Net interest income was up £121 million ($357 million), or 6%, to £2,013 million ($3,317 million) driven by a larger investment portfolio, loan growth including the transfer of assets from Non-Core, the benefit of interest rate swaps and deposit pricing discipline. This was partially offset by a reduction in loan spreads, reflecting the impact of the relatively persistent low-rate environment on loan yields, higher borrowing costs related to subordinated debt issuances and the impact of lost revenue from the Illinois franchise sale.
($3.4 billion) transfer of assets from Non-Core, commercial loan growth, auto loan organic growth and purchases of residential mortgages and auto loans, which were partially offset by a reduction in home equity loans.
Excluding the gain on the sale of the Illinois franchise of £170 million
($283 million), non-interest income was down £175 million ($205 million), or 16%, to £898 million ($1,474 million) reflecting lower securities gains of £70 million ($116 million), lower mortgage banking fees of £32 million
($52 million), as refinancing volumes have slowed, lower deposit fees of £32 million ($52 million) due to a change in the posting order of transactions and the impact of lost revenue from the Illinois franchise sale. This was partially offset by underlying strength in commercial banking fee income. Mortgage origination activity has slowed as market rates have risen, leading to lower applications combined with lower levels of gains on sales of mortgages.
Restructuring costs include costs related to the sale of the Illinois franchise, separation from RBS, as well as efforts to improve processes and enhance efficiency.
Impairment losses increased by £41 million ($80 million) to £197 million
2013 compared with 2012 Operating profit of £605 million ($947 million) was down £155 million
Excluding the £88 million ($138 million) litigation settlement in 2012 relating to a class action lawsuit regarding the way overdraft fees were assessed on customer accounts prior to 2010 and the £8 million ($13 million) litigation reserve associated with the sale of Visa B shares, total expenses of £2,204 million ($3,448 million) were broadly in line with prior year. This largely reflects a mortgage servicing rights impairment recapture driven by the increase in long-term rates offset by the cost of regulatory compliance and new technology investments and a one-off £21 million ($33 million) pension gain in 2012.
Notes: (1) Performing assets are those with an internal asset quality band of AQ1-AQ9; and non-performing assets are in AQ10 with a probability of default being 100%. (2) RWA equivalent (RWAe) is an internal metric that measures the equity capital employed in segments. RWAe converts both performing and non-performing exposures into a consistent capital measure, being the sum of the regulatory RWAs and the regulatory capital deductions, the latter converted to RWAe by applying a multiplier. RBS applies a CET1 ratio of 10% for RCR; this results in an end-point CRR RWAe conversion multiplier of 10.
(3) The most significant component of capital deductions relate to expected loss less impairment provisions of £518 million. The negative capital deductions for performing exposures are a result of the latent loss provisions held in respect of the performing portfolio.
Funded assets 1 January 31 December 2014 Repayments Disposals (1) Impairments Other 2014 £bn £bn £bn £bn £bn £bn
RWA equivalent (4) 1 January Risk 31 December 2014 Repayment Disposals (1) parameters (2) Impairments Other (3) 2014 £bn £bn £bn £bn £bn £bn £bn
Notes: (1) Includes disposal groups. (2) Impairment (releases)/losses include those relating to AFS securities; sector analyses above include allocation of latent impairment charges.
RCR funded assets were reduced by £14 billion, or 48%, during 2014, driven by disposals and repayments.
The original target was for RCR to reduce funded assets by between 55% to 70% by the end of 2015 and by 85% over three years from 1
RCR continues to be funded primarily by RBS Treasury and has no material third party deposits.
The funding is based on the original target of reducing third party assets by 85% over three years from the creation of RCR on 1 January 2014.
Loan impairment charge as a % of gross customer loans and advances
Notes: (1) Includes losses on disposals of £221 million for 2013 (2012 - £14 million). (2) Asset-backed products include super asset-backed structures and other asset-backed products. (3) Includes £3,118 million pertaining to the creation of RCR and related strategy. (4) Includes disposal groups.
Approximately £12 billion of assets which were managed by Non-Core were returned to the relevant originating segments, with the remaining assets transferring to RCR from 1 January 2014.
Risk-weighted assets were £31 billion lower, driven by disposals and run-off.
strategy to exit these assets over a shorter timeframe than previous plans, which has led to increased impairment losses on the nonperforming assets.
Operating loss before impairment losses was £298 million higher with a reduction in net interest income of £343 million, £207 million additional disposal losses and £104 million further fair value writedowns offset by £506 million lower losses from trading activities.
Consolidated balance sheet at 31 December 2014 2014 2013 2012 £m £m £m
Total assets of £1,050.8 billion at 31 December 2014 were up £22.9 billion, 2%, compared with 31 December 2013. This was driven by markto -market increases in derivative assets, partly offset by a reduction in funded assets, primarily in CIB and RCR.
(‘reverse repos’), down £5.8 billion, 22%, to £20.7 billion, bank placings declined £4.5 billion, 16%, to £23.0 billion.
(equivalent 2013 - £50.6 billion) of customer balances relating to Citizens together with run-down and disposals in RCR.
Equity shares decreased by £3.2 billion, 36%, to £5.6 billion primarily due to the ongoing run-down of the CIB equities business.
Property, plant and equipment decreased by £1.7 billion, 22%, to £6.2 billion driven largely by disposals of investment properties and the transfer of Citizens to assets of disposal groups.
Deposits by banks decreased £3.3 billion, 5%, to £60.7 billion, with increases in inter-bank deposits, up £0.5 billion, 1%, to £35.8 billion and decreases in repurchase agreements and stock lending (‘repos’), down £3.8 billion, 13%, to £24.9 billion, as a result of the transfer of £6.8 billion of Citizens’ bank deposits to liabilities of disposal groups, partly offset by higher derivative cash collateral.
Group’s Main scheme as part of the schedule of additional contributions to eliminate the deficit in the scheme which were agreed following completion of the triennial valuation of the Main scheme.
Total assets of £1,027.9 billion at 31 December 2013 were down £284.4 billion, 22%, compared with 31 December 2012. This was driven by the downsizing of the CIB business, primarily reflected in decreases in loans to banks and customers, debt securities and derivatives balances, and a further decrease in loans and advances to banks and customers due to
(‘reverse repos’), down £8.3 billion, 24%, to £26.5 billion, bank placings declined £1.6 billion, 6%, to £27.6 billion.
Loans and advances to customers declined £59.4 billion, 12%, to £440.7 billion. Within this, reverse repurchase agreements were down £20.1 billion, 29%, to £49.9 billion. Customer lending decreased by £39.3 billion, 9%, to £390.8 billion, or £35.2 billion to £416.0 billion before impairments. This reflected reductions in Non-Core of £19.9 billion, along with declines in CIB, £11.1 billion, Ulster Bank, £1.9 billion, UK Personal
Movements in the value of derivative assets, down £153.9 billion, 35%, to £288.0 billion, and liabilities, down £148.8 billion, 34% to £285.5 billion, primarily reflects upward shifts in major yield curves which resulted in significant mark-to-market decreases on interest rate contracts.
Property, plant and equipment decreased by £1.9 billion, 19%, to £7.9 billion driven largely by the disposal of Non-Core assets.
Intangible assets decreased by £1.2 billion, 9%, to £12.4 billion primarily as a result of the write-down of goodwill relating to the former
Deposits by banks decreased £37.4 billion, 37%, to £64.0 billion, with decreases in inter-bank deposits, down £21.7 billion, 38%, to £35.3 billion and repurchase agreements and stock lending (‘repos’), down £15.7 billion, 35%, to £28.7 billion, as a result of lower funding requirements and reduced derivative cash collateral.
Banking, £1.0 billion and Ulster Bank, £0.7 billion, which included the impact of £3.2 billion of customer deposits being transferred to liabilities of disposal groups at 31 December 2013, and the effect of exchange rate and other movements of £3.4 billion. These decreases were partially offset by increases in UK Personal & Business Banking, £9.8 billion.
Debt securities in issue decreased £26.8 billion, 28%, to £67.8 billion due to lower funding requirements as a result of the reduction in the overall size of the balance sheet, with most of the reduction in medium term notes in issue.
Net cash outflows from financing activities of £404 million relate primarily to the repayment of subordinated liabilities of £3,480 million and interest paid on subordinated liabilities of £854 million partly offset by the issue of subordinated liabilities of £2,159 million and proceeds of non-controlling interests issued of £2,147 million.
The major factors contributing to the net cash outflow from operating activities of £30,631 million were the decrease of £28,780 million in operating assets and liabilities, the net loss before tax of £8,066 million from continuing and discontinued operations, loans and advances written-off net of recoveries of £4,090 million and other provisions utilised of £2,066 million. These were partially offset by provisions for impairment losses of £8,432 million and other provisions charged net of releases of
The major factors contributing to the net cash outflow from operating activities of £45,113 million were the decrease of £48,736 million in operating assets and liabilities, the net loss before tax of £5,388 million from continuing and discontinued operations, loans and advances written off net of recoveries of £3,925 million and other non-cash items of £1,491 million. These were partially offset by the elimination of foreign exchange differences of £7,140 million, provisions for impairment losses of £5,283 million and depreciation and amortisation of £1,854 million.
The following table analyses RBS's regulatory capital resources on a fully consolidated basis at 31 December as monitored by the Prudential Regulation
Note: (1) Common Equity Tier 1 ratio with effect from 1 January 2014.
It is RBS's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, RBS
has regard to the supervisory requirements of the PRA. The PRA uses risk asset ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are 'weighted' to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31
December 2014, RBS's total RAR on an end-point CRR basis was 13.7% (2013 - 16.5% on a Basel 2.5 basis) and the Tier 1 RAR on an end-point CRR
Loss from discontinued operations, net of tax (3,445) — — (3,445)
Profit from discontinued operations, net of tax 558 — — 558
Loss attributable to ordinary and B shareholders (8,995) — — (8,995)
Reallocation of one-off items CFG (1) Statutory £m £m £m £m
Balance Disposal disposal Balance Disposal disposal Balance Disposal disposal sheet groups (1) groups sheet groups (2) groups sheet groups (3) groups £m £m £m £m £m £m £m £m £m
Loans and advances to banks 43,735 1,745 45,480 54,071 63 54,134 63,951 2,112 66,063
Loans and advances to customers 378,238 60,550 438,788 440,722 1,765 442,487 500,135 1,863 501,998
Notes: (1) Primarily Citizens. (2) Primarily investment in associate (Direct Line Group) and Illinois branches of Citizens. (3) Primarily Direct Line Group. (4) Excludes reverse repos.
Capital and risk management 176 Risk governance 180 Risk appetite and culture 184 Conduct risk 187 Operational risk 191 Regulatory risk 193 Reputational risk 195 Capital management 216 Liquidity and funding risk 231 Credit risk 274 Balance sheet analysis 298 Market risk 323 Country risk 331 Pension Risk 332 Business risk 333 Strategic risk
Overview 170 Presentation of information 170 Business model and associated risks 171 Risk coverage 174 Top and emerging risk scenarios
Except as otherwise indicated by an asterisk (*), information in the
Capital and risk management section (pages 168 to 334) is within the scope of the Independent auditor’s report. Disclosures in this section include disposal groups in relevant exposures unless otherwise indicated.
Refer to pages 166 and 167 for the Analysis of balance sheet pre and post-disposal groups.
RBS aims to become a bank that its customers and all other stakeholders can depend on. It intends to do so by focusing on Personal & Business
Ulster Bank, part of PBB, offers loan and investment products, as well as transactional services, to individuals and businesses in Ireland.
The products are delivered through a diverse array of channels, including extensive branch networks, in-store branches and call centres, in addition to online and mobile channels.
Finally, RBS is also exposed to a range of other risks through its customer businesses including pension, business, regulatory, reputational and strategic risk. This is set out in the Risk coverage section and illustrated by the concentration of risk-weighted assets (RWAs) by segment below.
Conduct risk exists across all stages of RBS’s relationships with its customers, from sales through service delivery to post-sales processes. It also exists in the activities RBS undertakes to manage its business, from the development of business strategies, through governance and human resource management. Conduct risk also exists if RBS does not take effective action to prevent fraud, bribery and money laundering.
LIBOR submissions, and simplifying RBS’s retail product offering and sales processes. The conduct risk framework was also further developed, with the embedding of a new Conduct and Regulatory Affairs (C&RA) operating model, and the orientation of C&RA’s assurance coverage and testing towards customer outcomes.
The level of regulatory risk remained high as policymakers and regulators continue to strengthen regulations and supervision in response to the events of 2007 and 2008. RBS will in future focus CIB’s business model on its leading positions in UK rates, debt capital markets and foreign exchange; this will leave
AFS portfolio. A £3.1 billion improvement in CET1 capital and a £73 billion reduction in RWAs resulted in the CET1 ratio improving during the year by 260 basis points from 8.6% to 11.2%. Risk reduction strategies contributed to the
RWA reduction, £40 billion in CIB and £25 billion in RCR. The improvement in
From 1 January 2015, 56% of the total Pillar 2A or 2.0% of RWAs will be met from CET1 capital.
requirement would be 10.5% in 2019. Assuming a 13% a steady state CET1 capital ratio is achieved, RBS currently estimates that it would have a 2.5%
A significant reduction of £142 billion or 13% in the leverage exposure to £940 billion and a year on year increase in Tier 1 capital (100% CET1 currently)
contributed to an 80 basis points improvement in leverage ratio from 3.4% to 4.2%. Full implementation of the 2014 Basel III leverage ratio framework, particularly on securities financing transactions, also contributed to the leverage exposure reduction.
The most material threat to RBS’s reputation continued to originate from historical and more recent conduct deficiencies.
RBS has been the subject of investigations and review by a number of regulators, some of which have resulted in fines and public censure.
RBS’s credit risk portfolio continued to improve with an overall reduction in exposure, an improvement in credit quality and a material provision release in 2014. These improvements were driven by supportive economic and market conditions in the UK
Balance sheet credit exposure after credit mitigation decreased by 9% to £353 billion and credit RWAs fell by £62 billion or 17% to £295 billion primarily reflecting risk reduction and RCR
disposal strategy. The wind-down of CIB’s US asset-backed products business contributed to a £13 billion decrease in asset-backed securities, now at £25 billion, an £86 billion reduction on the 2008 peak of £111 billion.
Favourable market conditions, particularly in Ireland, resulted in impairment releases of £3.6 billion more than offsetting new impairment charges of £2.4 billion. This led to a net release of £1.2 billion, of which £1.3 billion was in RCR and £0.4 billion in
Ulster Bank, partly offset by net impairment charges of £0.3 billion in UK PBB and £0.2 billion in CFG.
Market risk The majority of RBS’s traded market risk exposure arises in CIB and
The majority of its non-traded market risk exposure arises from retail and commercial banking activities in all franchises from assets and liabilities that are not classified as held for trading.
RBS’s traded market risk profile decreased significantly, with market risk limits being reduced across all businesses, in some instances by 50-60%. Average trading value-at-risk (VaR)
Bank of Scotland Group Pension Fund (‘Main scheme’) and this is the principal source of pension risk.
It has the potential to affect all parts of RBS’s portfolio across wholesale and retail activities that are directly or indirectly linked to the country in question.
RBS maintained a cautious stance as many clients continued to reduce debt levels. Total eurozone net balance sheet exposure decreased by £5 billion or 5% to £97.6 billion. Within this amount, eurozone periphery exposures decreased by £10 billion, or 25%, to £31 billion, primarily in Spain, reflecting the disposal of legacy liquidity portfolio bonds, and in Ireland and
Russia and Ukraine were adjusted, additional credit restrictions were placed on new business and exposures were reviewed against international sanctions.
RBS reduced its business risk profile as it curtailed riskier activities in CIB, made disposals through RCR, and announced an intensified cost management programme.
Strategic risk Strategic risk arises from strategic decisions that fail to reflect the operating environment, or which do not take adequate account of execution challenges. These include decisions related to RBS
In early 2014, RBS announced the results of a strategic review with a defined plan to shift the business mix towards the UK
As part of the risk management process, top and emerging risk scenarios are identified and monitored. These are events that, should they materialise, would lead to a significant unexpected negative outcome, thereby causing RBS as a whole, or a particular business, to fail to meet one or more strategic objectives. In assessing the potential impact of risk materialisation, both financial and reputational considerations are taken into account.
Further information on these and other risks facing RBS is detailed in
The top and emerging risks were as follows: Macro-economic and other external risks
RBS remains vulnerable to changes in the external economic environment. Among other scenarios, the following could have a material negative impact: a recession in the UK in any of our other major markets; a resumption of the eurozone crisis (including a worsening of the situation in Greece); global deflation; large house price falls in the UK; and major geopolitical instability.
The ability to hit strategic targets could be reduced owing to multiple effects, including lower-than-expected revenues, increases in impairments and a material deterioration in key prudential metrics. Exiting non-strategic businesses or portfolios could be disrupted by market volatility.
RBS has improved its capital, liquidity and leverage ratios and has passed regulatory stress tests. A number of higher risk portfolios have been exited or reduced. Stress testing is used to inform strategic planning.
Political party statements suggest that the election outcome will affect matters that are material to RBS’s strategy, including banking levy rates, banking sector competition and remuneration, the approach to sale of the public stake, and the UK’s position in the EU. Of note is the potential for a referendum on the UK’s membership of the EU during the next parliament, which would increase macro-economic and operational uncertainty.
(i) Risks to income, costs and business models arising from existing and future regulatory requirements or decisions
RBS faces potentially sustained increases in regulatory capital needs, but also risks related to regulatory intervention that affect its business models. These include: the results of a review of the personal current account and small business banking markets; Independent Commission on Banking ring fencing proposals and US Intermediate Holding
(ii) Risks to income, costs and business models arising from existing and future regulatory requirements specifically related to conduct
RBS continues to manage issues related to its past business conduct.
Remediation costs for some of these could remain high, while the impact of outcomes of other reviews remains uncertain. Moreover, it faces ongoing scrutiny of its business conduct, particularly towards retail customers, and of its ability to embed a strong appreciation of risk and good conduct across the bank.
RBS continues to work to deal with past conduct breaches. Major programmes are in place to ensure that future conduct meets the expectations of external stakeholders and to ensure that a strong and pervasive risk culture is embedded throughout RBS.
RBS has a number of transformational, execution and IT development projects under way, the successful conclusion of which are essential to meet new regulatory and strategic requirements. These new requirements affect its organisational structure, its business strategies, its information technology systems, its operational processes and its product offerings. Given the number, scale and complexity of these projects, there is a risk that it will not complete them successfully.
Failure to complete these projects successfully would affect RBS’s ability to achieve its strategic objectives. It may also incur regulatory fines, lose market share and suffer damage to its reputation.
RBS is working to implement change in line with its project plans while assessing the risks to implementation and taking steps to mitigate those risks where possible.
RBS has established various pension schemes for its employees as a result of which it has incurred certain obligations as sponsor of these schemes. If economic growth stagnates and interest rates remain low as a result, the value of pension scheme assets may not be adequate to fund the pension scheme’s liabilities. All of the businesses are exposed to this risk.
The trustee is responsible for the investment of the Main scheme’s assets, which are held separately from RBS’s own assets. To restrict liability increases, defined benefit pension schemes are closed to new members and terms for existing members have been altered. Deficitclosing payments are spread over ten years to reduce the strain on income.
(iii) Impaired performance due to an inability to recruit or retain suitable staff
RBS is undergoing significant organisational change, the result of a need to implement new business strategies and respond to a changing external environment. The pace of change, coupled with the associated uncertainty may cause experienced staff members to leave and prospective staff members not to join. Although these risks concern all customer businesses, they particularly affect CIB and CFG.
If it cannot retain or attract the necessary staff members, the RBS may be unable to implement its business strategies or meet regulatory requirements on time, or at all. It may also experience control failures. Its reputation may suffer as a result.
RBS has communicated expected changes in its organisational structure to members of staff, implementing plans aimed at minimising unexpected staff losses. It is also working to develop and implement an enhanced recruitment strategy.
RBS has experienced cyber attacks, which are increasing in frequency and severity across the industry. This risk affects all customer businesses.
RBS has participated in an industry-wide cyber attack simulation. It has also initiated a large-scale programme to improve controls over user access. It has reviewed its websites and taken steps to rationalise them, put additional anti-virus protections in place and taken steps to educate staff on information protection.
The information technology systems are complex and at risk of disruption. Recovering from failure can be challenging.
Risk governance 177 Governance structure 178 Three lines of defence 179 Management structure
RBS is committed to achieving the highest standards of corporate governance in every aspect of its business, including risk management. A key aspect of the Board’s responsibility as the main decision-making body is the setting of risk appetite (refer to page 181 for more information on risk appetite) to ensure that the levels of risk RBS is willing to accept in the attainment of its strategic business and financial objectives are clearly understood. The
The risk governance structure and the main purposes of each of the committees is illustrated below: *unaudited
The three lines of defence model is used industry-wide for the management of risk. It provides a clear set of principles by which to implement a cohesive operating model, one that defines accountabilities and responsibilities for managing risk across the organisation.
Responsibilities include: • Owning, managing and supervising, within a defined risk appetite, the risks which exist in the business area.
• Ensuring that the culture of the business supports balanced risk decisions and compliance with policy, laws and regulations.
The second line of defence includes RBS Risk Management and Conduct and Regulatory Affairs.
• Analysing the aggregate risk profile and ensuring that risks are being managed to the desired level (risk appetite).
RBS’s management structure and the main elements of each role are illustrated below.
RBS Risk Management is an independent function, structured by risk discipline to facilitate the effective management of risk.
In 2014, Risk Management, which had previously been spread across the different business segments, re-organised itself into five functional areas: Operational Risk, Support Functions & Divested Businesses; Credit Risk; Market Risk; Enterprise-Wide Risk Management and Risk Infrastructure. Directors of Risk were also appointed for each of the franchises and for Services. The streamlined structure consolidates risk information, allowing for more efficient decision-making.
The directors of risk functions are responsible for RBS-wide risk appetite and standards within their respective disciplines and report directly to the CRO.
CROs are in place for certain jurisdictions and legal entities to meet local regulatory and governance requirements. They lead the risk management teams locally in support of functional risk heads where teams follow a functional operating model. The key CRO roles report directly to the RBS CRO.
Conduct & Regulatory Affairs (C&RA) is led by the Chief Conduct & Regulatory Affairs Officer, who reports directly to the Chief Executive. It is responsible for providing oversight of conduct risk and regulatory risk at RBS, and does so by setting bank-wide policy and standards, providing advice to each customer business, and ensuring that the mitigating controls are suitable. C&RA also provides leadership of the bank’s relationships with its regulators.
The functional heads (the directors of Remediation, Compliance Services, RBS Americas, Financial Crime, Regulatory Affairs and Advisory) report directly to the Chief Conduct & Regulatory Affairs Officer. Each is responsible, where appropriate, for the bank-wide risk appetite and standards of their respective areas: A Chief Compliance Officer in each franchise, reporting to the Director of C&RA Advisory, provides advisory support to assist businesses in their management of conduct, regulatory affairs and financial crime.
Risk appetite and culture 181 Risk appetite 181 Strategic risk objectives 182 Risk appetite measures 183 Culture, values and remuneration
The risk appetite framework seeks to ensure that each business can withstand significant deteriorations in economic and market conditions.
• Wider obligations to stakeholders - If RBS is safe and sound and puts serving customers at the heart of its thinking, it will also perform well for its owners, employees, regulators and communities.
Risk management plays an integral role in the delivery of strategic goals.
Financial strength and resilience are at the heart of the strategic plan.
RBS has defined this level of robustness as that which is capable of achieving and sustaining a standalone credit rating (i.e. without government support) that is in line with those of its strongest international peers.
• Ensure stable and efficient access to funding and liquidity. To ensure that there is sufficient funding to meet its obligations, taking account of the constraint that some forms of funding may not be available when they are most needed.
Each objective is essential in its own right, but also mutually supportive of the others. The strategic risk objectives are the bridge between the RBSwide business strategy and the frameworks, limits and tolerances that are used to set risk appetite and manage risk in the business franchises on a day-to-day basis.
Board and is cascaded through key targets, limits and risk tolerances that influence decision making at all levels.
• Qualitative risk appetite targets - The fourth strategic risk objective of maintaining stakeholder confidence covers qualitative aspects relating to the culture of risk management and controls and meeting stakeholder expectations. Stakeholders include customers, employees, investors, societies and communities.
Risk appetite supports value creation in a safe, sustainable way. It is embedded within the annual planning and budgeting process. The risk implications of business strategies are assessed to ensure that those strategies will not cause RBS to exceed agreed risk appetite. A range of different but complementary tools has been developed to measure whether strategic plans are consistent with risk appetite, to test broader
‘what if’ questions and to assess the impact of changes in key assumptions: • Stress testing - assesses how earnings, capital and funding positions change under an unfavourable, yet plausible, scenario.
• Economic capital - provides complementary insights, with a breadth of understanding of risk profile changes and ‘tail risks’ across millions of different modelled scenarios.
• Sensitivity analysis - provides ‘ready reckoners’ around changes in key variables. It offers a high-level view on questions such as ‘what if gross domestic product worsened by a further 1%’, identifying certain tipping points where the bank’s risk profile moves outside appetite.
By setting a clear risk appetite and embedding a strong risk culture throughout its businesses, RBS can identify, measure and control risk exposures and respond effectively to shocks. Each franchise is responsible for ensuring its strategic plans are consistent with its approved risk appetite.
The Group Policy Framework directly supports the qualitative aspects of risk appetite, helping to rebuild and maintain stakeholder confidence in
RBS’s risk control and governance. Its integrated approach is designed to ensure that an appropriate standard of control is set for each of the material risks it faces, with an effective assurance process put in place to monitor and report on performance. Risk appetite has its own policy standard within the Group Policy Framework. This standard sets out clear roles and responsibilities to set, measure, cascade and report performance against risk appetite, and provides assurances that business is being conducted within approved risk limits and tolerances.
The establishment of a strong risk culture is essential to the realisation of
A core principle behind the development of the risk appetite framework is that risk appetite contributes to a strong risk management culture, in which risk is clearly and meaningfully aligned with business behaviours and outcomes. RBS’s values - of “serving customers”, “working together”,
“doing the right thing” and “thinking long term” - act as a clear starting point for a strong and effective risk culture. A wide range of communication and engagement activities (detailed below) has been undertaken to discuss the meaning of each value with employees and how they affect and guide day-to-day activities.
• Is what I am doing meeting the standards of conduct required?
RBS’s values. It ensures that employees can think through decisions that do not have a clear answer, guiding the judgements behind their decisions and actions.
RBS-wide remuneration policy requires remuneration to be aligned with, and to support, effective risk management. The policy ensures that the remuneration arrangements for all employees reflect the principles and standards prescribed by the UK Remuneration Code. For further information refer to page 91.
Conduct risk is the risk that the behaviour of RBS and its staff towards customers, or in the markets in which it operates, leads to unfair or inappropriate customer outcomes and results in reputational damage, financial loss or both. The damage or loss may be the result of breaches of regulatory rules or laws, or of failing to meet customers’ or regulators’
Conduct risk exists across all stages of RBS’s relationships with its customers, from the development of its business strategies, through governance arrangements, to post-sales processes. Activities through which conduct risk may arise are diverse and include product design, marketing and sales, complaint handling, staff training, and handling of confidential and non-public price sensitive information. Conduct risk also exists if RBS does not take effective action to prevent fraud, bribery and money laundering.
The level of conduct risk remained high throughout 2014. As set out in the Litigation, investigations and reviews section on page 430, RBS and certain members of it are party to legal proceedings and are subject to investigation and other regulatory action in the UK, the US and other jurisdictions.
The conduct risk framework was also further developed. Key elements included: • Orientating C&RA’s assurance coverage and testing towards customer outcomes, and away from controls and policy compliance; • Establishing a Conduct Advisory function with the expertise and skills to effectively interrogate and assess business models, strategy and products; provide oversight, challenge and technical policy advice; and make selective risk-based interventions; • Transferring accountability for RBS-wide customer remediation to
• Strengthening the whistleblowing framework by aligning the policy with RBS values.
Effective conduct risk management is a commercial imperative for the bank: customers, clients and counterparties demand it as a precursor to building trust. It also reflects the developing regulatory environment in the
Key elements of the governance structure are set out below: • The C&RA Executive Committee considers emerging issues material to the C&RA strategy, and implements Board and
Under the RBS Policy Framework, C&RA owns 26 conduct risk policies, grouped under employee, corporate and market conduct, and; and conduct towards customers. Each policy is designed to provide both highlevel direction and RBS-wide requirements. The policies and chapters are designed to ensure RBS meets its regulatory obligations; and to provide the necessary clarity for staff on their conduct obligations.
A conduct risk appetite framework is being developed to ensure that
RBS’s senior boards and committees receive updates on conduct risk exposures and action plans through monthly C&RA initiated reporting.
An annual Money Laundering Reporting Officer’s Report is submitted to the Board and the FCA. Covering the operation and effectiveness of the systems and controls in place to comply with Anti-Money Laundering law and regulation, it also describes RBS’s AML framework. In addition, it covers the systems and controls in place to prevent the financing of terrorism and to ensure compliance with sanctions as well as embargoes and export controls imposed by the UN, governments and other supranational bodies.
Update Report. It details cases by internal reporting categories based on the Public Interest Disclosure Act (1998) category, identifies underlying causal and subject trends, and highlights the outcome of investigations and actions taken.
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or external events. It arises from day-to-day operations and is relevant to every aspect of the business.
Operational risk failures may also have a link with conduct risk as evidenced by customer complaints made in connection with Payment
Operational risk may arise from a failure to manage operations, transactions and assets appropriately. It may arise from forms of human error, an inability to deliver change on time or adequately, or the unavailability of technology services or the loss of customer data. Fraud and theft are sources of operational risk, as is the impact of natural and man-made disasters. It may also arise from a failure to take appropriate measures to protect assets or take account of changes in law.
RBS’s transformation programme is material and complex, affecting all business areas and functions simultaneously, and so it has the potential to increase the operational risk profile at least in the short term. The risks associated with transformation are being managed in accordance with the operational risk framework and the programme management infrastructure.
A key component of the programme was the implementation in 2014 of a new functional operating model for operational risk to ensure it is managed in a more standardised and consistent manner. The new operating model supplemented activity undertaken by the customer businesses to increase understanding of the operational risk profile and the actions required to mitigate risks outside of appetite.
(ORMF). This will continue in 2015 and beyond. The intention is to improve the ability to identify and assess operational risk by delivering an
Following the major IT incident that occurred in 2012, a programme was created to address the weaknesses identified, with its core objective to deliver improvements to the technology processes, as well as the efficiency and resilience of those processes, through a number of key workstreams. In 2014, this programme improved technology resilience for core banking services, operating practices and risk management across the three lines of defence. Significant investments were made in upgrading infrastructure and in improving a broad range of processes and tools.
A strong operational risk management function is vital to support the bank’s profitability. Better management of operational risk directly supports RBS’s strategic objective of improving stakeholder confidence and is vital for stability and reputational integrity.
The operational risk function, an independent second line of defence, plays a leadership role and seeks to achieve a robust risk management framework and culture across the bank. The Director of Operational Risk,
The operational risk function is responsible for the design and maintenance of the ORMF. The Operational Risk Policy and associated standards are incorporated in the Group Policy Framework and provide direction for the consistent identification, assessment, management, monitoring and reporting of operational risk.
The Operational Risk Executive Committee (OREC), which is a subcommittee of the Executive Risk Forum, acts on all operational risk matters. This includes reviewing the exposure against risk appetite; identifying and assessing material operational risks, encompassing both current and emerging material risks; reviewing and monitoring the operational risk profile; and reviewing and approving material policy changes.
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 customer journey and the cost of minimising the risk against the resultant reduction in exposure. Strategies to manage operational risk include avoiding undertaking a particular type of activity or operating in a particular market; transferring the risk to a third party; accepting the risk as a cost of doing business; or mitigating the risk by implementing controls.
Operational risk appetite measures and frameworks are reviewed annually by the Executive Risk Forum (ERF). The operational risk appetite statement comprises a number of specific measures of risk, including operational risk capital adequacy and earnings volatility based on the relationship between operational risk losses and the bank’s estimated gross income. It also includes metrics covering control environment performance. To confirm that RBS operates within the set risk appetite, the high-level statement is aligned with strategic risk objectives.
Operational risk appetite measures will be further refined in 2015, with particular focus on developing an integrated operational risk appetite framework which will be used to translate high-level objectives into achievable risk appetite measures across RBS.
The process is designed to confirm that risks are effectively managed and prioritised in line with the stated risk appetite. Controls are tested frequently to verify that they remain fit for purpose and operate effectively. Risk assessments are typically commenced in a workshop, bringing together subject matter experts and key stakeholders from across the bank. Financial and non-financial risk impacts are captured and a risk appetite decision is made.
In 2014 there was a continued focus on implementing and embedding risk assessments across the bank. This included the strengthening of links between risk assessments and other elements of the operational risk framework. In 2015, the risk framework will be further enhanced by the introduction of end-to-end risk assessments which will help provide a fuller understanding of the risk profile of the bank’s key services and products.
The New Product Risk Assessment (NPRA) process aims to ensure that the risks represented by new products (and material variations to existing products) are identified and assessed before launch. There is now a requirement to demonstrate that all products provide fair outcomes to customers. Further enhancements to the NPRA process are under review and are expected to be introduced in 2015.
Monitoring and reporting are part of RBS’s operational risk management processes, which aim to ensure that risks and issues are identified, escalated and managed quickly. Emerging risks, and actions taken to mitigate them, are discussed at OREC. These are reported to the Board and the ERF. Exposures specific to each business are communicated through monthly risk and control reports that are discussed at business risk committees.
Scenario analysis is used to assess the impact of extreme but plausible operational risks and is a key input to the capital model. It provides a forward-looking basis for managing risk exposures, with a structured and consistent approach to scenario scoping and measurement. Coupled with internal and external loss data, it has a major impact on the estimated capital requirements. Scenarios, along with internal and external loss data, are a key input into the capital model and influence the capital required significantly.
The impact of the Prudential Regulation Authority’s Anchor 6 scenario on operational risk capital, as calculated under the standardised approach, was also projected based on the outputs of the bank’s stress-testing exercises. Operational risk impacts are also assessed based on additional economic stress scenarios developed internally. This is used as part of the overall stress input to capital planning and internal capital adequacy assessment process (ICAAP).
As a true risk sensitive measurement, this model is being rolled out across RBS to ensure better information is available to businesses to help manage their risk profile.
RBS senior management. RBS has continued to focus on the timely and accurate capture of operational risk losses; the use of a single RBS-wide repository of operational risk events; and the escalation of material operational risk events.
At 31 December 2014, four categories accounted for around 94% of all operational risk events. These were: (i) clients, products and business practices; (ii) execution, delivery and process management; (iii) fraud; and (iv) employment practices and workplace safety. This proportion was broadly in line with that of 2013
A small number of operational risk events contribute a high percentage of the total losses. In 2014, around 1% of the events contributed 96% of the losses. This was in line with that of 2013.
Regulatory risk is the risk of material loss or liability, legal or regulatory sanctions, or reputational damage, resulting from the failure to comply with (or adequately plan for changes to) relevant official sector policy, laws, regulations, or major industry standards, in any location in which
Regulatory risk arises from the regulatory, business or operating environment and from RBS’s response to it.
Bank-Wide Investment Committee, and comprises representatives of the bank’s customer businesses and functions. The MCAC acts as the
Committee also captures all material investigations and tracks the status of, and trends in, key regulatory relationships.
C&RA also communicates information on regulatory developments and follow-up engagement with customer-facing businesses and functions, helping them identify and execute any required mitigating changes to strategy or business models. The key regulatory policies are reviewed annually.
Early identification and effective management of changes in legislation and regulation, as well as other requirements, is critical to the successful mitigation of regulatory risk. All regulatory and compliance changes are managed to ensure timely compliance readiness. Those changes assessed as having a ‘high’ or ‘medium-high’ impact are managed especially closely, with the aim of mitigating the impact through, for instance, changes to strategy or business activities, or external engagement.
Reputational risk 194 Sources of risk 194 Key developments in 2014 194 Risk appetite 194 Risk monitoring and measurement 194 Risk mitigation
A high-level Reputational Risk Policy was also developed to help employees, businesses and functions effectively identify, assess and manage issues that present reputational risks.
The Board and the Executive Committee have the ultimate responsibility for managing RBS’s reputation although all staff have some responsibility. The Board has set RBS’s Purpose, Vision and Values, which outline the objective, which is “to be trusted, respected and valued by our customers, shareholders and communities”. Refer to the Risk governance section on page 176.
Prohibited. Customers or transactions designated Sensitive require enhanced due diligence and escalation to a reputational risk forum or individual while those rated Normal can be approved by the business without additional escalation. The team also helps set risk appetite to manage reputational risk related to business engagements and customer relationships in some sensitive industry sectors, such as mining and defence, through the ESE policy framework.
A Reputational Risk Policy has also been developed to help employees, businesses and functions effectively identify, assess and manage issues that potentially represent a reputational risk. In addition, other policies, such as those related to conduct, address key sources of reputational risk. These policies are implemented in accordance with the Policy
Operational risk section on page 187). Reputational aspects also form a core part of the RBS conduct risk framework, with a series of enhanced policies developed in line with conduct risk appetite.
BRC, may also discuss reputational risks facing RBS, and the annual
Reputational risk is mitigated through governance frameworks and training of staff to ensure early identification, assessment and escalation of customers, transactions or products with potential reputational risk, if appropriate. This includes creating appropriate fora, for example reputational risk committees or individual reputational risk approvers.
Capital management 196 Capital strategy 196 Overview and key developments 196 Regulatory capital requirements 197 Capital and stress testing management framework 198 Assessing, monitoring and maintaining adequate capital 199 Risk identification and material integrated risk assessment (MIRA)
203 Capital planning 204 Future regulatory developments 205 Other developments 206 - Capital and leverage ratios 210 - Risk-weighted assets 212 EAD and RWA density 214 Accounting to regulatory consolidation bridge 215 Balance sheet to EAD bridge
RBS has set out its strategy to be truly customer-centric, built upon high levels of customer service and trust, delivering attractive and consistent returns and underpinned by unquestioned safety and soundness. It includes key risk metrics aligned to the strategic objectives (for example a target Common Equity Tier 1 (CET1) ratio).
RBS has devised a risk appetite framework aligned to the above. This framework establishes appetite targets on quantitative and qualitative measures which are set by the Board and aligned with its key strategic risk objectives including maintaining sufficient capital resources to meet regulatory requirements and cover the potential for unexpected losses
• RBS’s CET1 ratio was 11.2% at 31 December 2014, an improvement of 260 basis points compared with 8.6% as at 31
• Key milestones achieved in 2014 include: ° partial IPO of CFG; ° run down of RCR and CIB assets; and
° disposal of €9 billion of higher risk legacy available-for-sale securities, thereby reducing stressed capital and RWAs.
CIB restructuring and expects to achieve this by the end of 2016.
CRD IV imposes the following minimum requirements to be met by 2019: • Pillar 1 requirement of: CET1 of 4.5% of RWAs; Tier 1 of 6%; and total capital of 8%; • Capital buffers: capital conservation buffer of 2.5% of RWAs; countercyclical capital buffer of up to 2.5%; Global-Systemically
allocation of Pillar 2A is restricted to 19% Tier 1 and 25% Tier 2.
• All regulatory deductions from capital must align CET1 with the endpoint definition from January 2014, effectively making fully loaded
Basel III the regulatory definition, a stricter approach than the CRR
On 31 October 2014 the Financial Policy Committee (FPC) published its recommendation on the overall leverage ratio framework for the UK
banking system as follows: • Minimum Tier 1 leverage ratio of 3%. To be met 75% by CET1 and a maximum 25% AT1; • A supplementary leverage buffer applying to G-SIBS equal to 35%
of the corresponding risk-weighted systemic risk buffer rates to be met with CET1; and
• A countercyclical leverage ratio buffer equal to 35% of the riskweighted countercyclical capital buffer rate to be met from CET1.
This section covers a number of tools and processes which taken together contributed to an integrated view of capital management and is best presented by the diagram below.
The Board is the main decision making forum at RBS. It sets the strategic direction and ensures RBS manages risk effectively by approving and monitoring RBS’s strategic risk appetite, considering RBS-wide stress scenarios and agreed mitigants, as well as identifying longer-term strategic threats to the business operations. The Board approves the
relative to risk appetite, provide oversight of the effectiveness of key
Authority is delegated to the BRC by the Board and the BRC reports and makes recommendations to the Board as required.
and makes recommendations to the ERF on asset quality reviews and stress testing, including the key vulnerabilities and scenario themes identified, the results from the generated scenarios and expanded metrics to be used in both internal and regulatory enterprise-wide stress tests.
STC ensures these are relevant and reflect RBS business model vulnerabilities, and the results of both internal stress, reverse stress and regulatory enterprise-wide stress tests (including mitigants).
Guidance or minimum CET1 levels are met. RBS has a control framework in place to guard against accidental breaches in capital ratios.
Principal among these is a profitability metric, which assesses the effective use of the capital allocated to the business. Projected and actual return on equity is assessed against strategic objectives. The allocations also reflect strategic priorities, the intensity of regulatory capital use and the usage of other key resources such as balance sheet liquidity and funding.
Economic profit is also planned and measured for each business annually. It is calculated by deducting the cost of equity utilised in the particular business from its operating profit after tax and measures the value added over and above the cost of equity.
The franchises use return on capital metrics when making pricing decisions on products and transactions, to ensure customer activity is appropriately aligned with RBS and segmental targets.
• MIRAs are annual ‘top down’ processes to: ° help identify material risks; ° understand the nature and magnitude of these risks clearly; and
• MIRAs provide a process to assess the size and nature of exposure to all risk types in the risk taxonomy, which is an exhaustive, structured list of the types of risk that RBS can and could face.
Stress testing is part of the financial and capital planning process and results are presented to senior management (and BRC/Board) at least semi-annually. It is now an integral part of enterprise risk management and used to assess the impact of business decisions on the bank's capital position. The stress testing process has four key stages: • Define stress scenario: ° RBS-specific vulnerabilities are identified and linked to development of relevant stresses; ° Scenario is defined, severity calibrated and full parameterisation completed; and
° Governance is put in place for stress theme approval and scenario validation.
• Consolidation and capital planning: ° Segmental results are consolidated to provide the total view of stress impact; ° Stressed profit and loss and RWA assessment contribute towards arriving at a stressed capital plan; ° Additional capital impacts under stress are considered such as pension deficit, foreign exchange reserves; and
° Final stressed CET1 ratios are produced for each year of the scenario.
RBS’s business model unviable. For example, RBS’s most recent reverse stress test, which applied a pure macroeconomic stress only, indicated that an instantaneous global shock of a similar scale as the 2008 financial crisis which lasted for a full year could potentially render RBS’s business model unviable. However, the successful execution of RBS’s transformation plan, including the proposed restructuring of CIB, balance sheet reduction and the implementation of the ring-fencing requirements, would mitigate this risk.
RBS also takes part in a number of external stress tests as part of wider stress testing frameworks implemented by regulatory authorities to test industry-wide vulnerabilities under crystallising global systemic risks. In 2014, RBS participated in two regulatory scenarios designed by the
Unfortunately, in November 2014 an error was identified in the calculation of the modelled CET1 ratio in the EBA stress test results which led to
RBS’s published CET1 stress test ratios being overstated. Independent assurance was sought and the error was corrected. The BRC will continue to closely monitor the actions being taken to avoid a repeat of this error.
UK suffers a severe recession with economic uncertainty damaging confidence and causing both business investment contraction and a significant rise in unemployment.
at 30 September 2014 prior to the publication of the BOE concurrent stress test results in December 2014.
(ECB). The comprehensive assessment considered both a stress test and an asset quality review (AQR). The assessment was conducted to increase transparency in bank exposures, and to increase confidence in the European banking sector by identifying whether institutions held sufficient capital under a stress scenario. The AQR and stress test were the first assessments carried out by the ECB under the single supervisory mechanism.
• Manage business through improved understanding of the underlying risk. Examples: ° Tail risk assessment: identification of risky portfolios that breach series of pre-determined triggers.
° Business vulnerabilities analysis: assessment of business model weaknesses through cross-functional discussions.
The ICAAP assesses RBS’s material risks and determines how much capital is required to cover these risks.
- Pillar 2A - additional capital requirements for risks not captured or not adequately captured in Pillar 1. A MIRA is performed to ensure that all material risks are identified, appropriately managed and adequately capitalised where appropriate.
Capital planning RBS aims to maintain an appropriate level of capital to meet its business needs and regulatory requirements, and operates within an agreed risk appetite.
RBS uses the budgeting cycle to forecast the future levels of capital required at CET1, Tier 1, Tier 2 and total capital levels including bail-in or gone-concern capital at both RBS level and for each of the major operating entities. Those forecasts are then measured against minimum regulatory requirements as well as specific regulatory guidance such as the Individual Capital Guidance. Operating entities such as UBIL, RBS
Stress testing is an integral part of capital planning. Stress testing results are produced through the same capital planning models used for the budget. Models will be adjusted to reflect the specific parameters of a particular stress test.
The capital plan outputs are subject to executive and Board review and approval. The capital plan and performance against capital metrics are reviewed each month at ALCo.
Strategic considerations in the medium-term capital plan will be driven by key impacts such as a more restrictive approach to the capital base, higher capital ratio targets and enhanced risk coverage: • Absolute capital levels will need to be higher earlier; • Higher relative risk-weighted assets will exacerbate the absolute capital required and the stress impact; and
Statement PS8/13, requiring firms to prepare, maintain and review recovery plans. These rules were supplemented by a supervisory statement (SS18/13), (2), which sets out in more detail what the PRA
Recovery Plans are required to be updated annually; it is anticipated that
Directive of 2014 and the European Banking Authority’s regulatory technical standards on recovery planning. These rules would require a bank to notify the PRA, without delay, if it decides to take action under the recovery plan or refrains from taking action.
The UK government has transposed the RRD's provisions into law with a requirement that the Bank of England adopt further secondary legislation to implement MREL requirements by 2016 which will take into account the regulatory technical standards to be developed by the EBA specifying the assessment criteria that resolution authorities should use to determine the minimum requirement for own funds and eligible liabilities for individual firms.
The EBA noted that the technical standards would be compatible with the proposed term sheet published by the FSB on TLAC requirements for G-
As the implementation of the capital requirements under RRD is the subject to the adoption of secondary legislation and implementation in the
The PRA launched a consultation paper in January 2015 on the Pillar 2 capital requirements for UK banks. Proposed changes are intended to support a more risk sensitive and consistent approach to setting Pillar 2A
RWAs plus fixed add-ons instead of the current method where P2A
(CPB). Use of the buffer will not be a breach in capital requirements and will not result in capital distribution restrictions however, failure to meet Pillar 2B (P2B) buffer may result in enhanced supervisory action; • The P2B buffer will be calculated as a percentage of RWAs rather than absolute terms and is to be met with CET1; • Firms already subject to a CPB will be required to meet P2B with
P2A charge from 1 January 2016. Component parts of P2A and the
Regulatory proposals relating to domestically systemically important banks (DSIBs) continue to be progressed and could impact the level of
CET1 that is required to be held by RBS and specific legal entities including NatWest and the Royal Bank. The EBA published in December 2014 a quantitative methodology as to how European regulators could quantify which firms would qualify as DSIBs. In addition the FPC intends to consult with firms in the UK on the UK framework during 2015.
In January 2015, HM Treasury issued an explanatory memorandum on the systemic risk buffer for banks, building societies and investment forms. The regulation implements Articles 133 and 134 of Directive 2013/36/EU and addresses the outstanding capital buffer element of the ring-fencing policy recommended by the Independent Commission on
The purpose of the systemic risk buffer is to prevent and mitigate long term non-cyclical systemic or macro prudential risks not covered by existing regulation where there is potential for serious negative consequences for the financial system and real economy.
The systemic risk buffer will apply to large banks with core (ring fenced entity) deposits of more than £25 billion and large building societies with deposits of more than £25 billion. Implementation will occur from 1
The FPC will set out the framework for determining which institutions fall into scope and the size of the buffer to be held. A consultation paper will be published in 2015 and methodology by 31 May 2016. The PRA will be responsible for applying the framework and will have ultimate discretion over which firms must hold the buffer and its specific size.
IV buffer rather than the TLAC due to the no double counting principle.
° Are reviewing the calibration of the operational risk calculation, with revised rules due in 2015 and applicable from 2017.
Notes: (1) Capital Requirements Regulation (CRR) as implemented by the Prudential Regulation Authority in the UK, with effect from 1 January 2014. (2) Estimated. (3) Common Equity Tier 1 (CET1) ratio with effect from 1 January 2014. (4) Based on end-point CRR Tier 1 capital and revised 2014 Basel III leverage ratio framework.
CRD IV and Basel III impose a minimum CET1 ratio of 4.5%. Further, CET1 requirements will be imposed through buffers in the CRD. There are three buffers that will affect RBS: the capital conservation buffer set at 2.5% of RWAs; the counter-cyclical capital buffer (up to 2.5% of RWAs), which will be calculated as the weighted average of the countercyclical capital buffer rates applied in the countries where RBS has relevant credit exposures; and the highest of Global-Systemically Important Institution (G-SII), Other-Systemically Important Institution or systemic risk buffers set by the supervisory authorities. RBS has been provisionally allocated a G-SII buffer of 1.5%. The regulatory target capital requirements will be phased in through CRR, and are expected to apply in full from 1 January 2019. Until then, using national discretion the PRA can apply a top-up. As set out in the PRA’s Supervisory Statement SS3/13, RBS and other major UK banks and building societies are required to maintain a CET1 ratio of 7%, after taking into account certain adjustments set by the PRA.
From 1 January 2015, RBS must meet at least 56% of its Pillar 2A capital requirement with CET1 capital and the balance with Additional Tier 1 and/or Tier 2 capital. The Pillar 2A capital requirement is the additional capital that RBS must hold, in addition to meeting its Pillar 1 requirements in order to comply with the PRA’s overall financial adequacy rule.
Capital base: (1) Own funds are based on shareholders’ equity. (2) Includes the nominal value of B shares (£0.5 billion) on the assumption that RBS will be privatised in the future and that they will count as permanent equity in some form by the end of 2017. (3) The adjustment arising from the application of the prudent valuation requirements to all assets measured at fair value, has been included in full. The prudential valuation adjustment relating to assets under advanced internal ratings approach has been included in impairment provisions in the determination of the deduction from expected losses. (4) Where the deductions from AT1 capital exceed AT1 capital, the excess is deducted from CET1 capital. The excess of AT1 deductions over AT1 capital in year one of transition is due to the application of the current rules to the transitional amounts. (5) Insignificant investments in equities of other financial entities (net): long cash equity positions are considered to have matched maturity with synthetic short positions if the long position is held for hedging purposes and sufficient liquidity exists in the relevant market. All the trades are managed and monitored together within the equities business. (6) Based on our current interpretations of the Commission Delegated Regulation issued in December 2013 on credit risk adjustments, RBS’s standardised latent provision has been reclassified to specific provision and is not included in Tier 2 capital.
Risk-weighted assets (RWAs): (1) Current securitisation positions are shown as risk-weighted at 1,250%. (2) RWA uplifts include the impact of credit valuation adjustments and asset valuation correlation on banks and central counterparties. (3) RWAs reflect implementation of the full internal model method suite, and include methodology changes that took effect immediately on CRR implementation. (4) Non-financial counterparties and sovereigns that meet the eligibility criteria under CRR are exempt from the credit valuation adjustments volatility charges. (5) The CRR final text includes a reduction in the risk-weight relating to small and medium-sized enterprises.
Net unrealised available-for-sale (AFS) losses — — — — 308 346
Goodwill and other intangible assets (7,781) (7,781) (12,368) (12,368) (12,368) (13,545)
Qualifying instruments issued by subsidiaries and held by third parties — 1,648 — 1,749 — —
Tax on expected losses less impairments — — — — 6 618 *unaudited
Qualifying instruments and related share premium 5,542 6,136 3,582 4,431 — —
Unrealised gains on AFS equity shares — — — — 114 63
The table below analyses the movement in end-point CRR CET1 and Tier 2 capital for the year.
Loss for the year including reclassification of CFG, net of movements in fair value of own credit (3,571) — (3,571)
• On the reclassification of CFG to disposal groups at 31 December 2014, the carrying value exceeded its fair value less costs to sell by £4 billion. The consequential write down has been ascribed to goodwill relating to CFG.
subordinated notes and $2.25 billion 5.125% subordinated notes, both maturing in 2024.
Notes: (1) Based on end-point CRR Tier 1 capital and revised 2014 Basel III leverage ratio framework. (2) Capital Requirements Regulation (CRR) as implemented by the Prudential Regulation Authority in the UK, with effect from 1 January 2014. (3) Estimated.
The PFE on credit derivatives is based on add-on factors determined by the asset quality of the referenced instrument. Qualifying credit derivatives attract a PFE add-on of 5% and have reference securities issued by public sector entities, multilateral development banks or other investment grade issuers. Non-qualifying credit derivatives attract a PFE add-on of 10%.
<1 year 1-5 years >5 years Qualifying Non-qualifying Total 2014 £bn £bn £bn £bn £bn £bn *unaudited
Note: (1) Refer to RWA notes on page 206 for further information.
At 1 January 2014 (Basel 2.5 and CRR bases) 22.4 7.9 30.3 41.8 72.1
(2) Methodology changes included: - Commercial Banking: revisions to both currency netting and maturity dates for securitisation liquidity facilities.
- CIB: £2.0 billion primarily represents inclusion of hedges in the credit valuation adjustments calculation. In addition there were offsetting movements of £11.4 billion reflecting transition of trading book securitisations from credit risk to market risk; and £7.5 billion reflecting reclassification of new CRR related charges, primarily asset value correlation and certain exchange traded derivatives from non-counterparty credit risk to counterparty credit risk.
(3) The following models were updated during the year: - UK PBB: revised retail LGD model. - Commercial Banking and RCR: new large corporate PD model. - CIB: reduction due to the impact of exposure at default model £2.6 billion was offset by the new large corporate PD model.
• The RCR disposal strategy and run-off resulted in a £25 billion reduction in RWAs, £9 billion each in real estate finance and corporate, and a further £5 billion and £2 billion in Markets and
Additional analysis of exposure at default and credit risk measures such as credit risk mitigation, counterparty credit risk and provisions and their associated RWAs under the approaches according to the PRA permissions in force provided in RBS’s Pillar 3 Report 2014.
Accounting of insurance and associates/ Regulatory Accounting of insurance and associates/ Regulatory balance sheet other entities (1) other entities (2) consolidation balance sheet other entities (1) other entities (2) consolidation £m £m £m £m £m £m £m £m
Prepayments, accrued income and other assets 5,878 (38) (508) 5,332 7,614 (488) (533) 6,593
Accruals, deferred income and other liabilities 13,346 (241) 398 13,503 16,017 (33) 139 16,123
Notes: (1) RBS can only include particular types of subsidiary undertaking in the regulatory consolidation. Insurance undertakings and non-financial undertakings are excluded from the regulatory consolidation, although they are included in the consolidation for financial reporting. (2) RBS must proportionally consolidate its associates for regulatory purposes where they are classified as credit institutions or financial institutions. These will generally have been equity accounted for financial reporting purposes.
Balance sheet to EAD bridge The table below provides a bridge between the balance sheet and credit EAD by balance sheet caption.
(5) Capital deductions are excluded as EAD only captures exposures for credit RWAs. (6) Amounts reclassified to balance sheet lines for EAD. (7) Primarily includes: - Loans and advances: offset related to cash management pooling arrangements not allowed under IFRS and standardised approach credit risk mitigation. - Derivatives: EAD valuation adjustments offset by difference between netting arrangements and netting within regulatory model sets. - Property, plant and equipment: includes residual value of operating leases.
Liquidity and funding risk is the risk that RBS is unable to meet its financial obligations, including financing wholesale maturities or customer deposit withdrawals, as and when they fall due.
• The liquidity coverage ratio (LCR) was 112% at 31 December 2014, based on RBS’s interpretation of the EU guidelines. The improvement in LCR from 102% at year end 2013 reflects reductions in wholesale funding due to CIB balance sheet and risk reduction and an increase in retail deposits. With effect from 1
(2013 - 145%) under the worst case stress scenario. The improvement in 2014 reflected lower stress outflows due to balance sheet reductions in CIB.
Internal liquidity policies are designed to ensure that RBS: • Has a clearly stated liquidity risk tolerance: appetite for liquidity risk is set by the Board as a percentage of the Individual Liquidity
• Has in place strategies, polices and practices to ensure that RBS
maintains sufficient liquidity: the risk management framework determines the sources of liquidity risk and the steps that can be taken when these risks exceed certain actively monitored limits.
The Asset and Liability Management Committee (ALCo) sets and reviews the liquidity risk management framework and limits within the risk appetite set by the Board. ALCo, and by delegation the Liquidity Committee, oversees the implementation of liquidity management across RBS. RBS
Treasury conducts the review, challenge and reporting of RBS’s liquidity performance, while the Liquidity Committee’s management of liquidity risk is overseen by ALCo, the Executive Risk Forum, Executive Committee and the Board.
RBS operates across multiple jurisdictions and is subject to a number of regulatory regimes.
Liquidity Guidance, which influences the size and overall composition of RBS liquid asset portfolio.
N.V. are both subject to oversight by the European Central Bank with effect from 1 November 2014.
The Basel Committee on Banking Supervision (BCBS) has introduced a new liquidity regime for banks, Basel III, which includes two liquidity metrics, the LCR and NSFR, to be used by banks to monitor their liquidity risk.
In January 2013, the BCBS published its final guidance for calculating the
LCR. This will be implemented in law across the EU by the European
EU Journal in January 2015. The Delegated Act will introduce the LCR as a regulatory minimum standard from 1 October 2015 on a phased basis, such that banks are required to meet a 100% LCR ratio by 1 January 2018. In November 2014, the PRA confirmed in a consultation paper that the current BIPRU 12 regime will be revoked on 1 October 2015 in favour of the LCR, and that UK banks will be required to maintain a minimum ratio of 80% from this point. The LCR will be a Pillar 1 metric, meaning that the PRA will apply firm-specific Pillar 2 liquidity add-ons above and beyond the minimum LCR requirement. The PRA has invited feedback from UK banks on the consultation paper, but has not released any guidance on the detailed calculation of LCR. Pending PRA reporting guidelines, RBS monitors the LCR using its own internal interpretations of existing guidance.
RBS maintains a CFP, which forms the basis of analysis and management actions to be undertaken in a liquidity stress. The CFP is linked to stress test results and forms the foundation for liquidity risk limits. The CFP sets out the circumstances under which the plan would be invoked; this includes material worsening of early warning indicators. It also prescribes a communications plan, roles and responsibilities, as well as potential management actions to take in response to various levels of liquidity stress. On invocation of the CFP, the Contingency Liquidity Team would be convened to identify the likely impact of the stress event and determine the appropriate management response.
Under the liquidity risk management framework RBS maintains the ILAA, a component of which is an assessment of net stressed liquidity outflows.
These liquidity stress tests apply scenario-based behavioural and contractual assumptions to cash inflows and outflows under the worst of three severe stress scenarios, as prescribed by the PRA. These are a market-wide stress, an idiosyncratic stress and a combination of both.
A stress event can occur when either firm-specific or market-wide factors or a combination of both lead to depositors and investors withdrawing or not renewing funding on maturity. This could be caused by many factors including fears over the viability of the firm. Additionally, liquidity stress can be brought on by customers choosing to draw down on loan agreements and facilities.
Simulated liquidity stress testing is performed at least monthly for each business as well as the major operating subsidiaries in order to evaluate the strength RBS’s liquidity risk management. The stressed outflows are measured over certain time periods which extend from two weeks to three months. RBS is expected to be able to withstand the stressed outflows through its own resources (primarily through the use of the liquidity portfolio) without having to resort to extraordinary central bank or governmental assistance.
Stress tests are designed to examine the impact of a variety of firmspecific and market-wide scenarios on the future adequacy of the liquidity reserves. Stress test scenarios are designed to take into account RBS’s experiences during the financial crisis, recent market conditions and events. These scenarios can be run at any time in response to the emergence of firm-specific or market-wide risks that could have a material impact on RBS’s liquidity position. In the past these have included credit rating changes and political and economic conditions changing in particular countries.
• Net wholesale funding - Outflows at contractual maturity of wholesale funding, with no rollover/new issuance, prime brokerage, 100% loss of excess client derivative margin and 100% loss of excess client cash.
Liquidity risks are mitigated by a centrally managed liquidity portfolio. The size of the portfolio is determined under the liquidity risk management framework with reference to the RBS’s risk appetite.
Liquidity Group (UK DLG) comprising RBS’s five UK banks: The Royal
Financial Group Inc, and Ulster Bank Ireland Limited - hold locally managed portfolios of liquid assets that comply with local regulations that differ from PRA rules. These portfolios are the responsibility of the local
Separately from the liquidity portfolio, RBS holds high quality assets to meet payment systems collateral requirements, these are managed by
RBS categorises its liquidity portfolio, including its locally managed liquidity portfolios, into primary and secondary liquid assets.
• Primary liquid assets that are eligible liquid assets, such as cash and balances at central banks, treasury bills and other high quality government and US agency bonds.
The composition of the liquidity portfolio is subject to policies and limits set by the Board, ALCo and the Liquidity Committee, it is influenced by quality of counterparty, maturity mix and currency mix. The liquidity value of the portfolio is determined with reference to current market prices and the haircuts necessary to generate cash from the asset.
Liquidity risk continued Liquidity metrics* The table below sets out the key liquidity and related metrics monitored by RBS. 2014 2013 2012
The table below shows RBS’s liquidity portfolio by product, liquidity value and by carrying value. Liquidity value is lower than carrying value as it is stated after discounts applied by the Bank of England and other central banks to instruments, within the secondary liquidity portfolio, eligible for discounting.
AA- to AA+ rated governments and US agencies 6,902 9,281 1,448 17,631 12,792 12,287 12,423 9,621 9,300
Limited, Coutts & Co and Adam & Company. In addition, certain of RBS’s significant operating subsidiaries - RBS N.V., Citizens Financial Group Inc. and Ulster Bank Ireland Limited - hold liquidity portfolios of liquid assets that comply with local regulations that may differ from PRA rules.
The table below shows the composition of RBS’s NSFR, based on RBS’s interpretation of the rules published by BCBS in October 2014. RBS’s NSFR
Derivative liabilities after mtm netting arrangements 55 11 44 9 60 12 20
RBS’s primary funding source is its customer deposit base, primarily built through its retail and commercial franchises in the UK, Ireland and the
Complementary to its deposit funding, RBS maintains access to various wholesale markets for funding, on both a public and private basis, across a range of currencies, geographies and maturities. These include longterm secured and unsecured debt, short-term money markets and repurchase agreements. RBS has set policies for the prudent use of wholesale funding, as part of its wider liquidity policies.
RBS may access various funding facilities offered by central banks from time to time. The use of such facilities can be both part of a wider strategic objective to support initiatives to help stimulate economic growth or as part of the broader liquidity management and funding strategy.
At 31 December 2014, RBS’s participation in central bank financing operations amounted to £0.8 billion under European Central Bank’s
Targeted Long Term Refinancing Operations. RBS remains committed to supporting the objectives of the Funding for Lending scheme.
The structural composition of the balance sheet is augmented as needed through active management of both asset and liability portfolios. The objective of these activities is to optimise the liquidity profile, while ensuring adequate coverage of all cash requirements under extreme stress conditions.
As set out below, RBS’s asset and liability types broadly match.
Bank deposits (short-term only) (1) 13 14 13 18 Loan and advances to banks (1)
Term wholesale funding (1) 57 69 94 90 Primary liquidity portfolio
Notes: (1) Excludes held for trading. (2) Financial instruments classified as held-for-trading (HFT) excluding security financing transactions and derivatives. (3) Includes non-HFT financial instruments and non financial assets/liabilities.
Net derivative derivative derivative derivative inter-bank collateral collateral collateral collateral funding £bn £bn £bn £bn £bn £bn £bn
Notes: (1) Short-term wholesale funding is funding with a residual maturity of less than one year. (2) Excludes derivative cash collateral. (3) Primarily short-term balances.
Funding sources The table below shows RBS's principal funding sources excluding repurchase agreements (repos).
Short-term Long-term Short-term Long-term Short-term Long-term less than more than less than more than less than more than
By product 1 year 1 year Total 1 year 1 year Total 1 year 1 year Total £m £m £m £m £m £m £m £m £m
The table below shows customer loans, deposits, loan:deposit ratios and funding surplus/(gap) by segment.
Direct Line Group n/a n/a n/a n/a n/a n/a — (881)
Notes: (1) Excludes reverse repo agreements and net of impairment provisions. (2) Excludes repo agreements. (3) All conduits relate to CIB and have been extracted and shown separately as they were funded by commercial paper issuance until the end of the third quarter of 2012.
Customer deposits insured through deposit guarantee schemes totalled £160 billion (2013 - £161 billion) the more material of them being Financial
Services Compensation Scheme £112 billion; US Federal Deposit Insurance Corporation £37 billion and Republic of Ireland’s Deposit Guarantee
The table below analyses RBS's repos by counterparty type. 2014 2013 2012 £m £m £m
The liquidity risk RBS is exposed to through security financing transactions is significantly lower than in relation to unsecured funding. RBS limits any exposure by setting limits and monitoring any mismatch of quality, maturity or currency. The exposure is also monitored in the context of the available liquid assets.
The following table shows repos gross of IFRS offset arrangements (refer to Balance sheet analysis - Financial assets summary on page 275) by asset quality and maturity.
The contractual maturity of balance sheet assets and liabilities reflects the maturity transformation role banks perform, lending long-term but obtaining funding predominantly through short-term liabilities such as customer deposits. In practice, the behavioural profiles of many liabilities exhibit greater stability and longer maturity than the contractual maturity. This is particularly true of many types of retail and corporate deposits which, despite being repayable on demand or at short notice, have demonstrated very stable characteristics even in periods of acute stress. In analysis to assess and manage asset and liability maturity gaps RBS determines the expected customer behaviour through qualitative and quantitative techniques, incorporating observed customer behaviours over long periods of time. This analysis is subject to governance through Asset and Liability Management
Contractual maturity analysis and net behavioural funding surplus/(gap) are set out below.
Less than Greater than Less than Greater than Less than Greater than Less than Greater than 1 year 1-5 years 5 years Total 1 year 1-5 years 5 years Total 1 year 1-5 years 5 years Total 1 year 1-5 years 5 years Total 2014 £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn *unaudited
Cash and balances at central banks 75,494 — — — 75,494 — — — 75,494 — 75,494
Customer reverse repos — — — — — — — — — 49,897 49,897
From time to time RBS encumbers assets to serve as collateral to support certain wholesale funding initiatives. The three principal forms of encumbrance are own asset securitisations, covered bonds and securities repurchase agreements.
• Not currently encumbered but can for instance be used to access funding from market counterparties or central bank facilities as part of RBS’s contingency funding.
• Not currently encumbered. In this category, RBS has in place an enablement programme which seeks to identify assets which are capable of being encumbered and to identify the actions to facilitate such encumbrance whilst not impacting customer relationships or servicing.
Excluding balances relating to derivative and securities financing transactions 11 11 13
Loans and advances to banks 4.6 0.3 11.5 — 0.5 16.9 68 1.7 2.1 4.1 — 24.8
Secured encumbered % of related Liquidity Other (4) Cannot be and conduits bonds balances assets (2) assets portfolio Other realisable encumbered (5)
Loans and advances to banks 5.8 0.5 10.3 — — 16.6 60 0.1 10.9 — — 27.6
Reverse repurchase agreements and stock borrowing — — — — — — — — — — 76.5 76.5
Prepayments, accrued income and other assets — — — — — — — — — — 8.6 8.6
(6) In accordance with market practice, RBS employs securities recognised on the balance sheet, and securities received under reverse repo transactions as collateral for repos. Secured derivative liabilities reflect net positions that are collateralised by balance sheet assets.
Credit risk 232 Sources of credit risk 232 Key developments 233 Risk governance 233 Risk management 235 Risk measurement 237 Credit risk assets 237 - Balance sheet to CRA bridge 239 - Sector and geographical regional analyses 242 Wholesale credit risk management 242 - Risk appetite frameworks 243 - Problem debt management 246 - Sector and geographical regional analyses 248 - AQ10 or non-performing 251 - Key credit portfolios 251 - Commercial real estate 255 - Oil and gas 257 - Counterparty credit risk 258 Personal credit risk management 258 - Problem debt management
RBS is exposed to credit risk as a result of a wide range of business activities. The most significant source of credit risk is lending. RBS offers a number of lending products where it has an obligation to provide credit facilities to a customer. To mitigate the risk of loss, security may be obtained in the form of physical collateral such as commercial real estate assets and residential property, or financial collateral such as cash or bonds. Exposures arising from leasing activities are also included in lending.
The second most significant source of credit risk arises from activities in the derivatives and securities financing transaction markets. These result in counterparty credit risk, which is the risk of financial loss arising from the failure of a counterparty to meet obligations that vary in value by reference to a market factor. To mitigate the risk of loss, collateral and netting are used along with the additional legal rights provided under the terms of over-the-counter contracts.
RBS holds some debt securities generally for liquidity management purposes, and is exposed to credit risk as a result.
RBS is also exposed to credit risk from off-balance sheet products such as trade finance activities and guarantees as well as through committed but undrawn lending facilities.
UK personal lending - The growth in UK PBB gross mortgage lending was within credit risk appetite and against a backdrop of house price increases over most of the year. Due to the withdrawal of products with promotional rates in line with strategy, credit card exposure declined during the year. Refer to Key portfolios - UK PBB on page 261.
Ulster Bank - Following the creation of RCR, exposure to personal customers now represents 68% of the total Ulster Bank exposure. In the personal portfolio, Ulster Bank’s proactive offers of forbearance to help customers through financial difficulties saw significant uptake in the
The quality of the Ulster Bank wholesale portfolio improved following the transfer of commercial real estate (CRE) assets to RCR, with an associated material decrease in impairments. Refer to Segment performance - Ulster Bank on page 133.
Europe and China. Exposures to this sector continue to be closely managed through the sector concentration framework as well as ongoing customer and sub-sector reviews, with stress testing highlighting specific sub-sectors or customers particularly vulnerable to sustained low oil prices. Risk appetite to the overall oil and gas sector was reduced during the year, and action continues to mitigate exposure where possible. For further information, refer to the Key credit portfolios section on page 255.
The RBS credit risk management function, which is led by the Group
The Executive Risk Forum (ERF) has delegated approval authority to the
Committee to manage provisions adequacy, both individual and collective. The RBS Provisions Committee, which is chaired by either the
The first component is the RBS Credit Policy Standard, which is part of the RBS Policy Framework. It sets out the rules that must be followed to ensure that credit risks are identified and effectively managed through the credit lifecycle.
The second component is a policy compliance assessment activity that credit risk undertakes to provide the GCCO with evidence of the effectiveness of credit risk management controls in place across RBS.
The results of these reviews support the self-certification that credit risk must complete every six months.
Risk appetite across all risk types is set using specific quantitative targets under stress, including earnings volatility and capital adequacy. The credit risk appetite framework has been designed to reflect the factors that influence the ability to meet those targets. These include product and asset class, industry sector, single name and country concentrations. Any of these factors could generate higher earnings volatility under stress and, if not adequately controlled, they could undermine capital adequacy.
Various tools and techniques are deployed during this part of the credit cycle including the offering of forbearance. Practices differ across the wholesale and personal portfolios. For further information refer to the
However, impairments and write-offs are used as key indicators of credit quality as part of the overall assessment of credit risk incurred by RBS.
A financial asset is impaired if there is objective evidence that an event or events since initial recognition of the asset has adversely affected the amount or timing of future cash flows from it. The loss is measured as the difference between the carrying value of the asset and the present value of estimated future cash flows discounted at the original effective interest rate.
For both wholesale and personal exposures, days-past-due measures are typically used to identify evidence of impairment. In both corporate and personal portfolios, a period of 90 days past due is used. In sovereign portfolios, the period used is 180 days past due. Other factors are considered including: the borrower’s financial condition; a forbearance event; a loan restructuring; the probability of bankruptcy; or any evidence of diminished cash flows.
If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. The current net realisable value of the collateral will be taken into account in determining the need for a provision. This includes cash flows that may result from foreclosure less the costs of obtaining and selling the collateral, whether or not foreclosure is probable. No impairment provision is recognised in cases where amounts due are expected to be settled in full on realisation of the security. RBS uses one of the following three different methods to assess the amount of provision required: individual; collective; and latent.
Loans and securities above a defined threshold deemed to be individually significant are assessed on a case-by-case basis. Assessments of future cash flows take into account the impact of any guarantees or collateral held. Estimating the amount and timing of future cash flows involves judgement based on the facts available at the time and assumptions related to the future financial performance of the customer or counterparty and any guarantors as well as future economic conditions and the value of collateral. Projected cash flows are reviewed on subsequent assessment dates as new information becomes available.
Provisions on impaired credits below an agreed threshold are assessed on a portfolio basis, reflecting the homogeneous nature of the assets.
In the performing portfolio, latent loss provisions are held against losses incurred but not identified before the balance sheet date. Latent loss provisions reflect probability of default (PD) and loss given default (LGD)
as well as emergence periods. The emergence period is the period between the occurrence of the impairment event and the identification and reporting of a loan as impaired.
Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as coupon period and repayment terms, and the duration of the administrative process required to report and identify an impaired loan as such. Emergence periods vary across different portfolios from 120 to 270 days (365 days for forborne exposures). They are based on actual experience within the particular portfolio and are reviewed regularly.
RBS’s personal businesses segment their performing loan books into homogeneous portfolios such as mortgages, credit cards or unsecured loans, to reflect their different credit characteristics. Latent provisions are computed by applying portfolio-level LGDs, PDs and emergence periods.
Refer to pages 288 to 296 for analysis of impaired loans, related provisions and impairments and 353 to 354 for details of accounting policies.
Key assumptions relating to impairment levels of secured lending relate to the valuation of the security and collateral held, the timing of asset disposals based on the underlying market depth and liquidity and customer cooperation. Assumptions on timing also include an assessment of the ease and timing of the enforceability of loan agreements in varying legal jurisdictions. Assumptions are made on a case by case basis in the case of individually assessed provisions and are often based on judgement.
• Credit cards: Write-off of the irrecoverable amount usually occurs at 12 months in arrears; the rest is expected to be recovered over a further three years following which any remaining amounts outstanding are written off.
Amounts recovered after a loan has been written-off are credited to the loan impairment charge for the period in which they are received.
• Counterparty exposures - measured using the marked-to-market value of derivatives after the effect of enforceable netting agreements and regulator-approved models but before the effect of collateral. Counterparty exposures include rate risk management, which includes those arising from foreign exchange transactions, interest rate swaps, credit default swaps and options.
CRA exclude issuer risk (primarily debt securities) and securities financing transactions. CRA take account of regulatory netting although, in practice, obligations are settled under legal netting arrangements that provide a right of legal set-off but do not meet the offset criteria under
PD models assess the probability of a customer failing its credit obligations over a one-year period.
must always be equal to, or higher, than current utilisation. Exposure can be reduced by a legally enforceable netting agreement.
RBS reviews and updates models on an ongoing basis, reflecting the impact of more recent data, changes to products and portfolios, and new regulatory requirements. Extensive changes were made to wholesale models in 2012 and 2013. This continued in 2014 with further changes, notably in the corporate exposure class.
The roll-out will be completed by mid-2015. The updated calibrations associated with these new models, which reference over 20 years of rating agency default experience, may result in downwards rating migrations across internal asset quality bands. For further information regarding the impact of this change refer to the Asset quality section on
Model changes affect year-on-year comparisons of risk measures in certain disclosures. Where meaningful, in its commentary RBS has differentiated between instances where movements in risk measures reflect the impact of model changes, and those where such movements reflect changes in the size of underlying credit portfolios or their credit quality.
(the assumption that groups of obligors share a common factor) and contagion risk (for example, the risk that the weakening of the sovereign’s credit worthiness has a significant impact on the creditworthiness of a business operating in that country).
Mitigation tools applied can include: structuring a security interest in a physical or financial asset; use of credit derivatives, including credit default swaps, credit-linked debt instruments and securitisation structures; and use of guarantees and similar instruments (for example, credit insurance) from related and third parties.
When seeking to mitigate risk, at a minimum RBS considers the following: • The suitability of the proposed risk mitigation, particularly if restrictions apply; • The means by which legal certainty is to be established, including required documentation, supportive legal opinions and the steps needed to establish legal rights; • The acceptability of the methodologies to be used for initial and subsequent valuation of collateral, the frequency of valuations and the advance rates given; • The actions which can be taken if the value of collateral or other mitigants is less than needed; • The risk that the value of mitigants and counterparty credit quality may deteriorate simultaneously; • The need to manage concentration risks arising from collateral types; and
The RBS business and credit teams are supported by specialist in-house documentation teams. RBS uses industry-standard loan and security documentation wherever possible. However, when non-standard documentation is used, external lawyers are employed to review it on a case-by-case basis. For further information refer to the Wholesale credit risk management and Personal credit risk management sub-sections.
The table below provides a bridge between balance sheet captions and the related components of credit risk assets (CRA). Methodology
Non-Core and RCR are therefore not directly comparable year on year.
• Excluding RCR, CRA in PBB and CPB represented 48% of exposures while CIB represented 28% and CFG 12%. CPB
• The creation of RCR and run-down of assets within it has contributed significantly to the reduction in wholesale exposure during the year. In particular there has been a significant decrease in wholesale exposures in Ulster Bank. Ulster Bank’s portfolio now comprises 68% personal exposure, up from 61% at 2013, with the majority of wholesale exposure to SME customers.
exposure was in the property sector as RBS continued to reduce its concentration in this sector, in particular relating to CRE. For further analysis of exposures in the wholesale portfolio refer to pages 242 to 257.
Note: (1) Comprises Central and Eastern Europe, the Middle East, Central Asia and Africa, and supranationals such as the World Bank.
• CRA fell in all geographic regions except North America. The increase in North America resulted from increased exposures to sovereigns and banks as well as increased exposure in both the wholesale and personal portfolios in CFG. Foreign exchange movements also contributed to the increased exposure in North
• The main driver behind the wholesale reduction in the UK was reduced exposure in central bank and CRE (down 22% and 18%
CRA. Customers are assigned credit grades based on various credit grading models that reflect the key drivers of default for each customer type. All credit grades map to both a RBS level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures, used for internal management reporting across portfolios.
Accordingly, measures of risk exposure may be aggregated and reported at differing levels of detail depending on stakeholder or business requirements. Performing loans are defined as AQ1-AQ9 (where the PD
• In addition to driving provision releases on individual cases, the improvement in credit quality had a positive impact on the underlying risk metrics (PD and LGD) used in collective and latent provisioning.
Wholesale credit risk management focuses on the credit risks arising from activities with corporate and SME clients as well as banks, other financial institutions and sovereigns.
Four formal frameworks are used to manage wholesale credit concentration risk. RBS continually reassesses its frameworks to ensure they remain appropriate for its varied business franchises and current economic conditions as well as to reflect further refinements in RBS’s risk measurement models.
A single name concentration (SNC) framework addresses the risk of outsized loss arising from a concentration of credit risk to a single borrower or borrower group. The framework includes elevated approval authority, additional reporting and monitoring, and the requirement for plans to address exposures in excess of appetite.
However, material reductions have been achieved since the framework was introduced. This trend continued during the year, with a 52%
The sector concentration framework was revised in 2014. Previously, sectors were classified according to size. Under the revised sector framework, sectors are classified according to their risk (based on EC
and various qualitative factors) as well as size. This classification drives the level of oversight and frequency of sector reviews. Reviews may include an assessment of business strategy, credit risk profile, key risks and mitigants, the current and expected future external environment, vulnerability to stress events, regulatory developments and economic capital usage to derive a proposed risk appetite along with transaction acceptance standards.
As a result of the reviews carried out in 2014, RBS further reduced its risk appetite in its most material corporate sector, CRE, as well as a number of other corporate sectors such as retail, leisure and oil and gas. This was in addition to the reduction of RCR exposures. For further details on sector-specific strategies, exposure reduction and key credit risks, refer to pages 251 to 273.
The country concentration framework is described in the Country risk section on pages 323 to 329.
The credit risk function assesses, approves and manages the credit risk associated with a borrower or group of related borrowers.
The framework requires at least two individuals to approve each credit decision, one from the business and one from the credit risk function.
All collateral is assessed case-by-case to ensure that it will retain its value independently of the provider. RBS monitors the value of the collateral and, if there is a shortfall, will seek additional collateral.
For customers not managed in RCR, there are three Watch classifications - Amber, Red and Black - reflecting progressively deteriorating conditions. Watch Amber customers are performing customers who show early signs of potential financial difficulty, or have other characteristics that warrant closer monitoring. Watch Red customers are performing customers who show signs of declining creditworthiness and so require active management usually by
Customers managed in RCR are by their nature subject to heightened scrutiny and regular review against specific disposal plans. RCR
customers are separately identified in RBS’s internal Watchlist reporting, with their Watchlist classification based on asset quality.
Separately to the Credit Risk management function, the Restructuring team manages RBS’s wholesale problem debt portfolio in cases where its exposure to the customer exceeds £1 million. In addition, Restructuring has a specialist credit function, the Strategy Management Unit, for distressed bilateral lending where the exposure is between £250,000 and
The factor common to all customers managed by Restructuring is that
Restructuring is to restore customers to an acceptable credit profile, minimise losses to RBS and protect RBS’s capital.
Specialists in Restructuring work with customers experiencing financial difficulties, and showing signs of financial stress, with the aim of restoring their business to financial health whenever possible. The objective is to find a mutually acceptable solution, including repayment, refinancing or transfer to another bank if that is the customer’s preferred option.
If the customer’s finances are not viable and a mutually agreed exit is not possible, insolvency may be considered as a last resort. However, helping the customer return to financial health and restoring a normal banking relationship is always the desired goal.
Forbearance takes place when a concession is made on the contractual terms of a loan in response to a customer’s financial difficulties.
Concessions granted where there is no evidence of financial difficulty, or where any changes to terms and conditions are within usual risk appetite
A number of options are available. These are tailored to the customer’s individual circumstances. The aim is to restore the customer to financial health and to minimise risk to RBS. To ensure that forbearance is appropriate for the needs and financial profile of the customer, RBS
Wholesale forbearance may involve the following types of concessions: Payment concessions and loan rescheduling, including extensions in contractual maturity, may be granted to improve the customer’s liquidity.
Concessions may also be granted on the expectation that the customer’s liquidity will recover when market conditions improve. In addition, they may be granted if the customer will benefit from access to alternative sources of liquidity, such as an issue of equity capital. These options have been used in CRE transactions, particularly during periods where a shortage of market liquidity has ruled out immediate refinancing and made short-term collateral sales unattractive.
Debt may be forgiven, or exchanged for equity, where the customer’s business condition or economic environment is such that it cannot meet obligations and where other forms of forbearance are unlikely to succeed.
Loans may be forborne more than once, generally where a temporary concession has been granted and circumstances warrant another temporary or permanent revision of the loan’s terms. All customers are assigned a PD and related facilities a LGD. These are re-assessed prior to finalising any forbearance arrangement in light of the loan’s amended terms and any revised grading is incorporated in the calculation of the impairment loss provisions for RBS’s wholesale exposures. Where forbearance is no longer viable, RBS will consider other options such as the enforcement of security, insolvency proceedings or both.
The ultimate outcome of a forbearance strategy is unknown at the time of execution. It is highly dependent on the cooperation of the borrower and the continued existence of a viable business. The following are generally considered to be options of last resort: • Enforcement of security or otherwise taking control of assets -
• Insolvency - Where there is no suitable forbearance option or the business is no longer sustainable, insolvency will be considered.
Provisions for forborne wholesale loans are assessed in accordance with normal provisioning policies. The customer’s financial position and prospects as well as the likely effect of the forbearance, including any concessions granted, are considered in order to establish whether an impairment provision is required.
There was a significant amount of credit impairment release during 2014, in particular in RCR where the favourable environment and efficient deal execution supported the disposal strategy. Improved market appetite and greater liquidity was demonstrated, particularly in Ireland, where assets have been realised more quickly and at better prices, than previously anticipated.
PBB and CPB resulted in modest new impairments in the wholesale portfolio. The majority of provisions in the wholesale portfolio relate to
CRE. For further analysis of the provisions in the CRE portfolio refer to page 251.
Geographical region is based on the location of the customer’s operations (or, in the case of individuals, location of residence).
The revised RBS strategy and the creation of RCR as well as the general economic environment had a direct impact on the portfolios during the year, with the following key trends observed: Financial institutions
• Exposures to a range of financial companies, the largest of which were funds (26% - 25% in 2013), securitisation vehicles (19% - 22%
• The sovereign portfolio comprised exposures to central banks, central governments and sub-sovereigns such as local authorities, primarily in the UK, US and Western Europe. Exposures to central banks were £75.3 billion at the year end, a reduction of 6% from 2013 driven by fluctuations in RBS Treasury activities.
The remainder comprised lending to construction companies and building materials groups, which decreased by 5% (following a 15%
reduction in 2013), and housing associations, which increased by 14% (2013 - 12%) and contributed to an improvement in the credit quality of the property portfolio. 23% of total property exposure was in RCR and the run-down of RCR property exposure contributed significantly to the improvement of portfolio asset quality. The CIB
and CPB franchises accounted for 75% of total non-RCR property exposure. Property exposures in Ireland (including RCR)
• RBS’s exposure to the shipping sector, which is mostly within RCR
and CIB, declined 9% during the year, from £11.4 billion to £10.4 billion. The reduction was a result of scheduled loan repayments, secondary sales (RCR) and prepayments.
• Of the total exposure to the shipping sector, £7.9 billion (2013 - £8.6 billion) related to asset-backed ocean-going vessels. £5.7 billion of the asset-backed ocean-going vessel exposures were in CIB.
• The main concentration risks were the bulk sector which represented 38% of the portfolio; tankers at 29% and containers at 17%. The remaining exposures comprised gas, including liquid petroleum gas (10%) and others (6%).
• Conditions remained generally subdued during 2014. There has been a recent upturn in rates for tankers due to the fall in oil prices but difficulties remained for containers due to over supply. The majority of RBS’s exposure is extended against security in vessels of recent build (average age across the portfolio of 6.4 years including RCR) with less than 3% of the CIB book being above 15 years of age. 87% of the portfolio was below 10 years.
• Within natural resources, RBS had £10.7 billion of CRA in exposure to the oil and gas sector. CRA increased by 5% (£528 million) during 2014. Further disclosures regarding exposure to this sector are detailed on page 256.
during the year mostly driven by a 22% reduction in telecoms.
AQ10 CRA by sector RCR RCR Total assets Non-Core Non-Core Total assets Non-Core Non-Core Total assets
Notes: (1) Includes cash held at central banks. (2) Excludes net investment in operating leases in shipping and aviation portfolios as they are accounted for as property, plant and equipment. However, operating leases are included in the monitoring and management of these portfolios.
• The proportion of the wholesale portfolio rated AQ10 fell significantly during the year. This was driven by asset disposals as well as writeoffs.
At 31 December 2014, exposures to customers reported as Watchlist Red and managed by Restructuring were £2.9 billion (2013 - £12.7 billion) and those managed in the business were £1.1 billion (2013 - £3.2 billion).
The following table shows a sector breakdown of Watchlist Red customers managed by Restructuring.
Performing performing Total coverage (1) Performing performing Total coverage (1) Performing performing Total coverage (1)
Wholesale forbearance during the year by arrangement type (1) 2014 2013 2012
Forgiveness of all or part of the outstanding debt 4 9 21
Notes: (1) Total exceeds 100% as an individual case can involve more than one type of forbearance.
“in process” and are not included in the tables above. 84% of these were non-performing loans, with associated provision coverage of 48%; and 16% were performing loans. The principal types of arrangements offered were payment concessions and loan rescheduling.
• The value of loans forborne during 2013 and 2014 and still outstanding at 31 December 2014 was £12.2 billion (2013 - £18.4 billion; 2012 - £17.7 billion), of which £3.4 billion related to
• Additional provisions charged in 2014 relating to loans forborne during 2013 totalled £0.6 billion, predominantly driven by RCR and
• Non-RCR customers managed by Restructuring were granted forbearance on loan facilities totalling £1.3 billion during 2014. This equates to 34.1% of loans managed by Restructuring (excluding loans to customers where recovery procedures have commenced).
• Of the loans granted forbearance by Restructuring (excluding those transferred to RCR) in 2013, 24% returned to performing portfolios managed by the originating businesses by 31 December 2014.
Some non-forborne loans were also returned from Restructuring to performing portfolios managed by the originating businesses.
• £4.8 billion of completed forbearance granted during the year was to customers managed by RCR. RCR uses forbearance as a tool to assist with the orderly realisation of assets. By value, 94% of the performing non-RCR loans granted forbearance in 2013 remained performing at 31 December 2014.
• The data presented in the tables above include loans forborne during 2012 and 2013 which individually exceeded thresholds set at franchise or reportable segment level. RBS continues to refine its reporting processes for forborne loans. During 2012 the reporting threshold ranged from nil to £10 million and from 2013 until April 2014 thresholds ranged from nil to £3 million. From April 2014 no threshold were in use.
The commercial real estate (CRE) sector comprised exposures to entities involved in the development of, or investment in, commercial and residential properties (including house builders). The analysis of lending utilisations below is gross of impairment provisions and excludes rate risk management and contingent obligations.
Investment Development Total Investment Development Total Investment Development Total £m £m £m £m £m £m £m £m £m
(excl NI (2)) (ROI and NI (2)) (other) US RoW (2) Total
• The overall gross lending exposure to CRE fell by £9.3 billion (18%)
to £43.3 billion. Most of the decrease occurred in RCR exposure originated by Ulster Bank, CPB and CIB and was due to repayments, asset sales and write-offs.
• The RCR portfolio of £12.6 billion represented 29% of the RBS CRE
Ireland, 22% in the UK, 10% in Western Europe and 1% in the US
Maturity profile of portfolio £m £m £m £m £m £m £m £m 2013 Non-Core 2012 Non-Core
Notes: (1) Includes on-demand and past-due assets. (2) Predominantly comprises overdrafts for which there is no single maturity date. (3) The UK PBB portfolio comprises Business Banking and Williams & Glyn CRE exposure. Williams & Glyn accounts for £3.3 billion (79%).
• The overall maturity profile has changed, with the proportion of short-term (1 year) maturities reducing in favour of more medium term (> 3 years) maturities. This reflected the reductions in RCR as well as new lending activity in Commercial Banking and CFG.
By asset quality band AQ1-AQ2 AQ3-AQ4 AQ5-AQ6 AQ7-AQ8 AQ9 AQ10 Total £m £m £m £m £m £m £m
• The overall asset quality of the portfolio has improved, including a significant reduction in the proportion rated AQ10. This was a result of reductions in RCR, improving general market conditions and the quality of new lending activity which is subject to the policies and controls put in place in recent years.
• The average LTV for the performing book improved from 65% to 57% over the past year. The LTV for the performing portfolio in the
UK was 56%. The reductions in the higher LTV bands occurred mainly in the RCR book originated by Ulster Bank and CIB, reflecting reductions through repayments, asset sales and write-offs.
Notes: (1) Excludes property related lending to customers in other sectors managed by Real Estate Finance. (2) Data at 31 December 2014 includes CRE lending from Private Banking in CPB of £1.3 billion that was excluded from 2013 and 2012 data. At 31 December 2013 CRE lending in Private Banking
Loans Provisions Loans Provisions Loans Provisions £m £m £m £m £m £m
The price of natural gas is not highly correlated to oil prices.
The table below provides a breakdown of oil and gas sector exposure on both a CRA basis and total exposure (including committed but undrawn exposure and contingent obligations) basis by business segment.
The committed lending exposure included legal commitments to syndicated bank facilities, with tenors up to five years. These committed facilities are for general corporate purposes including funding of operating needs and capital expenditures. These facilities are available as long as counterparties remain compliant with the terms of the credit agreement.
Contingent obligations relate to guarantees, letters of credit and suretyships provided to customers.
At the year end, RBS’s exposure to commodities financing was £1.0 billion, predominantly in relation to oil (£0.7 billion), metals (£0.2 billion)
(including committed but undrawn exposure) - split by sub-sector and geography. The analysis is based on RBS’s sector concentration framework.
Other wholesale and trading activities 295 794 683 907 — 122 2,801
Producers (incl. integrated oil companies) 748 1,065 5,333 459 5 748 8,358
Other wholesale and trading activities 297 915 553 893 — 147 2,805
Note: (1) Includes exposures to Central and Eastern Europe as well as the Middle East and Africa.
The sub-sector within which a customer operates is a primary consideration for assessing the credit risk of a customer. Current areas of focus are towards customers involved in exploration and production principally in producers (E&P) and oilfield service providers (OFS). E&P
companies are the primary customers for the service providers and are experiencing an adverse impact on their financial performance from a reduced level of contracts and lower contract rates as well as pressure to re-price existing services.
and NOC are less vulnerable to the oil price decline due to scale, diversification and in the case of NOC, explicit support from governments.
The table below provides a breakdown of the asset quality of CIB’s oil and gas sector portfolios.
At the year end 83%, of the portfolio exposure was investment grade
At the year end, the proportion of RBS’s total oil and gas portfolio, excluding RCR, designated as Watchlist Red (performing customers who show signs of declining creditworthiness and so require active management) was 0.4%, of which 0.02% was managed by Restructuring.
RBS mitigates counterparty credit risk arising from both derivatives and repurchase agreements through the use of netting, collateral and market standard documentation.
Amounts owed by RBS to a counterparty are netted against amounts the same counterparty owes it, in accordance with relevant regulatory and internal policies. However, generally, this is only done if a netting and collateral agreement is in place as well as a legal opinion to the effect that the agreement is enforceable in the relevant jurisdictions.
Industry standard documentation, such as master repurchase agreements and credit support annexes accompanied by legal opinion, is used for financial collateral taken as part of trading activities.
RBS limits counterparty credit exposures by setting limits which take into account the potential adverse movement of an exposure after adjusting for the impact of netting and collateral where applicable.
Notes: (1) In accordance with normal market practice, at 31 December 2014 £60.2 billion (2013 - £63.7 billion; 2012 - £100.7 billion) had been resold or re-pledged as collateral for RBS's own transactions. (2) At fair value.
These limits apply to a range of credit risk related measures including expected loss of the portfolio, the expected loss in a given stress scenario, projected credit default rates and the LTV of personal mortgage portfolios.
Price Index in the US, the Central Statistics Office Residential Property
Ireland. For automobile lending in the US, new vehicles are valued at cost and used vehicles at the average trade-in value.
Additionally, in the UK and Ireland support is provided to customers with unsecured loans who establish a repayment plan with RBS through a debt advice agency or a self-help tool. Such “breathing space” suspends collections activity for a 30-day period to allow time for the repayment plan to be put in place. Arrears continue to accrue for customer loans granted breathing space.
Forbearance takes place when a concession is made on the contractual terms of a loan in response to a customer's financial difficulties. It is granted either permanently or temporarily, following an assessment of the customer's circumstances.
Types of forbearance offered in the unsecured portfolios vary by reportable segment.
RBS has agreed to capitalise interest past due for 90 days or more.
Performing loans in UK PBB and Ulster Bank are subject to a latent loss provision but form a separate risk pool (for 24 months in UK PBB and for the period of forbearance in Ulster Bank). The higher of the observed default rates, or PD, is used in UK PBB in the latent provisioning calculations for these loans to ensure that appropriate provision is held.
In Ulster Bank, the PD model used in latent provision calculations is calibrated separately for forborne loans, using information on the historic performance of loans subject to similar arrangements. Furthermore, for these portfolios the latent provision incorporates extended emergence periods. Once such loans are no longer separately identified, the use of account level PDs, refreshed monthly in the latent provision methodology, captures the underlying credit risk without a material time lag. There is no reassessment of the PD at the time forbearance is granted but the loan is subject to the latent provisioning methodology described above.
carrying amount over the present value of expected future cash flows.
Notes: (1) It is possible for a mortgage loan to appear in more than one category. (2) There are other less material categories of personal lending not listed.
Private Private UK PBB Ulster Bank Banking CFG UK PBB Ulster Bank Banking CFG
The majority of the UK PBB personal portfolio consists of mortgages.
• Based on the Halifax Price Index at September 2014, the portfolio average indexed LTV by volume was 50.4% (2013 - 54.1%) and 57.3% by weighted value of debt outstanding (2013 - 62.0%). The ratio of total outstanding balances to total indexed property
had an average LTV by weighted value of 70.5%, which was higher than 2013 (66.6%), reflecting growth in the market and RBS’s strong support for the Help To Buy scheme. Within this: owner-occupier lending was £16.6 billion (2013 - £13.2 billion) and had an average
LTV by weighted value of 71.7% (2013 - 66.9%). Buy-to-let lending was £3.1 billion (2013 - £1.3 billion) with an average LTV by
• All new mortgage business is subject to a comprehensive assessment which includes: i) an affordability test; ii) credit scoring; iii) a maximum loan-to-value of 90% (75% on buy-to-let), with the exception of government-backed schemes, for example Help to Buy and New Buy, where lending of up to 95% is provided; and iv) a range of policy rules that restrict the availability of credit to riskier borrowers.
• The arrears rate (more than three payments in arrears, excluding repossessions and shortfalls after property sale), fell from 1.3% to 1.0%. The number of repossessions was also lower (1,129 compared with 1,532 in 2013). The arrears rate for buy-to-let
Notes: (1) As a percentage of mortgage loans. (2) Until June 2014, forbearance in UK PBB included all changes to the contractual payment terms, including those where the customer was up-to-date on payments and there was no obvious evidence of financial difficulty. From July 2014, only customers exhibiting signs of financial stress are reported in forbearance disclosures. (3) Includes the current stock position of forbearance deals agreed since early 2008 for UK PBB.
Term extensions - capital repayment and interest only 2,308 2,478 2,271
• Conversions to interest only have only been permitted on a very exceptional basis since the fourth quarter of 2012 and have not been permitted for customers in financial difficulty since 2009.
UK PBB stopped offering interest only terms for owner-occupier mortgages from 1 December 2012. This policy is reviewed periodically. Interest only repayment remains an option for buy-to-let mortgages. Exposure to interest only reduced by 5% during 2014.
The tables below show interest only mortgage portfolios (excluding mixed repayment mortgages) split by type and by contractual year of maturity.
(also known as a bullet payment) at the time of maturity. Typically such loans have remaining terms of between 10 and 20 years.
• Of the £24.3 billion interest only mortgages, £17.0 billion (70.0%)
and £7.3 billion (30.0%) related to buy-to-let lending (2013 - £5.6 billion).
• Of the bullet loans that matured in the six months to 30 June 2014, 60.3% had been fully repaid by 31 December 2014. The unpaid balance totalled £58.8 million, of which 94.4% continued to meet agreed payment arrangements (including balances with a term extension agreed on either a capital and interest or interest only basis). Of the £58.8 million unpaid balance, 84.1% of the loans had an indexed LTV of 70% or less with 2.6% above 90%.
• UK PBB personal recognises impairment provisions in respect of interest-only mortgages that are due to mature within five years. The impairment calculation is based on historical analysis coupled with data obtained from a sample of customers who were asked about how they intended to repay their borrowing at the end of term. The impairment provision held recognises that a proportion of customers may not be able to fulfil their contractual obligation to repay the debt.
The UK PBB personal lending portfolio comprised credit cards, unsecured loans and overdrafts, and totalled £12.3 billion at 31
reflecting RBS’s withdrawal from the 0% interest rate balance transfer market. Unsecured loans fell by 6.3% and overdrafts fell by 10.3%.
The majority (97%) of the Ulster Bank personal portfolio related to mortgage lending. Total gross lending of £18.1 billion comprised 10.1% of
RBS’s gross lending of £179.8 billion. £17.5 billion related to mortgage lending and £0.6 billion to other lending (loans and overdrafts).
The table below shows LTVs for the Ulster Bank residential mortgage portfolio split between performing (AQ1-AQ9) and non-performing
Notes: (1) Interest only loans. (2) Average LTV weighted by value is calculated using the LTV on each individual mortgage and applying a weighting based on the value of each mortgage.
• Ulster Bank stopped offering interest only loans as a standard mortgage offering for new lending in the Republic of Ireland in 2010 and in Northern Ireland in 2012.
• The average individual LTV on new originations was 75% in 2014,
• Based on updated house price indices as at October 2014, the portfolio average indexed LTV improved from 108% to 92% during 2014, reflecting positive house price index trends over the last 12 months. In particular, the Republic of Ireland house price index increased by 16% during 2014, with the Irish market being led by the
Dublin area, where the index increased by 22% during the year. The
Republic of Ireland house price index is 38% below its peak, which was in September 2007.
• Repossessions increased to 497 in 2014 from 262 in 2013.
• Ulster Bank provisioning methodology used a point-in-time provision rate based on the latest available house price index prepared by the
Central Statistics Office. This is used to create an indexed valuation at property level, which also takes into account costs of realisation and a discount for forced sales, and is one of the primary factors used in the determination of the likely size of the loss upon crystallisation. Loss likelihood rates are also determined and
(amongst other considerations) assess whether an active forbearance arrangement is in place. The provision rate is then a combination of these measures and is updated as required depending on the movement of the drivers applied as part of the methodology.
Credit risk continued Arrears status and provisions The mortgage arrears information for accounts in forbearance and related provision are shown in the tables below.
Notes: (1) As a percentage of mortgage loans. (2) Forbearance in Ulster Bank includes all changes to the contractual payment terms, including those where the customer is up-to-date on payments and there is no obvious evidence of financial difficulty. (3) Includes the current stock position of forbearance deals agreed since early 2009 for Ulster Bank.
Term extensions - capital repayment and interest only 501 325 183
Notes: (1) An individual case can include more than one type of arrangement. (2) Includes all arrangements agreed during the year (new customers and renewals) including those deals that have expired at the year end. Balances are as at the year end.
• At 31 December 2014, 22.2% of total mortgage assets (£3.9 billion)
(£2.8 billion) from 31 December 2013. This reflects Ulster Bank’s proactive strategies to contact customers in financial difficulty to offer assistance.
• Although the forbearance stock increased by 40% during the year, the number of customers approaching Ulster Bank for assistance for the first time has declined through 2014. This can be attributed to a greater number of mortgages being moved to longer-term arrangements, and therefore not exiting forbearance.
• The mix of forbearance treatments in Ulster Bank changed, with an increase in longer-term solutions. A total of 61% of forbearance loans were subject to a long-term arrangement at 31 December 2014 (2013 - 41%). These long-term arrangements were comprised of: i) Capitalisations which represented 30% of forbearance stock at
of forbearance loans at 31 December 2014 (2013 - 18%). This reflects Ulster Bank’s strategy to transition customers in financial difficulty to long-term arrangements.
Ulster Bank stopped offering interest only loans as a standard mortgage offering for new lending in the Republic of Ireland in 2010 and in Northern
Notes: (1) 2015 includes pre-2015 maturity exposure. (2) Includes £0.3 billion (2013 - £0.5 billion) of repayment mortgages that have been granted interest only concessions (forbearance). (3) Maturity date relates to the expiry of the interest only period. (4) 2014 includes pre-2014 maturity exposure.
• Of the bullet mortgages that matured in the six months to 30 June 2014 (£3.3 million), 37% had been fully repaid by 31 December 2014 leaving residual balances of £2.1 million, 81% of which were meeting the terms of a revised repayment schedule. Of the amortising loans that matured in the six months to 30 June 2014
(£232.6 million), 66% were either fully repaid or meeting the terms of a revised repayment schedule.
• Of the £1.3 billion interest only mortgages £0.9 billion related to owner-occupier mortgages and £0.3 billion related to buy-to-let mortgages.
The Ulster Bank personal lending portfolio comprised credit cards, unsecured loans and overdrafts, and totalled £591 million at 31
Unsecured retail forbearance was £4m in 2014 (out of £591m unsecured loans).
RBS’s gross personal lending of £179.8 billion. £8.9 billion related to mortgage lending and £5.2 billion to other lending (loans, overdrafts and current accounts).
(AQ10), with the average LTV calculated on a weighted value basis. Loan balances are shown as at the end of the year whereas property values are calculated using property index movements since the last formal valuation.
Non- Of Which: Non- Of Which: Non- Of Which: Performing performing Total IOL (1)
Loan-to-value ratio by value £m £m £m £m £m £m £m £m £m £m £m £m
Average LTV on new originations during the year (3) 48% 52%
Notes: (1) Interest only loans. (2) Where no indexed LTV is held. (3) Average LTV weighted by value is calculated using the LTV on each individual mortgage and applying a weighting based on the value of each mortgage.
2014 2013 Mortgages Other loans Mortgages Other loans £m £m £m £m
Note: (1) Mortgages with partial interest only and partial capital repayments.
Notes: (1) 2015 includes pre-2015 maturity exposure. (2) 2014 includes pre-2014 maturity exposure. (3) Maturity date relates to the expiry of the interest only period.
The majority of the CFG personal portfolio relates to mortgage lending.
Total gross lending of £32.0 billion comprised 17.8% of RBS’s gross personal lending of £179.8 billion. £21.1 billion related to mortgage lending and £10.9 billion to other lending (loans and overdrafts) and auto loans.
The table below shows LTVs for CFG, residential mortgages split between performing (AQ1-AQ9) and non-performing (AQ10), with the average LTV calculated on a weighted value basis. Loan balances are shown as at the end of the year whereas property values are calculated using property index movements since the last formal valuation.
Non- Of which: Non- Of which: Non- Of which: Performing performing Total IOL (2)
Notes: (1) Includes residential mortgages and home equity loans and lines. (2) Interest only loans. (3) Where no indexed LTV is held. (4) Average LTV weighted by value is calculated using the LTV on each individual mortgage and applying a weighting based on the value of each mortgage.
Others (SBO) portfolio, which is predominantly (95%) second lien, is included in the home equity book.
• CFG continued to focus on its ‘footprint states’ of New England, Mid-
Atlantic and Mid-West regions. At 31 December 2014, the portfolio consisted of £17.1 billion (82% of the total portfolio) within footprint.
• The SBO portfolio, which was closed to new purchases in the third quarter of 2007, decreased from £1.4 billion to £1.3 billion.
The mortgage arrears information for accounts in forbearance and related provision are shown in the tables below.
The incidence of the main types of personal forbearance on the balance sheet are shown below.
Term extensions - capital repayment and interest only 56 35 —
Notes: (1) Includes £18 million of loans (2013 - £62 million) where an interest rate discount has been agreed resulting in a reduction of contractual cash flows through forgiveness of interest. (2) As an individual case can include more than one type of arrangement, the analysis above exceeds the total value of cases subject to forbearance.
2014 2013 Mortgages Other loans Mortgages Other loans £m £m £m £m *unaudited
Notes: (1) 2015 includes pre-2015 maturity exposure. (2) Maturity date relates to the expiry of the interest only period. (3) 2014 includes pre-2014 maturity exposure.
The table below shows the arrears status of personal mortgages and HELOC loans by type.
Bullet principal Conversion to Bullet principal Conversion to repayment amortising Other Total repayment amortising Other Total £m £m £m £m £m £m £m £m
• CFG has a portfolio of interest only bullet repayment HELOC loans
• Of the bullet repayment loans that matured in the six months to 30
The auto portfolio totalled £7.9 billion at 31 December 2014 of which £6.9 billion has been originated through dealer networks and £1.0 billion of purchased pools of prime auto loans. CFG increased its exposure to auto loans during the year, within the risk appetite set as part of CFG’s strategy.
Credit risk assets analysed on pages 237 to 241 are reported internally to senior risk management. However, they exclude certain exposures, primarily securities and reverse repurchase agreements and take account of legal netting agreements, that provide a right of legal set-off but do not meet the criteria for offset in IFRS. The tables that follow are therefore provided to supplement the credit risk assets analysis and other analysis to reconcile to the balance sheet. All the disclosures in this section are audited.
Gross IFRS Carrying Balance sheet Real estate and other Credit mitigation and exposure offset (1) value (2) offset (3) Cash (4) Securities (5) Residential (6) Commercial (6) enhancement(7) enhancement £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Cash and balances at central banks 75.5 — 75.5 — — — — — — 75.5
Securities Clearing Corporation. (2) The carrying value on the balance sheet represents the exposure to credit risk by class of financial instrument. (3) Balance sheet offset reflects the amounts by which RBS’s credit risk is reduced through master netting and cash management pooling arrangements. Derivative master netting agreements include cash pledged with counterparties in respect of net derivative liability positions and are included in lending. (4) Includes cash collateral pledged by counterparties based on daily mark-to-market movements of net derivative positions with the counterparty. (5) Securities collateral represent the fair value of securities received from counterparties, mainly relating to reverse repo transactions as part of netting arrangements. (6) Property valuations are capped at the loan value and reflect the application of haircuts in line with regulatory rules to indexed valuations. Commercial collateral includes ships and plant and equipment collateral. (7) Credit enhancement comprises credit derivatives (bought protection) and guarantees and reflects notional amounts less fair value and notional amounts respectively.
• Financial assets after credit mitigation and enhancement fell by £35 billion or 9% principally reflecting lower funded assets (£35 billion)
• The major components of net exposure are cash and balances at central banks, unsecured commercial, corporate and bank loans, debt securities and short-term settlement balances.
• Of the £102 billion of debt securities, £25 billion are asset-backed but underlying collateral is not reflected above as RBS only has access to cash flows from the collateral.
Finance leases and instalment credit — 14,030 21 — 26 — 14,077 (1) 14,076
Finance leases and instalment credit — 13,609 82 1 13 — 13,705 — 13,705
(2) Includes loans made by consolidated conduits to asset owning companies.
• Overall exposure before impairment provision post offset fell by £35.3 billion or 5% in 2014 to £671.2 billion. This was in line with
Ulster Bank where repayments outstripped new lending. CFG also saw an increase reflecting portfolio acquisition as well as through foreign currency movements
• Property and construction exposure fell by £12.0 billion, £9.3 billion of which was in commercial real estate lending (refer to Credit risk -
The mapping to the S&P ratings is used by RBS as one of several benchmarks for its wholesale portfolios, depending on customer type and the purpose of the benchmark. The mapping is based on all issuer types rated by S&P. It should therefore be considered illustrative and does not, for instance, indicate that exposures reported against S&P ratings either have been or would be assigned those ratings if assessed by S&P. In addition, the relationship is not relevant for retail portfolios, smaller corporate exposures or specialist corporate segments given that S&P
Cash and Derivative Derivative balances and balances at Reverse cash Bank Reverse cash Customer other financial Contingent central banks repos collateral loans Total repos collateral loans Total assets DerivativesCommitments liabilities Total Total
• Reverse repos: AQ1 balances decreased by £6.6 billion reflecting reduced overall trading in line with balance sheet management strategies. Also, changes to the large corporate grading models resulted in migrations from higher to lower quality AQ bands; this contributed to the £7.2 billion increase in AQ3.
• Asset quality of customer lending in AQ1-AQ3 remained stable with higher cash collateral against increased fair value of derivatives, partially offset by a reduction in traded loans in CIB asset-backed products.
• The increase of £23 billion in AQ4 customer loans was primarily due to the recalibration of UK residential mortgage models following improvements in observed default rates and the implementation of the large corporate PD model.
model also resulted in increases of £6.6 billion and £15.1 billion in
• Past due loans decreased by £0.9 billion including £0.5 billion in
(2013 - £2.2 billion) of accruing past due 90 days or more loans included within risk elements in lending and £6.6 billion (2013 - £6.8 billion) of loans that are past due less than 90 days. Of the total past due loans, £4.8 billion (2013 - £5.2 billion) relates to personal loans.
The table below analyses debt securities by issuer and IFRS measurement classifications. US central and local government includes US federal agencies. The other financial institutions category includes US government sponsored agencies and securitisation entities, the latter principally relating to asset-backed securities (ABS).
decreased reflecting sales and continued focus on balance sheet reduction and capital management in CIB. The increase in other government bonds reflected higher activity and timing of auctions.
• AFS - Treasury took advantage of improved market conditions to reduce legacy banks and other financial institutions positions; consequently it no longer has any mortgage-backed covered bonds
The table below summarises the ratings of asset-backed securities on the balance sheet.
Of which: Of which: Of which: 27,357 4,571 2,453 784 5,730 4,523 720 3,026 4,421 53,585 Notes: (1) Residential mortgage-backed securities (RMBS) and commercial mortgaged-backed securities (CMBS) are securities that represent an interest in a portfolio of residential and commercial mortgages respectively. Repayments made on the underlying mortgages are used to make payments to holders of the mortgage-backed securities (MBS). The risk of the MBS 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 MBS notes. The main categories of mortgages that serve as collateral to RMBS held by RBS are set out below and described in the Glossary on pages 505 to 511. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for RBS's RMBS categorisation.
(2) Includes US agency and Dutch government guaranteed securities. (3) Comprises HFT £387 million (2013 - £1,275 million; 2012 - £1,177 million), DFV nil (2013 - nil; 2012 - £7 million), AFS £645 million (2013 - £1,138 million; 2012 - £1,173 million) and LAR £28 million
(2013 - £158 million; 2012 - £317 million). (4) Comprises HFT £100 million (2013 - £504 million; 2012 - £808 million), AFS £30 million (2013 - £26 million; 2012 - £149 million) and LAR £728 million (2013 - £924 million; 2012 - £130 million).
The table below analyses holdings of equity shares for eurozone countries and other countries with balances of more than £100 million by country, issuer and measurement classification. The HFT positions in CIB, primarily in run-off and recovery businesses, are used mainly for economic hedging of debt issuances and equity derivatives. The AFS portfolios include capital stock in the Federal Home Loan Bank (a government sponsored entity, included in other financial institutions) and the Federal Reserve Bank, which together amounted to £0.6 billion (2013 - £0.6 billion; 2012 - £0.7 billion)
that CFG are required to hold. The remaining AFS balances are individually small holdings in unlisted companies, mainly acquired through debt for equity transactions in Restructuring.
Notes: (1) Designated as at fair value through profit or loss balances are £301 million (2013 - £400 million; 2012 - £533 million), of which £130 million are other financial institutions (2013 - £105 million; 2012 - £61 million) and £171 million are corporate (2013 - £295 million; 2012 - £472 million). (2) Includes government sponsored entities. (3) HFT short positions of £211 million (2013 - £259 million; 2012 - £611 million) included £15 million (2013 - £75 million; 2012 - £101 million) relating to non-periphery eurozone countries.
• Interest rate contracts: notional balances were £8.3 trillion lower due to increased participation in trade compression cycles in 2014. The fair value increased due to significant downward shifts in major yields following further rate cuts by the European Central Bank,
European instability including Germany as well as concerns over falling oil prices. This was partially offset by the impact of strengthening of sterling against the euro and participation in tear ups.
• Foreign exchange contracts: the increase in fair value is driven by the strengthening of the US dollar against the Japanese yen as the portfolio was materially positioned long US dollar and short
• Credit derivatives: notional and fair value decreased reflecting participation in trade compression cycles and reduction in the US
may have netting arrangements in place, but operational capability does not support collateral posting. Transactions include foreign exchange hedges and interest rate swaps.
° Other financial institutions: transactions with securitisation structured purpose entities and funds where collateral posting is contingent on RBS’s external rating.
Client-led trading/residual risk (1) 52.1 50.0 0.9 1.3 124.7 111.7 1.2 1.5 250.7 240.7 3.4 3.1
Notional Notional Net exposure Notional Net exposure £bn £bn £bn £bn £bn of which: Notes: (1) Residual risk relates to legacy positions in RCR in 2014 and in Non-Core in 2013 and 2012. (2) Credit hedging in the banking book principally relates to portfolio management in RCR and Non-Core. (3) Credit valuation relating to monoline insurers and credit derivative product companies (CDPCs) were £47 million (2013 - £99 million; 2012 - £506 million).
Impairment losses/(releases) for year ended 31 December 2014 31 December 2014
Gross Releases Gross Releases Gross Releases Gross Releases Individual Collective Latent £m £m £m £m £m £m £m £m £m £m £m
• Overall customer loans fell by £5.0 billion to £412.8 billion reflecting
• UK PBB’s mortgage book grew strongly by £3.9 billion to £103.2 billion as advisor capacity increased (refer to Credit Risk Key credit portfolios on page 261 for more details). This was partially offset by lower unsecured lending.
• releases of £3.5 billion (£2.3 billion in RCR) partially offset by new charges of £2.4 billion (£1.0 billion in RCR) and currency and other movements.
• Disposal of assets by RCR, primarily in the second half of the year, at higher than anticipated sale prices together with favourable market conditions in Ireland and the UK resulted in impairment releases. Overall, there was a net loan impairment release of £1.2 billion, £1.3 billion in RCR for 2014.
• In Ulster Bank, REIL as a proportion of loans decreased to 19%
from 27% in 2013 and provision coverage of REIL reduced to 57%
to £2.5 billion, with £0.6 billion of the reduction due to the creation of
Gross as a % of as a % as a % of charge/ Amounts loans REIL Provisions gross loans of REIL gross loans (release) written-off of which: Commercial real estate 43,317 13,345 9,027 30.8 68 20.8 (1,067) 2,750
The table below analyses REIL between UK and overseas, based on the location of the lending office.
Non-Core Non-Core Total Non-Core Non-Core Total £m £m £m £m £m £m £m £m £m
Note: (1) Gross loans and advances to customers includes disposal groups but excludes reverse repos.
Currency translation and other adjustments 8 134 8 2 (15) — (21) 116 279 395
Notes: (1) Represents transfers between REIL and potential problem loans. (2) For details on impairment methodology refer to Credit risk on page 231 and Accounting policy 15 Impairment of financial assets on page 353.
RBS’s consumer portfolios, which consist of high volume, small value credits, have highly efficient largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods. Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements.
Note: (1) Transfers in Non-Core dissolution and RCR creation includes amounts in relation to latent.
Disposal of subsidiaries — — — — — — — — (77) (77)
Unwind of discount (recognised in interest income) (85) (81) (26) (3) (6) — — (201) (190) (391)
The table below shows loans and advances to customers that were past due at the balance sheet date but are not considered impaired.
Charge/(release) to income statement 268 (365) 77 (5) (9) (12) 197 151 (1,306) (1,155)
Loans to banks — — — — (15) — — (15) — (15)
UK US Other Total UK US Other Total UK US Other Total £m £m £m £m £m £m £m £m £m £m £m £m
Market risk is the risk of losses arising from fluctuations in interest rates, credit spreads, foreign currency rates, equity prices, commodity prices and other factors, such as market volatilities, that may lead to a reduction in earnings, economic value or both.
RBS is exposed to traded market risk through its trading activities and to non-traded market risk as a result of its banking activities. In many respects, it manages its traded and non-traded market risk exposures separately, as described in this section, largely in line with the regulatory definitions of the trading and non-trading books.
° the decision to exit the US asset-backed product (ABP) trading business.
Technology and process improvements continued to be made to enhance the measurement and management of market risk exposures. This covered key systems spanning areas such as market data and information technology architectures.
Longer-term interest rates remained at historically low levels during 2014. RBS maintained its structural hedge of invested equity and rateinsensitive customer deposit portfolios. The aim of the hedge is to stabilise interest earnings. During the year, the duration profile of the hedge did not change materially but action was taken to match the hedge’s currency profile more closely to underlying balance sheet exposures.
The increased hedging of US dollar structural exposures was related to the planned disposal of CFG. This was balanced by the requirement to maintain RBS’s current capital ratio sensitivity to foreign exchange rate movements within risk limits.
The primary objective of RBS’s trading activities is to provide a range of financing, risk management and investment services to its customers including major corporations and financial institutions around the world.
RBS undertakes transactions in financial instruments including debt securities, loans, deposits and equities, as well as securities financing and derivatives.
The majority of RBS’s non-traded market risk exposure arises from retail and commercial banking activities in all franchises from assets and liabilities that are not classified as held for trading.
The management of non-traded market risk is largely organised in line with the following three key categories: non-traded interest rate risk; nontraded foreign exchange risk; and non-traded equity risk.
Equity exposures may arise through strategic acquisitions, venture capital investments and certain restructuring arrangements.
Net loans and advances to banks 24.8 11.2 13.6 Interest rate
Net loans and advances to customers 394.8 23.2 371.6 Interest rate
Net loans and advances to banks 27.6 9.3 18.3 Interest rate
Market risk continued Trading balance sheet and VaR linkage The table below shows the trading business balance sheet split by trading portfolios within CIB and the associated trading VaR for the period ended
Currencies Provides currency services to corporate, institutional and retail clients globally covering FX, emerging and short-term markets.
Structures and distributes mortgage-backed securities, asset-backed securities and commercial mortgagebacked securities, covering both agency and nonagency segments of the market, from executing flow business to creating complex structured derivatives.
Credit Provides liquidity and capital to corporates and operates across investment-grade, high-yield and distressed credit. Offers a full-service credit-trading platform covering derivatives, bonds, bank loans and trade claims.
Management desk which manages counterparty risk exposures arising from over-the-counter derivative contracts, primarily credit risk and funding risk.
Notes: (1) The VaR amounts presented above represent the risk associated with external and internal transactions within each portfolio. VaR diversification represents the degree of correlation between portfolios within RBS. The diversification factor is the sum of the VaR on individual businesses less the total portfolio VaR. (2) Assets and liabilities presented above represent external transactions for each portfolio. (3) VaR in Centre relates primarily to market risks arising from credit valuation adjustment (CVA), funding valuation adjustment (FVA) and the related hedges which are booked and managed centrally.
The corresponding assets and liabilities are reflected in the underlying portfolio amounts where the CVA and FVA risks arise.
The market risk control and assurance framework has three key components: market risk policy; assurance approach policy; and independent assurance.
The Group Market Risk Policy Standard is part of the Group Policy
Market Risk Assurance forms part of Risk Assurance. This independent second line of defence function provides assurance on the robustness of the market risk framework within RBS, via centralised analysis of the control framework, complemented by the application of expert judgement through qualitative reviews. These findings are escalated to senior management and plans to address any shortcomings are recorded and tracked in the operational risk system. Market Risk Assurance activities are also reported directly and independently to the Group Audit
Market risk appetite is the level of market risk that RBS accepts when pursuing its business objectives, taking into account stressed scenarios.
These define the governance, responsibilities, control framework and requirements for the identification, measurement, analysis, management and reporting of market risk arising from trading and non-trading activities. These policies are also cascaded, as appropriate, to the legal entities, franchises and businesses to ensure there is a consistent control framework throughout.
(SVaR) and sensitivity and stress limits (for more details on VaR and
SVaR, refer to pages 304 to 309). The limit framework at the lower levels also comprises additional metrics that are specific to the market risk exposures within its scope. These additional metrics aim to control various risk dimensions such as product type, exposure size, aged inventory, currency and tenor.
The limits are reviewed to reflect changes in risk appetite, business plans, portfolio composition and the market and economic environments.
Identification and assessment of traded market risk is achieved through gathering, analysing, monitoring and reporting market risk information by business line or at a consolidated level. Industry expertise, continued system developments and techniques such as stress testing are also used to enhance the effectiveness of the identification and assessment of all material market risks.
A market risk update is also included in the RBS Risk Management
RBS uses a comprehensive and complementary set of methodologies and techniques to measure traded market risk that collectively ensure a complete approach to the measurement of material market risks.
and SVaR. Risks that are not adequately captured by these model methodologies are captured by the Risks Not in VaR
• Currency risk, which arises from the impact of changes in currency rates and volatilities.
Examples of such risk types include: • Basis risk, which is the risk that imperfect correlation between two instruments in a hedging strategy creates the potential for excess gains or losses, thus adding risk to the position; • Prepayment risk, which is the risk associated with early unscheduled return of principal on a fixed rate security; and
• Historical simulation VaR may not provide the best estimate of future market movements. It can only provide a forecast of portfolio losses based on events that occurred in the past. The RBS model uses the previous two years of data; this period represents a balance between model responsiveness to recent shocks and risk factor data coverage.
‘tail’ risks. These risks are more appropriately assessed using measures such as Stressed VaR and stress testing.
• The use of a one-day time horizon does not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day. This may not fully reflect market risk at times of severe illiquidity in the market when a one-day period may be insufficient to liquidate or hedge positions fully. Thus, the regulatory
• When RBS uses ten-day risk factor changes in the calculation of the regulatory VaR, the ten-day periods overlap, which can introduce an autocorrelation bias in the 99% confidence level VaR statistic. The analysis performed has shown the bias to be small and acceptable for a ten-day period.
• Risk factors relevant to a specific portfolio may be omitted, due to a lack of reliable data, or the use of proxy risk factors, for example.
• Total traded VaR decreased significantly in 2014 compared with 2013, on both a period-end and average basis, for the following two key reasons: ° the inclusion of CVA and FVA trades in the internal VaR
• The declines in interest rate and credit spread VaR were also affected by specific factors: ° Interest rate VaR declined in Q1 2014 due to reduced risk appetite for flow market-making in the Rates business in CIB.
• Total VaR was notably volatile in the second half of the year, largely as a result of heightened geopolitical risks given the Ukraine/Russia crisis and Middle East tensions and the developments in the eurozone periphery.
• The decrease in the average and period end RCR VaR reflects the inclusion of CVA and FVA trades in the calculation of internal VaR
In addition, independent VaR model reviews are carried out by Model
As well as being an important market risk measurement and control tool, the VaR model is also used to determine a significant component of the market risk capital requirement (refer to page 311 for more information on calculation of capital requirements). Therefore, it is subject to not only ongoing internal review and validation but also regulator-prescribed backtesting.
The main approach employed to assess the ongoing model performance is back-testing, which counts the number of days when a loss exceeds the corresponding daily VaR estimate, measured at a 99% confidence level.
The Clean P&L for a particular business day is the firm’s actual P&L for that day in respect of the trading activities within the scope of the firm’s regulatory VaR model, including any intraday activities, adjusted by stripping out: • Fees and commissions; • Brokerage; • Additions to, and releases from, reserves that are not directly related to market risk; and
Hypo P&L exceeds the VaR level on a given day. Such an event may be caused by a large market movement or may highlight issues such as missing risk factors or inappropriate time series. Any such issues identified are analysed and addressed through taking appropriate remediation or development action. RBS monitors both Clean and Hypo back-testing exceptions.
The table below shows regulatory back-testing exceptions for a period of 250 days for 1-day 99% traded regulatory VaR vs. Clean and Hypo P&L for the legal entities approved by the PRA and De Nederlandsche Bank.
• Statistically RBS would expect to see back-testing exceptions 1% of the time over a one-year period. From a capital requirement perspective, the PRA categorises a firm’s VaR model as green, amber or red. A green model status is consistent with a satisfactory
VaR model and is achieved for models that have four or fewer exceptions in a continuous 12 month period. RBS’s VaR model has maintained a green status for its regulated legal entities and hence has considered that no action is required to rectify or adapt its VaR
Credit business relating to the mining and chemical sectors and from losses on inflation securities.
• The exceptions at the NatWest level were driven by: the re-marking in August of certain inflation products following independent price verification; losses on euro and sterling positions as foreign exchange spot rates moved significantly in September; and a oneday delay in booking by a trader in September.
• The exception at the RBS N.V. level in December was primarily driven by the unwinding of a Brazilian fund.
The table below shows internal back-testing exceptions for a period of 250 days for 1-day 99% traded internal VaR vs. Clean and Hypo P&L for major
Note: (1) The business classification for the purpose of back-testing has been revised to bring it in line with the new RBS business hierarchy effective 3 February 2014. Back-testing exceptions for these businesses are also counted from this date.
• The top-level businesses presented in the table above are subject to quarterly governance by the PRA. For some of these businesses, exceptions were noted during 2014 and analysis conducted as explained below.
• The exceptions in the Currencies business occurred in the normal course of business and were mainly due to market moves adversely affecting spot and volatility foreign exchange positions in the business.
• CIB RoR experienced one actual and two hypothetical exceptions during 2014. All exceptions were due to fair value differences on the execution of a risk migration trade.
• The period end traded SVaR declined in 2014 compared with 2013.
The RNIV approach is used for market risks that fall within the scope of
The RNIV calculations provide a capital estimate of risks not captured in the VaR model and are regularly reported and discussed with senior management and the regulator. The methodology used in the material
RBS’s ongoing model and data improvement efforts to capture all market risks in scope for model approval in VaR and SVaR. Since the introduction of the RNIV framework, progress has been made in transitioning RNIVs into the VaR model.
The top ten RNIVs represent approximately two thirds of the total RNIV
• Interpolation and re-bucketing inaccuracy: to cover residual errors resulting from the pre-processing of risk factors into a standard set across tenors.
• Static pricing parameters: to cover the possibility that suboptimal assumed values are used for certain unobserved parameters in pricing models.
The most material of these are proxied sensitivities, followed by higherorder sensitivity terms.
RNIVs that are related specifically to instruments that have level 3 valuation hierarchy assumptions (refer to pages 388 and 389) are mainly included in the following categories: proxied sensitivities or risk factors; higher-order sensitivity terms; and static pricing parameters.
Traded market risk continued The table below analyses capital requirements related to RNIVs. 2014 2013 £m £m
• The RNIV charge increased by 41% year on year. This was primarily due to the removal of the materiality threshold in Q1, and hence all
RNIVs are now subject to capital requirements, following an agreement with the PRA. This initial increase was partially offset by risk reductions across the portfolio in H2.
RBS undertakes daily market risk stress testing to identify vulnerabilities and potential losses in excess of or not captured in VaR. The calculated stresses measure the impact of changes in risk factors on the fair values of the trading and available-for-sale portfolios.
The associated models calculate the market and default risk in the trading book and are aligned with other models that are used for limit setting and market risk management. The results are annualised to be consistent with the other economic capital models to permit consolidation of all risk types as part of the RBS-wide economic capital programme.
• The all price risk model covers the generally lower-liquidity correlation trades and their liquid hedges (such as first-to-default basket trades). RBS ceased using an internal model for all price risk during Q2 2014, refer to the following page.
Market risk RWAs of £24 billion and minimum capital requirement of £1.9 billion are analysed below.
RBS’s VaR model has been approved by the PRA to calculate its regulatory market risk capital requirement for the trading book for those legal entities under its jurisdiction. These legal entities are The Royal
The dependency of positions is modelled using a single-factor Gaussian copula, which facilitates an efficient calculation of the charge using numerical integration.
IRC is mainly driven by three-month transition, default and correlation parameters. The portfolio impact of correlated defaults and rating changes is assessed by observing changes in the market value of positions using stressed recovery rates and modelled credit spread changes. Revaluation matrices are used to capture any non-linear behaviour.
The following table analyses RBS’s total market risk minimum capital requirement of £1,917 million at 31 December 2014, calculated in accordance with the Capital Requirements Regulation (CRR); this represents 8% of the corresponding RWA amount, £24 billion. It comprises a number of regulatory capital requirements split into two categories: (i) the standardised position risk requirement (PRR) of £459 million, which has several components; and
(ii) the Pillar 1 model-based PRR of £1,458 million, which comprises several modelled charges. For 2013 and 2012, the capital requirements were calculated in accordance with Basel 2.5.
The following table analyses the principal contributors to the Pillar 1 model based PRR presented in the previous table. Following the implementation of the CRR on 1 January 2014, credit hedges eligible for CVA are no longer included in the modelled market risk capital charges. Such hedges are now included in the CVA capital charge, which forms part of the capital calculation for counterparty credit risk. CRR Basel 2.5 Basel 2.5
• RBS’s total market risk minimum capital requirement fell in 2014, largely driven by the decreases in the Pillar 1 model-based contributors (primarily VaR, SVaR and the IRC). The standard method requirement rose, chiefly driven by the rise in the specific interest rate risk of securitisation positions.
• The decrease in the commodity position risk requirement was driven by a change in the treatment of options under the CRR standardised approach.
• The foreign currency position risk requirement increased, reflecting increased foreign currency cash positions over the period.
• The decrease in the VaR and SVaR charges was primarily driven by the removal of the CVA eligible hedges (as noted above) in Q1 and ongoing risk reduction in Q2 and Q3 relating to the asset backed product portfolio as part of the risk reduction strategy.
• The IRC declined by 32%, notably in Q4 reflecting a reduced exposure to the eurozone periphery and continued risk reduction in the US ABP portfolio. The IRC figures presented in the table above differ from those in the table on the following page for the reasons explained in the note to that table.
• Given the reduction in the size of the correlation trading portfolio,
RBS ceased using an internal model for all price risk during Q2.
• For details of the drivers of the increase in the RNIV charge, refer to the commentary on page 310.
• The decrease in the AAA rating category reflects the continued reduction in US ABP business.
The following table shows the capital requirement for trading book securitisation positions by rating.
AAA AA A BBB grade Unrated Total (1,2) STD PRR (3) deductions
For more information on valuation controls, refer to page 303. The validation of pricing models is discussed below.
RBS uses a variety of models to manage and measure market risk, as described below. These models comprise pricing models (used for valuation of positions) and risk models (for risk measurement and capital calculation purposes). They are developed in both RBS-level and lowerlevel functions and are subject to independent review and sign-off.
Risk - performs reviews of relevant models in two instances: (i) for new models or amendments to existing models and (ii) as part of its ongoing programme to assess the performance of these models.
A new model is typically introduced when an existing model is no longer fit for purpose or a new product requires a new methodology or model to quantify the risk appropriately. Amendments are usually made when a weakness is identified during use of a model or following analysis either by the model developers or by Model Risk.
These committees comprise representatives of the major stakeholders in the valuation process - trading, finance, market risk, model development and model review functions.
The review process comprises the following steps: • The committees prioritise models for review by Model Risk, considering the materiality of the risk booked against the model and an assessment of the degree of model risk, that is the valuation uncertainty arising from the choice of modelling assumptions.
• Model Risk quantifies the model risk by comparing front office model outputs with those of alternative models independently developed by
All new risk models are subject to review and sign-off by Model Risk.
exceeding 5% at legal entity level or 15% at a major business level are also subject to Model Risk review and sign-off as are all model changes that require regulator approval before implementation.
Risk assesses changes since the last approval along the following dimensions: change in size/composition of the portfolio, market changes, model performance, model changes, status of any outstanding issues, scheduled activities including work carried over from previous reviews.
holds appropriate capital for the market risk to which it is exposed.
The model testing team in Market Risk also performs regular VaR model testing, which is discussed in more detail under Risk measurement value -at-risk on page 304.
RBS manages the three key categories of non-traded market risk separately. The categories are: non-traded interest rate risk; non-traded foreign exchange risk; and non-traded equity risk.
The ERF approves the non-traded market risk framework. The nontraded market risk policy statement sets out the governance and risk management framework through effective identification, measurement, reporting, mitigation, monitoring and control.
• The two risk factors above incorporate the duration risk arising from the reinvestment of maturing swaps hedging net free reserves (or net exposure to equity and other low fixed-rate or non-interestbearing liability balances including, but not limited to, current accounts).
• Optionality risk, which arises when customers have the right to terminate, prepay or otherwise alter a transaction without penalty, resulting in a change in the timing or magnitude of the cash flows of an asset, liability or off-balance sheet instrument. This risk primarily arises in the US mortgage business in CFG where long-term fixedrate loans are the norm and prepayment penalties are rare.
In order to manage exposures within these limits, RBS aggregates its interest rate positions and hedges them externally using cash and derivatives - primarily interest rate swaps.
This task is primarily carried out by RBS Treasury, to which all businesses except CFG and CIB transfer most of their NTIRR. The main exposures and limit utilisations are reported to the ALCo and the Board monthly.
The only material non-traded open currency positions are the structural foreign exchange exposures arising from investments in foreign subsidiaries, branches and associates and their related currency funding.
RWAs equals RBS’s CET1 ratio. The sensitivity of the CET1 capital ratio to exchange rates is monitored monthly and reported to the ALCo at least quarterly.
NTIRR can be measured from either an economic value-based or earnings-based perspective (or both). Value-based approaches measure the change in value of the balance sheet assets and liabilities over a longer timeframe, including all cash flows. Earnings-based approaches measure the potential short-term (generally one year) impact on the income statement of charges in interest rates.
• The decline in VaR between 2013 and 2014 reflects RBS policy to reduce economic exposure to changes in interest rates. This notably related to US dollar and sterling interest rate exposures.
To analyse earnings sensitivities, forecasts are generated using implied forward rates, projected new business volumes, mix and pricing generated using business assumptions. Based on the balance sheet at the most recent month end, two NII forecasts are calculated each month: (i) a forecast for the current full year, which incorporates actuals monthly as the year progresses; and (ii) a base-case 12 month rolling forecast.
In addition, the 12 month rolling forecast is re-run using alternative rates under various scenarios, incorporating changes in customer behaviour and business assumptions as appropriate. Variances between these scenarios are analysed to identify key drivers. These forecasts and sensitivities form part of the information used by senior management to manage the bank's NII targets.
The following table shows the sensitivity of net interest income, over the next 12 months, to an immediate upward or downward change of 100 basis points to all interest rates. In addition, the table includes the impact of a gradual 400 basis point steepening (bear steepener) and a gradual 300 basis point flattening (bull flattener) of the yield curve at tenors greater than a year.
+ 100 basis point shift in yield curves (28) 347 214 (17) 516 154
− 100 basis point shift in yield curves (34) (298) (87) (12) (431) (85)
− 100 basis point shift in yield curves (29) (333) (82) (15) (459) (76)
+ 100 basis point shift in yield curves (29) 472 119 27 589 255
− 100 basis point shift in yield curves (20) (257) (29) (11) (317) (76)
• Interest rate exposure remains asset sensitive, such that rising rates will have a positive impact on net interest income.
• The decreased sensitivity to parallel shifts in the yield curve over a 12 month horizon is due to increased exposure to fixed rate assets and changes in assumptions regarding the impact on customer pricing.
Product structural hedges are used to minimise the volatility on earnings related to specific products, primarily customer deposits. The balances are primarily hedged with medium-term interest rate swaps, so that reported income is less sensitive to movements in short -term interest rates. The size and term of the hedge are based on the stability of the underlying portfolio.
Equity structural hedges are used to minimise the volatility on earnings arising from returns on equity. The hedges managed by Treasury relate mainly to the UK banking businesses and contributed £0.8 billion to these businesses in 2014 (2013 - £0.8 billion), which is an incremental benefit relative to short-term wholesale cash rates. The size of the hedge increased from £39 billion in 2013 to £41 billion in 2014. The fall in yield mainly results from reinvestment of maturing hedges at lower rates.
Notes: (1) Non-controlling interests (NCI) represents the structural foreign exchange exposure not attributable to owners’ equity, which consisted mainly of CFG in US dollar in 2014 (2013 and 2012: mainly
• Net assets of overseas operations declined by £5.4 billion, largely due to write-downs relating to CFG and US deferred tax assets.
• Non-controlling interests increased by £2.4 billion, as a result of the partial disposal of CFG during the year.
• Net investment hedges increased by £1.8 billion, primarily due to an increase in US dollar hedging to manage the disposal of CFG.
weakening would result in a loss of £0.6 billion in equity (2013 - £1 billion).
Unrealised gains included in Tier 1 or Tier 2 capital 199 232 168
Gains on equity securities designated at fair value through profit or loss but not held for trading purposes were £222 million for 2014 (2013 - gains of £96 million; 2012 - gains of £184 million).
Average Period end Maximum Minimum Average Period end Maximum Minimum £m £m £m £m £m £m £m £m £m £m £m £m
Notes: (1) RBS benefits from diversification as it reduces risk by allocating positions across various financial instrument types, currencies and markets. The extent of the diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR. (2) The table above excludes the structured credit portfolio and loans and receivables.
The capital calculations under internal capital adequacy assessment process are also used for economic capital purposes.
Country risk 324 Sources of risk 324 Risk appetite 325 Risk mitigation 325 Risk monitoring 325 Basis of preparation 326 Summary of country exposures
Country risk is the risk of losses occurring as a result of either a country event or unfavourable country operating conditions. As country events may simultaneously affect all or many individual exposures to a country, country event risk is a concentration risk. For other types of concentration risks such as product, sector or single-name concentration, refer to the
Country risk has the potential to affect all parts of RBS’s portfolio across wholesale and retail activities that are directly or indirectly linked to the country in question. It arises from possible economic or political events in each country to which RBS has exposure, and from unfavourable conditions affecting daily operations in a country.
assumed supervisory responsibility for the 130 largest banks of the eurozone, after concluding a detailed Asset Quality Review of their books, adjusting balance sheets and stress testing their capital positions.
The other pillar will be the Single Resolution Mechanism, scheduled for
Important shifts in exposure occurred in 2014 as a result of the sale of a significant portion of RBS N.V.’s liquidity portfolio AFS bonds following internal asset quality reviews and stress tests. The sale consisted of
In 2015, recovery in the advanced economies will likely remain uneven, with widening differentials between the US and Europe in growth, price levels and policies. The policy divergence will be amplified by the January 2015 ECB announcement of a €1,000 billion quantitative easing programme, aimed at reversing deflation and stimulating credit growth, while the US Federal Reserve is expected to start tightening interest rates in the second half of 2015.
For further information on governance, refer to the Risk governance section on page 176.
Part of RBS’s exposure is mitigated by guarantors or insurers (including export credit agencies), credit default swap (CDS) protection providers, or collateral in third countries, which will not be directly affected by a country event in the obligor’s country. Further details on credit mitigation instruments are provided in the Credit risk section.
CDS contracts are used to hedge either entire portfolios or specific individual exposures. These transactions are subject to regular margining, which usually takes the form of cash collateral. For European peripheral sovereigns, credit protection is purchased from a number of major European banks, mostly outside the country of the reference entity.
In a few cases where protection was bought from banks in the country of the reference entity, giving rise to wrong-way risk, this risk is mitigated through specific collateralisation and monitored weekly.
A country risk Watchlist process identifies emerging issues, facilitating the development of mitigation strategies. Monthly reports discussing
RBS’s main country risks and trends are sent to the CRC leadership team, with any key risks reported to the Executive Committee and the
Detailed portfolio reviews are conducted to ensure that the composition of country portfolios remains aligned with RBS’s country risk appetite in light of economic and political developments. Changes in sovereign ratings or country Watchlist status trigger a review of appetite and, where appropriate, are referred to the CRC for discussion.
In this section, country exposure includes wholesale and retail net onbalance sheet exposure (drawn amounts under lending facilities, net of provisions, mark-to-market derivatives positions and issuer-risk debt securities positions in the banking book and trading book) together with off-balance sheet exposure (contingent obligations and undrawn commitments).
RBS also estimates its funding mismatches at risk of redenomination in vulnerable eurozone countries. These mismatches are defined as the exposures (net of provisions) that would be expected to convert to a new national currency minus the liabilities that would be expected to redenominate at the same time. Exposures exclude balances at low risk of redenomination, as identified through consideration of the relevant documentation, particularly the currency of exposure, governing law, court of jurisdiction, precise definition of the contract currency (for euro facilities), and location of payment.
RBS may be either a net buyer or a net seller of protection.
Net balance sheet exposure Analysis of net balance sheet exposures Offnotional
Sovereign Banks FI Corporate Personal Total lending AFS/LAR HFT (net) Derivatives SFT sheet exposure fair value Derivatives SFT
(9) Sovereign - Comprises central, regional and local government, and central banks. (10) Eurozone periphery - Ireland, Italy, Spain, Portugal, Greece and Cyprus. (11) Other eurozone - Austria, Estonia, Finland, Latvia, Malta, Slovakia and Slovenia.
• Net balance sheet and off-balance sheet exposure to most countries declined across most products. RBS maintained a cautious stance and many clients continued to reduce debt levels. The euro depreciated against sterling by 6.5% while the US dollar appreciated
Germany, Spain and France) and to the Irish personal sector; in cash deposits held with central banks in Germany and the
(HFT) government bond positions in Italy and Spain. Net HFT debt securities in Germany, France, the Netherlands, Belgium and a few other countries increased, driven by trading activity and auctions.
• Eurozone periphery net balance sheet exposure decreased by £10.4 billion to £31.4 billion.
to £22.6 billion, with exposure to corporates and households decreasing by £3.3 billion and £1.2 billion respectively, reflecting sales, repayments and write-offs (partly offset by impairment write-backs) plus currency movements. Provisions fell by £2.2 billion to £8.5 billion, reflecting improved collateral values. Cash deposits with the Central Bank of Ireland increased by £0.5 billion as part of Ulster Bank’s preparations for the new Capital Requirements Regulation liquidity coverage ratio requirements which come into effect in 2015.
° Italy - exposure fell by £0.9 billion to £4.2 billion, largely reflecting fluctuations in net HFT. Most AFS government bonds were sold, and lending and derivatives exposure to non-bank financial institutions fell by £0.5 billion. Net derivatives exposure to banks increased by £1.2 billion, driven by the acquisition of a fully cash-collateralised exposure from another bank.
This comprised mostly collateralised derivatives exposure to banks and corporate lending, including exposure to local subsidiaries of international companies. Net of collateral held under credit support annex and reflecting the effect of credit agency cover and parental guarantees, total committed exposure was approximately £120 million net of provisions, mostly in RCR. Contingency planning, including any potential operational and system changes, has been refreshed to ensure readiness for any downside scenario.
- Spain £0.5 billion (down from £6.5 billion, largely due to the reduction in AFS securities).
- Italy £1.5 billion (up from £0.5 billion due to higher derivatives exposure, lower euro deposits and as the central bank funding line was no longer used).
- Portugal £0.5 billion (slightly up due to higher debt trading).
The net positions for Greece and Cyprus were minimal. With the possible exception of Greece, risks of eurozone break-up
(redenomination events) have materially receded since 20112012, owing to major improvements in liquidity conditions, driven by the availability of substantial new tools for the
• Germany - net balance sheet exposure rose by £2.9 billion to £26.6 billion, as a result of increases in net HFT exposure, AFS debt securities and derivatives exposure to non-bank financial institutions. This was partially offset by decreases in corporate lending (particularly in CRE) and to securitisation vehicles, and in cash deposits with the Bundesbank. Off-balance sheet exposure decreased by £1.1 billion, mostly in the insurance and corporate sectors. Government bond holdings were £14.0 billion (AFS - £6.7 billion; HFT long positions - £7.3 billion) at the end of the year.
• France - net balance sheet exposure rose by £2.2 billion to £16.1 billion, mainly reflecting debt trading fluctuations and increased derivatives exposure to banks and SFT. Lending to the public, CRE
• Netherlands - net balance sheet exposure fell by £1.2 billion to £14.7 billion, as a result of reductions in AFS debt securities in the
• India - net balance sheet exposure fell by £1.7 billion to £2.0 billion, with reductions in corporate lending, particularly in the oil and gas and mining and metals sectors, and in lending to banks, largely trade finance. The reductions in part reflected increasing capital requirements and sales of low-yielding assets.
• Russia - net balance sheet exposure was £1.8 billion and included £0.9 billion of corporate lending and £0.7 billion of bank lending, around half of which was fully hedged. Internal ratings were reviewed, additional credit restrictions placed on new business, and limits adjusted downwards. Exposures were reviewed against all international sanctions.
• South Korea - net lending to banks and corporate clients decreased by £0.4 billion, reflecting a greater focus on capital efficiency. Net balance sheet exposure was £1.3 billion.
• Turkey - net balance sheet exposure fell by £0.4 billion to £1.2 billion, mainly reflecting lower lending to corporates.
Other risks 331 Pension risk 332 Business risk 333 Strategic risk
Pension risk is the risk arising from contractual or other obligations to, or with respect to, RBS’s pension schemes, whether established for its employees or for those of a related company. It is also the risk that RBS
may make payments or other contributions to, or with respect to, a pension scheme because of a moral obligation, or for any other reason.
Pension scheme liabilities vary with changes in long-term interest rates and inflation as well as with pensionable salaries, the longevity of scheme members, and legislation. Meanwhile, pension scheme assets vary with changes in interest rates, inflation expectations, credit spreads, exchange rates and equity and property prices. RBS is exposed to the risk that the schemes’ assets together with future returns and any additional future contributions are insufficient to meet liabilities as they fall due. In such circumstances, it could be obliged (or might choose) to make additional contributions to the schemes or be required to hold additional capital to mitigate this risk.
The 31 March 2013 triennial funding valuation of the Main scheme was agreed in May 2014. It showed the value of liabilities exceeded the value of assets by £5.6 billion at the valuation date, a ratio of assets to liabilities of 82%. RBS and the trustee agreed a plan to fund the Main scheme. To eliminate this deficit, RBS agreed to pay additional contributions from 2014 until 2023. Contributions will start at £650 million in 2014 to 2016 and will fall to £450 million (indexed in line with inflation) for the period 2017 to 2023. These contributions are in addition to regular annual contributions of around £270 million for ongoing accrual of benefits as well as contributions to meet the expenses of running the scheme. The agreed deficit payments supersede all previous schedules of contributions.
Bank of Scotland plc. The trustee board currently comprises six directors selected by RBS and four directors nominated by members. The trustee is supported by RBS Investment Executive Ltd (RIEL), a team specialising in pension investment and risk management.
RBS Asset and Liability Committee, formulates RBS’s view of pension risk. The PRC considers mechanisms that could potentially be used for managing risk within the funds as well as financial strategy and employee welfare implications, and also reviews actuarial assumptions from a sponsor perspective as appropriate. The PRC is a key component of
RBS’s approach to pension risk where risk management, asset strategy and financing issues are reviewed and monitored on behalf of RBS. The
PRC also serves as a formal link between RBS, RIEL and the trustee.
As the sponsor of its defined benefit pension schemes, RBS manages the risk it faces using a pension risk management framework. This encompasses risk monitoring, modelling, stress testing and reporting. As sponsor, RBS maintains an independent view of the risk inherent in its pension funds. In addition to the scrutiny provided by the PRC, RBS also achieves this through regular pension risk monitoring and reporting to the
In October 2012, RBS confirmed that it was offering employees in the
Main scheme the choice between an increase to the charge, made through its flexible benefits programme, of 5% of salaries and an increase in Normal Pension Age from 60 to 65 in respect of service from October 2012 with no additional charge.
Monthly Management Report. The report includes a measurement of the overall deficit or surplus position based on the latest data and estimated capital requirements, and an assessment of the sensitivities of the pension schemes to interest rates, inflation and credit spreads.
Pension stress tests take the form of both stochastic (one that cannot be predicted precisely) and deterministic stresses over time horizons from one to five years in duration. They are designed to examine the behaviour of the pension schemes’ assets and liabilities under a range of financial and demographic shocks. The results of the stress tests and their consequential impact on RBS’s balance sheet, income statement and capital position are incorporated into the overall enterprise-wide stress test results.
Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields 447 413 34
Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields 932 1,159 (227)
At 31 December 2013 Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields 217 333 (116)
Fall in credit spreads of 0.25% at all durations with no change in nominal or real swap yields 60 1,245 (1,185)
RBS reduced its business risk profile as it curtailed riskier activities in
CIB, made disposals through RCR, and announced an intensified cost management programme.
An increase in regulatory scrutiny of the industry’s approach to stress testing affected the management of business risk in 2014. Additional stress testing was undertaken in response, and scenario modelling capability was enhanced further. In the US, CFG strengthened its capital planning capabilities following the Federal Reserve’s Comprehensive
The Board has ultimate responsibility for business risk. Refer to the Risk governance section on page 176.
RBS and its underlying businesses are within risk appetite. Each franchise is responsible for the implementation of its business plan and the management of associated risks within approved risk appetite targets.
Business risk is reported, assessed and challenged at every governance level within the organisation. Each franchise monitors its revenues and costs relative to plans, reporting this on a regular basis to the finance directors of each franchise and to bank-wide functions. The Finance function challenges financial results and reports performance against plan to the Board and executive committees, focusing on revenue generation, cost management initiatives and risk mitigation.
Business risk is reviewed and assessed through RBS’s planning cycles, which are discussed with RBS Risk Management, and performance management processes.
Strategic risk arises from decisions that fail to reflect the operating environment, or which do not take adequate account of execution challenges. These include decisions related to RBS products and services which have implications for profitability, risk, the customer base, and for business growth.
RBS announced the results of a strategic review with a defined plan to shift the business mix towards the UK and the retail and commercial banking segments, with the aim of a lower risk profile for the bank.
The year saw good progress against this plan. Business results in general exceeded targets and the run-down and sell-off of non-core assets were ahead of schedule. RBS’s capital ratios increased markedly, a significant step towards targeted levels of financial strength which, when attained, will provide RBS with more strategic options.
Corporate Development team. The Risk and Finance functions are key contributors to strategic planning. As part of the process, each customer business develops a strategic plan for its business within a framework set by the bank’s senior management. The strategic plans are consolidated at bank-wide level, and reviewed and assessed against risk appetite by the CEO, the CFO and the bank’s Director of Strategy and Corporate
Strategic plans are assessed against, and must comply with, RBS’s strategic risk objectives (refer to Risk appetite section, page 180). These objectives are intended to ensure that RBS’s chosen strategies do not expose it to an inappropriate degree of financial and non-financial risk.
RBS employs robust strategy development processes which consider the implications of economic, industrial, market, technological and customer developments and trends. RBS Risk Management is involved in defining risk appetite for the customer businesses, and in challenging and reviewing strategic plans.
In addition, there are “top risks” and “emerging risks” processes in place which aim to identify early, monitor closely and avoid or otherwise manage effectively strategic risks that have the highest likelihood of impacting strategic plans.
A major part of the top risks process is to ensure that all appropriate action is taken to mitigate the most material risks to strategic objectives.
The financial statements comprise the accounting policies, the consolidated and company balance sheets as at 31 December 2014, 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 2014, the related Notes 1 to 42 on the consolidated financial statements, the related Notes 1 to 16 on the company financial statements and the information identified as “audited” in the Capital and risk management section of the Business review. The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the
• Collective assessments are made on a portfolio, modelled basis where the loans and advances are homogeneous in nature, for example the personal banking and smaller corporate portfolios.