With hard work, determination and a willingness to take tough decisions we have the people and capabilities to enable the Group to recover. We can make it a profitable investment, a model corporate citizen in all of the countries in which it operates and an excellent place to work.
Justifying the support of our shareholders Twice during 2008 the Group sought additional capital from shareholders to enable it to weather the very testing environment and to achieve the higher capital ratios that markets now demand. On the second occasion, the capital raising was underwritten by the UK government and in November it became the Group’s majority shareholder.
An inevitable but regrettable consequence of the successive capital raising exercises has been the dilution of the interests of existing shareholders. My predecessor Sir Tom McKillop apologised to shareholders for the impact on them of the erosion of their investments, a sentiment I echo. Those of us now charged with leading RBS are committed to implementing measures which will allow us to restore the Group to standalone financial health in the interests of all shareholders.
We owe our continued independence to the UK government and taxpayers and are very thankful for their support. The external environment has seen unprecedented turbulence in bank and other financial markets and deteriorating economic conditions around the world. Our disappointing financial results reflect these circumstances and our exposure to them.
We will appoint a further three Non-Executive Directors in due course.
We must also engage our people with a new employment proposition which sets incentives that reward them for delivering sustained and sustainable success.
We recognise that our reputation has been damaged by the events of the last year. So, too, has the reputation of the banking industry in countries across the globe. We are determined to rebuild our reputation, and to demonstrate leadership in the industry in this respect, partly through our core purpose of business success, but also by playing a constructive and responsible role in the communities in which we operate.
The way forward I am confident that we can, must and will restore the RBS Group to standalone financial strength. Last year was undeniably tough and a worsening economic environment means that 2009 will present significant challenges in all of our markets. The path to recovery will be neither smooth nor straight. But we build on a number of strengths: excellent businesses, talented people and, above all, millions of loyal customers around the world who recognise the quality of service that we provide. By doing our best by them, in all of our enduring franchises around the world, we will take the actions that will deliver once again sustainable returns for our shareholders.
2008 Results While a downturn was anticipated, no one could have foretold the unprecedented market disruption and global economic downturn that we now experience. With roots in economic imbalances across many countries, the downturn has weakened many. However, that is little consolation for the particular vulnerability that RBS has exhibited.
In 2008 the Group’s overall results were bad, with net attributable losses, before goodwill impairments, of £7.9 billion. This is particularly disappointing since many parts of our business did well, serving customers and generating high quality profitability. All our Divisions were profitable except Global Banking & Markets (‘GBM’) and Asia Retail & Commercial Banking. Even in GBM, underlying income reached £10.2 billion on the back of many strong business performances. Unfortunately, these profits were more than wiped out by credit and market losses in concentrated areas around proprietary trading, structured credit and counterparty exposures. Over 50% of these losses pertained to ABN AMRO-originated portfolios.
As this is my first letter to RBS shareholders, I should open by saying how aware we all are of the responsibility for leading this institution into better times. We have a great importance to 40 million customers, to many corporations and governments worldwide, to our shareholders and to all those in the communities we serve. In common with many, we are facing tough times. We will do our best to work through these, to support our customers and to restore RBS to standalone financial health and success.
Our strategic plans will take three to five years to execute, given the headwinds of economic downturn. Nevertheless, we expect to make strong and purposeful progress each and every year.
We should be known for our businesses and how we manage them. We want to focus on enduring customer franchises, with top tier competitive positions where we choose to compete. Our businesses will target 15%+ return on equity and primarily organic growth at rates consistent with the markets in which they operate. Our businesses should reinforce each other with shared products, customers and expertise. Our risks should be diversified, well controlled and proportionate to the business and customer opportunity.
• In addition to eliminating expenses associated with the NonCore Division, the restructuring plan will make efficiency savings across the Group, aimed at achieving run-rate reductions by 2011 of greater than £2.5 billion (16% of 2008 cost base) at constant exchange rates. This will involve re-engineering and other measures and, regrettably, reductions in employment. This target excludes any impact of inflation, incentive pay movements or cost reductions arising from business exits or the impact of new projects (if any). It includes the £0.5 billion of ABN AMRO integration benefits previously announced but not reflected in 2008 expenses. We will book one-off charges against these actions over the next three years, with run-rate cost savings expected to provide ‘payback’ in 1.5 to 1.75 years.
• We plan to retain each of our major business Divisions since we believe, with intensive restructuring, they can meet the attractive business characteristics outlined as targets above. In many cases the restructuring of these businesses to achieve our goals will be far-reaching. The greatest element of restructuring will be in GBM. A substantial shrinkage of size, product and geographic scope will take place. This should leave GBM positioned around those of its existing core strengths that rest on profitable customer franchise business with significantly less illiquid risk overall.
• Alongside our business restructuring activities will be substantive changes to management and internal processes. There will continue to be changes of personnel as we promote and reassign internal talent and add to our ranks externally.
Our Manufacturing Division will re-align with our customer-facing businesses. Businesses will have clear bottom-line returns, allocated equity and balance sheet and funding goals. While we drive for profit, there will be a concentration on earnings quality and sustainability, driven by strategic plans, to ensure alignment of our businesses to their markets and their risk targets. People evaluation and incentivisation will meet best practice levels to support the revised mission of the company.
Outlook To make any forecast is hazardous, beyond the expectation that 2009 will be a very tough year for the world economy. RBS, in common with all banks, will see some erosion of underlying income levels as a result of weaker business activity and low interest rates squeezing savings margins whilst credit costs rise, probably sharply. We hope that markets will be less disrupted than in 2008, with lower associated write-downs, but time will tell. 2009 has, in fact, started well for our businesses.
We have confirmed our intended participation in HM Treasury’s Asset Protection Scheme (APS). This would be subject to shareholder approval. More information will be made available as soon as practicable.
Notwithstanding the challenging outlook, our businesses all around the world are inherently good and fully engaged in sustaining as robust a performance as the environment permits. And the strategic restructuring we have embarked on will see high levels of activity designed to reposition RBS successfully.
RBS should again become one of the world’s premier financial institutions, anchored in the UK but serving individual and institutional customers here and globally, and doing it well.
A strategic understanding of our businesses and a focus on long-term, quality profitability
Total income before credit market write-downs and unusual items was £10,214 million, down 6% from 2007. In addition to losses on previously identified credit market exposures of £7,781 million, GBM incurred £5,776 million in trading asset write-downs. Although direct expenses were cut by 18% as we addressed the challenges facing the business, credit impairments rose sharply. The operating loss for the year was £10,994 million. On an indicative basis, the return on equity (‘ROE’) of GBM was -35%.
Despite the disappointing headlines and the difficulties encountered by individual business lines, market volatility provided opportunities. The rates and currencies business
Divisional review continued achieved a particularly strong performance, with high volumes of customer activity and flow trading resulting in a 40% increase in income from rates trading to £3,543 million and 55% growth in currencies income to £1,697 million. The Sempra Commodities joint venture performed well in the nine months after its formation, with GBM’s commodities income reaching £778 million for the year.
The task that GBM faces is to rebuild a business in which profit is sustainable. We start from a very solid foundation of strong underlying revenues. In addition, we enjoy global top five rankings in corporate lending, foreign exchange rates, commodities and interest rates and options. Our problems have largely arisen in trading structured credit products and taking significant longer term underwriting risk. In doing so, we strayed from the model which had originally brought us success: of focusing on the needs of our customers and trading in markets only in order to support them. As a result, our balance sheet has grown in ways that added risk without corresponding returns.
Strategic review Following the review, GBM intends to focus its business around its core corporate and institutional customer set across the world. These clients are global in nature and are multi-product users. GBM will deploy capital and resources in support of this customer base and will continue to arrange and distribute credit (loans and bonds) and build sustained competitive advantage in its core financing, risk management and investment products, and flow trading businesses.
RBS is renewing its commitment to product areas where GBM has market-leading competitive positions across its customer– centric origination, advisory and trading activities. It has strong market positions in loans, bonds, foreign exchange, rates, commodities and equities and will drive these businesses, restructured where necessary, in a focused manner around customers’ needs. GBM will discontinue all illiquid proprietary trading activities and correlation trading in equity and credit markets. It will drastically scale back activity in structured real estate, leveraged and project finance, and exit lending in these areas entirely. All businesses, and notably GBM’s asset finance businesses, will be managed within strict capital guidelines.
Globally, the intention is for GBM to move increasingly towards a hub-and-spoke model. Risk will be managed from regional hubs. It is intended that distribution and coverage will be delivered from a mix of hub countries and a scaled-back presence in some local offices. The aim, over time, will be to reduce much of the on-shore trading activity outside the key financial centres.
Assets, products and geographies that fit GBM’s new clientfocused proposition will be defined as core and will remain within the division. Assets, business lines and some geographies that are non-core will be transferred to the new Non-Core Division. These non-core activities accounted for approximately £205 billion of third party assets at end 2008.
GTS enjoyed a strong year. Income grew by 12% to £2,472 million, the growth rate being maintained in the second half of the year, despite difficult market conditions. Direct expenses were 9% higher at £594 million, mainly as a result of investment in the franchise to support growth. Operating profit increased by 12% to £1,339 million. On an indicative basis, the ROE of GTS was 60%.
• our cards businesses process six billion transactions per annum worth £233 trillion, peaking at approximately 500 transactions per second.
Strategic review GTS remains a strategically attractive business for RBS, providing important working capital and payment solutions to the Group’s customers and substantial scope remains to crosssell global transaction services to our corporate and financial institutions clients, particularly those in the UK. GTS plans to right-size its global network consistent with developing Europe as its core base, it will retain the capability to continue to serve both locally and globally all multi-national customers who are at the heart of the core GBM proposition, whilst at all times maintaining service levels during the change. The business also plans to increase efficiency through development of a lower cost front and back-office operating model and explore joint ventures for growth and selective disposals.
RBS UK holds a leading market share across all of the business & commercial and corporate sectors. Through its network of relationship managers it distributes a full range of banking, finance and risk management services, including market-leading invoice finance and asset finance offerings.
UK Retail Banking Total income was unchanged on the year at £6,794 million. Direct costs rose modestly, by 1% to £1,832 million. Impairments increased by 8% to £1,281 million. Operating profit declined by 12% to £1,764 million.
• Mortgage balances at 31 December 2008 were 11% higher than a year earlier, in the face of weaker demand in the second half of the year. Market share of net mortgage lending increased to 19% from 2% at the end of 2007.
• As part of our Help Me Programme, we proactively identify customers showing signs of financial stress enabling us to contact customers to offer advice and solutions to help them manage their money. We are continually enhancing our systems and processes to gain greater insights into our customers’ behaviour and ensure we offer the appropriate solution, at the right time and through the right channel for each customer.
Support for customers is evident in the 18% growth of average loans and advances. Average deposit balances increased by 3% despite volatility and acute competition in that market.
UK Wealth Total income grew robustly, by 9% to £859 million. Direct expenses increased by 13% to £324 million. This figure included one-off cost provision items resulting from economic conditions. Operating profit increased by 5% to £403 million.
Strategic review UK Retail and Commercial Banking retains an extremely strong franchise and represents the core of the RBS Group. However, the external environment over the next few years will present significant challenges with pressure on income as a result of very low interest rates, lower fee income, and impairment costs, which are likely to increase further.
Citizens is engaged in retail and corporate banking activities through its branch network in 13 states in the United States and through non-branch offices in other states. Citizens was ranked the tenth-largest commercial banking organisation in the United States based on deposits as at 30 September 2008 and is a top tier bank in its New England and Mid Atlantic regional markets.
In a year of continued, acute market turbulence and a sharp slowdown in economic activity, the Division’s total income was essentially unchanged at $5,578 million, a rise of 8% in sterling terms to £3,010 million. Operating profit fell by 57% to $972 million and by 54% in sterling terms to £524 million. Direct expenses rose by 5% to $2,012 million, reflecting both the continued expansion of commercial banking relationship management teams and write-downs on mortgage servicing rights and other costs related to loan workout and collection activity. The indicative ROE of US Retail & Commercial Banking was 8%.
Average core customer deposits declined by 5% and the division further reduced its reliance on brokered deposits by 80%, leading to an overall decline of 11% in average customer deposits. Net interest margin was held steady, reflecting widening asset margins and careful management of savings rates in a competitive deposit market.
The Division continued to evaluate opportunities to optimise capital allocation by exiting or reducing exposure to lower growth or sub-scale segments. In the fourth quarter of 2008, 18 rural branches in the Adirondack region of New York were sold to Community Bank System. An agreement has also been reached to sell the Indiana retail branch network, consisting of 65 branches, and the Indiana business banking and regional banking activities, to Old National Bank. These and other measures will also assist in containing costs in future.
One benefit of increased volatility in the economy was that the Commercial Markets business generated strong revenues as customers sought to manage risks. Revenues from interest rate and foreign exchange products increased significantly on 2007 figures, with foreign exchange particularly strong. The Division continued to innovate to enhance customer service. Citizens upgraded its Online Banking and Bill Pay system, giving customers the ability to pay bills more quickly and to track and
Strategic review Citizens has a high quality retail and commercial banking franchise in the north eastern US. New England and the Mid Atlantic are attractive banking markets, and Citizens is well positioned in them in terms of market share and key local market coverage. The business intends to invest in this core business through increased marketing activity and targeted technology investments, whilst reducing activity in its out-offootprint national businesses in consumer and commercial finance. This strategy will allow Citizens to be become fully funded from its own customer deposits over time, and will support a low risk profile.
In weakened economic conditions, operating profit after Manufacturing costs fell by 85% to £70 million. Total income reached £1,518 million, an increase of 6% in sterling terms, although reflecting a drop of 5% when stated on a constant currency basis. Direct expenses rose by 12% in sterling terms, although were flat when viewed on a constant currency basis, reflecting disciplined management of the cost base, particularly in the second half of 2008. The main impact on performance in the division was a significant increase in impairment losses, albeit from a low base, particularly in Ulster Bank, where impairments rose to £394 million. This reflects the impact on credit quality of the slowdown in the Irish economy and the increased flow of cases into the problem debt management process.
Average loans and advances to customers increased by 25% versus prior year, or 12% when stated on a constant currency basis.
Average deposit balances in the E&ME division were 13% higher in sterling terms and largely flat at constant exchange rates reflecting particularly the highly competitive market for resources in Ireland in 2008. Deposit flows in Ulster Bank were strong in the latter part of the year and into the early months of 2009.
Over 119,000 personal current accounts were opened by Ulster Bank across the island of Ireland in 2008, up 17% on 2007. In the UAE, RBS issued 170,000 credit cards in 2008, taking the total number in circulation over 430,000.
In Ireland, Ulster Bank has been pro-active in responding to the challenging local and global market conditions through a programme of initiatives, which includes the move to a single brand strategy under the Ulster Bank brand. This will see the merger of the operations of Ulster Bank and First Active in the Republic of Ireland (‘RI’) by the end of 2009. A series of cost management initiatives has also commenced across the business.
To support personal customers, the Group’s MoneySense financial education programme is being rolled out across the island of Ireland with trained advisors being introduced to all Ulster Bank branches. The Momentum and Secure Step mortgages have been launched in NI and RI respectively to support first time buyers.
Total assets under management for the Division at 31 December 2008 were 7% higher than a year earlier at £21.2 billion, while customer deposits were 40% higher, partly reflecting exchange rate movements.
Strategic review Asia Retail & Commercial Banking has established operations in a number of fast growing and attractive markets. However, the franchise is thinly spread and in general has not yet achieved significant scale. The Group intends to exit its retail and commercial activities in these areas. RBS Coutts will remain a core business.
Its brands include Direct Line, which sells general insurance products direct to the customer, while the Churchill and Privilege brands sell both directly to the customer and via selected price comparison websites. In addition, NIG sells general insurance products through independent brokers and Green Flag is RBS Insurance’s provider of the rescue product. Internationally, RBS Insurance sells general insurance, mainly motor, in Spain, Germany and Italy under the Direct Line brand.
RBS Insurance made strong progress in 2008. Operating profit after manufacturing costs rose by £99 million to a record £780 million, an increase of 15%. Excluding the impact of the 2007 floods and prior year reserve releases, operating profit grew by 6%. Direct expenses grew by 4% to £771 million. Net claims fell by 7% to £3,733 million and by 3% if the effects of the 2007 floods and reserving review are excluded. The indicative ROE of RBS Insurance was 38%.
During 2008, RBS Insurance continued its strategy of growing own brand business, with income increasing 7%. Within the partnership market, RBS Insurance continued to focus on the more profitable opportunities which resulted in discontinuing some of the less profitable partnership contracts. Consequently, the number of partnership and broker policies in-force at December 2008 was down 9% compared with a year earlier although contribution increased by 27%.
The success of RBS Insurance in 2008 was delivered by another strong performance from our people. This was illustrated by the Group-wide ‘Your Feedback’ survey, which showed that RBS Insurance improved its position in 11 out of 15 categories compared with 2007 and exceeded the global financial services norm in 12 of the 15 categories.
Throughout 2008, RBS Insurance continued to develop and enhance its operating model. This involved a focus on low-cost customer acquisition through multiple distribution channels, efficiency enhancements to our low-cost operations, and improved underwriting risk selection and claims handling. This has given the company a strong foundation and leaves it well placed for future profitable growth despite the ongoing impacts of the current economic market conditions.
Strategic review The Group has decided to retain RBS Insurance, reflecting the strength of its franchise as the leading UK personal lines insurer. It provides high quality earnings, which are differentiated from the Group’s banking businesses, providing valuable diversity and strong returns. The business plans to pursue additional growth through building its position in the online insurance aggregator channel, through the bank channels and in the commercial market. The business retains competitive advantage through its market leading brands, low cost operating model and the benefits of scale on its claims costs.
Our approach RBS tries to be a responsible corporate citizen wherever we operate. Our approach is distinctive. It involves regular and direct consultation with our stakeholders to find out what they think about how we do business and the actions they believe we should prioritise. We use that intelligence to help plan how we run the business. Progress towards achieving our plans is measured and monitored, allowing us to demonstrate the advances we made in 2008.
As well as responding to what we learn from stakeholders, we have to be flexible, adapting what we do as circumstances change. The turbulence in financial markets in 2008 and its effects on our customers were precisely the types of events to which a responsible financial services company has to respond. During the year we gave much greater emphasis to supporting our customers through the economic downturn, while continuing to work on the priorities which had previously been identified. What this demonstrates above all is that at RBS social responsibility is business as usual.
Financial crime is at the heart of our most basic responsibility as a bank: to keep our customers’ money secure. During the year we: • promoted Risk Guardian – a fraud screening product to help reduce merchant liability from card fraud;
• continued to offer customers the additional security for online transactions afforded by two factor authentication, with over three million customers now registered to use it; • increased the use of online customer identification and address verification systems.
• developed our ‘Expert Managed Solutions‘ product proposition enabling customers to access industry-wide fund management expertise.
School Money allows young people to practise the skills they have learned. It is a school bank, run by pupils and for pupils and was established in 2006. Last year saw the opening of the 100th inner city school bank, with a total of 332 in operation.
Corporate Responsibility continued in branches, through published guides and leaflets, and over the internet. Each month, more than 10,000 copies of the MoneySense guide are distributed to customers and the MoneySense website receives an average of 60,000 visitors.
Recognising the impact that worsening economic conditions would have on household budgets, RBS expanded MoneySense for Adults in December 2008. Following a successful pilot exercise which had already taken place earlier in the year in NatWest branches in London, the Group significantly increased its investment in the provision of financial advice. An additional 1,000 MoneySense Advisers were introduced to RBS and NatWest branches. This made RBS the first bank to offer free, impartial financial guidance to everyone, including customers of other banks and people without bank accounts. The Group worked with the Consumer Credit Counselling Service – a charity which offers free and confidential advice and support to anyone worried about debt – to train retail customer service officers for this role. These new MoneySense Advisers were nominated for the positions based on their exceptional customer-oriented skills. Their job is to focus on helpful guidance, not selling products.
MoneySense is also being expanded to other countries in which the Group operates. In the United States of America, Citizens Financial Group is involved in a number of financial inclusion and capability initiatives. In Vermont, Citizens runs a Federal Deposit Insurance Corporation Money Smart Series through the branch network. The Money Smart curriculum helps individuals build financial knowledge, develop financial confidence, and use banking services effectively. Citizens Bank Connecticut is a lead partner with Empower New Haven’s Financial Literacy programme – New Haven $AVE$. This initiative promotes economic security for low income families in New Haven, offering accounts for first time homebuyers and young people saving for higher education. Financial education and asset specific training are required and participants are matched $2 for every $1 saved up to a total of $2,000. Plans are currently in progress to introduce MoneySense across the US through Citizens, with additional programmes launching in 2009.
Ulster Bank is introducing MoneySense to both RI and NI. MoneySense for Schools modules have been made available online and plans are in development to broaden the schools programme and launch MoneySense services for adults during 2009. Ulster Bank in NI also provides financial support for the provision of independent debt advice by sponsoring the Citizens Advice Debt Advice handbook. This is a reference book for face-to-face debt advisers working in NI.
Supporting business customers RBS has implemented a range of measures designed to assist both businesses and households in the current difficult economic climate.
In February 2009, the Group announced additional funding for small and medium-sized enterprises (‘SME’). This will be delivered through 12 Regional SME Funds in England, Wales and Scotland, with Ulster Bank providing the Fund for businesses in NI. Along with providing traditional debt finance, the Funds will offer businesses the opportunity to access other avenues to help them manage their capital and cash flow through the economic downturn.
Environment Through the RBS Group Environment Programme, we have been contributing to the global shift to a more sustainable and efficient use of natural resources. We have provided a number of financial products and services that support the environmental objectives of our customers, such as our Citizens Bank Green$ense account which rewards environmental behaviour and our highly successful green savings products. In 2008 we were one of the world’s leading arrangers of finance to renewable power projects and we continued to procure renewable electricity for our UK properties. We completed large-scale energy efficiency upgrades to several of our main buildings around the world and continue to help our employees play their part in protecting the environment.
Our efforts in managing environmental risks and opportunities were recognised through our inclusion for the second year running in the Carbon Disclosure Project’s Leadership Index and our score in the Dow Jones Sustainability Index increased.
More than three million customers registered to use two factor authentication which provides additional security for online transactions
MoneySense lessons delivered to more than 700,000 pupils 100th inner city school bank opened
MoneySense being introduced in the island of Ireland by Ulster Bank
New mortgage repossession policy to help customers who fall into arrears
Inclusion in the Carbon Disclosure Project’s Leadership Index for the second year running
Acquisition of ABN AMRO On 17 October 2007, RFS Holdings B.V. (‘RFS Holdings’), a company jointly owned by RBS, Fortis Bank Nederland (Holding) N.V. (‘Fortis’) and Banco Santander S.A. (‘Santander’) (together the ‘consortium members’) and controlled by RBS, completed the acquisition of ABN AMRO Holding N.V. (‘ABN AMRO’).
Pro forma results Pro forma results have been prepared that include only those business units of ABN AMRO that will be retained by RBS and assuming that the acquisition of ABN AMRO was completed on 1 January 2007. No adjustments have been made for the placing and open offer in December 2008. The per share data have been calculated on the assumption that the rights issue of 11 shares for 18 held for 200 pence per share and the capitalisation issue of 1 share for every 40 held occurred on 1 January 2007. The financial review and divisional performance in the Business review include the pro forma results. The basis of preparation of the pro forma results are detailed on page 74.
Statutory results RFS Holdings is jointly owned by the consortium members. It is controlled by the company and is therefore fully consolidated in its financial statements. Consequently, the statutory results of the Group for the year ended 31 December 2007 and 2008 include the results of ABN AMRO for 76 days and the full year respectively. The interests of Fortis, and its successor the State of the Netherlands, and Santander, in RFS Holdings are included in minority interests.
Organisational structure and business overview The Group’s activities are organised in the following business divisions: Global Markets (comprising Global Banking & Markets and Global Transaction Services), Regional Markets (comprising UK Retail & Commercial Banking, US Retail & Commercial Banking, Europe & Middle East Retail & Commercial Banking and Asia Retail & Commercial Banking), RBS Insurance and Group Manufacturing. A description of each of the divisions is given below.
Global Transaction Services ranks among the top five global transaction services providers, offering global payments, cash and liquidity management, as well as trade finance, United Kingdom and international merchant acquiring and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States.
In the Retail market, RBS UK serves over 15 million personal customers through the RBS and NatWest brands. It offers a full range of banking products and related financial services including mortgages, bancassurance products, deposit accounts, and credit and charge cards.
US Retail & Commercial Banking provides financial services primarily through the Citizens and Charter One brands.
Europe & Middle East Retail & Commercial Banking comprises Ulster Bank and the Group’s combined retail and commercial businesses in Europe and the Middle East.
Ulster Bank provides a comprehensive range of financial services across the island of Ireland. Its retail banking arm has a network of branches and operates in the personal, commercial and wealth management sectors, while its corporate markets operations provides services in the corporate and institutional markets.
Asia Retail & Commercial Banking is present in markets including India, Pakistan, China, Taiwan, Hong Kong, Indonesia, Malaysia and Singapore. It provides financial services across four segments: affluent banking, cards and consumer finance, business banking and international wealth management, which offers private banking and investment services to clients in selected markets through the RBS Coutts brand.
RBS Insurance sells and underwrites retail and SME insurance over the telephone and internet, as well as through brokers and partnerships. Its brands include Direct Line, Churchill and Privilege, which sell general insurance products direct to the customer, as well as Green Flag and NIG. Through its international division, RBS Insurance sells general insurance, mainly motor, in Spain, Germany and Italy. The Intermediary and Broker division sells general insurance products through independent brokers.
Group Manufacturing comprises the Group’s worldwide manufacturing operations. It supports the customer-facing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services. Manufacturing drives efficiencies and supports income growth across multiple brands and channels by using a single, scalable platform and common processes wherever possible. It also leverages the Group’s purchasing power and has become the centre of excellence for managing large-scale and complex change.
Competition The Group faces strong competition in all the markets it serves. However, the global banking crisis has reduced the capacity of many institutions to lend and has resulted in the withdrawal or disappearance of a number of market participants and significant consolidation of competitors, particularly in the US and UK. Competition for retail deposits has intensified significantly reflecting the difficulties in the wholesale money markets.
Competition for corporate and institutional customers in the UK is from UK banks and from large foreign financial institutions who are also active and offer combined investment and commercial banking capabilities. In asset finance, the Group competes with banks and specialised asset finance providers, both captive and non-captive. In European and Asian corporate and institutional banking markets the Group competes with the large domestic banks active in these markets and with the major international banks.
In the personal banking segment the Group competes with UK banks and building societies, major retailers and life assurance companies. In the mortgage market the Group competes with UK banks and building societies. A number of competitors have either left or scaled back their lending in the mortgage and unsecured markets. The Group’s life assurance businesses compete with Independent Financial Advisers and life assurance companies.
In Europe, Asia and the Middle East, the enlarged Group now competes in retail banking with local and international banks. In a number of these markets there are regulatory barriers to entry or expansion, and the state ownership of banks. Competition is generally intensifying as more players enter markets that are perceived to be de-regulating and offer significant growth potential.
In Wealth Management, The Royal Bank of Scotland International competes with other UK and international banks to offer offshore banking services. Coutts and Adam & Company compete as private banks with UK clearing and private banks, and with international private banks. Competition in wealth management remains strong as banks maintain their focus on competing for affluent and high net worth customers.
The stabilisation options may only be exercised if the FSA is satisfied that a UK-incorporated institution with permission to accept deposits (i) is failing, or is likely to fail, to satisfy the threshold conditions set out in the FSA’s Handbook and (ii) it is not reasonably likely that action will be taken that will enable the relevant entity to satisfy those threshold conditions. The threshold conditions are conditions which an FSAauthorised institution must satisfy in order to retain its FSA authorisation. They are relatively wide-ranging and deal with most aspects of a relevant entity’s business, including, but not limited to, minimum capital resource requirements. It is therefore possible that the FSA may trigger the Special Resolution Regime before a relevant entity is in severe difficulties.
The stabilisation options may be exercised by means of powers to transfer property, rights or liabilities of a relevant entity and shares and other securities issued by a relevant entity. HM Treasury may also take the parent company of a relevant entity (such as the company) into temporary public ownership provided that certain conditions set out in Section 82 of the Banking Act are met. Temporary public ownership is effected by way of a share transfer order.
If HM Treasury makes the decision to take the holding company of a relevant entity, such as the company, into temporary public ownership, it may take various actions in relation to securities issued by the holding company, including: • to transfer securities free from any or contractual or legislative restrictions on transfer; • to transfer securities free from any trust, liability, or encumbrance; • to extinguish rights to acquire securities; • to delist securities; or
If the company does not raise sufficient capital through the Placing and Open Offer (including as a result of the Resolutions not being approved or the termination of the underwriting commitments of HM Treasury), it may be unable to access additional funds or find alternative methods of increasing its Core Tier 1 capital ratio and redeeming the Preference Shares.
The purpose of the Placing and Open Offer is to allow the Group to raise sufficient funds to effect the Preference Share Redemption, thereby improving the quality of the Group’s capital structure by increasing its Core Tier 1 capital ratio and enhancing significantly its financial flexibility in the face of continuing turbulence and uncertainty in the global economy. If the Resolutions are not approved by independent shareholders (that is, shareholders excluding HM Treasury) and/or the company is unable to raise sufficient funds through the Placing and Open Offer to effect the Preference Share Redemption (including as a result of the termination of the underwriting commitment of HM Treasury), the Group will remain subject to the terms and conditions of the Preference Shares, and will be required to find alternative methods for increasing its Core Tier 1 capital ratio. Such methods could include an accelerated reduction in risk-weighted assets, disposal of certain businesses, increased reliance on alternative government supported liquidity schemes and other forms of government assistance. There can be no assurance that any of these alternative methods will be available or would be successful in increasing the company’s Core Tier 1 capital ratio to the desired level or on the timetable currently envisaged or enable the Group to redeem the Preference Shares. If the company is unable to raise sufficient funds through the Placing and Open Offer and increase its Core Tier 1 capital ratio sufficiently and redeem the preference shares, its business, results of operations and financial condition may suffer, its credit ratings may drop, its ability to access funding will be further limited, its cost of funding may increase and its share price may decline.
The performance of the Group has been and will continue to be influenced by the economic conditions of the countries in which it operates, particularly the United Kingdom, the United States and other countries throughout Europe and Asia. Recessionary conditions are present in many of these countries, including the United Kingdom and the United States, and such conditions are expected to continue or worsen over the near to medium term. In addition, the global financial system is continuing to experience the difficulties which first manifested themselves in August 2007, and the financial markets have deteriorated significantly since the bankruptcy filing by Lehman Brothers in September 2008. These conditions have led to severe and continuing dislocation of financial markets around the world and unprecedented levels of illiquidity, resulting in the development of significant problems at a number of the world’s largest corporate institutions operating across a wide range of industry sectors, many of whom are the Group’s customers and counterparties in the ordinary course of its business. In response to this economic instability and illiquidity in the market, a number of governments, including the UK Government, the governments of the other EU member states and the US Government, have intervened in order to inject liquidity and capital into the financial system, and, in some cases, to prevent the failure of these institutions.
Despite such measures, the volatility and disruption of the capital and credit markets have continued at unprecedented levels, and global recessionary conditions are expected to continue. These conditions have produced and will continue to produce downward pressure on stock prices and on availability and cost of credit for financial institutions, including the Group, and will continue to impact on the credit quality of the Group’s customers and counterparties. Such conditions, alone or in combination with regulatory changes or actions of other market participants, may cause the Group to experience further reductions in business activity, increased funding costs and funding pressures, lower share prices, decreased asset values, additional write downs and impairment charges and lower profitability or losses.
Lack of liquidity is a risk to the Group’s business and its ability to access sources of liquidity has been, and will continue to be, constrained.
The Group’s liquidity management focuses on maintaining a diverse and appropriate funding strategy for its operations, controlling the mismatch of maturities and carefully monitoring its undrawn commitments and contingent liabilities. However, the Group’s ability to access sources of liquidity (for example, through the issue or sale of financial and other instruments or through the use of term loans) during the recent period of liquidity stress has been constrained to the point where it, like other banks, has had to rely on shorter term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks.
In addition, there is also a risk that corporate and institutional counterparties with credit exposures may look to reduce all credit exposures to banks, given current risk aversion trends. It is possible that credit market dislocation becomes so severe that overnight funding from non-government sources ceases to be available.
Furthermore, like many banks, the Group relies on customer deposits to meet a considerable portion of its funding requirements and such deposits are subject to fluctuation due to certain factors outside the Group’s control, such as a loss of confidence, competitive pressures or the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors which could result in a significant outflow of deposits within a short period of time. Any material decrease in the Group’s deposits could, particularly if accompanied by one of the other factors described above, have a negative impact on the Group’s liquidity unless corresponding actions were taken to improve the liquidity profile of other deposits or to reduce assets.
There can be no assurance that these measures, alongside other available measures, will succeed in improving the funding and liquidity in the markets in which the Group operates, or that these measures, combined with any increased cost of any funding currently available in the market, will not lead to a further increase in the Group’s overall cost of funding, which could have an adverse impact on the Group’s financial condition and results of operations or result in a loss of value in RBS shares.
The financial performance of the Group has been and will be affected by borrower credit quality.
The Group’s earnings and financial condition have been, and its future earnings and financial condition are likely to continue to be, affected by depressed asset valuations resulting from poor market conditions. Financial markets are currently subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by recent events affecting asset backed collateralised debt obligations (CDOs), the US sub-prime residential mortgage market and the leveraged loan market. In dislocated markets, hedging and other risk management strategies have proven not to be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties, including monoline and other insurance companies and credit derivative product companies. Severe market events have resulted in the Group recording large write-downs on its credit market exposures in 2007 and 2008. The Group expects that the deterioration in economic and financial market conditions will lead to further impairment charges and write-downs during the current financial year. Moreover, recent market volatility and illiquidity has made it difficult to value certain of the Group’s exposures. Valuations in future periods, reflecting, among other things, then-prevailing market conditions and changes in the credit ratings of certain of the Group’s assets, may result in significant changes in the fair values of the Group’s exposures, even in respect of exposures, such as credit market exposures, for which the Group has previously recorded write-downs. In addition, the value ultimately realised by the Group may be materially different from the current or estimated fair value. Any of these factors could require the Group to recognise further significant write-downs or realise increased impairment charges, any of which may adversely affect its financial condition and results of operations or result in a loss of value in RBS shares.
Changes in interest rates, foreign exchange rates, bond, equity and commodity prices, and other market factors have significantly affected and will continue to affect the Group’s business.
The Group’s borrowing costs and its access to the debt capital markets depend significantly on its credit ratings.
On 19 January 2009, Fitch cut the Group’s individual rating to E from B/C and downgraded the Group’s Tier 1 preference shares to BB- from A+ and upper tier 2 hybrid capital instruments to BB from A+. The longterm credit rating for senior unsecured debt of AA- and short term rating of F1+ were affirmed. On the same date, Standard & Poor’s
lowered its ratings on the Group’s hybrid capital issues to BB from BBB. The long-term and short-term credit ratings of the Group of A+ and A-1 respectively were affirmed. The outlook of the Group was confirmed as stable. On 20 January 2009, Moody’s lowered the Bank Financial Strength Rating of B to C- and downgraded the senior long-term debt and deposit ratings of the Group to A1 from Aa2, both with a negative outlook. The short-term P-1 rating was affirmed. These and any future reductions in the long-term credit ratings of the Group or one of its principal subsidiaries (particularly the Royal Bank) could further increase its borrowing costs. Any further reductions may also limit the Group’s access to the capital markets and trigger additional collateral requirements in derivative contracts and other secured funding arrangements. Credit ratings of the Group and the Royal Bank are also important to the Group when competing in certain markets, such as over-the-counter derivatives. As a result, any further reductions in the Group’s or the Royal Bank’s credit ratings could adversely affect its access to liquidity and competitive position, increase its funding costs and have a negative impact on the Group’s earnings and financial condition or result in a loss of value in RBS shares.
Effective management of the Group’s capital is critical to its ability to operate its businesses, to grow organically and to pursue its strategy. The Group is required by regulators in the United Kingdom, the United States, the Netherlands and in other jurisdictions in which it undertakes regulated activities, to maintain adequate capital. The maintenance of adequate capital is also necessary to enhance the Group’s financial flexibility in the face of continuing turbulence and uncertainty in the global economy. Accordingly, the purpose of the First Placing and Open Offer and the issue of the Preference Shares was to allow the company to strengthen its capital position. As at 31 December 2008 the Group’s Tier 1 and Core Tier 1 capital ratios were 9.9 per cent. and 6.6 per cent. respectively, as reported on a proportional consolidated basis using the Basel II methodology. Although the net proceeds of the First Placing and Open Offer and the Preference Share Issue have strengthened the Group’s capital base significantly, and the net proceeds of the Placing and Open Offer will be used to redeem the existing £5 billion of Preference Shares and thereby improve the quality of the Group’s capital by increasing the Group’s Core Tier 1 capital ratio, any change that limits the Group’s ability effectively to manage its balance sheet and capital resources going forward (including, for example, reductions in profits and retained earnings as a result of write-downs or otherwise, increases in risk-weighted assets, delays in the disposal of certain assets or the inability to syndicate loans as a result of market conditions or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and regulatory capital position or result in a loss of value in RBS shares.
Under IFRS, the Group recognises at fair value: (i) financial instruments classified as ‘held-for-trading’ or ‘designated as at fair value through profit or loss’; (ii) financial assets classified as ‘available-for-sale’; and (iii) derivatives, each as further described in ‘Accounting Policies’ on page 182 of the financial statements. Generally, to establish the fair value of these instruments, the Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to changes in market conditions, as has been the case during the current financial crisis. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value. In common with other financial institutions, these internal valuation models are complex, and the assumptions, judgements and estimates the Group is required to make often relate to matters that are inherently uncertain, such as expected cash flows, the ability of borrowers to service debt, residential and commercial property price appreciation and depreciation, and relative levels of defaults and deficiencies. Such assumptions, judgements and estimates may need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could continue to have a material adverse effect on the Group’s earnings and financial condition. Also, recent market volatility and illiquidity has challenged the factual bases of certain underlying assumptions and has made it difficult to value certain of the Group’s financial instruments. Valuations in future periods, reflecting prevailing market conditions, may result in further significant changes in the fair values of these instruments, which could have a negative effect on the Group’s results of operations and financial condition or result in a loss of value in RBS shares.
The Group is undertaking a strategic review of its operations in light of the recently changed global economic outlook, which is expected to focus on achieving appropriate risk-adjusted returns under these changed circumstances, reducing reliance on wholesale funding and lowering exposure to capital intensive businesses. The Group will also continue with its disposal programme and review its portfolio to identify further disposals of certain non-core assets. Although the Group expects the proceeds of the Placing and Open Offer to improve the quality of its capital by replacing the existing £5 billion of Preference Shares with £5 billion of Core Tier 1 capital, the global credit markets remain challenging and the Group’s execution of its current and future strategic plans may not be successful. In connection with the implementation of these plans, the Group may incur restructuring charges, which may be material. Furthermore, if the Group’s plans, including any planned disposals, are not successful or fail to achieve the results expected, the Group’s business, capital position financial condition, results of operations and future prospects may be negatively impacted or this could result in a loss of value in RBS shares.
Recent consolidation among banking institutions in the United Kingdom, the United States and throughout Europe is changing the competitive landscape for banks and other financial institutions. This consolidation, in combination with the introduction of new entrants into the US and UK markets from other European and Asian countries, could increase competitive pressures on the Group. Moreover, if financial markets continue to be volatile, more banks may be forced to consolidate.
The Group could fail to attract or retain senior management or other key employees.
Other areas where governmental policies and regulatory changes could have an adverse impact include, but are not limited to: • the monetary, interest rate, capital adequacy and other policies of central banks and regulatory authorities; • general changes in government or regulatory policy or changes in regulatory regimes that may significantly influence investor decisions in particular markets in which the Group operates or may increase the costs of doing business in those markets; • changes to financial reporting standards; • other general changes in the regulatory requirements, such as prudential rules relating to the capital adequacy framework and the imposition of onerous compliance obligations, restrictions on business growth or pricing and requirements to operate in a way that prioritises objectives other than shareholder value creation; • changes in competition and pricing environments; • further developments in the financial reporting environment; • differentiation amongst financial institutions by governments with respect to the extension of guarantees to bank customer deposits and the terms attaching to such guarantees, including requirements for the entire Group to accept exposure to the risk of any individual member of the Group, or even third party participants in guarantee schemes, failing; • implementation of, or costs related to, local customer or depositor compensation or reimbursement schemes; • transferability and convertibility of currency risk; • expropriation, nationalisation, confiscation of assets; • changes in legislation relating to foreign ownership; and
• other unfavourable political, military or diplomatic developments producing social instability or legal uncertainty which, in turn, may affect demand for the Group’s products and services.
The Group maintains a number of defined benefit pension schemes for past and current employees. Pensions risk is the risk that the liabilities of the Group’s various defined benefit pension schemes which are long term in nature will exceed the schemes’ assets, as a result of which the Group is required or chooses to make additional contributions to the schemes. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios and returns from them may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities. In these circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes, and during recent periods, the Group has voluntarily made such contributions. Given the current economic and financial market difficulties and the prospects for them to continue over the near and medium term, the Group may be required or elect to make further contributions to the pension schemes and such contributions could be significant and have a negative impact on the Group’s capital position results of operations or financial condition or result in a loss of value in RBS shares.
The Group’s operations are diverse and complex and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the United Kingdom, the United States and other jurisdictions, including class-action litigation. Furthermore, the Group, like many other financial institutions, has come under greater regulatory scrutiny over the last year and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the earlier stages of a case or investigation. Adverse regulatory action or adverse judgements in litigation could result in restrictions or limitations on the Group’s operations or result in a material adverse effect on the Group’s reputation or results of operations or result in a loss of value in RBS shares. For details about certain litigation and regulatory investigations in which the Group is involved, see Note 32 on the financial statements.
The Group’s activities are subject to tax at various rates around the world computed in accordance with local legislation and practice. Action by governments to increase tax rates or to impose additional taxes would reduce the Group’s profitability. Revisions to tax legislation or to its interpretation might also affect the Group’s results in the future.
The Group’s insurance businesses are subject to inherent risks involving claims.
Future claims in the Group’s general and life assurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in mortality and other causes outside the Group’s control. These trends could affect the profitability of current and future insurance products and services. The Group reinsures some of the risks it has assumed and is accordingly exposed to the risk of loss should its reinsurers become unable or unwilling to pay claims made by the Group against them.
The Group’s operations have inherent reputational risk. Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the Group’s business. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.
In addition, to the extent that other jurisdictions where the Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the United States with the Federal Deposit Insurance Corporation), the Group may make further provisions and may incur additional costs and liabilities, which may negatively impact its financial condition and results of operations or result in a loss of value in RBS shares.
The Group’s business and earnings may be affected by geopolitical conditions.
The recoverability of certain deferred tax assets recognised by the Group depend on the Group's ability to generate sufficient future taxable profits and there being no adverse changes to tax legislation In accordance with IFRS, the Group has recognised deferred tax assets on losses available to relieve future profits from tax only to the extent that it is probable that they will be recovered. The losses are quantified on the basis of current tax legislation and are subject to change in respect of the rate of tax or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax legislation may reduce the recoverable amount of the recognised deferred tax assets.
Key financials Pro forma Statutory for the year ended 31 December £m £m £m £m
Basic (loss)/earnings per share (pence) (5) (61.0p) 40.8p (145.7p) 64.0p Adjusted (loss)/earnings per share (pence) (5, 6) (5.2p) 44.5p — —
(4) Pro forma cost:income ratio represents operating expenses excluding purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs and share of shared assets expressed as a percentage of total income excluding credit market write-downs and one-off items.
(5) Prior year per share data have been restated to reflect the rights issue in June 2008 and the capitalisation issue in September 2008.
(6) Adjusted earnings per share is based on earnings adjusted for purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs, share of shared assets and credit market write-downs and one-off items.
Fees and commissions receivable 8,839 9,171 9,831 8,278 Fees and commissions payable (2,391) (2,147) (2,386) (2,193) Other non-interest income (1,221) 8,176 (6,578) 6,125 Insurance net premium income 5,709 5,982 6,326 6,087 Non-interest income excluding credit market write-downs and one-off items 10,936 21,182 7,193 18,297 Credit market write-downs and one-off items (5,641) (1,268) — —
Operating expenses excluding one-off items 15,916 16,618 54,033 13,942 One-off items — (242) — — Profit/(loss) before other operating charges 5,318 15,920 (28,165) 16,424
Operating profit before impairment 1,401 11,392 (32,595) 11,800 Impairment losses before reclassified asset impairment 6,962 2,104 8,072 1,968 Impairment losses on reclassified assets 466 — — —
Notes: (1) Pro forma Group operating (loss)/profit excludes purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs and RBS share of consortium shared assets.
(2) Prior year data have been restated to reflect the rights issue in June 2008 and the capitalisation issue in September 2008.
Losses from previously disclosed credit market exposures increased to £7,781 million, compared with £2,387 million in 2007, with the great majority incurred in the first half of the year. Other one-off items amounted to a credit of £1,674 million, 23% higher than in 2007, principally as a result of a £1,232 million increase in the carrying value of own debt carried at fair value. After integration costs, restructuring costs, amortisation of purchased intangibles, write-down of goodwill and other intangible assets and share of shared assets, the Group recorded a loss before tax of £25,038 million, compared with a profit before tax of £8,962 million in 2007.
Non-interest income Non-interest income was severely affected by the weakness in financial markets experienced over the course of the year, particularly in the fourth quarter. Excluding credit market write-downs and one-off items, non-interest income totalled £10,936 million, 48% lower than in 2007. While the decline was particularly marked in GBM’s credit markets and equities businesses, with reduced business volumes and mounting mark-to-market trading losses, Regional Markets also saw non-interest income fall in the latter part of the year as declining consumer confidence led to lower demand for credit and other financial products.
Net insurance claims Net insurance claims fell by 13% to £3,917 million. General insurance claims fell by 7%, reflecting improved risk selection, better claims management and the non-recurrence of the severe floods experienced in 2007. Bancassurance claims declined by 64% as a result of movements in financial market values.
Impairment losses Credit impairment losses (excluding reclassified assets) increased to £6,962 million in 2008, compared with £2,104 million in 2007. The Group experienced a pronounced deterioration in impairments in the second half of the year, as financial stress spread to a broad range of customers. The greatest increase in impairments occurred in GBM, where fourth quarter impairments totalled £2,938 million, including a loss of approximately £900 million on the Group’s exposure to LyondellBasell. However, the Regional Markets businesses in all geographies also experienced a noticeable increase in impairments in the second half, particularly in the UK and Irish corporate and US personal segments.
Impairments represented 0.46% of gross loans and advances, excluding reverse repos, in the first half but reached 1.41% in the second half. For 2008 as a whole, impairments amounted to 0.91% of loans and advances, excluding reverse repos, compared with 0.37% in 2007.
Risk elements in lending and potential problem loans at 31 December 2008 represented 2.69% of loans and advances, excluding reverse repos, compared with 1.49% a year earlier. Provision coverage was 50%, compared with 59% at 31 December 2007 reflecting the higher proportion of secured loans included in risk elements in lending and potential problem loans.
These impairments have no cash impact, and minimal impact on the Group’s capital ratios.
Other non-operating items Integration and restructuring costs totalled £1,357 million, primarily reflecting the integration of ABN AMRO into the Group, while the amortisation of purchased intangibles increased to £443 million from £124 million.
Balance sheet Total assets of £2,218.7 billion at 31 December 2008 were up £623.6 billion, 39%, compared with 31 December 2007. At constant exchange rates the increase was £313 billion or 16%.
2008 compared with 2007 – statutory Loss Loss before tax was £40,667 million compared with a profit of £9,832 million in 2007. The results have been adversely affected by credit market write-downs of £7,781 million and write-down of goodwill and other intangible assets of £32,581 million.
Total income Total income was down 15% to £25,868 million, principally due to the credit market write-downs.
Net interest income increased to £18,675 million and represents 72% of total income (2007 – 40%).
Operating expenses Operating expenses rose to £54,033 million. Integration and restructuring costs were £1,357 million compared with £108 million in 2007. Write-down of goodwill and other intangible assets was £32,581 million.
Net insurance claims Bancassurance and general insurance claims, after reinsurance, decreased by 4% to £4,430 million.
Risk elements in lending and potential problem loans represented 2.52% of gross loans and advances to customers excluding reverse
Balance sheet Total assets of £2,401.7 billion at 31 December 2008 were up £560.8 billion, 30%, compared with 31 December 2007.
Loans and advances to customers were up £46.2 billion, 6%, at £874.7 billion or £68.0 billion, 8% following the disposal of the Banco Real and other businesses to Santander and Tesco Personal Finance. Within this, reverse repos decreased by 72%, £103.0 billion to £39.3 billion. Excluding reverse repos, lending rose by £149.2 billion, 22% to £835.4 billion reflecting both organic growth and the effect of exchange rate movements following the weakening of sterling during the second half of 2008.
Yields, spreads and margins of the banking business % % % %
Average balance sheet and related interest Pro forma 2008 Pro forma 2007
Loans and advances to customers – UK 321,066 19,055 5.93 276,660 19,062 6.89
Customer accounts: other time deposits – UK 95,181 3,964 4.16 90,067 4,269 4.74
Total interest-bearing liabilities – banking business (2, 3) 690,675 26,447 3.83 558,278 25,390 4.55
Loans and advances to customers – UK 321,066 19,066 5.94 269,460 18,541 6.88
Total interest-earning assets – banking business (2, 3) 887,194 49,938 5.63 525,457 32,650 6.21
Total interest-earning assets 1,312,648 838,567 Non-interest-earning assets (2, 3) 728,037 284,405
Customer accounts: savings deposits – UK 42,870 1,708 3.98 36,334 1,658 4.56
Debt securities in issue – UK 111,099 4,617 4.16 67,310 3,582 5.32
Total interest-bearing liabilities 1,298,960 791,144 Non-interest-bearing liabilities: Demand deposits – UK 27,700 18,416
(3) Interest income has been adjusted by £332 million (2007 – £313 million) and interest expense by £860 million (2007 – £536 million) to record interest on financial assets and liabilities designated as at fair value through profit or loss. Related interest-earning assets and interest-bearing liabilities have also been adjusted.
2008 over 2007 – pro forma 2008 over 2007 – statutory
Fees and commissions receivable 8,839 9,171 9,831 8,278 Fees and commissions payable (2,391) (2,147) (2,386) (2,193) (Loss)/income from trading activities (1,647) 4,808 (8,477) 1,292 Other operating income (excluding insurance net premium income) 426 3,368 1,899 4,833
Excluding general insurance premium income, non-interest income fell by £9,973 million to £5,227 million.
Other operating income also decreased, falling by 87%, £2,942 million to £426 million. This was principally due to a fall in the fair value of securities and other financial assets and liabilities.
General insurance premium income, after reinsurance, decreased by 5% to £5,709 million primarily reflecting a fall in insurance premium income following the discontinuation of less profitable partnership contracts.
Excluding general insurance premium income, non-interest income fell by £11,343 million to £867 million.
(2) Figures represent the Group’s remaining net exposure to its previously reported credit market exposures.
The Group’s ratio of operating expenses (excluding one-off items, writedown of goodwill and other intangible assets, purchased intangibles amortisation, integration costs restructuring costs and share of shared assets) to total income was 59.2% compared with 49.5% in 2007, largely reflecting the impact on income of the year’s difficult market conditions.
2008 compared with 2007 – statutory Operating expenses increased by £40,091 million to £54,033 million, primarily reflecting the write-down of goodwill and other intangible assets of £32,581 million following a review of the carrying value of goodwill and other purchased intangible assets. Cost growth in the Group’s core retail and commercial banking franchises was offset by efficiency programmes and a significant reduction in Global Banking & Markets staff costs. The 2008 costs reflect a full year of the retained ABN AMRO businesses in comparison with 76 days in 2007.
The Group’s ratio of operating expenses to total income was 208.9% compared with 45.9% in 2007, largely reflecting the impact on income of the year’s difficult market conditions and the write-down of goodwill and other intangible assets.
Note: (1) Pro forma excludes one-off items, write-down of goodwill and other intangible assets, purchased intangibles amortisation, integration costs, restructuring costs and share of shared assets.
Integration costs in 2008 were £1,050 million compared with £108 million in 2007. The significant increase reflects a full year of integration costs being incurred in respect of the ABN AMRO acquisition, compared to 76 days in 2007.
Staff costs 251 — Premises and equipment 15 — Other administrative expenses 41 —
Total balance sheet provisions for impairment amounted to £9,451 million compared with £4,956 million in 2007.
2008 compared with 2007 – statutory Credit impairment losses increased to £8,072 million in 2008, compared with £1,968 million in 2007. The Group experienced a pronounced deterioration in impairments during the year, as financial stress spread to a broad range of customers. The greatest increase in impairments occurred in Global Banking & Markets. However, the Regional Markets businesses in all geographies also experienced a noticeable increase in impairments during the year, particularly in the UK SME and US personal segments.
Total balance sheet provisions for impairment amounted to £11,016 million compared with £6,452 million in 2007.
Comprising: Impairment of available-for-sale securities 484 22 981 22 Charge to income statement 6,962 2,104 8,072 1,968
Note: (1) Pro forma excludes the tax effect on the write-down of goodwill and other intangible assets of £715 million.
The performance of each of the divisions is reviewed on pages 51 to 67.
Pro forma Group operating (loss)/profit is before purchased intangibles amortisation, write-down of goodwill and other intangible assets, integration costs, restructuring costs and RBS share of consortium shared assets.
Global Markets Global Banking & Markets 278.5 211.9 188.7 Global Transaction Services 19.6 16.8 15.4
Total Global Markets 298.1 228.7 204.1 Regional Markets UK Retail & Commercial Banking 152.5 153.1 179.0 US Retail & Commercial Banking 78.0 53.8 57.1 Europe & Middle East Retail & Commercial Banking 30.9 30.3 36.7 Asia Retail & Commercial Banking 6.4 4.9 3.3
Net interest income from banking activities 4,034 2,214 1,544 Net fees and commissions receivable 1,562 2,351 1,373 Income from trading activities 4,043 4,407 4,019 Other operating income (net of related funding costs) 575 1,908 1,659 Trading asset write-downs (5,776) — — Non-interest income before credit market write-downs* 404 8,666 7,051 Total income before credit market and other trading asset write-downs* 4,438 10,880 8,595 Credit market write-downs and one-off items* (6,958) (1,776) (1,776)
Contribution before impairment (6,872) 3,773 3,720 Impairment before reclassified asset impairments 3,177 122 67 Reclassified asset impairments 466 — —
Operating (loss)/profit before credit market write-downs, one-off items and reclassified asset impairments (3,570) 4,641 5,052
** excluding repos 2008 compared with 2007 – pro forma While Global Banking & Markets produced good performances in a number of its businesses, most notably in rates and currencies, the turmoil in financial markets severely affected the division’s results in 2008, with a particularly adverse impact in the fourth quarter. GBM incurred £5,776 million of losses, write-downs or reserves largely on credit trading, counterparty risk (including CDPCs), counterparty failure (notably Lehman and Madoff) and sovereign events as the effects of the down-turn widened. In addition, losses on previously identified credit market exposures totalled £7,781 million, including impairments of £466 million on reclassified assets. These were only partly offset by gains on the fair value of own debt.
Total income before these credit market write-downs and unusual items was £10,214 million, down 6% from 2007. After these items, GBM recorded negative income of £2,520 million. Although direct costs were cut by 18%, credit impairments rose sharply, resulting in a 2008 operating loss of £10,994 million.
Net interest income grew by 82% to £4,034 million, with the rates business benefiting from the declining interest rate environment. Before credit market write-downs, other one-off items and trading asset writedowns, non-interest income reduced by 29% to £6,180 million, with fees and commissions falling as origination volumes declined, and income from trading activities decreasing by 8% to £4,043 million. Other operating income fell sharply from £1,908 million to £575 million, reflecting losses incurred on European loan sales and much reduced gains on other portfolio assets, partially offset by the gain on sale of Angel Trains of £570 million.
By business line, the rates and currencies business achieved a particularly strong performance in 2008, with high volumes of customer activity and flow trading resulting in an 40% increase in income from rates trading to £3,543 million and 55% growth in currencies income to £1,697 million. The Sempra Commodities joint venture performed ahead of expectations in the nine months since its formation, with GBM’s commodities income reaching £778 million for the year.
Equities saw reduced customer flow and also experienced losses on illiquid trading positions as markets deteriorated rapidly, leading to a drop in income from £1,169 million in 2007 to £415 million.
Asset and portfolio management income remained resilient, but some losses were incurred, including on capital and credit exposure management, and income declined by 28% to £2,415 million.
Direct expenses were reduced by 18% to £4,352 million, with staff costs falling, despite the inclusion of Sempra, by 30% to £2,687 million, as a result of a sharp reduction in bonus payments. Non-staff expenses increased by 13%, principally reflecting increased transactional, legal and professional costs, inflation and foreign exchange movements, offset by reduced operating lease depreciation following the sale of Angel Trains.
Credit impairments increased sharply to £3,643 million, including £466 million on assets reclassified out of the held for trading category following the amendments to IAS 39 issued in October. Of the total impairment charge, £2,938 million was incurred in the fourth quarter of 2008, including £918 million relating to the Group’s exposure to Lyondell Basell.
RBS is renewing its commitment to product areas where GBM has market-leading competitive positions across its customer–centric origination, advisory and trading activities. It has strong market positions in loans, bonds, FX, rates, commodities and equities and will drive these businesses, restructured where necessary, in a focused manner around customers’ needs. GBM will discontinue all illiquid proprietary trading activities and correlation trading, in equity and credit markets. It will drastically scale back activity in structured real estate, leveraged and project finance, and exit lending in these areas entirely. All businesses, and notably GBM’s asset finance businesses, will be managed within strict capital guidelines.
Assets, products and geographies that fit GBM’s new client-focused proposition will be defined as “core” and will remain within the division. Assets, business lines and some geographies that are non-core will be transferred to the new Non-Core Bank. These non-core activities accounted for approximately £205 billion of third party assets at end 2008.
2008 compared with 2007 – statutory Global Banking & Markets contribution fell from £3,653 million in 2007 to a loss of £10,515 million. This sharp decline reflected the effect of the market turmoil on the enlarged business.
Global Markets – Global Transaction Services Pro forma Statutory £m £m £m
Net interest income 909 846 595 Non-interest income 1,563 1,359 1,183
Strategic review GTS remains a strategically attractive business for RBS, providing important working capital and payment solutions to the Group’s customers and substantial scope remains to cross-sell global transaction services to our corporate and financial institutional clients, particularly those in the UK. GTS plans to right-size its global network consistent with developing Europe as its core base, it will retain the capability to continue to serve both locally and globally all multi-national customers who are at the heart of the Core GBM proposition, whilst at all times maintaining service levels during the change. The business also plans to increase efficiency through development of a lower cost front and back-office operating model and explore joint ventures for growth and selective disposals.
The business plans to respond to this environment through reducing costs and increasing productivity by investing in online service channels, automation of activities and re-design of end-to-end processes. The business will tailor the cost of service for different client segments more closely to their value generation.
Regional Markets – UK Retail & Commercial Banking Pro forma Statutory £m £m £m
Investment management assets – excluding deposits 22.5 25.8 25.8 Non-performing loans 7.9 5.5 5.5 * net of insurance claims ** excluding bancassurance
Net interest income increased 5% to £4,390 million as a result of strong balance sheet growth. Net interest income performance in the personal segment was strong, up 7%, as a result of good volume growth coupled with improving new lending margins. The small business sector has seen more pressure on asset margins, from increased funding costs, which has restricted net interest income growth to 4%. Average loans and advances to customers increased 7% and average deposits were up 6% with personal savings growing 9% and small business deposits growing 3%. At year end deposit balances were in line with 2007 levels, reflecting increasing competitive pressure in a slowing market. Net interest margin reduced from 3.92% to 3.85%, reflecting increased funding and liquidity costs.
Risk weighted assets totalled £63.8 billion at year end, a fall of 3% from 1 January 2008. The upward pressure from procyclicality, especially on the mortgage book, and book growth was offset by the disposal of TPF and improvements in Basel II methodologies.
2008 compared with 2007 – pro forma and statutory UK Corporate & Commercial Banking experienced a solid performance in the first half of 2008, with the second half of 2008 being impacted by the marked deterioration in economic conditions. Total income increased 5% to £3,161 million and contribution before impairments increased by 2%. Growth in impairments, especially in the second half of the year, resulted in a 30% fall in operating profit to £1,116 million.
Net interest income increased 7% to £2,130 million. Average loans and advances were 18% higher than 2007, reflecting the Group’s continuing support for the UK economy. New business margins widened in the second half to reflect increasing risk premia, however, higher funding costs on the back book suppressed growth in net interest income.
Impairment losses totalled £671 million, a sharp increase from the historically low levels seen in 2007. 48% of the charge related to house builder and property development companies. Losses were concentrated in the smaller end of the corporate sector, although a number of specific exposures in the larger corporate sector have also impacted the charge. The commercial businesses charge was £368 million (2007 – £100 million) and the corporate business charge was
Regional Markets – UK Retail & Commercial Banking UK Corporate & Commercial Banking
UK Wealth generates earnings from both private banking and investment services, and this has enabled the division to maintain strong organic growth, despite the deterioration in global market conditions. Coutts & Co. performed particularly well, with contribution up by 15%.
Average loans and advances to customers rose by 17% and average customer deposits by 11%, underpinning a 13% rise in net interest income to £570 million.
Non interest income grew by 3% to £289 million as higher fee income was offset by lower investment income. Although average assets under management were 4% higher than in 2007, lower stock market levels in the latter part of the year reduced assets under management by 11% to £16.8 billion.
Net interest income 570 506 506 Net fees and commissions 250 254 254 Other non-interest income 39 27 27 Non-interest income 289 281 281
Investment management assets – excluding deposits 16.8 18.8 18.8 Non-performing loans 0.1 — —
Net interest income 2,106 1,935 1,935 Non-interest income 904 846 846
Non-performing loans 1.1 0.6 0.6 Average exchange rate – US$/£ 1.853 2.001 2.001 Spot exchange rate – US$/£ 1.460 2.004 2.004 2008 compared with 2007 – pro forma and statutory US Retail & Commercial Banking held income steady in 2008 at $5,578 million, but experienced a sharp increase in impairment losses as economic conditions progressively worsened over the course of the year. As a result, operating profit declined to $972 million, down 57%. In sterling terms, total income increased by 8% to £3,010 million while operating profit declined by 54% to £524 million.
Total income of $5,578 million was essentially unchanged, with 11% growth in commercial banking to $1,231 million offsetting a 2% decline in retail banking income to $4,347 million. Both segments were affected by the deterioration in credit conditions, with retail contribution down 58% to $926 million and commercial contribution down 7% to $711 million.
Direct expenses increased by 5% to $2,012 million, reflecting increased costs from the expansion of the commercial banking relationship management teams, write-downs on mortgage servicing rights, and higher costs related to loan work-out and collection activity.
Credit conditions worsened significantly over the course of the year as the housing market continued to deteriorate and unemployment rose, exacerbating already challenging conditions. Impairment losses totalled $1,929 million, up 184% from 2007 reflecting the deterioration in economic conditions.
Credit quality has continued to deteriorate sharply in the externally sourced home equity portfolio (the Serviced By Others (SBO) portfolio). This portfolio, now managed by a separate work-out group and in runoff, has been reduced by $1.5 billion over the last year to $7.1 billion at 31 December 2008. Non-performing SBO loans represent 2.66% of SBO balances. Impairment losses in relation to the SBO portfolio totalled $592 million for 2008, with $268 million incurred in the second half of 2008 compared with $324 million in the first half. Closing SBO provision balances amounted to $474 million at 31 December 2008, up from $413 million at 30 June 2008, providing a coverage ratio of 2.5 times non-performing loans.
The US business has continued to evaluate opportunities to optimise capital allocation by exiting or reducing exposure to lower growth or sub-scale segments. In the fourth quarter, 18 rural branches in the Adirondacks region were sold to Community Bank System. An agreement has also been announced to sell the Indiana retail branch banking network, consisting of 65 branches, and the business banking and regional banking activities, to Old National Bank.
Strategic review Citizens has a high quality retail and commercial banking franchise in the north eastern US. New England and the Mid Atlantic are attractive banking markets, and Citizens is well positioned in them in terms of market share and key local market coverage. The business intends to invest in this core business through increased marketing activity and targeted technology investments, whilst reducing activity in its out-offootprint national businesses in consumer and commercial finance. This strategy will allow Citizens to become fully funded from its own customer deposits over time, and will support a low risk profile.
Non-performing loans 3.3 0.7 0.7 2008 compared with 2007 – pro forma The significant deterioration in global and local market conditions has impacted the main Europe & Middle East markets, with operating profit falling to £70 million, 85% lower than in 2007. The main driver of this reduction has been an increase of £390 million in impairments, albeit from a low base, reflecting deterioration in credit quality particularly in the property and construction sectors, as economic conditions have slowed. Operating profit excluding impairment losses held steady at £596 million.
Total income was up £80 million, 6% to £1,518 million benefiting from movements in exchange rates. Adjusting for this, income declined by 5%. While average loans and deposits grew by 25% and 13% respectively net interest margin reduced by 21bps in the year to 2.02%, impacted primarily by higher funding costs and the effect of discontinued businesses. Direct expenses were up 12% to £563 million. At constant exchange rates direct expenses were flat reflecting the benefit of cost saving initiatives. Impairment losses rose to £526 million from £136 million reflecting the economic environment.
In sterling terms the results have been materially affected by the movement in the euro exchange rate and references to percentage movement in the following analysis are in constant currency terms.
Average mortgage balances in Ulster Bank were 11% higher than 2007. New mortgage volumes in the second half of the year were significantly lower than in the first six months, although levels of redemptions have also fallen.
Direct expenses rose by 8% to £432 million, reflecting the full year impact of the now completed investment programme in Ulster Bank’s footprint and operations. Cost growth in the second half of 2008 was significantly lower, reflecting disciplined management of the cost base.
In January 2009, Ulster Bank announced its intention to adopt a single brand strategy under the Ulster Bank brand. This will see the merger of the operations of Ulster Bank and First Active in the Republic of Ireland (‘RI’) by the end of 2009. This action is being taken to strengthen the Ulster Bank Group franchise by positioning it to deal with the prevailing local and global market conditions. A number of cost management initiatives have also commenced across the business.
The Momentum and Secure Step mortgages have been launched in NI and RI respectively to support First Time Buyers and the Bank has confirmed its pledge of a six-month moratorium to mortgage customers facing potential repossession. In support of our retail customers across the island of Ireland, the Group’s MoneySense programme is being rolled out, with trained advisers being introduced to all Ulster Bank branches.
The sale of the European Consumer Finance business to Santander was completed on 1st July 2008, while the Imagine business in Spain was sold to Bank of America in the second half of 2008. The former ABN retail business in Russia was also closed during the year.
Strategic review Ulster Bank, which remains a core part of the Group’s global banking operations, has a strong franchise in both Northern Ireland, where it is the leading bank, and the Republic of Ireland where it is overall the third-positioned bank. It has the product and distribution capability to grow profitably and well in normal market conditions. However, the economic difficulties that the Irish markets currently face are expected to persist for some time. Ulster Bank has been pro-active in responding to these market conditions through a programme of initiatives. The business plans to manage its balance sheet over the medium term, with particular focus on reducing risk concentrations as market conditions allow, whilst increasing and diversifying its customer deposit base.
The E&ME Retail and Commercial franchises outside of Ireland lack scale and breadth. They would require a very significant investment of capital and management resource to be able to achieve levels of shareholder return equivalent to those possible from more established core franchises in the Group. The Retail and Commercial businesses in E&ME outside of Ireland will be transferred to the non-core division. We have commenced a review to consider future options for these businesses, including options for sale.
Impairment losses rose sharply to £526 million from £118 million in 2007 leading to a decline in contribution of £340 million to £429 million. Contribution before impairment losses increased by £68 million.
Regional Markets – Asia Retail & Commercial Banking Pro forma Statutory £m £m £m
Net interest income 379 294 123 Net fees and commissions 309 338 161 Other non-interest income 93 63 71 Non-interest income 402 401 232
Affluent banking income slowed markedly in the second half of 2008 due to reduced structured product and equity fund sales, as investors stayed out of volatile markets. Despite this, Royal Preferred Banking client numbers have increased by 13% and assets under management in the affluent segment have increased by 3%.
Total assets under management for the division at 31 December 2008 were 7% higher than a year earlier at £21.2 billion, while customer deposits were 40% higher at £15.1 billion, partly reflecting exchange rate movements.
Impairments increased by 44% to £171 million, reflecting an increase in provisioning levels across a number of consumer finance markets in the region.
Impairments increased from £24 million to £171 million, reflecting the full year impact of the acquired ABN AMRO businesses which are predominately consumer focused.
In-force policies (000’s) – Own-brand motor 6,964 6,713 6,713 – Own-brand non-motor (home, rescue, pet, HR24) 5,642 3,752 3,752 – Partnerships and broker (motor, home, rescue, SMEs, pet, HR24) 8,450 9,302 9,302
Own-brand businesses increased income by 4% and contribution before impairments by 13%. In the UK motor market the Group increased premium rates to offset claims inflation and continued to target lower risk drivers, with price increases concentrated in higher risk categories in order to improve profitability. During 2008 selected brands were successfully deployed on a limited number of aggregator web sites. Our international businesses in Spain, Italy and Germany performed well, with income up 24% and contribution up 37%. Over the last year own-brand motor policy numbers have again begun to increase, and rose by 4% to 7.0 million.
In own-brand non-motor insurance we have continued to achieve good sales through the RBS Group, where home insurance policies in force have increased by 33%. In addition, Privilege and Churchill have grown home policies by 90% and 13% respectively compared with 2007, mainly due to an increase in online sales as a result of successful marketing campaigns. A new commercial insurance offering, Direct Line for Business, was launched, and has grown rapidly over the year with particularly strong performances in Residential Property and Tradesman policies. Overall own-brand non-motor policies in force have grown by 50% to 5.6 million, benefiting from the addition of rescue cover to RBS and NatWest current account package customers.
Total manufacturing costs 4,793 4,481 3,773 2008 compared with 2007 – pro forma Group Manufacturing costs have increased by 7% to £4,793 million in 2008. At constant exchange rates, costs rose by 2%.
Group Property costs rose by 14% (8% at constant exchange rates), reflecting further development of the Group’s Corporate Banking branch network as well as investment in Manufacturing infrastructure.
* excluding one-off items 2008 compared with 2007 – pro forma Central costs increased by 26% to £2,233 million.
Funding costs rose by £128 million, 11% to £1,331 million primarily due to higher cost of funds including those relating to the Bank of England Special Liquidity Scheme. The Group seeks to hedge its interest rate risk economically, and it is not always possible to achieve hedge accounting in accordance with IFRS. The movements in interest rates, currencies and inflation indices, particularly in the latter part of 2008, resulted in volatility for accounting purposes, leading to a charge of £204 million compared with a credit of £102 million in 2007. These costs were largely offset by increased dividends from Bank of China and benefits from the additional capital raised during the year.
Other corporate items amounted to a net credit of £4 million, compared with a net credit of £271 million in 2007. The reduction reflects the Financial Services Compensation Scheme levy of £150 million and gains realised in 2007.
2008 compared with 2007 – statutory Central costs increased by £123 million to £675 million.
Departmental costs rose by £227 million to £665 million, including the full year impact of the acquisition of ABN AMRO.
Global Banking & Markets 20,200 24,100 Global Transaction Services 4,500 3,700 UK Retail & Commercial Banking 46,500 46,200 US Retail & Commercial Banking 17,600 17,800 Europe & Middle East Retail & Commercial Banking 7,900 7,900 Asia Retail & Commercial Banking 11,500 8,900 RBS Insurance 16,600 17,300 Group Manufacturing 44,900 42,500
Integration 900 — Share of shared assets 400 1,200 RFS minority interest 24,500 21,600 Group total 199,800 195,400
Assets Cash and balances at central banks 11,830 14,240 12,400 17,866 Loans and advances to banks 129,408 211,000 138,197 219,460 Loans and advances to customers 731,165 700,191 874,722 828,538
Prepayments, accrued income and other assets 20,715 16,631 24,402 15,662 Assets of disposal groups 67 395 1,581 45,850 Share of shared assets 2,047 27,222 — —
Debt securities in issue 269,188 220,577 300,289 274,172 Settlement balances and short positions 54,264 89,829 54,277 91,021
Movements in the value of derivatives, assets and liabilities, primarily reflect changes in interest and exchange rates, together with an 7% growth in trading volumes on a constant currency basis.
Deposits by banks declined by £41.6 billion, 14% to £261.9 billion. This reflected decreased repurchase agreements and stock lending (‘repos’), down £78.2 billion, 48% to £83.7 billion partly offset by increased inter-bank deposits, up £36.6 billion, 26% to £178.3 billion.
Customer accounts were down £38.7 billion, 7% to £518.5 billion. Within this, repos decreased £61.9 billion, 52% to £58.1 billion. Excluding repos, deposits rose by £23.3 billion, 5%, to £460.3 billion.
Settlement balances and short positions were down £35.6 billion, 40%, to £54.3 billion reflecting reduced customer activity.
Accruals, deferred income and other liabilities decreased £4.4 billion, 16%, to £23.5 billion.
Equity minority interests increased by 1% to £5.4 billion. Attributable profits of £0.4 billion, £0.8 billion equity raised as part of the Sempra joint venture and other equity raised, £0.3 billion, and the effect of exchange rate movements of £1.2 billion were partially offset by equity withdrawals of £0.9 billion, reductions in the market value of availablefor -sale securities of £1.3 billion in respect of the investment in Bank of China attributable to minority shareholders, and dividends paid of £0.3 billion.
Loans and advances to banks decreased by £81.3 billion, 37%, to £138.2 billion. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were down by £117.2 billion, 67% to £58.8 billion. Excluding reverse repos, bank placings increased by £35.9 billion, 83%, to £79.4 billion.
Intangible assets declined by £29.9 billion, 60% to £20.0 billion, reflecting impairment of £32.6 billion and the disposals of the Asset Management business of ABN AMRO, Banca Antonveneta and the Banco Real and other businesses of ABN AMRO acquired by Santander, £7.2 billion. This was offset by exchange rate movements of £11.8 billion, goodwill of £0.2 billion arising on the Sempra joint venture and £0.3 billion on the buyout of the outstanding ABN AMRO shareholdings not previously owned by the Group.
Customer accounts were down £42.9 billion, 6% to £639.5 billion or £21.6 billion, 3% excluding disposals of subsidiaries. Within this, repos decreased £76.8 billion, 57% to £58.1 billion. Excluding repos, deposits rose by £33.9 billion, 6%, to £581.4 billion.
Debt securities in issue were up £26.1 billion, 10% to £300.3 billion mainly resulting from the effect of exchange rate movements.
Settlement balances and short positions were down £36.7 billion, 40%, to £54.3 billion reflecting reduced customer activity.
Retirement benefit liabilities increased by £1.6 billion to £2.0 billion due to reduced asset values only partly offset by the effect of increased discount rates.
Equity minority interests decreased by £16.8 billion, 44% to £21.6 billion. Attributable losses of £10.8 billion, including £15.7 billion of write downs of goodwill and other intangible assets in respect of the State of the Netherlands investment in RFS Holdings, equity withdrawals of £13.6 billion, including £12.3 billion by Santander following the disposals of Banca Antonveneta and Banco Real, reductions in the market value of available-for-sale securities of £1.4 billion, mainly the investment in Bank of China attributable to minority shareholders, movements in cash flow hedging reserves, £0.8 billion, actuarial losses on defined benefit pension schemes net of tax of £0.5 billion and dividends paid of £0.3 billion, were partially offset by effect of exchange rate movements of £9.1 billion of which £8.0 billion related to the State of the Netherlands and Santander investments in RFS Holdings, the £0.8 billion equity raised as part of the Sempra joint venture and £0.4 billion additional equity in respect of the buy-out of the ABN AMRO minority shareholders.
Net cash flows from operating activities (75,338) 25,604 Net cash flows from investing activities 16,997 15,999 Net cash flows from financing activities 15,102 29,691 Effects of exchange rate changes on cash and cash equivalents 29,209 6,010 Net (decrease)/increase in cash and cash equivalents (14,030) 77,304
The acquisition of ABN AMRO, included within net investment in business interests and intangible assets of £13,640 million, was the largest element giving rise to net cash flows from investing activities of £15,999 million, with cash and cash equivalents acquired of £60,093 million more than offsetting the cash consideration paid of £45,856 million. Net sales and maturities of securities of £1,987 million and net disposals of property, plant and equipment, £706 million less the net cash outflow of £597 million in respect of other acquisitions and disposals represented the other principle factors.
Basis of preparation of pro forma results The pro forma financial information shows the underlying performance of the Group including the results of the ABN AMRO businesses to be retained by RBS. This information is being provided to give a better understanding of what the results of the operations might have looked like had the acquisition of ABN AMRO as well as the transfers of businesses to the other Consortium Members occurred on 1 January 2007.
• ABN AMRO pre acquisition credit market write-downs and the impact of the LaSalle sale; • RBS share of ABN AMRO’s shared assets; • amortisation of purchase accounting adjustments in 2007; • amortisation of purchased intangible assets; • write-down of goodwill and other intangible assets; • integration costs; • restructuring costs; and
Pro forma interest assets items costs assets Statutory £m £m £m £m £m £m £m
Profit/(loss) before other operating charges 5,318 (14,476) (296) — (1,800) (16,911) (28,165) Insurance net claims 3,917 513 — — — — 4,430 Operating profit/(loss) before impairment 1,401 (14,989) (296) — (1,800) (16,911) (32,595) Impairment losses before reclassified asset impairments 6,962 640 4 466 — — 8,072 Impairment losses on reclassified assets 466 — — (466) — — —
Pro forma AMRO adjustments assets interest items costs Statutory £m £m £m £ £m £m £m £m
Insurance net premium income 5,982 — — — 105 — — 6,087 Non-interest income excluding credit market write-downs and one-off items 21,182 (1,866) 16 (54) 287 (1,268) — 18,297
Credit market write-downs and one-off items (1,268) — — — — 1,268 — —
Operating expenses excluding one-off items 16,618 (3,376) — 37 535 (242) 370 13,942 One-off items (242) — — — — 242 — — Profit before other operating charges 15,920 160 493 (76) 297 — (370) 16,424 Insurance net claims 4,528 — — — 96 — — 4,624
Amortisation of purchased intangible assets 124 53 — — 85 — (262) — Integration costs 108 — — — — — (108) — Share of shared assets 94 (21) — (73) — — — —
Property, plant and equipment 17,169 1,768 12 18,949 Prepayments, accrued income and other assets 20,715 2,829 858 24,402
Assets Cash and balances at central banks 14,240 3,626 — 17,866 Loans and advances to banks 211,000 2,599 5,861 219,460 Net loans and advances to customers 558,075 126,711 1,395 686,181 Reverse repurchase agreements and stock borrowing 142,116 241 — 142,357 Loans and advances to customers 700,191 126,952 1,395 828,538
Property, plant and equipment 16,913 1,826 6 18,745 Prepayments, accrued income and other assets 16,631 285 (1,254) 15,662
The Group has responded to the changing business and economic conditions by reducing leverage, building and improving liquidity, raising additional capital and through augmenting its risk management resources to drive forward a number of strategic initiatives. The overall risk operating model has been strengthened to ensure its adequacy for changing market conditions and additional capital management disciplines are being embedded across the Group. There is an increased emphasis on the independence of the control functions, capital allocation, stress testing and risk return throughout the Group.
Group Executive Ensures implementation of strategy consistent with risk Business and function heads, as determined by the Management Committee appetite. Group Chief Executive/Board (GEMC)
Group Credit Committee Approves credit proposals under the authority Members as determined by GEMC (GCC) delegated to the committee by the Board and/or the
Group Chief Executive’s Acts as a forum for the provision of information and Group Chief Executive Advisory Group advice to the Group Chief Executive. Forms part of the Group Finance Director (GCEAG) control process of the Group. Chairman and Chief Executives from each division
Independence underpins the approach to risk management, which is reinforced throughout the Group by appropriate reporting lines. Risk Management and Group Treasury functions are independent of the revenue generating business. As part of the move toward greater functional independence, the divisional Chief Risk Officers now have a direct reporting line to the Group Chief Risk Officer.
Risk appetite (unaudited) Risk and capital management across the Group is based on the risk appetite set by the Board, which is established through setting strategic direction, contributing to, and ultimately approving annual plans for each division and regularly reviewing and monitoring the Group’s performance in relation to risk through monthly Board reports.
Risk appetite is defined in both quantitative and qualitative terms as follows: • Quantitative: encompassing stress testing, risk concentration, valueat -risk, liquidity and credit related metrics.
Different techniques are used to ensure that the Group’s risk appetite is achieved.
The GEMC is responsible for ensuring that the implementation of strategy and operations are in line with the risk appetite determined by the Board. This is reinforced through a policy framework ensuring that all staff within the Group make appropriate risk and reward trade-offs within pre-agreed boundaries.
Customers Identifying our customers. Treating our customers fairly. Delivering customer value. Respecting customer confidentiality.
The annual business planning and performance management process and associated activities ensure the expression of risk appetite remains appropriate. GRC and GALCO support this work.
Composition of capital The Group’s regulatory capital resources at 31 December 2008 on both proportional and fully consolidated bases, and in accordance with Financial Services Authority (FSA) definitions were as follows: Proportional basis Statutory basis
Basel II Basel II Basel I Basel II Basel II Basel I 31 December 1 January 31 December 31 December 1 January 31 December £m £m £m £m £m £m
Capital base: Core Tier 1 capital: ordinary shareholders’ funds and minority interests less intangibles 35,473 19,596 19,596 47,623 27,324 27,324 Preference shares and tax deductible securities 23,091 14,704 14,704 24,038 17,040 17,040 Less deductions from Tier 1 capital (1,440) (1,187) n/a (1,814) (1,457) n/a
Risk asset ratio: Capital (unaudited) The Group aims to maintain appropriate levels of capital, in excess of regulatory requirements, to ensure its capital position remains appropriate given the economic and competitive environment. Capital adequacy and risk management are closely aligned. The Group undertakes a regular assessment of its internal capital requirement based on a quantification of the material risks to which it is exposed.
Basel II The Group adopted Basel II on 1 January 2008. Pillar 1 focuses on the calculation of minimum capital required to support the credit, market and operational risks in the business. For credit risk, the majority of the Group uses the Advanced Internal Ratings Based Approach (AIRB) for calculating RWAs, making the Group one of a small number of banks whose risk systems and approaches have reached the regulatory standards.
Using these approaches, the RWA requirements, by division, are as follows: Basel II Basel II Basel I
Global Markets – Global Banking & Markets 278.5 211.9 188.7 – Global Transaction Services 19.6 16.8 15.4
• Exposure at default (EAD) models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. The EAD may be assumed to be higher than the current utilisation (e.g. in the case where further drawings may be made on a revolving credit facility prior to default) but will not typically exceed the total facility limit.
• Loss given default (LGD) models estimate the economic loss that may occur in the event of default and represent the debt that cannot be recovered. The Group’s LGD models take into account the type of borrower, facility and any risk mitigation such as security or collateral held.
Risk coverage The main risks facing the Group are shown below.
Credit risk The risk arising from the possibility that the Group will Loss characteristics vary materially across portfolios. (including country incur losses from the failure of customers to meet their and political risks) financial obligations to the Group. Significant correlation between losses and the macroeconomic environment.
Market risk The risk that the value of an asset or liability may change Potential for large material losses. as a result of a change in market rates.
Operational risk The risk of financial loss or reputational impact resulting Generally immaterial losses. from fraud; human error; ineffective or inadequately designed processes or systems; improper behaviour; legal events; or from external events.
Regulatory risk The risks arising from regulatory changes/enforcement. Risk of regulatory changes. Compliance with regulations. Potential for fines and/or restrictions in business activities.
Other risk The risks arising from reputation and pension fund risk. Additional regulation can be introduced as a result of other risk losses.
• Customers with emerging credit problems are identified early and classified accordingly. Remedial actions are implemented promptly and are intended to restore the customer to a satisfactory status and minimise any potential loss to the Group.
Specialist credit risk teams oversee the credit process independently, making credit decisions within their discretion, or recommending decisions to the appropriate credit committee.
Different approaches are used for the management of wholesale and retail businesses: • Wholesale businesses: exposures are aggregated to determine the appropriate level of credit approval required and to facilitate consolidated credit risk management. Credit applications for corporate customers are prepared by relationship managers (RMs) in the units originating the credit exposures, or by the RM team with lead responsibility for a counterparty where a customer has relationships with different divisions and business units across the Group. This includes the assignment of counterparty credit grades and LGD estimates using approved models, which are also independently checked by the credit team.
Independent model validation is performed by the Group. This includes an evaluation of the model development and validation for the data set used, logic and assumptions, and performance of the model analysis. Where required, the Group has engaged external risk management consultants to undertake independent reviews and report their findings to the Wholesale or Retail Credit Model Committee. This provides a benchmark against industry practices.
• Guarantees: third party guarantees are taken from banks, government entities, export credit agencies, and corporate entities. The Group’s recovery value estimation methodology is sensitive to the variations in the credit quality of guarantors. Standby letters of credit are also given value in LGD models. Conditional guarantees are accepted, in accordance with internal requirements, and are included as appropriate in PD and LGD estimates (e.g. small firms loan guarantee schemes, completion guarantees). Personal guarantees are considered in the normal credit process where there is a charge over specific assets. While personal guarantees may be called for and are always accepted, no value is given to unsupported personal guarantees in any credit models.
• Credit derivatives: credit derivative activity is conducted through designated units within GBM to ensure consistency and appropriate control. Group policies are designed to ensure that the credit protection is appropriate to support offset for an underlying trading book asset or improvement to the LGD of a banking book asset. Within the banking book, credit derivatives are used as risk and capital management tools. The principal counterparties are banks, investment firms and other market participants, with the majority subject to collateralisation under a credit support annex. In accordance with internal policy, stress testing is conducted on the counterparty credit risk created by the purchase of credit protection.
– UK Retail & Commercial Banking 223.5 202.1 – US Retail & Commercial Banking 82.9 58.1 – Europe & Middle East Retail & Commercial Banking 64.7 47.1 – Asia Retail & Commercial Banking 7.5 6.8
Pages 86 to 93 include analyses of credit risk assets on a pro forma basis, excluding RFS Holdings minority interests and share of shared assets, in line with management’s view of the business.
Credit risk assets (audited) Credit risk assets consist of loans and advances (including overdraft facilities), instalment credit, finance lease receivables and other traded instruments across all customer types. The Group uses a series of models to measure the size of its exposure to credit risk and to calculate expected EAD in both its trading and banking books. In so doing, the Group recognises the effects of credit risk mitigation that reduces potential loss.
Credit concentration risk (including country risk) (audited) The Group defines three key areas of concentration in credit risk that are monitored, reported and managed at Group and divisional levels. These are single name concentration, industry/sector and country risk. The Group has a series of quantitative and qualitative controls in place to limit the amount of concentration risk in credit portfolios.
A threshold is set on the aggregate LGD to a single customer group above which approval is required from the Group’s most senior credit committee, the Advances Committee.
During the year work progressed on an enhancement of the frameworks for managing single name and sector concentrations. These enhancements are planned to be fully implemented in 2009 to improve the identification and management of concentrations in the portfolio through the introduction of additional parameters and increased scrutiny of concentration limit excesses.
A stress testing framework, Correlated Exposure Loss Testing, assesses the impact on the Group’s impairment charge of non-systemic events that affect groups of inter-related sectors in order to limit the impact of these scenarios to within defined tolerances.
Country risk arises from sovereign events (e.g. default or restructuring); economic events (e.g. contagion of sovereign default to other parts of the economy, cyclical economic shock); political events (e.g. convertibility restrictions and expropriation or nationalisation) and natural disaster or conflict. Losses are broadly defined and include credit, market, liquidity, operational and franchise risk related losses. The acquisition of ABN AMRO materially increased the Group's country risk profile, therefore significant enhancements to the Group’s country risk framework have been implemented and continue to be developed.
The country risk table below shows credit risk assets exceeding £1 billion by borrower domicile and is stated gross of mitigating action which may have been taken to reduce or eliminate exposure to country risk events.
Note: (1) Risk countries are defined as those with an internal rating of A+ and below. In addition, United Arab Emirates is included which has a rating of AA.
As at 31 December 2008, 26% of credit risk assets (2007 – 27%) related to personal and includes mortgage lending and other smaller loans that are intrinsically well-diversified. Corporate industry exposure comprised 48% of credit risk assets (2007 – 50%), which are well diversified across a range of sectors. Banks and financial services account for 21% of credit risk assets (2007 – 19%) and public sector and quasi government credit risk assets make up the remaining 5% (2007 – 4%).
Note: (1) Graph data are shown net of provisions, reverse repurchase agreements and issuer risk for 2008 and 2007.
PD Range New AQ1- Old AQ1-5 Master grading scale Lower Upper 10 bands bands
(unaudited) As at 31 December 2008, including ABN AMRO net of minority interest, exposure to investment grade counterparties (AQ1) accounted for 47% (2007 – 37%) of credit risk assets and 46% (2007 – 59%) of exposures were to counterparties between AQ2 and AQ4. The exposure to the lowest asset quality (AQ5) is 7% (2007 – 4%).
Minimum Midpoint Maximum S&P Asset quality grade % % % equivalent
AQ1 0.00 0.10 0.20 AAA to BBBAQ2 0.21 0.40 0.60 BB+ to BB AQ3 0.61 1.05 1.50 BB- to B+
Whilst the Group expects to see an overall deterioration in LTV ratios, 72% of the portfolio within GBM and UKCB continue to have an LTV less than 75% and an average interest coverage ratio (ICR) for GBM of 164% and 151% for RBS UK. The Group’s lending approach has always been predominantly cash flow driven and areas of stress in the portfolio will primarily be impacted by the wider corporate and economic environment affecting tenant quality with the retail sector being an area of focus at the present time.
The Group has experienced a number of defaults in its Spanish portfolio with current limits of £2 billion managed via the Global Restructuring Group. Total impaired limits across the portfolio are £3.9 billion. Limits currently subject to a higher level of monitoring (watch) total £18.9 billion and are actively risk managed.
Residential mortgages The Group originates residential mortgages through retail channels in all four divisions within Regional Markets however activity is primarily in the UK, the US and Ireland.
The Serviced By Others (SBO) portfolio consists of purchased pools of home equity loans and lines whose LTV and geographic profiles have in the current economic conditions resulted in a higher write-off rate of 4.8% in 2008 than core portfolios. SBO was closed to new purchases in the third quarter of 2007 and is in run-off with exposure down from $8.3 billion (31 December 2007) to $7.0 billion (31 December 2008).
Ireland residential mortgages The residential mortgage portfolio in Ireland across the Ulster Bank and First Active brands totalled £24.6 billion (as at 31 December 2008) with 92.8% in the Republic of Ireland and 7.2% in Northern Ireland. This represents growth of 6% in the Republic of Ireland (ignoring exchange rate movements) and 6% in Northern Ireland. During the course of 2008, Ulster Bank exited the 100% LTV market and tightened LTV and affordability criteria in other segments. The arrears rate (three or more payments missed) increased to 1.6% at 31 December 2008 from 0.8% at end 2007 driven by deteriorating economic conditions. Repossession remained low and totalled 37 for 2008.
2008 was a difficult year for the hedge funds sector. More hedge funds collapsed during 2008 than in the previous ten years and the values of many declined significantly. The spate of redemptions from investors forced major hedge fund groups to halt withdrawals. The trends are set to continue in 2009 and the contraction of this sector is expected.
Corporate sectors (unaudited) This section discusses the automotive, shipping, oil and gas sectors, given their significance in the current market environment.
The majority of the exposures are strong relationships with loans structured to capture direct vessel cash flows, secured on the vessels themselves with the benefit of full security over the asset and all related cash flows. The Group’s approach to the sector recognises the cyclical nature of shipping with a focus on experienced independent owners with strong liquidity; customer deposits across the portfolio total £5 billion. Assets financed are non-specialist dry bulk, double hulled tankers and containers.
Global Restructuring Group (GRG) (audited) GRG was formed in 2008, tasked with managing the Group’s problem and potential problem exposures to help rejuvenate and restore customers to profitable business. This may include assisting with the restructuring of their businesses and/or renegotiation.
GRG is structured with specialist teams focused on: large corporate cases (higher value, multiple lenders); small/mid size business cases (lower value, bilateral relationships); and recovery/litigations. Given the negative trends in the portfolio in 2008, the size of GRG has grown substantially and further investment in staffing is expected in 2009.
Originating business units liaise with GRG upon the emergence of a potentially negative event or trend that may impact a borrowers’ ability to service its debt. This may be a significant deterioration in some aspect of the borrowers’ activity, such as trading, where a breach of covenant is likely or where a borrower has missed or is expected to miss a material contractual payment to the Group or another creditor.
At the start of 2008, the volume and value of cases managed by GRG was low relative to historic levels. During the year, the rate of transfer of cases to GRG accelerated sharply. Cases originated from all divisions and across most sectors although the rate of value growth was sharply higher due to the transfer of a number of high value cases from GBM. Commercial property cases made up a significant proportion of transfers from all divisions.
There have been material increases in staffing levels in all collections functions to manage the increase in the number of customers in financial difficulty. In the UK and Ireland, there is a common collection and recovery operational model managed by Group Manufacturing. During 2008, there was significant investment in systems development and staff training to make collections activity more efficient and effective.
In the UK there have been several initiatives to ensure fair and appropriate treatment of customers experiencing difficulties. For mortgage customers the Group will not initiate repossession proceedings for at least six months after arrears are evident.
Balance sheet analysis (audited) The following analysis is presented on a statutory basis.
Cash and balance at central banks 12,400 — — — — — — — 12,400 Loans and advances to banks (2) 131,963 872 1,247 282 943 — 129 (127) 135,309 Loans and advances to customers 310,950 141,849 187,899 150,705 59,191 15,667 19,350 (10,889) 874,722
Cash and balance at central banks 17,866 — — — — — — — 17,866 Loans and advances to banks (2) 204,083 5,797 4,937 407 1,119 — 25 (3) 216,365 Loans and advances to customers 275,715 174,074 221,561 84,791 55,273 13,236 10,337 (6,449) 828,538
(2) Excluding items in the course of collection of £2,888 million (2007 – £3,095 million).
Industry risk – geographical analysis (audited) The following table analyses financial assets by location of office and by industry type.
Loans and Debt advances to banks securities and Netting and and customers equity shares Derivatives Other(1) Total offset (2) 2008 £m £m £m £m £m £m
Individuals: Finance leases and instalment credit 17,363 3 25 — 17,391 119
Individuals: Finance leases and instalment credit 1,815 15 — — 1,830 —
Finance leases and instalment credit 111 5 — — 116 — Interest accruals 428 — — — 428 — Total Rest of the World 59,413 22,652 45,139 552 127,756 31,926
Loans and Debt advances to banks securities and Netting and and customers equity shares Derivatives Other(1) Total offset(2) 2008 £m £m £m £m £m £m
Individuals: Finance leases and instalment credit 15,632 131 27 — 15,790 5
Service industries and business activities 16,474 2,190 233 1 18,898 18 Agriculture, forestry and fishing 20 4 — — 24 —
Rest of the World Central and local government 2,592 18,821 94 — 21,507 —
Service industries and business activities 14,449 1,825 661 — 16,935 103 Agriculture, forestry and fishing 1,941 — — — 1,941 —
Impairment (audited) The Group classifies impaired assets as either Risk Elements in Lending (REIL) or Potential Problem Loans (PPL). REIL represents non-accrual loans, loans that are accruing but are past due 90 days and restructured loans. PPL represents impaired assets which are not included in REIL but where information about possible credit problems cause management to have serious doubts about the future ability of the borrower to comply with loan repayment terms.
The analyses of risk elements and impairment charges as discussed below form a key part of the data provided to senior management on the credit performance of the Group’s portfolios.
Total Total Total provision Total provision provision as % of provision as % of REIL and Total as % of REIL & REIL and Total as % of REIL &
Other — — — — — — — — — 14 — — RBS share of shared assets — — — — — — — — — 16 — — Group before RFS Holdings
REIL and PPL as % of customer loans and advances – gross (4) 2.52% 2.69% 1.64% 1.49%
Notes: (1) All loans against which an impairment provision is held are reported in the non-accrual category.
• Collectively assessed provisions: provisions on impaired credits below an agreed threshold which are assessed on a portfolio basis, to reflect the homogeneous nature of the assets, such as credit cards or personal loans. The provision is determined from a quantitative review of the relevant portfolio, taking account of the level of arrears, security and average loss experience over the recovery period.
• Latent loss provisions: provisions held against the estimated impairment in the performing portfolio which have yet to be identified as at the balance sheet date. To assess the latent loss within the portfolios, the Group has developed methodologies to estimate the time that an asset can remain impaired within a performing portfolio before it is identified and reported as such.
– Global Banking & Markets 3,643 67 – Global Transaction Services 60 14
Latent loss impairment charge 822 769 88 25 Collectively assessed impairment charge 2,606 2,391 1,584 1,813
Charge as a % of customer loans and advances – gross (2) 0.82% 0.91% 0.28% 0.37%
Total provision as a % of customer loans and advances – gross (2) 1.3% 1.3% 0.9% 0.9%
Provisions coverage (audited) The Group’s provision coverage ratios are shown in the table below.
Total provision expressed as a: The coverage ratio of closing provisions to REIL and PPL decreased from 57% to 51% during 2008. Excluding RFS Holdings minority interest, the coverage ratio was 50%. The lower coverage ratio reflects amounts written-off and the changing mix from unsecured to secured exposures.
Individually Collectively Total Individually Collectively Total assessed assessed Latent 2008 2007 assessed assessed Latent 2008 2007 £m £m £m £m £m £m £m £m £m £m
Acquisition of subsidiaries — — — — 129 — — — — 2,221
Global Global UK Retail & US Retail & Retail & Retail & Share of Holdings Banking & Transaction Commercial Commercial Commercial Commercial Central Shared minority Total Markets Services Banking Banking Banking Banking Items Assets interest 2008 2007 £m £m £m £m £m £m £m £m £m £m £m
Transfers to disposal groups — — — — — — — — (767) (767) — Currency translation
Liquidity risk (audited) The Group’s liquidity policy is designed to ensure that the Group can at all times meet its obligations as they fall due.
Liquidity management within the Group addresses the overall balance sheet structure and the control, within prudent limits, of risk arising from the mismatch of maturities across the balance sheet and from exposure to undrawn commitments and other contingent obligations.
The management of liquidity risk within the Group is undertaken within a formal governance structure. The Group Board of Directors oversees the liquidity risk appetite and strategy of the Group; the Group Executive Management Committee reviews the key liquidity metrics and trends in the context of the Group’s overall risk profile; the Group Asset and Liability Management Committee (GALCO), chaired by the Group Finance Director and including the chief executives of the business divisions as well as the Group Treasurer, Group Chief Risk Officer and heads of other relevant Group functions, sets explicit metrics across a number of asset and liability targets and these are cascaded to the business and monitored by the Group Treasury and risk functions.
Group Treasury has overall responsibility for the daily monitoring and control of the Group’s liquidity and funding positions. The Liquidity Managers’ Forum is chaired and directed by the Group Treasurer with membership including the Head of Short Term Markets and Financing, GBM. The forum typically meets weekly with more frequent, ad hoc, meetings as necessary. There are Regional and Country ALCOs that oversee Group policy in our business in Europe, Asia and the Americas. The Group is divided into Liquidity Reporting Units each of which is required to have its own liquidity limits and contingency funding plan. In addition, all subsidiaries and branches outside the UK are required to comply with local regulatory liquidity requirements and are subject to Group Treasury oversight.
Daily management The primary focus of the daily management activity is to ensure access to sufficient liquidity to meet cash flow obligations within key time horizons, in particular out to one month ahead. The short-term maturity structure of the Group’s liabilities and assets is managed daily to ensure that all material or potential cash flow obligations, arising from undrawn commitments and other contingent obligations can be met.
Stress testing The Group performs stress tests to simulate how events may impact its funding and liquidity capabilities. Such tests inform the overall balance sheet structure and help define suitable limits for control of the risk arising from the mismatch of maturities across the balance sheet and from undrawn commitments and other contingent obligations. The form and content of stress tests are updated where required as market conditions evolve.
Contingency planning Contingency funding plans have been developed to anticipate and respond to approaching or actual material deterioration in market conditions. The Group reviews its contingency plans in the light of evolving market conditions. The contingency funding plan covers: the available sources of contingent funding to supplement cash flow shortages; the lead times to obtain such funding; the roles and responsibilities of those involved in the contingency plans, including the communication lines for escalation of events which give rise to liquidity stress; assumptions, including the expected change impact of market conditions; and the ability and circumstances within which the Group accesses central bank liquidity.
Global developments (unaudited) The global financial system has experienced its greatest crisis in the post war period and the dislocation became most acute in the second half of 2008. This loss of confidence in the world’s banking system led to massive dislocation in the capital markets and resulted in the effective closure of the term debt and securitisation markets and money markets. Government intervention in, and support for, the international financial system has increased to unprecedented levels taking the form of capital injections, guaranteed funding, asset insurance schemes and expanded facilities from a number of central banks: • In September 2007, the Bank of England announced that to alleviate strains in longer-maturity money markets, it would conduct auctions to provide funds at three month maturity against a wider range of collateral, including mortgage collateral, than in its weekly open market operations.
• In April 2008, the Bank of England launched a special liquidity scheme allowing banks to swap temporarily illiquid mortgage and other assets for Treasury Bills. The scheme closed to new issuances on 30 January 2009. However, it will provide liquidity support for a further three years.
• In October 2008, the pool of eligible collateral securities for its open market operations was extended to include bank debt guaranteed under the Government’s bank debt guarantee scheme.
• In October 2008, the Government announced a credit guarantee scheme. It will guarantee new unsecured borrowing in return for a fee. Initially the guarantee period ended on 9 April 2009 but on 19 January 2009 the Government announced an extension to 31 December 2009. It also announced new arrangements, expected to start in April 2009, to guarantee asset-backed securities issued by banks.
• In October 2008 the European Central Bank expanded its list of eligible collateral to include marketable debt instruments denominated in non-euro currencies (and issued in the euro area) among others. This is to remain in force until the end of 2009. Enhancements were also made to the provision of longer-term refinancing operations including conducting them through a fixed rate tender procedure with full allotment. This is to stay in place for as long as needed and at least until 31 March 2009.
• In January 2009, it was announced that the Bank of England will permit drawings from the discount window facility with a term of 364 days, in addition to the standard option to draw for 30 days.
• In January 2009, the Government announced that the Bank of England had been authorised to purchase up to £50 billion of highquality private sector assets under an asset purchase facility. The following sterling assets are initially eligible for purchase: commercial paper, corporate bonds, paper issued under the Credit Guarantee Scheme (CGS), syndicated loans and asset-backed securities created in viable securitisation structures.
• In January 2009, the Government announced an asset protection scheme. The Government will insure, for a commercial fee, certain bank assets against losses. It is anticipated that the scheme will commence in April 2009. The UK banks, including the Group, have been in discussions with the Tripartite Authorities about the scheme’s terms.
• On 3 February 2009 the Federal Reserve Bank announced an extension to a number of its liquidity facilities until 30 October 2009. These included the Term Securities Lending Facility (TSLF), originally announced in March 2008. Under the TSLF, the Federal Reserve Bank of New York auctions 28-day term loans of Treasury securities to primary dealers in exchange for other program eligible collateral.
Repo agreements are borrowings collateralised by a range of debt securities and other assets undertaken with a range of corporate and institutional customers and banks. These reduced significantly in the course of 2008 as the Group took strategic actions and wholesale markets retrenched.
The Group raised £27 billion of equity capital during the course of 2008 from a rights issue of £12 billion in June 2008 and a placing and open offer in December 2008 which provided a further £15 billion of equity capital. In December 2008 a further £5 billion was raised from a preference share issue.
Undrawn commitments – the Group provides undrawn commitments to both its corporate and personal customers in the form of products such as overdrafts and credit card facilities. The commitments portfolio is well diversified in terms of customers, geography and business type. The total amount of the Group’s undrawn commitments at the end of 2008 was £352 billion.
Deposits by banks (excluding repos) 174,378 13 178,268 15 149,256 10 141,637 12
The total assets held by the Group’s sponsored conduits are £49.9 billion (2007– £48.1 billion). Since these liquidity facilities are sanctioned on the basis of total conduit purchase commitments, the liquidity facility commitments will exceed the level of assets held, with the difference representing undrawn commitments.
The Group values the funding flexibility and liquidity provided by the ABCP market to fund client and Group-originated assets. Whilst there are plans to decrease the multi-seller conduit business in line with the Group’s balance sheet, the Group is reviewing the potential for new own-asset conduit structures to add funding diversity.
Outlook for 2009 (unaudited) The market outlook for 2009 remains uncertain with the prospect of recession on a global scale. The wholesale funding markets remain difficult with a high degree of risk aversion towards the banking market and no restoration of the unguaranteed debt capital markets for bank issuance yet visible. The continuation of these conditions means that the use of central bank and other government facilities are likely to be required for some time. Other deposit initiatives have commenced to widen wholesale and other retail deposit gathering actions.
The tables above show the timing of cash inflows and outflows to settle financial assets and liabilities. They have been prepared on the following basis: Financial assets have been reflected in the time band of the latest date on which they could be repaid unless earlier repayment can be demanded by the reporting entity; financial liabilities are included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If the repayment of a financial asset or liability is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the latest date on which it can repay regardless of early repayment whereas the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period whatever the level of the index at the year end. The settlement date of debt securities in issue issued by certain securitisation vehicles consolidated by the Group depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date. As the repayment of assets and liabilities are linked, the repayment of assets in securitisations are shown on the earliest date that the asset can be prepaid as this is the basis used for liabilities.
This contractual analysis highlights the maturity transformation of the balance sheet that is fundamental to the structure of banking. In practice, this is not a reflection of the actual behaviour of assets or liabilities. In particular the customer funding of the balance sheet exhibits much greater stability and maturity than the tables indicate. This is because the funding franchise of the Group is diversified across an extensive retail network.
Regulatory environment (audited) The Group is subject to the FSA’s liquidity regime, whilst overseas subsidiaries and branches are subject to local regimes.
Sterling liquidity The FSA requires the Group, on a consolidated basis, to maintain daily a minimum ratio of 100% between: • a stock of qualifying high quality liquid assets (primarily UK and EU government securities, treasury bills and cash held in branches); and
Given the developments in 2008 the FSA has published new proposals for liquidity management (CP08/22) to replace the current regulatory framework. The FSA is proposing a major overhaul of liquidity risk regulation that will include: • Improved systems and controls including governance standards, pricing, intra day systems and collateral management.
Market risk (audited) Market risk arises from changes in interest rates, foreign currency, credit spread, equity prices and risk related factors such as market volatilities. Market risk is actively managed and aligned with the Group’s risk appetite. Market conditions were difficult throughout 2008 with significant volatility and write-downs across markets and portfolios.
The Group manages market risk in the trading and non-trading (treasury) portfolios using the market risk management framework. The framework includes value-at-risk (VaR) limits, backtesting, stress testing, scenario analysis, position/sensitivity analysis and model validation.
The focus through 2008 has been on overhauling and reviewing the market risk limits for trading book activities, reflecting market performance and events.
Measurement (audited) A number of techniques are used to calculate the Group’s exposure to market risk, including VaR, sensitivity analysis and stress testing.
Assets and liabilities in the trading book are measured at their fair value. Fair value is the amount at which the instrument could be exchanged in a current transaction between willing parties. The fair values are determined following IAS 39 guidance which requires banks to use quoted market prices or valuation techniques (models) that make the maximum use of observable inputs. When marking to market using a model, the valuation methodologies are reviewed and approved either by the market risk function in the business or at Group level. Group Risk provides an independent evaluation of the model for transactions deemed by the Model Product Review Committee (MPRC) to be large, complex and/or innovative. Any profits or losses on the revaluation of positions are recognised in the daily profit and loss.
The 2008 data in the table above excludes exposures to super-senior tranches of asset backed CDOs, as VaR no longer produces an appropriate measure of risk for these exposures due to the illiquidity and opaqueness of the pricing of these instruments over an extended period. For these exposures, the maximum potential loss is equal to the aggregate net exposure, which was £1,398 million as at 31 December 2008. For more information, please refer to the discussion of Credit market and related exposures – Super senior CDOs on page 132 and Financial statements: Note 11, Financial instruments – Valuation – level 3 portfolios – collateralised debt obligations on pages 204 and 205.
RBS Sempra Commodities LLP, the commodities-marketing joint venture between RBS and Sempra Energy, was formed on 1 April 2008, and its trading risks were included in the disclosed VaR from that date.
Backtesting, stress testing and sensitivity analysis (audited) The Group undertakes a programme of daily backtesting, which compares the actual profit or loss realised in trading activity to the VaR estimation. The results of the backtesting process are one of the methods by which the Group monitors the ongoing suitability of its VaR model.
A ‘Risks not in VaR’ framework has been developed to address those market risks not adequately captured by the market standard VaR methodology. Where risks are not included in the model various non-VaR controls (e.g. position monitoring, sensitivity limits, triggers or stress limits) are in place.
The Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from exceptional but plausible market events. Stress testing measures the impact of abnormal changes in market rates and prices on the fair value of the Group`s trading portfolios. GEMC approves the high-level market stress test limit for the Group. The Group calculates historical stress tests and hypothetical stress tests.
Historical stress tests calculate the loss that would be generated if the market movements that occurred during historical market events were repeated. Hypothetical stress tests calculate the loss that would be generated if a specific set of adverse market movements were to occur.
In addition to VaR and stress testing, the Group calculates a wide range of sensitivity and position risk measures, for example interest rate ladders or option revaluation matrices. These measures provide valuable additional controls, often at individual desk or strategy level.
Model validation governance (audited) Pricing models are developed and owned by the front office. Where pricing models are used as the basis of books and records valuations, they are all subject to independent review and sign-off. Models are assessed by MPRC as having either immaterial or material model risk (valuation uncertainty arising from choice of modelling assumptions), the assessment being made on the basis of expert judgement. Those models assessed as having material model risk are prioritised for independent quantitative review. Independent quantitative review aims to quantify model risk by comparing model outputs against alternative independently developed models. The results of independent quantitative review are used by Market Risk to inform risk limits and by Finance to inform reserves. Governance over this process is provided by MPRC, a forum which brings together front office quants, market risk, finance and QuaRC (Quantitative Research Centre, Group Risk’s independent quantitative model review function). Risk (market risk, incremental default risk, counterparty credit risk) models are developed both within business units and by Group functions. Risk models are also subject to independent review and sign-off. Meetings are held with the FSA every quarter to discuss the traded market risk, including changes in models, management, back testing results, other risks not included in the VaR framework and other model performance statistics.
• A temporary increase in the limit (for instance, in order to allow orderly unwinding of positions) can be granted.
Non-traded portfolios (audited) Risks in non-traded portfolios mainly arise in retail and commercial banking assets and liabilities and financial investments designated as available-for-sale and held-to-maturity.
Various banking regulators review non-trading market risk as part of their regulatory oversight. As home regulator, the FSA has responsibility for reviewing non-trading market risk at a Group consolidated level.
The Group is exposed to the following non-traded risks: Interest Rate Risk in the Banking Book (IRRBB) represents exposures to instruments whose values vary with the level or volatility of interest rates. These instruments include, but are not limited to, loans, debt securities, equity shares, deposits, certificates of deposits, and other debt securities issued, loan capital and derivatives. Hedging instruments used to mitigate these risks include related derivatives such as options, futures, forwards and swaps. Interest rate risk arises from the Group’s non-trading activities in four principal forms: • Repricing risk – arises from differences in the repricing terms of the Group’s assets and liabilities.
• Basis risk – arises, for example, where one month LIBOR is used to fund base rate assets.
• Yield curve risk – arises as a result of non-parallel changes in the yield curve.
From an economic perspective, it is the Group’s policy to minimise the sensitivity to changes in interest rates in its retail and commercial businesses and, where interest rate risk is retained, to ensure that appropriate resources, measures and limits are applied.
Risk is managed within VaR limits approved by GALCO, through the execution of cash and derivative instruments (see Note 13 on the accounts, on page 214). Execution of the hedging is carried out by the relevant division through the Group`s treasury functions. The residual risk position is reported to divisional asset and liability committees, GALCO and the Board.
Foreign Exchange Risk in the Banking Book (FXRBB) represents exposures to changes in the values of current holdings and future cashflows denominated in other currencies. Hedging instruments used to mitigate these risks include foreign currency options, currency swaps, futures, forwards and deposits. Foreign exchange risk results from the Group’s investments in overseas subsidiaries, associates and branches in three principal forms: (i) Structural foreign currency exposures that arise from net investment in overseas subsidiaries, associates and branches; (ii) Transactional/commercial foreign currency exposures that arise from mismatches in the currency balance sheet; and
Treasury (audited) The Group’s treasury activities include its money market business and the management of internal funds flow within the Group’s businesses. In addition, this includes GBM trading portfolio assets that have been reclassified to available-for-sale. Money market portfolios include cash instruments (principally debt securities, loans and deposits) and related hedging derivatives. VaR for the Group’s treasury portfolios, which relates mainly to interest rate risk including credit spreads, was £52.0 million at 31 December 2008 (2007 – £5.5 million). During the year the maximum VaR was £52.0 million (2007 – £6.4 million), the minimum £4.8 million (2007 – £1.3 million) and the average £8.3 million
Non-trading interest rate VaR (audited) Non-trading interest rate VaR for the Group’s treasury and retail and commercial banking activities was £70.6 million at 31 December 2008 (2007 – £42.9 million) with the major exposure being to changes in longer term US dollar interest rates. During 2008, the maximum VaR was £117.6 million (2007 – £53.6 million), the minimum was £53.9 million (2007 – £32.9 million) and the average was £75.1 million (2007 – £43.2 million).
Citizens Financial Group (CFG) was the main contributor to overall nontrading interest rate VaR. CFG manages non-trading interest rate risk with the objective of minimising accrual accounted earnings volatility. To do so it uses a variety of income simulation and valuation risk measures that more effectively capture the risk to earnings due to mortgage prepayment and competitive deposit pricing behaviour than a VaRbased methodology would. This balance sheet management approach is common for US retail banks. Interest rate risk in the banking book is managed by a professional treasury function which optimises the yield, whilst staying within approved limits on interest rate risk, liquidity and capitalisation.
Mortgages, home equity loans and mortgage-backed securities (MBS) comprise a large portion of CFG’s assets. In the US, mortgage and home equity customers may prepay loans without penalty. However, under the requirements of FAS 133, the risk that they may do so cannot be hedged in a cost effective manner and must be born by the lender. Prepayment risk is a primary component of interest rate risk in the banking book at CFG.
MBS – total – high grade (AA or AAA rated) 26,268 25,893 26,848 26,572 – rated C to A 602 600 — —
MBS – commercial – high grade (AA or AAA rated) 2,253 2,089 2,205 2,211
• Economic value of equity (EVE) sensitivity to a series of parallel movements in interest rates. EVE is only used within CFG and to meet the FSA prescribed standard shock test of +/- 200bp parallel shock.
The projections also assume that interest rates of all maturities move by the same amount and therefore do not reflect the potential effect on net interest income of some rates changing whilst others remain the same.
The Group aims, through its management of market risk in non-trading portfolios, to mitigate the effect of prospective interest movements which could reduce future net interest income, whilst balancing the cost of such hedging activities on the current net revenue stream.
+ 100bp shift in yield curves 138.9 – 100bp shift in yield curves (234.1)
2% parallel downward 2% parallel movement in upward US interest movement in rates (No US interest negative rates
Note: (1) Economic value of equity is the net present value of assets and liabilities calculated by discounting expected cash flows of each instrument over its expected life. Risk to EVE is quantified by calculating the impact of interest rate changes on the net present value of equity and is expressed as a percentage of CFG regulatory capital.
Currency risk (audited) The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding. The Group’s policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in foreign subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the Group’s or the subsidiary’s regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by GALCO. Foreign exchange differences arising on the translation of foreign operations are recognised directly in equity together with the effective portion of foreign exchange differences arising on hedging instruments.
Retranslation gains and losses on the Group’s net investments in operations together with those on instruments hedging these investments are recognised directly in equity. Changes in foreign currency exchange rates will affect equity in proportion to the structural foreign currency exposure. A five percent strengthening in foreign currencies would result in a gain of £1,010 million (2007 – £1,200 million) recognised in equity, while a five per cent weakening in foreign currencies would result in a loss of £960 million (2007 - £1,140 million) recognised in equity. These movements in equity would offset retranslation effects on the Group's foreign currency denominated risk weighted assets, reducing the sensitivity of the Group's Tier 1 capital ratio to movements in foreign currency exchange rates.
The table below sets out the balance sheet value of equity exposures at December 2008.
Group before RFS Holdings minority interest 4,211 2,759 6,970 RFS Holdings minority interest 56 259 315 * excludes equity exposures held-for-trading purposes and by insurance/assurance entities.
Risk control (unaudited) The prime risk control mechanism for non-traded market risk exposures is the completion of monthly IRRBB and quarterly FXRBB returns by the Group’s business units, collated as part of month-end reporting by Group Treasury to GALCO. In relation to equity risk, risk is mitigated by proper controls in relation to identification of risk prior to investing.
For FXRBB, the Group policy states that any foreign currency exposure is managed to de-minimus limits. Group Treasury monitors adherence to this policy via a quarterly return.
Insurance risk arises through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting. Insurance risk is managed in four distinct ways: • Underwriting and pricing risk management: is managed through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted, pricing policies by product line and brand and centralised control of wordings and any subsequent changes.
• Reinsurance risk management: is used to protect against adverse claims experience on business within normal risk appetite (e.g. catastrophic events, adverse frequency of large claims) and to provide protection on business not within its risk appetite (e.g. quota share reinsurance on certain classes of business).
• Property insurance contracts (residential and commercial): the major causes of claims for property insurance are weather (flood, storm), theft, fire, subsidence and various types of accidental damage.
An analysis of gross and net insurance claims can be found in Note 24 on the report and accounts (see page 231).
The Group’s long-term assurance contracts include whole-life, term assurance, endowment assurance, flexible whole life, pension and annuity contracts that are expected to remain in force for an extended period of time. Contracts under which the Group does not accept significant insurance risk are classified as investment contracts. Long term business provisions are calculated in accordance with the UK accounting standard FRS 27 ‘Life Assurance’.
Sensitivity factor Description of sensitivity factor applied Interest rate and investment return Change in market interest rates of ±1%
The test allows consistently for similar changes to investment returns and movements in the market value of backing fixed interest securities
The above UK sensitivity factors are applied through actuarial and statistical models, with the following impact on the financial statements.
Operational risk (unaudited) Operational risk is the risk of financial loss or reputational impact resulting from fraud; human error; ineffective or inadequately designed processes or systems; improper behaviour; legal events; or from external events. Operational risk is an integral and unavoidable part of the Group’s business as it is inherent in the processes it operates to provide services to customers and generate profit for shareholders.
• Key risk indicators: business units monitor key risk indicators against their material risks. These indicators are used to monitor the operational risk profile and exposure to losses against thresholds which trigger risk management actions.
The graph below shows the operational risk events by category and value for 2007 and 2008, for the Group on a statutory basis.
Financial crime Financial crime remains a big challenge for the Group, especially given the sophistication of the criminal fraternity. However, the Group continues to respond to such threats, by continuing to invest in people and processes for both detective and preventative measures especially relating to card fraud and cyber crime. Key initiatives include changes to authentication of payments, ATM security, software enhancements and improvement in counterfeit detection.
Physical security environment The number of physical attacks on our retail business was broadly static in 2008 compared with 2007. Business plans and controls have been enhanced to reflect the increase in size of the global business during the year, for example changes to retail and ATM security and sharing best practice with competitors and law enforcement agencies.
The Group recognises information security, relating to the loss of confidentiality, integrity or availability of our information and systems, as a specific risk, which is managed through a Group Information Security Policy. This is reviewed annually and includes processes for managing and ensuring compliance with the policy. The same standards apply to information controlled by the Group or managed by authorised third parties. The Group continues to invest in programmes to enhance and maintain information security controls and systems. For example, during 2008, security reviews on third party suppliers and vendors were significantly increased.
• The management of effective relationships with regulators to ensure constructive engagement.
Under a Group-wide framework of high-level policies, the Group and its subsidiaries engage co-operatively with all regulatory authorities in all the relevant jurisdictions, whether in response to regulatory change, ongoing supervisory requirements or regulatory investigations.
Reputation risk Reputation is the body of perceptions and opinions held by the stakeholders of an organisation; customers, suppliers, employees, investors, interest groups, regulators and government. Reputation determines how stakeholders are likely to behave towards an organisation. Reputation risk arises from any activity that could have an adverse impact on the reputation of the Group. There are several important drivers of the reputation of a company (and reputation risk) including: financial performance; corporate governance and quality of management; ethical, social and environmental performance; marketing, innovation and customer relationships; and regulatory compliance and litigation.
The Group protects its reputation by understanding and managing reputation risks, including failure to meet the expectations of stakeholders.
It is the responsibility of the management of all Group companies, acting through individual business units, to ensure that appropriate controls and procedures are in place to identify and manage the risks to the reputation of the Group arising from their activity.
The Board has ultimate responsibility for managing any impact on the reputation of the Group arising from its operations. However all parts of the Group take responsibility for reputation management.
Pension risk The Group is exposed to risk to its defined benefit pension schemes as assets comprise investment portfolios which are held to meet projected liabilities to scheme members. Risk arises because returns from these investments may be less than expected or there may be greater than expected increases in the estimated value of the schemes’ liabilities. In such circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes.
Risk appetite and investment policy are agreed by the Board of Trustees with quantitative and qualitative input from the scheme actuaries and investment advisers. The Board of Trustees also consults with the Group to obtain its view on the appropriate level of risk within the pension fund.
Credit market and related exposures Explanatory note (unaudited) These disclosures provide information for certain of the Group’s business activities affected by the unprecedented market events of 2008, the majority of which arose within Global Banking and Markets (GBM). The disclosures are focused around GBM’s credit markets activities, including the conduit business, which have been particularly affected by the widespread market disruptions, as well as similar exposures in US Retail & Commercial (‘Citizens’) and Group Treasury.
An indication of the continued decline in the price of asset backed securities (ABS), in particular those collateralised with sub-prime assets, is shown in the following graph. While not fully representative of the Group’s ABS exposures or pricing basis, the ABX series of indices charted in the graph show, in bond price terms, how differently rated ABS referencing US sub-prime mortgages securitised in 2007 have performed during the year.
The graph below provides an indication of the change in credit worthiness of corporate entities to which the Group has significant exposure through its credit products in the form of credit derivatives and bonds. The MarkiT iTraxx Europe graph demonstrates the impact of the movement of credit spreads in price terms for a basket of European corporate entities (prices rebased to 100 at the beginning of the year).
During the second quarter ABS prices initially rallied and steadied, however towards the end of the quarter a negative house price trend in the UK became clear, and in the US, market reaction to sub-prime mortgages extended to prime and near prime lending. Corporate credit spreads followed a similar pattern reacting to rising oil prices, inflationary pressures and continuing high LIBOR despite base rate cuts to 5% in April.
Credit spreads continued to widen across the market through the third quarter and liquidity levels reduced further, resulting in pressure on banks and economies worldwide. This culminated in the demise of Lehman Brothers in September and further market consolidation and global state intervention to provide support to the banking sector.
The tables below summarise the net exposures and balance sheet carrying values of these securities by measurement classification and references to sections with further information on specific products.
During 2008, as the problems in the sub-prime sector spread to other asset classes on a global basis and credit spreads widened due to concerns over creditworthiness of underlying assets, securitisation volumes continued to be thin. Over the preceding years GBM had established itself as an active arranger of third-party securitisations and a secondary dealer in these securities, and GBM had therefore accumulated assets that became difficult to sell given market conditions.
The Group has exposures to ABS which are predominantly debt securities but can be held in derivative form. These positions had been acquired primarily through the Group’s activities in the US leveraged finance market which were expanded during 2007. These include residential mortgage backed securities (‘RMBS’), commercial mortgage backed securities (‘CMBS’), ABS CDOs and other ABS. In many cases the risk on these assets is hedged via credit derivative protection purchased over the specific asset or relevant ABS indices. The counterparty to some of these hedge transactions are monoline insurers (see Monoline insurers on page 135).
The majority of the Group’s RMBS portfolio at 31 December 2008, in terms of net exposure, was AAA rated guaranteed or effectively guaranteed securities of £51.1 billion, comprising: • £33.5 billion of US agency securities
The tables below analyse carrying values of these debt securities by measurement classification and rating and fair value hierarchy level.
Sub-prime conforming Guaranteed Other CMBS CDOs/CLOs Other ABS Total 2008 £m £m £m £m £m £m £m £m
Designated at fair value 16 — — 166 9 — — 191
Designated at fair value — — — — 4 — 41 45
Of which carried at fair value: Notes: (1) Credit ratings are based on those from S&P, Fitch or Moody’s and have been mapped on to S&P scale.
(2) Valued using techniques based significantly on observable market data. Instruments in this level are valued using: (a) quoted prices for similar instruments in markets which are not considered to be active; or (b) valuation techniques where all the inputs that have a significant effect on the valuation are directly or indirectly based on observable market data.
Designated at fair value — — — 72 37 7 — 116
Available-for-sale — — — — — — 14 14 Loans and receivables 5 — — — — — 72 77 Designated at fair value 16 — — — — — — 16
(2) Credit ratings are based on those from rating agencies Standard & Poor’s (S&P), Moody’s and Fitch and have been mapped onto S&P scale
(3) Valuation is based significantly on observable market data. Instruments in this category are valued using: – quoted prices for similar instruments or identical instruments in markets which are not considered to be active; or
(4) Instruments in this category have been valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation is not based on observable market data.
Several tranches of notes are issued, each secured against the same portfolio of mortgages, but providing differing levels of seniority to match the risk appetite of investors. The most junior (or equity) notes will suffer early capital and interest losses experienced by the referenced mortgage collateral, with each more senior note benefiting from the protection provided by the subordinated notes below. Additional credit enhancements may be provided to the holder of senior RMBS notes, including guarantees over the value of the exposures, often provided by monoline insurers.
The main categories of mortgages that serve as collateral to RMBS held by the Group are described below. As can be seen from the table below, the Group’s RMBS portfolio covers a range of geographic locations and different categories are used to classify the exposures depending on the geographical region of the underlying mortgage. These categories are described below. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for the Group’s RMBS categorisation.
Other prime mortgages are those of a higher credit quality than nonconforming and sub-prime mortgages, and exclude guaranteed mortgages.
Sub-prime conforming Guaranteed(2) Other(3) Total Sub-prime conforming Guaranteed(2) Other(3) Total £m £m £m £m £m £m £m £m £m £m
Notes: (1) Net exposures reflect the effect of hedge protection purchased from monolines and other counterparties but excludes the effect of counterparty credit valuation adjustment. Carrying value is the amount recorded on the balance sheet.
• £5.7 billion (2007 – £5.0 billion) guaranteed by US government via Ginnie Mae of which £0.5 billion (2007 – £0.3 billion) are held-for-trading
• £27.8 billion (2007 – £ 21.0 million) effectively guaranteed by the US government via its support for Freddie Mac and Fannie Mae of which £18.1 billon (2007 – £15.2 billion) are held-for-trading
(3) Other prime mortgage exposures include £10.0 billion (2007 – £7.8 billion) covered European mortgage bonds.
Sub-prime Alt-A Guaranteed Other Total Sub-prime Alt-A Guaranteed Other Total United States £m £m £m £m £m £m £m £m £m £m
Of which originated in: Non Non Sub-prime conforming Prime Total Sub-prime conforming Prime Total
Of which originated in: In other geographical regions not covered above, RMBS portfolios included: • net RMBS exposures of £314 million (2007 – £205 million) comprising: held-for-trading nil (2007 – £73 million); available-for-sale £308 million (2007 – £132 million) and loans and receivables £6 million (2007 – nil).
Citizens maintains an available-for-sale investment securities portfolio to provide high-quality collateral to provide a liquidity buffer and to enhance earnings. The size of the portfolio has been relatively stable through 2008, but both the absolute and relative size (% of earning assets) declined in 2006-2007. The portfolio comprises high credit quality mortgage-backed securities, to ensure both pledgeability and liquidity. The U.S. Government guarantees on MBS, whether explicit or implicit, put most of the portfolio in a secure credit position. The nonagency MBS holdings derive credit support in two ways. Firstly, there is senior and subordinated structuring, and Citizens hold only the most senior tranches. Secondly, there is high quality supporting loan collateral. The collateral quality is evidenced (a) by the vintages, with 82% issued in 2005 and earlier, (b) by the borrower’s weighted loan to value (LTV) ratio of 65%, and (c) by the borrower’s weighted-average FICO score of 734.
£7.6 billion (2007 – £6.0 billion) of the RMBS exposure consists of available-for-sale portfolio of European RMBS in Group Treasury, referencing primarily Dutch and Spanish government-backed loans, and accordingly the quality of these assets has held up relative to other RMBS types. A further £10.0 billion (2007 – £7.8 billion) European RMBS comprised covered mortgage bonds.
Overall, the Group has recognised significant fair value losses on RMBS assets during the year due to reduced market liquidity and deteriorating credit ratings of these assets. The Group has reduced its exposure to RMBS predominantly through fair value hedges and asset sales during the year. These decreases were partially offset by the weakening of sterling relative to the US dollar and euro.
US UK Europe ROW(1) Total US UK Europe ROW Total £m £m £m £m £m £m £m £m £m £m
The Group’s ABS CDO and CLO net exposures comprised: £m £m
The Group’s CDO exposures comprise CDOs structured by the Group from 2003 to 2007 that were unable to be sold to third parties due to prevailing illiquid markets with net exposures of £1.4 billion (2007 – £3.8 billion), as well as other CDO net exposures of £1.5 billion (2007 – £1.6 billion) purchased from third parties some of which are fully hedged through CDSs with other banks or monoline insurers.
Underlying RMBS sub-prime assets (origination) 69 91 79 69 91 79
Of which originated in: Collateral by rating at reporting date: (2)
Attachment point post write down 77 97 88 40 62 50
Notes: (1) The above table includes data for two trades liquidated in the last quarter of 2008 to provide consistency with comparatives.
(3) Attachment point is the minimum level of losses in a portfolio which a tranche is exposed to, as a percentage of the total notional size of the portfolio. For example, a 5 – 10% tranche has an attachment point of 5% and a detachment point of 10%. When the accumulated loss of the reference pool is less than 5% of the total initial notional of the pool, the tranche will not be affected. However, when the loss has exceeded 5%, any further losses will be deducted from the tranche’s notional principal until detachment point, 10%, is reached.
At origination, the reference assets of the high grade structures predominantly comprised investment grade tranches of sub-prime residential mortgage securitisations along with other senior tranches of some combination of ABS assets, including prime and Alt-A RMBS, CMBS, trust preferred ABS, student loan backed ABS and CDO assets. The underlying assets referenced by these super senior securities are primarily more recent vintages (the year the underlying loan was originated), with 48% being 2007. Generally, loans with more recent vintages carry greater discounts, reflecting the market perception of greater default levels than on earlier loan vintages.
The Group’s other asset-backed securities (carrying value) by underlying asset type and geographical region are shown below.
US UK Europe ROW Total US UK Europe ROW Total £m £m £m £m £m £m £m £m £m £m
The Group has CLO exposures resulting from a number of trading activities. They consist of exposures retained by the Group and from notes purchased from third-party structures. The Group holds super senior securities in two CLO structures which were originated by the Group in 2005 and 2007. The underlying collateral of these structures predominantly references leveraged loans.
The monoline insurer CVA is calculated on a trade-by-trade basis, and is derived using market observable monoline credit spreads. The majority of the monoline CVA is taken against credit derivatives hedging exposures to ABS. The CDPC CVA is calculated using a similar approach. However, in the absence of market observable credit spreads, the cost of hedging the counterparty risk is estimated by analysing the underlying trades and the cost of hedging expected default losses in excess of the capital available in each vehicle.
The CVA for all other counterparties, including those in respect of derivatives with banks, is calculated either on a trade-by-trade basis, reflecting the estimated cost of hedging the risk through credit derivatives, or on a portfolio basis reflecting an estimate of the amount a third party would charge to assume the risk.
During the year the market value of securities protected by monoline insurers continued to decline as markets deteriorated. As the fair value of the protected assets declined, the fair value of the CDS protection from monoline insurers increased. As the monoline insurers had concentrated their exposures to credit market risks, their perceived credit quality has deteriorated as concerns increased regarding the ability of these counterparties to meet their contractual obligations. This resulted in increased levels of CVA being recorded on the protection asset.
The change in exposure during the year has been driven by the increased value of purchased derivative protection and the strengthening of the US dollar against sterling as significantly all of the exposures are US dollar denominated. The combination of greater exposure and widening credit spreads has increased the level of CVA required. Towards the end of the year the Group reached settlement on a group of contracts with one monoline counterparty, thereby reducing the overall exposure.
Other mortgage-related exposures (unaudited) The Group’s whole loans and warehouse facilities collateralised by mortgages are analysed below. These facilities primarily relate to UK and European mortgages with US mortgages representing £260 million of whole loans, of which more than 75% comprised prime mortgages.
Whole Warehouse Whole Warehouse loans facilities loans facilities £m £m £m £m
RMBS — — — — — — — — CMBS — — — — — — — —
The change in CVA is analysed in the table below: £m
Notional Notional amount Fair value Credit amount Fair value Credit protected protected Gross valuation protected protected Gross valuation assets assets exposure adjustment assets assets exposure adjustment £m £m £m £m £m £m £m £m
Net benefit on CVA hedges 533 Net benefit on FX hedges 119 Net income statement effect 615 Balance at 31 December 2008 1,311
Credit derivative product companies A credit derivative product company (CDPC) is a company that sells protection on credit derivatives. CDPCs are similar to monoline insurers. However, unlike monoline insurers, they are not regulated as insurers.
Change in fair value (462) (156) (618) n/a n/a n/a Impairment provisions n/a n/a n/a (1,191) — (1,191)
In addition to the leveraged finance syndicated portfolio discussed above, the Group has £7 billion of portfolio positions, mostly to European companies, that have been classified as loans and receivables since origination.
Leverage finance (audited) Leveraged finance is commonly employed to facilitate corporate finance transactions, such as acquisitions or buy-outs. A bank acting as a lead manager will typically underwrite the loan, alone or with others, and then syndicate the loan to other participants.
The table below shows the carrying value of leveraged finance exposures by industry and geography.
SPEs and conduits SPEs (audited) The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms – trusts, partnerships and companies – and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.
It is primarily the extent of risks and rewards assumed that determines whether these entities are consolidated in the Group’s financial statements. The following section aims to address the significant exposures which arise from the Group’s activities through specific types of SPEs.
The Group’s conduits can be divided into multi-seller conduits and ownasset conduits. In line with market practice, the Group consolidates both types of conduit where it is exposed to the majority of risks and rewards of ownership of these entities. The Group also extends liquidity commitments to multi-seller conduits sponsored by other banks, but typically does not consolidate these entities as it is not exposed the majority of the risks and rewards.
Funding and liquidity The Group’s most significant multi-seller conduits have thus far continued to fund the vast majority of their assets solely through ABCP issuance. There were significant disruptions to the liquidity of the financial markets during the year following the bankruptcy filing of Lehman Brothers in September 2008 and this required a small amount of the assets held in certain conduits to be funded by the Group rather than through ABCP issuance. By the end of 2008 there had been an improvement in market conditions, supported by central bank initiatives, which enabled normal ABCP funding to replace this Group funding of the conduits.
The average maturity of ABCP issued by the Group’s conduits as at 31 December 2008 was 72.1 days (2007 – 60.9 days).
Assets purchased or financed by the multi-seller conduits include auto loans, residential mortgages, credit card receivables, consumer loans and trade receivables. All assets held by the conduits are recorded on the Group’s balance sheet either as loans and receivables or debt securities.
Group these liquidity facilities have been provided by third-party banks. This typically occurs on transactions where the third-party bank does not use, or have, its own conduit vehicles. Conduit commercial paper issuance is managed such that the spread of maturity dates of the issued ABCP mitigates the short-term contingent liquidity risk of providing back-up facilities. Limits sanctioned for such facilities as at 31 December 2008 totalled approximately £42.9 billion (2007 – £49.2 billion).
The Group’s maximum exposure to loss on its multi-seller conduits is £43.2 billion (2007 – £49.4 billion), being the total amount of the Group’s liquidity commitments plus the extent of programme-wide credit enhancements which relate to conduit assets for whom liquidity facilities were provided by third parties.
Own-asset conduits The Group also holds three own-asset conduits which fund assets which have been funded at one time by the Group. These vehicles represent 25% of the Group’s conduit business (as a percentage of the total liquidity and credit enhancements committed by the Group), with £14.8 billion of ABCP outstanding at 31 December 2008 (2007 – £10.4 billion). The Group’s maximum exposure to loss on its own-asset conduits is £15.9 billion (2007 – £13.5 billion), being the total drawn and undrawn amount of the Group’s liquidity commitments to these conduits.
Securitisation arbitrage conduits The Group no longer sponsors any securitisation arbitrage conduits. As part of the integration of ABN AMRO and a strategic review of the conduit business, the sole securitisation arbitrage conduit was dissolved in 2008. All of its assets were transferred to a centrally managed asset unit for run-off or sale.
The Group’s exposure from both its consolidated conduits, including those to which the Group is economically exposed and those which are shared with the other consortium members, and its involvement with third-party conduits are set out in the following table.
Consolidated Consolidated conduits Third party Total conduits Third party Total £m £m £m £m £m £m
(3) Maximum exposure to loss is determined as the maximum loss being the maximum amount by borrowers may drawn on their conduits facility for which the Group has provided committed liquidity and credit backstop facilities.
The Group’s exposure from the conduit shared with the other consortium members is set out below: £m £m
Collateral analysis, geographic, profile, credit ratings and weighted average lives of the assets in the assets relating to the Group’s consolidated conduits and related undrawn commitments are set out in the tables below.
Liquidity Liquidity Funded assets from third Total Funded assets from third Total
Loans Securities Total Undrawn parties exposure Loans Securities Total Undrawn parties exposure £m £m £m £m £m £m £m £m £m £m £m £m
UK Europe US ROW Total life AAA AA A BBB BBB 2008 £m £m £m £m £m £m £m £m £m £m £m
Sub-prime — — — — — — — — — — —
Buy-to-let — — — — — — — — — — —
Investment funds set up and managed by the Group (unaudited) The Group’s investment funds are managed by RBS Asset Management (RBSAM), which is an integrated asset management business, which manages investments on behalf of third-party institutional and high net worth investors, as well as for the Group. RBSAM is active in most traditional asset classes and employs both fund of funds structures and multi-manager strategies. Its offering includes money market funds, long only funds and alternative investment funds.
Money market funds The Group has established and manages a number of money market funds for its customers. When a new fund is launched, RBSAM as fund manager typically provides a limited amount of seed capital to the funds. RBSAM does not have investments in these funds greater than £25 million. As RBSAM does not have holdings in these funds of significant size and as the risks and rewards of ownership are not with the Group, these funds are not consolidated by the Group.
Non-money market funds RBSAM has also established a number of non-money market funds to enable investors to invest in a range of assets including bonds, equities, hedge funds, private equity and real estate. The Group does not have investments in these funds greater than £200 million. As RBSAM does not have holdings in these funds of significant size and as the risks and rewards of ownership are not with the Group, these funds are not consolidated by the Group.
The structure of the assets within the funds is designed to meet the liabilities of the funds to their investors who have no recourse other than to the assets of the funds. The risks to the Group as a result are restricted to reputational damage if the funds were unable to meet withdrawals when requested on a timely basis or in full, and the Group’s own investment in the funds.
Governance 146 Board of directors and secretary 148 Report of the directors 153 Corporate governance 159 Letter from the Chairman of the Remuneration Committee 160 Directors’ remuneration report 169 Directors’ interests in shares 170 Statement of directors’ responsibilities
Appointed to the Board in February 2006, Guy Whittaker joined RBS after spending 25 years with Citigroup where he was the group treasurer based in New York and prior to that had held a number of management positions within the financial markets business based in London.
Appointed to the Board on 1 October 2008, Arthur Ryan is the former chairman, chief executive officer and president of Prudential Financial Inc. Previously he held senior positions with Prudential Insurance and the former Chase Manhattan Bank NA. He is currently a non-executive director of Regeneron Pharmaceuticals Inc. and an active member of numerous community boards. He was a founding member of the Financial Services Forum.
Subsequently, on 19 January 2009, the company announced in conjunction with HM Treasury and UK Financial Investments Limited, that the preference shares held by HM Treasury will be replaced with new ordinary shares. Eligible shareholders will be able to apply to subscribe for approximately £5 billion of new ordinary shares pro rata to their existing shareholdings at a fixed price of 31.75 pence per share by way of an open offer. Any shares not taken up by shareholders in the open offer (or otherwise placed on behalf of the company) will be subscribed for by HM Treasury at a fixed price of 31.75 pence per share and the aggregate proceeds of the open offer will be used to fund the redemption of the preference shares held by HM Treasury, together with the redemption premium on the preference shares, accrued dividend, and commissions payable to HM Treasury on the offer. The preference shares will be redeemed at 101 per cent of their issue price. Dividends will continue to accrue on the preference shares until redemption. This may result in HM Treasury’s shareholding increasing to approximately 70% of the enlarged ordinary share capital of the company.
The company did not pay an interim dividend in 2008. On 15 September 2008, shareholders received one new ordinary share for every 40 shares held on the record date of 12 September 2008 by way of a capitalisation issue.
As part of an agreement with HM Treasury, the company undertook not to pay any dividends on the ordinary shares until such time as the £5 billion non-cumulative sterling preference shares issued to HM Treasury in December 2008 were repaid.
The Group is engaged principally in providing a wide range of banking, insurance and other financial services. Further details of the organisational structure and business overview of the Group, including the products and services provided by each of its divisions and the competitive markets in which they operate, is contained in the Business review on pages 26 and 27.
The reported results of the Group are also sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. Details of the Group’s critical accounting policies and key sources of accounting judgements are included in the Accounting policies on pages 178 to 188.
The Group’s approach to risk management, including its financial risk management objectives and policies and information on the Group’s exposure to price, credit, liquidity and cash flow risk, is discussed in the Risk, capital and liquidity management section of the Business review on pages 78 to 144.
The Group utilises a wide range of recruitment channels to ensure that the recruitment and development of its employees are fully aligned to its organisational requirements.
Employees are able to participate in incentive plans specific to their business, and the Buy As You Earn and Sharesave schemes align the interests of employees with those of shareholders.
In 2008, the response rate was 88%, the second highest response rate since the survey began. This represents over 156,000 employees participating in the survey, from more than 50 countries and in 20 languages. For the first time, this survey was extended to former ABN AMRO employees.
The Group recognises employee representative organisations such as trade unions and work councils in a number of businesses and countries. The Group has a European Employee Communication Council that provides elected representatives with an opportunity to understand better the impact on its European operations.
During 2008, the Group focused on the core themes of globalisation of safety, health and wellbeing, improving health and raising awareness, while continuing to manage safety and health risks.
Pre-employment screening The Group has a comprehensive pre-employment screening policy to guard against possible infiltration and employee-related fraud. In addition to existing workplace security measures, all people engaged on Group business are now being screened prior to commencing employment.
The code supports the Group’s aim to operate in a similar way across the many countries in which it operates and is therefore applicable to employees in all locations. The code is a high level collection of key policies to inform employees of the Group’s expectations of their behaviour and practices.
The Group’s business is managed in a way that takes account of the social and environmental impact of its activities. In order to identify the issues that matter most to its stakeholders, an annual research project is conducted. This work provides the foundation of the corporate responsibility strategy. It enables all parts of the Group to focus their efforts and resources on the most important issues. Having the right management structures in place and clear leadership helps set the framework against which this happens. There are issue-specific steering groups that feed into the Corporate Responsibility Forum, which considers the Group’s current performance and proposes new initiatives. The Group’s governance structure for corporate responsibility extends throughout the organisation.
The directors have reviewed the Group’s forecasts, projections and other relevant evidence including the ongoing measures from governments and central banks in the UK and around the world to sustain the banking sector. Whilst the Group has received no guarantees, the directors have a reasonable expectation, based on experience to date, of continued and sufficient access to the funding facilities referred to above and, accordingly, that the Group and the company will continue in operational existence for the foreseeable future. The financial statements of the Group and of the company have, therefore, been prepared on a going concern basis.
Details of the authorised and issued ordinary share capital at 31 December 2008 are shown in Note 27 on the accounts.
Details of the authorised and issued preference share capital at 31 December 2008 are shown in Note 27 on the accounts.
Authority to repurchase shares At the Annual General Meeting in 2008, shareholders renewed the authority for the company to make market purchases of up to 1,000,710,085 ordinary shares. The directors have not used this authority to date and there is no current intention that the authority will be exercised. This authority will lapse at the conclusion of the AGM of the company in 2009 and no renewal will be sought.
cumulative preference shares present in person or by proxy and entitled to vote shall have four votes for every share held. The Notice of the Annual General Meeting specifies the deadlines for exercising voting rights and appointing a proxy or proxies to vote in relation to resolutions to be passed at the meeting.
The rights and obligations of holders of non-cumulative preference shares are set out in Note 27 on the accounts on pages 242 to 244.
A change of control of the company following a takeover bid may cause a number of agreements to which the company is party to take effect, alter or terminate. In addition, a number of executive directors' service agreements may be affected on a change of control. All of the company’s employee share plans contain provisions relating to a change of control. Outstanding awards and options may vest and become exercisable on change of control, subject where appropriate to the satisfaction of any performance conditions at that time and prorating of awards. In the context of the company as a whole, these agreements are not considered to be significant.
Gordon Pell, Guy Whittaker, Colin Buchan, Archie Hunter and Joe MacHale served throughout the year and to the date of signing of the financial statements.
Stephen Hester, John McFarlane and Arthur 'Art' Ryan were appointed as directors on 1 October 2008.
Johnny Cameron ceased to be a director on 13 October 2008.
Philip Hampton, Stephen Hester, John McFarlane and Arthur ‘Art’ Ryan will retire and offer themselves for election at the forthcoming Annual General Meeting. Details of the service agreement for Stephen Hester are set out on page 161. No other director seeking election has a service agreement.
Charitable contributions In 2008 the contribution to the Group’s Community Investment programmes was £66.3 million (2007 – £57.7 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2008 was £24.8 million (2007 – £32.1 million).
The company’s community investment is focused on the issues most relevant to it as a financial institution, including preventing exclusion from banking services, promoting financial understanding and supporting small businesses and entrepreneurs.
Auditors The auditors, Deloitte LLP, have indicated their willingness to continue in office. A resolution to re-appoint Deloitte LLP as the company’s auditor will be proposed at the forthcoming Annual General Meeting.