
Deferred awards support a performance culture where employees recognise the importance of sustainable Group, business and individual performance. Under the Group-wide deferral arrangements a significant proportion of annual incentive awards for our more senior employees are deferred over a three year period. Deferred awards are subject to clawback.
In certain circumstances, formulaic short-term incentive arrangements are used to align the objectives of employees with the strategy of the relevant division in which they work. For such schemes, specific design principles are in place, with strict governance procedures that ensures that all existing and future incentive schemes support our business strategy and risk appetite.
All incentive awards are subject to appropriate governance, including independent review by the Risk Management, Finance and HR functions, with oversight from the Group Performance and Reward Committee, which has delegated authority from the Group Remuneration Committee over incentive schemes operating over a period of 12 months or less.
Base salaries are reviewed annually. Stephen Hester: £1,200,000 Bruce Van Saun: £750,000 (from 1 April 2011)
Executive directors have a normal maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).
For the 2011 performance year, the annual incentive was delivered as an allocation to Share Bank.
Stephen Hester: Provisional maximum allocation of 6.0 million shares to Share Bank. Final allocation based on performance: 3.6 million shares. Stephen Hester has waived this award.
Bruce Van Saun: Provisional maximum allocation of 3.75 million shares to Share Bank. Final allocation based on performance: 3.0 million shares.
Both Stephen Hester and Bruce Van Saun will have a maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).
Both Stephen Hester and Bruce Van Saun received share awards capped at 375% of basic salary.
Stephen Hester and Bruce Van Saun will be granted long term share awards which will ultimately vest in a range between zero and a cap of 300% of basic salary depending on performance over the next three years. These share awards have a notional value at grant assessed at £1.62 million and £1.01 million respectively.
None of the current executive directors are members of the Group's defined benefit pension plans. Current executive directors receive an allowance in lieu of pension contributions.
The mix of executive directors’ remuneration The charts below show the composition of remuneration opportunity for on-target annual performance, with the long term incentive awards shown at the expected value. Short term incentive payments earned in relation to 2012 performance will be deferred and will vest, subject to satisfactory performance. The actual value of the long term incentive awards will depend on performance over the period 2012 to 2014 and the share price at the time the awards vest.
Pension Base Salary 10% of maximum incentives29% of maximum total ti
Assessing past performance Executive directors’ annual incentive 2011 Executive directors have a normal maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary). Share Bank arrangements were put in place for the 2010 and 2011 performance years. The maximum potential allocation into Share Bank for the 2011 performance year was 6.0 million shares for the Group Chief Executive and 3.75 million shares for the Group Finance Director. This was based on the normal maximum annual incentive levels for executive directors at a share price of 40p per share (calculated as an average share price over December 2010).
The Group recovery strategy set out in 2009 has proven its effectiveness and in 2011, most tasks are on or ahead of Plan. This includes operation of Core/Non-Core structure, rebuilding management and operations and reducing risk. Key Group strategic plan risk measures set in 2009 were all significantly exceeded in 2011. However, the deterioration in external economic and financial conditions impacted profits and further led the Group to prioritise de-risking over driving returns, which affect profitability measures. An extra £1 billion was spent over 2011 in order to accelerate the achievement of RWAs reduction, liquidity and deposit-gathering goals. It was also necessary to make alterations to the strategic plan for the investment banking business in the light of new regulation and market developments.
Risk and control Funding, leverage ratio, risk measures and Asset protection Scheme (APS) compliance requirements.
Positive feedback from key shareholders and regulators. Increased engagement with external stakeholders in particular on sustainable lending policies. Good progress to address risks identified by UK/US regulators relating to TCF.
Stephen Hester is widely acknowledged internally and externally as having provided strong leadership to the Group in extraordinary circumstances. Talent and bench reviews completed in all businesses and actions plans agreed. Female executive representation increased to 18%. The Group’s ‘Your Feedback 2011’ staff survey results showed a continued upward trend in the vast majority of categories.
Bruce Van Saun Bruce Van Saun’s performance is measured against a number of Group and divisional targets. Bruce continues to perform at the level of a world class Chief Financial Officer (CFO), providing strong individual and broader finance contribution to the Group’s priority to strengthen the balance sheet and reduce risk. Group Treasury has facilitated a significant reduction on the Group’s reliance on short-term funding and Bruce Van Saun has displayed strong leadership on a number of key strategic projects including negotiation of the EU mandated sale of retail branches, the response to the Independent Commission on Banking (ICB) and the preparations for the divestment of RBS Insurance.
Increased effectiveness of strategic planning process resulting in successful Board offsite and strong contribution to GBM strategy revisions and the APA analyses.
Strong leadership displayed on key strategic projects including; branch disposal, ICB response, RBS Insurance divestment. 13 M&A transactions delivered, with 70% managed by an in house team led by the CFO.
Performance against agreed APS objectives was satisfactory and significantly improved compared with prior year.
Statutory/regulatory/management reporting. Strategic planning, budgeting and forecasting. Capital and funding planning.
Risk and control Regulatory change impacting capital, funding, liquidity, improve quality of risk and financial data.
Strong external feedback received on Investor Relations programme. Strong engagement with policy makers on the regulatory agenda; stronger relationship achieved with FSA. Major role in working with the FSA through capital and liquidity assessments, as well as the ICB response and RBS N.V. consolidation.
Key strategic hires made for Group Internal Audit and Group Strategy positions, which are a key part of upgrade agenda. External hiring complemented by robust programmes for internal talent implemented across all levels. Number of key executive positions filled internally in 2011. Strong focus on programmes in mentoring, diversity and training & development.
Core Bank Economic Profit 25% Ensures that performance reflects risk adjusted enduring earnings for the Bank.
Threshold: 25% vesting for average return on tangible equity over the performance period at a reasonable margin above the cost of capital.
Vesting will be qualified by Group Remuneration Committee discretion. Indicative vesting levels are: Over half of objectives not met: 0%; Half of objectives met: 25%; Two-thirds of objectives met: 62.5%; and
Awards to executive directors under the LTIP in 2010 are subject to improvements in Economic Profit, Relative TSR and Absolute TSR. The award is due to be assessed in May 2013 to determine the final level of vesting. The table below is an interim assessment and based on performance to date, the threshold targets have not yet been met.
Economic Profit 50% Ensures that performance reflects enduring earnings for the Bank.
Note: For the formulaic performance conditions applying to the executive directors, the percent vesting outcomes were calculated by PwC, based on incremental economic profit figures from Group Finance (Group operating profit less 25% tax less a charge of 10% of tangible equity) and TSR for the period up to and including 3 January 2012.
Threshold: 25% vesting if the Group’s TSR is at the median of the companies in the comparator group.
The TSR for the company and the indices have been rebased to 100 for 2006. The second graph shows the same performance of the company during 2011.
In addition, the weight of new regulation on European banks raised concerns about banks' ability to generate attractive returns. Specifically in the UK, the publication of the ICB report in September recommending the ring-fencing of retail banking operations was perceived as detrimental for RBS and its UK domestic peers, although details of the regulations are yet to be finalised.
Implementation of the Group’s recovery plan started in January 2009 with the publication of the preliminary 2008 losses. The share price reached a low point of just under 10p per share on the news.
Strategic progress Revise original Strategic Plan to respond to significant changes in the macro environment and outlook for wholesale banking. Deliver execution of revised strategy.
Implementation of effective regulatory changes impacting capital, funding, liquidity. Improve quality of risk and financial data. Continue development of Internal Audit function. Deliver against agreed APS objectives.
Stakeholder management Achievement of customer franchise measures, maintain strong and effective relationships with external stakeholders and continue progress on TCF actions.
Lead upgraded team and build positive culture. Contribute to overall Group management.
The Group Remuneration Committee will determine the actual value of the award by reference to the extent to which executive directors have met the performance targets. Awards will be paid entirely in shares and will vest in two equal tranches on the first and second anniversaries of the date of grant. Clawback provisions will apply prior to the vesting of the shares.
Long-term incentive plan (LTIP) 2012 Awards have four performance categories, each with equal weighting.
Core bank Economic Profit is defined as return attributable to shareholders less equity multiplied by the cost of equity, where: Return attributable to shareholders is Core Operating Profit reported in the financial statements, excluding movements in the fair value of own debt and APS, taxed at a standard tax rate.
Equity is defined as tangible equity allocated to the Core businesses, with adjustments to strip out distorting impacts arising from movements in the fair value of own debt, available-for-sale reserves and cash flow hedging reserve.
At the end of the performance period for the 2012 awards, the Group Remuneration Committee will assess economic profit performance against plan in light of targets set by it at the start of the performance period. Details of the actual targets, and performance against these, will be disclosed retrospectively once the awards vest.
Relative TSR Comparator Group Weighting 2 Lloyds Banking Group 3 HSBC 150% 4 Standard Chartered 5 Bank of America 50% 6 BBVA 7 BNP Paribas 8 Citigroup 9 Credit Agricole 10 Credit Suisse Group 11 Deutsche Bank 12 JP Morgan Chase 13 National Australia Bank Limited 14 Royal Bank of Canada 15 Santander 16 Societe Generale 17 The Toronto-Dominion Bank Group 18 UBS 19 Unicredito 20 Wells Fargo & Company
To receive any of the LTIP awards subject to this performance measure the Group’s performance must be at least as good as the median of the comparator companies, with vesting as follows (with a pro-rata proportion of the award vesting in between these points): 20% of the award will vest if the Group’s TSR is at the median of the companies in the comparator group.
Non-Core assets Cumulative Non-Core loss Core Tier 1 Capital Wholesale funding Liquidity reserves Leverage ratio Loan:deposit ratio
Earnings volatility Customer franchise Cost:income ratio in core bank Lending targets Sustainability performance
Both quantitative and qualitative strategic measures are used, including measures relating to reputation, customer excellence, organisational capability and sustainability, given that these will support the long term goals of the business. Targets for each measure are set at the start of the performance period and where applicable, are aligned with the Group’s strategic plan targets. At the end of the period each measure will be assessed against the target, and vesting will be based on the proportion of targets fully met (see below), qualified by the Group Remuneration Committee’s discretion, taking other relevant factors into account.
Does not meet 0% Over half of objectives not met Partially meets 25% Half of objectives met Significantly meets 62.5% Two-thirds of objectives met Fully meets 100% Objectives met or exceeded in all material respects Qualified by Group Remuneration Committee discretion taking into account changes in circumstances over the performance period, the relative importance of the measures, the margin by which individual targets have been missed or exceeded, and any other relevant factors.
Risk underpin and clawback The Group Remuneration Committee will also review financial and operational performance against the Strategic Plan and risk performance prior to agreeing vesting of awards. In assessing this, the Committee will be advised independently by the Board Risk Committee. If the Group Remuneration Committee considers that the vesting outcome calibrated in line with the performance conditions outlined above does not reflect the Group's underlying financial results or if the Committee considers that the financial results have been achieved with excessive risk, then the terms of the awards allow for an underpin to be used to reduce vesting of an award, or to allow the award to lapse in its entirety. All awards are subject to clawback.
Except as noted below, in the event of severance where any contractual notice period is not worked, the employing company may pay a sum to the executive in lieu of the notice period. In the event of situations involving breach of the employing company's policies resulting in dismissal, reduced or no payments may be made to the executive. Depending on the circumstances of the termination of employment, the executive may be entitled, or the Group Remuneration Committee may allow, outstanding awards under long-term incentive arrangements to vest, subject to the rules of the relevant plan.
Stephen Hester In the event of his personal underperformance, the company is entitled, after giving reasonable opportunity to remedy any failure, to terminate Stephen Hester’s contract by giving written notice with immediate effect and without making any payment in lieu thereof and Stephen Hester will forfeit any unvested stock awards. In the event that Stephen Hester's employment is terminated by the company (other than by reason of his personal underperformance), he will be entitled to receive a payment in lieu of notice to the value of base salary, bonus and benefits (including pension contributions). If he resigns voluntarily and the company does not require him to work out his notice period, Stephen Hester may receive a payment in lieu of notice based on salary only (i.e. no bonus or benefits). In both cases the treatment of any other unvested stock awards will be determined at the discretion of the Group Remuneration Committee.
Bruce Van Saun In the event that Bruce Van Saun's employment is terminated by reason of his personal underperformance, the company is entitled, after giving reasonable opportunity to remedy any failure, to terminate by giving written notice with immediate effect and without making any payment in lieu of notice. Any payment in lieu of notice that may be made to Bruce Van Saun would be based on salary only (i.e. no bonus or benefits). The company has agreed that, provided certain conditions are met, on leaving employment, Bruce Van Saun will not forfeit awards under the rules of the Group’s share plans.
Chairman and non-executive directors Information regarding the terms of appointment for the Chairman and non-executive directors is shown below.
Termination No compensation would be paid to any non-executive director in the event of termination of appointment.
Fees for non-executive directors The table below sets out the remuneration structure for non-executive directors for the year ended 31 December 2011. The Senior Independent Director and Chairs of the Board Committees receive a composite fee and therefore do not receive additional fees for membership of any other committees or the Group Board.
Non-executive directors The level of remuneration for non-executive directors reflects their responsibility and time commitment and the level of fees paid to non-executive directors of comparable major UK companies. Non-executive directors do not participate in any incentive or performance plan. Non-executive directors fees are reviewed regularly.
Long-Term Incentive Plan (LTIP) No variation was made to any of the terms of the plan during the year. Awards to executive directors under the LTIP in 2011 are subject to performance conditions detailed on page 284. Performance conditions for awards made in 2010 are detailed on page 285.
Deferred awards Below are details of deferred awards granted to executive directors. Awards are structured as conditional rights to receive shares and are subject to clawback. No variation has been made to any of the terms of the plan during the year.
Options held at 1 January 2011 Number of options exercised in 2011
The market price of the company's ordinary shares on 30 December 2011 was 20.18p and the range during the year ended 31 December 2011 was 17.34p to 49.0p.
Stephen Hester (1) 4,800,000 0.37 4,800,000 22.06.12 Bruce Van Saun (2) 1,810,611 0.57 1,810,611 22.06.12
Notes: (1) Stephen Hester has voluntarily agreed to retain any shares that he receives for a further two years past the vesting date. (2) End of qualifying period 22 June 2012, however award unavailable for exercise until 8 September 2012, three years from date of award.
2010 Full details of the 2010 LTIP measures are set out on page 259 of the 2010 Report & Accounts which can be found on ww.rbs.com.
2009 Full details of the 2009 performance measures are set out on page 235 of the 2009 Report & Accounts which can be found on www.rbs.com.
Note: (1) This amount includes additional employer pension contribution that Mr Van Saun sacrifices from his salary.
HM Treasury published a consultation on 6 December 2011 with draft regulations on remuneration disclosure. The proposals set out that all large banks operating in the UK should publish the pay details of their eight highest paid senior executive officers who are not main board directors.
For consistency, figures shown below are in GBP. Where applicable, currency conversion was based on the 2011 average exchange rate for fixed remuneration and the 31 December 2011 spot rate for bonus figures, in line with the approach taken in this Report. No sign-on or severance awards have been made during 2011 to any of the individuals detailed below.
Bruce Van Saun Executive 1 Executive 2 Executive 3 Executive 4 Executive 5 Executive 6 Executive 7 Executive 8
Upfront variable remuneration (shares subject to retention) — — 390 500 350 166 180 170 — 98
2009 GBM LTIP vesting In 2009 on adoption of the RBS Group recovery plan, John Hourican, the newly appointed Head of GBM, was awarded a conditional LTIP with performance conditions covering the 2009 - 2011 period. The performance period has now completed and 15,904,256 shares (and 5,566,490 share options with zero current intrinsic value), are due to vest on 3 April 2012. The table below summarises the GBM performance tests. The Group Remuneration Committee agreed a 73% vesting level based on performance for the period.
1. Remake of GBM post 2008 and no material adverse event 20 6 6 8 16 2. Achievement of 15% ROE and outlook 30 9 9 12 18 3. Sustaining key customer/market positions 20 6 6 8 14 5. Efficiency (Balance Sheet, Risk, Cost:income) 10 3 3 4 6
The context for this special LTIP award was the important role the restructuring and performance of GBM played in RBS recovery plan amidst the fall out from the financial markets crisis of 2008. GBM underwent a radical restructuring with wholesale management changes, exit of multiple business lines and geographies and a balance sheet reduction from c. £874 billion pre-crisis to £362 billion at year end 2011. During this period the success of this part of the restructuring, the stabilisation of GBM and the restoration of profitability in GBM were vital ingredients in the broader RBS recovery plan.
1. Aggregate remuneration expenditure During the year, there were 205 Code Staff classified as Senior Management and 181 other Code Staff. Aggregate remuneration expenditure was as follows: Global Banking & Markets £m
Fixed Remuneration Fixed remuneration paid in 2011 consisted of base salaries paid during the year plus fees for non-executive directors. There were no special discretionary pension benefits awarded during the year.
Variable remuneration for 2011 performance Variable remuneration payable in respect of 2011 performance consisted of cash bonuses, share or restricted share unit awards, and other awards primarily in the form of deferred bonds payable over three years. Cash bonuses were limited to a maximum of £2,000 per employee.
Long-term incentives Long term incentive awards made each year are paid three years after the date of award based on the extent to which performance conditions are met, and can result in zero payment if performance is not at the threshold level.
Others £m 3. Outstanding deferred remuneration through 2011 The table below includes deferred remuneration awarded or paid out in 2011, primarily for prior year performance. Deferred remuneration reduced during the year relates to long-term incentives lapsing when performance conditions are not met.
Unvested from prior year 108.6 152.8 Awarded during the financial year 91.7 143.1 Paid out 60.4 119.8 Reduced from prior years 0.2 — Unvested at year end 134.2 171.1 4. Sign-on and severance payments No sign-on or severance payments were made to Code Staff during the year.
Notes on the presentation of remuneration In the relevant tables above, assumptions have been made for the notional value of LTIP (verified by external advisors), forfeitures through resignation for deferred awards and the share price at 31 December has been used.
The Board has established a process for the identification, evaluation and management of the significant risks faced by the Group, which operated throughout the year ended 31 December 2011 and to 22 February 2012, the date the directors approved the Report and Accounts. This is confirmed by a semi-annual Control Environment Certification process which requires senior members of the executive and management to assess the adequacy and effectiveness of their internal control framework and the compliance of their business with Group policies and associated standards (in accordance with the Group Policy Framework), and they meet the requirements of Sarbanes-Oxley Section 404 and the UK Corporate Governance Code Section C2. The policies that govern these processes, and reports on internal controls arising from them, are regularly reviewed by the Board and meet the requirements of the guidance ‘Internal Control: Revised Guidance for Directors on the Combined Code’ issued by the Financial Reporting Council in October 2005. Enhancements have been made to the Risk Management framework throughout 2011 and further improvements will be made in 2012.
Based on its assessment, management has concluded that, as of 31 December 2011, the Group's internal control over financial reporting is effective.
The company has reviewed its corporate governance arrangements and is satisfied that these are consistent with the NYSE’s corporate governance listing practices, with the exception that the Chairman of the Board is also the Chairman of the Group Nominations Committee, which is permitted under the Code (since the Chairman was considered independent on appointment). The company’s Group Audit, Board Risk, Group Remuneration and Group Nominations Committees are otherwise composed solely of non-executive directors deemed by the Group Board to be independent. The NYSE corporate governance listing standards also require that a compensation committee has direct responsibility to review and approve the Group Chief Executive’s remuneration.
The Group Audit Committee complies with the provisions of the NYSE corporate governance listing standards that relate to the composition, responsibilities and operation of audit committees. In April 2011, the company submitted its required annual written affirmation to the NYSE confirming its full compliance with those and other applicable provisions. More detailed information about the Group Audit Committee and its work during 2011 is set out in the Group Audit Committee report on pages 263 to 267.
Following placing and open offers in December 2008 and in April 2009, HM Treasury (HMT) owned approximately 70.3% of the enlarged ordinary share capital of the company. In December 2009, the company issued a further £25.5 billion of new capital to HMT. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as Core Tier 1 capital.
In 2011, the company issued 770.3 million ordinary shares in connection with employee share schemes. At 31 December 2011, HMT’s holding in the company’s ordinary shares had reduced to 66.9%.
The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (other than companies in the RBS Holdings N.V. group, which are subject to different restrictions, see below) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) for a period of two years from 30 April 2010 (the “Deferral Period”), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.
The reported results of the Group are also sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. Details of the Group’s critical accounting policies and key sources of accounting judgments are included in Accounting policies on pages 314 to 326.
On 19 April 2011, the Group announced the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank. Subject to, among other matters, regulatory and other approvals and procedures, it is expected that the transfers will be implemented on a phased basis over a period ending 31 December 2013. A large part of the transfers is expected to have taken place by the end of 2012.
On 17 October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of the UK Financial Services and Markets Act 2000.
Employees As at 31 December 2011, the Group employed over 146,800 employees (full-time equivalent basis) throughout the world. Details of employee related costs are included in Note 3 on the consolidated accounts.
Employee communication Employee engagement is encouraged through a range of communication channels, at both divisional and Group level. These channels provide access to news and information in a number of ways, including the intranet, magazines, video, team meetings led by line managers, briefings held by senior managers and regular dialogue with employees and employee representatives.
Employee feedback Every year since 1999, through the Your Feedback survey, employees in all our businesses have shared their thoughts about what it’s like working for RBS. These insights inform what the Group needs to do to improve the way it works, whether it’s a local issue or something that affects everyone. Apart from an opportunity to listen to employees, the survey also enables the Group to monitor levels of employee satisfaction and engagement and how these compare with other companies.
This commitment to inclusion extends to supporting and participating in positive action programmes outside of the Group aimed at cultivating future leaders including, ‘An Inspirational Journey’, the FTSE-100 crosscompany mentoring and Glass Ladder programmes. The Group maintains its involvement with external charitable networks and events such as Manchester Pride.
Performance is monitored and reviewed at Group and divisional level and RBS is supportive of the recommendations of Lord Davies' Report. There are currently three female directors on the Board out of a total of 13 directors. The Group expects to meet the aspirational target of 25 per cent female Board representation in 2012. As at 31 December 2011, 18 per cent of executives in the Group and 53 per cent of employees were female.
The Group is committed to ensuring legal compliance and managing health and safety risks. During 2011, increased focus on leadership, governance and the effectiveness of controls delivered improvements in health and safety performance.
Pre-employment screening The Group has a comprehensive pre-employment screening process to guard against possible infiltration and employee-related fraud for all direct and non-direct staff engaged on Group business.
Code of conduct The code of conduct applies to everyone who works for RBS. It promotes honest and ethical conduct, including the handling of actual or apparent conflicts of interest between personal and professional relationships. The Group recognises that personal conduct, business integrity and the Group’s security are crucial, and the code of conduct serves to inform those who work for us of the Group’s expectations of their behaviour and practices.
The Group continues to do significant work and address challenges across five key themes: Fair banking, Supporting enterprise, Employee engagement, Safety and security and Citizenship and environmental sustainability. For more information on the Group Sustainability programme, see page 30.
Corporate governance The company is committed to high standards of corporate governance. Details are given in the Corporate governance report on pages 252 to 295. The Corporate governance report and compliance report (pages 296 and 297) form part of this Report of the directors.
The rights and obligations attaching to the company’s ordinary shares and preference shares are set out in the company’s Articles of Association, copies of which can be obtained from Companies House in the UK or can be found on the Group’s website www.rbs.com.
On a show of hands at a general meeting of the company every holder of ordinary shares and cumulative preference shares present in person or by proxy and entitled to vote shall have one vote. On a poll, every holder of ordinary shares present in person or by proxy and entitled to vote shall have one vote for every share held. On a poll, holders of cumulative preference shares present in person or by proxy and entitled to vote shall have four votes for every share held. The voting rights of holders of noncumulative preference shares are set out in Note 27 on the consolidated accounts. The notices of Annual General Meetings and General Meetings specify the deadlines for exercising voting rights and appointing a proxy or proxies to vote in relation to resolutions to be passed at the meeting.
Except in relation to the Dividend Access Share, the company is not aware of any agreements between shareholders that may result in restrictions on the transfer of securities and/or voting rights. There are no persons holding securities carrying special rights with regard to control of the company.
Directors The names and brief biographical details of the directors are shown on pages 253 to 256.
Sandy Crombie, Philip Hampton, Stephen Hester, Penny Hughes, Joe MacHale, John McFarlane, Brendan Nelson, Art Ryan, Philip Scott and Bruce Van Saun all served throughout the year and to the date of signing of the financial statements.
Alison Davis and Baroness Noakes were appointed as non-executive directors on 1 August 2011. Tony Di Iorio was appointed as a nonexecutive director on 1 September 2011. Colin Buchan retired as a nonexecutive director on 5 August 2011, having served just over nine years on the Board. John McFarlane will step down from the Board on 31 March 2012.
Shareholdings The table below shows shareholders that have notified the Group that they hold more than 3% of the total voting rights of the company at 31 December 2011.
The Group has not been notified of any changes to the above interests between 31 December 2011 and 22 February 2012.
To ensure it makes its community investments as effective as possible, the Group’s policy is to focus its resources on a small number of substantial strategic programmes. These are issues most relevant to a financial institution and relate broadly to financial education, supporting enterprise and microfinance and the charitable endeavours of employees.
Political donations At the Annual General Meeting in 2011, shareholders gave authority under Part 14 of the Companies Act, for a period of one year, for the company (and its subsidiaries) to make political donations and incur political expenditure up to a maximum aggregate sum of £500,000. This authorisation was taken as a precaution only, as the company has a longstanding policy of not making political donations or incurring political expenditure within the ordinary meaning of those words. During 2011, the Group made no political donations, nor incurred any political expenditure in the UK or EU and it is not proposed that the Group’s longstanding policy of not making contributions to any political party be changed. Shareholders will be asked to renew this authorisation at a reduced maximum aggregate sum of £100,000 at the Annual General Meeting in 2012.
At 31 December 2011, the Group’s trade creditors represented 27 days (2010 - 29 days) of amounts invoiced by suppliers.
No other current director had an interest in the company's ordinary shares during the year or held a non-beneficial interest in the shares of the company at 31 December 2011, at 1 January 2011 or date of appointment if later. The interests shown above include connected persons of the directors.
We, the directors listed below, confirm that to the best of our knowledge: the financial statements, prepared in accordance with International Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and the Business review, which is incorporated into the Directors' report, includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
Bruce Van Saun Sandy Crombie Alison Davis Tony Di Iorio Penny Hughes Joe MacHale John McFarlane Brendan Nelson Baroness Noakes Arthur ‘Art’ Ryan Philip Scott
306 Independent auditor’s report 307 Consolidated income statement 308 Consolidated statement of comprehensive income 309 Consolidated balance sheet 310 Consolidated statement of changes in equity 313 Consolidated cash flow statement 314 Accounting policies 327 Notes on the consolidated accounts 1 Net interest income 327 2 Non-interest income
We have audited the financial statements of The Royal Bank of Scotland Group plc (the "company") and its subsidiaries (together the "Group") for the year ended 31 December 2011 which comprise the accounting policies, the consolidated and company balance sheets as at 31 December 2011, the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and company statements of changes in equity and the consolidated and company cash flow statements for the year ended 31 December 2011, the related notes 1 to 42 on the consolidated financial statements, the related notes 1 to 17 on the company financial statements and the information identified as 'audited' in the Risk and balance sheet management section of the Business review. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRS) as adopted by the European Union and, as regards the company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
Under the Listing Rules we are required to review: the directors' statement contained within the Report of the directors in relation to going concern; the part of the corporate governance statement relating to the company's compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and certain elements of the Directors’ remuneration report.
Legislation in the United Kingdom governing the preparation and dissemination of financial statements differs from legislation in other jurisdictions.
Loss attributable to: Non-controlling interests 28 (665) 349 Preference shareholders 7 — 105 878 Paid-in equity holders 7 — 19 57 Ordinary and B shareholders (1,997) (1,125) (3,607)
Per ordinary and B share (1) Basic loss from continuing operations 9 (1.8p) (0.5p) (6.3p)
Total comprehensive loss is attributable to: Non-controlling interests (24) (197) (1,346) Preference shareholders — 105 878 Paid-in equity holders — 19 57 Ordinary and B shareholders (756) (598) (5,747) (780) (671) (6,158)
Consolidated statement of comprehensive income for the year ended 31 December 2011
Cash flow hedging reserve At 1 January (140) (252) (876) Amount recognised in equity 2,417 180 380 Amount transferred from equity to earnings (993) (59) 513 Tax (405) (67) (269) Recycled to profit or loss on disposal of businesses (3) — 58 — At 31 December 879 (140) (252)
Foreign exchange reserve At 1 January 5,138 4,528 6,385 Retranslation of net assets (382) 997 (2,322) Foreign currency (losses)/gains on hedges of net assets (10) (458) 456 Tax 23 63 9 Recycled to profit or loss on disposal of businesses 6 8 —
Own shares held At 1 January (808) (121) (104) Disposal/(purchase) of own shares 20 (700) (33) Shares issued under employee share schemes 19 13 16 At 31 December (769) (808) (121)
Non-controlling interests (see Note 26) At 1 January 1,719 16,895 21,619 Currency translation adjustments and other movements (54) (466) (1,434) Profit/(loss) attributable to non-controlling interests
- recycled to profit or loss on disposal of discontinued operations (4) — (7) — Movements in cash flow hedging reserve - amount recognised in equity — (120) (209) - tax — 39 59 - recycled to profit or loss on disposal of discontinued operations (5) — 1,036 — Actuarial gains recognised in retirement benefit schemes
Operating activities Operating loss before tax (766) (399) (2,647) Operating profit/(loss) before tax on discontinued operations 58 (541) (49) Adjustments for: Depreciation and amortisation 1,875 2,220 2,809 Write-down of goodwill and other intangible assets 91 10 363 Interest on subordinated liabilities 740 500 1,490 Charge for defined benefit pension schemes 349 540 659 Pension scheme curtailment gains — (78) (2,148) Cash contribution to defined benefit pension schemes (1,059) (832) (1,153) Gain on redemption of own debt (255) (553) (3,790) Elimination of foreign exchange differences 2,702 (691) 12,217 Other non-cash items 3,218 1,455 7,940 Net cash flows from trading activities 6,953 1,631 15,691 Changes in operating assets and liabilities (3,444) 17,095 (15,964) Net cash flows from operating activities before tax 3,509 18,726 (273) Income taxes (paid)/received (184) 565 (719) Net cash flows from operating activities 33 3,325 19,291 (992)
Net increase in cash and cash equivalents 125 8,344 9,261 Cash and cash equivalents at 1 January 152,530 144,186 134,925 Cash and cash equivalents at 31 December 37 152,655 152,530 144,186
Consolidated cash flow statement for the year ended 31 December 2011
1. Presentation of accounts The accounts are prepared on a going concern basis (see page 300 of the Report of the directors) and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (EU) (together IFRS). The EU has not adopted the complete text of IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the standard's hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 39 as issued by the IASB: the Group's financial statements are prepared in accordance with IFRS as issued by the IASB.
The accounts are prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held-for-trading financial assets and financial liabilities, financial assets and financial liabilities that are designated as at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged. The company’s financial statements and the Group's consolidated financial statements are presented in sterling which is the functional currency of the company.
Amendment to IAS 32 ‘Financial Instruments: Presentation’ - ‘Classification of Rights Issues’ amends IAS 32 so that rights, options or warrants that are fixed for fixed (i.e. a fixed amount of cash for a fixed number of instruments) offered pro rata to all owners of a class of instrument are classified as equity instruments regardless of the currency denomination of the exercise price.
Amendment to IFRIC 14 ‘IAS 19 ‘The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ – ‘Prepayments of a Minimum Funding Requirement’ applies in the limited circumstances where an entity is subject to minimum funding requirements and makes an early payment of contributions to cover those requirements. The amendment permits the benefit of such an early payment to be treated as an asset.
May 2010 ‘Annual Improvements to IFRS’ makes non-urgent but necessary amendments to standards, primarily to remove inconsistencies and to clarify wording.
Expenditure on internally generated goodwill and brands is written-off as incurred. Direct costs relating to the development of internal-use computer software are capitalised once technical feasibility and economic viability have been established. These costs include payroll, the costs of materials and services, and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended. During and after development, accumulated costs are reviewed for impairment against the benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred as are all training costs and general overheads. The costs of licences to use computer software that are expected to generate economic benefits beyond one year are also capitalised.
7. Property, plant and equipment Items of property, plant and equipment (except investment property - see Accounting policy 9) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and long leasehold buildings 50 years Short leaseholds unexpired period of the lease Property adaptation costs 10 to 15 years Computer equipment up to 5 years Other equipment 4 to 15 years
If an asset does not generate cash flows that are independent from those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s cash-generating units or groups of cash-generating units expected to benefit from the combination. The recoverable amount of an asset or cash-generating unit is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cashgenerating unit that have not been taken into account in estimating future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value is not greater than it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
As lessee The Group’s contracts to lease assets are principally operating leases. Operating lease rental expense is included in Premises and equipment costs and recognised as an expense on a straight-line basis over the lease term unless another systematic basis better represents the benefit to the Group.
12. Insurance General insurance General insurance comprises short-duration contracts where the Group (the insurer) has accepted significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. Due to the nature of the products sold - predominantly property and motor - the insurance protection is provided on an even basis throughout the term of the policy. Consequently, written premiums are recognised over the period of the policy. Insurance premiums exclude insurance premium tax. Unearned premiums represent the proportion of the net premiums that relate to periods of insurance after the balance sheet date and are calculated over the period of exposure under the policy, on a daily or 24th's basis, or allowing for the estimated incidence of exposure under policies which are longer than twelve months. Provision is made where necessary for the estimated amount of claims over and above unearned premiums including that in respect of future written business on discontinued lines under the run-off of delegated underwriting authority arrangements. The provision is designed to meet future claims and related expenses and is calculated across related classes of business on the basis of a separate carry forward of deferred acquisition expenses after making allowance for investment income.
Acquisition expenses relating to new and renewed business for all classes of general insurance business are expensed over the period during which the premiums are earned. The principal acquisition costs so deferred are commissions payable, and costs associated with the telesales and underwriting staff. Claims and the related reinsurance are recognised in the accounting period in which the loss occurs. The Group cedes insurance risk in the normal course of business. Reinsurance assets represent balances due from reinsurance companies. Amounts recoverable from reinsurers are estimated on a basis consistent with the outstanding claims provision or settled claims associated with the reinsurer's policies and are in accordance with the related reinsurance contract. Reinsurance assets are reviewed for impairment at each reporting date or more frequently when an indication of impairment arises during the reporting year. Provision is made for the cost of settling outstanding claims at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date, and claims handling expenses. Provisions are only discounted where claims, principally motor, either have been or are expected to be settled by periodical payments. Related reinsurance receivables are recognised on the same basis and at the same time.
Current tax is income tax payable or recoverable in respect of the taxable profit or loss for the year arising in income or in equity. Provision is made for current tax at rates enacted or substantively enacted at the balance sheet date.
Available-for-sale financial assets - financial assets that are not classified as held-to-maturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see Accounting policy 3) as are gains and losses attributable to the hedged risk on available-for-sale financial assets that are hedged items in fair value hedges (see Accounting policy 24). Other changes in the fair value of available-for-sale financial assets and any related tax are reported in other comprehensive income until disposal, when the cumulative gain or loss is reclassified from equity to profit or loss.
Reclassifications - held-for-trading and available-for-sale financial assets that meet the definition of loans and receivables (non-derivative financial assets with fixed or determinable payments that are not quoted in an active market) may be reclassified to loans and receivables if the Group has the intention and ability to hold the financial asset for the foreseeable future or until maturity. The Group typically regards the foreseeable future as twelve months from the date of reclassification. Additionally, held-fortrading financial assets that do not meet the definition of loans and receivables may, in rare circumstances, be transferred to available-forsale financial assets or to held-to-maturity investments. Reclassifications are made at fair value. This fair value becomes the asset's new cost or amortised cost as appropriate. Gains and losses recognised up to the date of reclassification are not reversed.
Financial liabilities designated as at fair value through profit or loss include structured liabilities issued by the Group: designation significantly reduces the measurement inconsistency between these liabilities and the related derivatives carried at fair value; and in 2009 investment contracts issued by the Group's life assurance businesses: fair value designation significantly reduces the measurement inconsistency that would arise if these liabilities were measured at amortised cost.
20. Derecognition A financial asset is derecognised when the contractual right to receive cash flows from the asset has expired or when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either (a) transfers the contractual rights to receive the asset's cash flows; or (b) retains the right to the asset's cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. The asset remains on the balance sheet if substantially all the risks and rewards have been retained. It is derecognised if substantially all the risks and rewards have been transferred. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If it has not retained control, the asset is derecognised. Where the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement.
A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires. On the redemption or settlement of debt securities (including subordinated liabilities) issued by the Group, the Group derecognises the debt instrument and records a gain or loss being the difference between the debt's carrying amount and the cost of redemption or settlement. The same treatment applies where the debt is exchanged for a new debt issue that has terms substantially different from those of the existing debt. The assessment of whether the terms of the new debt instrument are substantially different takes into account qualitative and quantitative characteristics including a comparison of the present value of the cash flows under the new terms with present value of the remaining cash flows of the original debt issue discounted at the effective interest rate of the original debt issue.
Gains and losses arising from changes in the fair value of derivatives that are not the hedging instrument in a qualifying hedge are recognised as they arise in profit or loss. Gains and losses are recorded in Income from trading activities except for gains and losses on those derivatives that are managed together with financial instruments designated at fair value; these gains and losses are included in Other operating income.