A formal single name concentration framework addresses the risk of outsized exposure to a borrower or borrower group. The framework includes specific and sometimes elevated approval requirements, additional reporting and monitoring, and the requirement to develop plans to address and reduce excess exposures over an appropriate timeframe.
At a minimum, credit relationships are reviewed and re-approved annually. The renewal process addresses: borrower performance, including reconfirmation or adjustment of risk parameter estimates; the adequacy of security; and compliance with terms and conditions. For certain counterparties, early warning indicators are also in place to detect deteriorating trends in limit utilisation or account performance, and to prompt additional oversight.
In 2012, the Group implemented further refinements to the single name exposure management controls already in place which allows the Group to differentiate more consistently between the different product types.
Controls and assurance* The Group’s credit control and assurance framework comprises three key components: credit policy, policy compliance assurance and independent assurance.
Reviews undertaken consistently address the four underlying risk pillars of: risk management, risk appetite, ratings and data integrity, and asset quality. Appropriate identification, escalation, remediation and related tracking of control breaches and improvements in operational processes are firmly embedded in the assurance process to ensure that divisions act upon review findings.
Credit risk management framework continued Credit risk measurement* The Group uses credit risk models to support quantitative risk assessments element within the credit approval process, ongoing credit risk management, monitoring and reporting and portfolio analytics. Credit risk models used by the Group may be divided into three categories, as follows.
Probability of default/customer credit grade These models assess whether a customer will be able to repay its obligations over a one year period.
Wholesale models - As part of the credit assessment process, the Group assigns each counterparty an internal credit grade based on its probability of default (PD). The Group uses a number of credit grading models which consider risk characteristics relevant to the customer. Credit grading models utilise a combination of quantitative inputs, such as recent financial performance and qualitative inputs such as management performance or sector outlook. The Group uses a credit grade in many of its risk management and measurement frameworks, including credit sanctioning and managing single-name concentration risk.
Retail models - Each customer account is scored using models based on the likelihood of default. Scorecards are statistically derived using customer data; customers are given a score that reflects their probability of default, and this score is used to support automated credit decision making.
Models that measure counterparty credit risk exposure are used for derivatives and other traded instruments, where the amount of credit risk exposure may depend on one or more underlying market variables, such as interest or foreign exchange rates. These models drive the Group’s internal credit risk management activities.
Loss given default models Loss given default (LGD) models estimate the amount that cannot be recovered by the Group in the event of default. When estimating LGD, the Group takes into account both borrower and facility characteristics, as well as any security held or credit risk mitigation, such as credit protection or insurance. The cost of collections and a time discount factor for the delay in cash recovery are also incorporated.
Changes to wholesale credit risk models The Group is updating its wholesale credit risk models, incorporating more recent data and reflecting new regulatory requirements applicable to wholesale internal ratings based (IRB) modelling. In 2012, the Group implemented updates to certain models, such as those used in the sovereign and financial institution asset classes; these updates affected the risk measures in the Group’s disclosures. Further updates, primarily of models used for the corporate asset class, are planned for 2013.
Updates to models have generally affected relatively low-risk segments of the Group’s portfolio. For example, the changes stemming from the introduction of updated probability of default models largely affected assets bearing the equivalent of investment-grade ratings.
In anticipation of these changes, the Group modified various risk frameworks, including its risk appetite framework and latent loss assessment. In addition, with the agreement of its regulators, the Group adjusted upwards the risk-weighted assets (RWAs) of some portfolios prior to the introduction of the new models.
Separately, as agreed with the Financial Services Authority (FSA), the Group has started to apply a slotting approach to calculate RWAs related to commercial real estate assets; this approach does not use modelled measures to determine RWAs and capital requirements.
Credit risk assets* The tables and commentary below refer to credit risk assets, which consist of: Lending - Comprises gross loans and advances to: central and local governments; central banks, including cash balances; other banks and financial institutions, incorporating overdraft and other shortterm credit lines; corporates, in large part loans and leases; and individuals, comprising mortgages, personal loans and credit card balances.
Derivatives - Comprises the mark-to-market (mtm) value of such contracts after the effect of enforceable netting agreements, but before the effect of collateral. Figures shown apply counterparty netting within the regulatory capital model used.
Credit risk assets exclude issuer risk (primarily debt securities) and reverse repurchase arrangements. They take account of legal netting arrangements that provide a right of legal set-off, but do not meet the offset criteria under IFRS.
UK Retail 114,120 111,070 108,302 UK Corporate 101,148 105,078 108,663 Wealth 19,913 20,079 18,875 International Banking 64,518 72,737 80,166 Ulster Bank 34,232 37,781 40,750 US Retail & Commercial 55,036 56,546 51,779 Retail & Commercial 388,967 403,291 408,535 Markets 106,336 114,327 124,330 Other 65,186 64,517 36,659 Core 560,489 582,135 569,524 Non-Core 65,220 92,709 125,383 625,709 674,844 694,907
Non-Core division. Exposure decreased in all divisions except UK Retail and Group Treasury (shown in ‘Other’). At the year end NonCore accounted for 10% of the overall assets (2011 - 14%).
The fall in the Markets division predominantly reflected reduction in exposure to banks, other financial institutions and sovereigns in Western Europe.
Personal 126,945 20,254 33,087 1,604 158 1,114 183,162 176,201 6,961 Banks 4,720 39,213 3,952 11,132 1,738 3,276 64,031 63,470 561 Other financial institutions 16,549 15,960 13,319 3,103 5,837 1,159 55,927 45,548 10,379 Sovereign (2) 21,053 31,374 31,391 3,399 78 1,581 88,876 87,617 1,259 Property 60,099 27,281 8,052 1,370 3,471 1,480 101,753 58,323 43,430 Natural resources 6,552 7,215 8,116 3,805 1,078 2,508 29,274 25,146 4,128 Manufacturing 9,583 7,391 7,098 2,126 1,011 1,381 28,590 26,525 2,065 Transport (3) 13,789 7,703 4,951 5,433 2,500 5,363 39,739 27,529 12,210 Retail and leisure 22,775 6,101 5,762 1,488 1,041 675 37,842 32,766 5,076 Telecoms, media and technology 5,295 4,941 3,202 1,944 139 609 16,130 12,180 3,950 Business services 17,851 3,719 6,205 910 629 206 29,520 26,830 2,690 305,211 171,152 125,135 36,314 17,680 19,352 674,844 582,135 92,709
Exposure to the property sector fell by 11% during the year driven by tighter portfolio controls in all regions and a £9.5 billion reduction in Non-Core resulting from focussed action on early and contractual repayments.
Exposure to banks and financial institutions declined by 5% as a result of subdued borrowing activity and a reduction in lending and derivatives to finance companies, financial services companies, funds, monoline insurers and Credit Derivative Product Companies (CDPCs).
Reported exposures are affected by currency movements. During 2012, sterling appreciated 4.4% against the US dollar and 2.6% against the euro resulting in a decrease in sterling terms of exposures denominated in these currencies (and in other currencies linked to the US dollar or euro).
The Group’s sovereign portfolio comprises exposures to central governments, central banks and sub-sovereigns such as local authorities, primarily in the Group’s key markets of the UK, Western Europe and the USA. The asset quality is high as exposures are largely cash balances placed with central banks such as the Bank of England, the Federal Reserve and the Eurosystem (including the European Central Bank and central banks in the eurozone). Exposure to sovereigns fluctuates according to Group liquidity requirements and cash positions. These are driven by inflows and outflows of deposits which determine the level of cash placed with central banks and have contributed to higher exposures at the Bank of England and lower exposures at European and US central banks. Information on the Group’s exposure to governments, including peripheral eurozone sovereigns, can be found in the Risk management section on Country risk.
Exposure to the banking sector is one of the largest in the Group’s portfolio. The sector is well diversified geographically with derivative exposures being largely collateralised. Exposures are tightly controlled through the combination of the single name concentration framework, bespoke credit policies and country limits. Exposures to the banking sector decreased by £3 billion in 2012 as a result of reduced interbank lending and derivative activity, and a reduction in limits to banks in countries under stress, such as the peripheral eurozone countries.
The Group’s exposure to the property sector was £91 billion (a fall of 11% during the year), the majority of which was commercial real estate in Ireland and the UK (see section on commercial real estate on pages 181 and 182 for further details). The remainder comprised lending to construction companies and building materials groups, which fell by £1.9 billion (15%), and housing associations, which remained stable. Most of the Group’s Core property exposure is within UK Corporate (73%).
The 22% decline in exposure to the retail and leisure sectors, was driven by the de-leveraging by customers and refinements in sector classifications within the Wealth division. Excluding the impact of sector reclassifications, the reduction in the retail and leisure portfolios was 15% in 2012. While the market outlook for this sector remains challenging and despite some high-profile failures among UK high street retailers, losses on the Group’s retail portfolio remained low during 2012. The sector continues to show wide variation in performance, however, credit metrics overall remained broadly stable. The leisure sector displayed weaker credit metrics than the wider corporate portfolio, in line with the industry trend. The Group’s risk appetite is driven by the importance of the leisure sector to the UK franchise, especially for the UK Corporate division, but is mitigated through tighter origination policies and a reduction in exposure to high risk sub-sectors. Leisure sector exposure fell by 8% in 2012 driven predominantly by Non-Core. The gambling subsector is subject to specific controls due to its high credit and reputational risk profile.
Asset quality Internal reporting and oversight of risk assets is principally differentiated by credit grades. Customers are assigned credit grades based on various credit grading models that reflect the key drivers of default for each customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures, used for internal management reporting across portfolios. Accordingly, measures of risk exposure may be readily aggregated and reported at increasing levels of granularity depending on stakeholder or business need. Performing loans are defined as AQ1-AQ9 (where the PD is less than 100%) and non-performing loans as AQ10 (where the PD is 100%).
Key points Trends in the asset quality of the Group’s credit risk exposures during 2012 reflected changes in the composition of the Core portfolio and the run-off and disposals of Non-Core assets as well as regrading through new and updated models, particularly in relation to the bank and personal sectors. Adjusting for those factors, the overall asset quality of the Group’s corporate exposure was broadly unchanged despite difficult external conditions in the UK and ongoing uncertainty in the eurozone.
The decrease in the Group’s Core exposures within the AQ1 band reflects the decrease in the Group’s exposure to sovereigns in Western Europe and North America and the change in the bank and sovereign Probability of Default (PD) rating models noted on page 162. The credit outlook for banks and sovereigns continues to be challenging and the transition to the updated PD models creates additional credit migration causing assets to move to higher PDs. While the nominal value and appearance of migration out of AQ1 is material most of the migration continues to occur within the range of stronger credit grades and hence the change in the credit quality of the portfolio is modest. The weighted PD percentage for banks and sovereigns increased by 5 basis points to 0.13% and 3 basis points to 0.04% respectively. The AQ composition of the Corporate portfolio has not changed materially during the year.
On a sector basis, the proportion of non-performing assets in the property sector increased slightly to 58% of total AQ10 exposure (2011 - 57%). Non-performing assets relating to property represent a material proportion of AQ10 exposure in Non-Core (85%), UK Corporate (56%) and Ulster Bank (30%). In particular, continued weakness in the Irish economy meant non-performing assets in the Ulster Bank portfolio continued to grow, driven by exposures in the personal and property sectors. Refer to the Key credit portfolios: Ulster Bank Group (pages 190 to 193) for more details. A small number of significant individual non-performing property cases led to the overall increase in the AQ10 population in UK Corporate.
Non-performing assets (AQ10) in Non-Core increased as a percentage of the overall Non-Core portfolio due to the run-off and disposals of better performing assets. The overall level of AQ10 assets in Non-Core fell due to repayments, assets returning to the performing book and the write off of certain real estate exposures in 2012.
Non-performing credit risk assets within International Banking decreased markedly as renegotiations led to the return of significant exposure in the transport sector to the performing book.
Collateral management to ensure that credit risk mitigation remains legally effective and enforceable.
Corporate exposures The type of collateral taken by the Group’s commercial and corporate businesses and the manner in which it is taken will vary according to the activity and assets of the customer.
The Group does not recognise certain asset classes as collateral: for example, short leasehold property and equity shares of the borrowing company. Collateral whose value is correlated to that of the obligor is assessed on a case-by-case basis and, where necessary, overcollateralisation may be required.
The existence of collateral has an impact on provisioning. Where the Group no longer expects to recover the principal and interest due on a loan in full or in accordance with the original terms and conditions, it is assessed for impairment. If exposures are secured, the current net realisable value of the collateral will be taken into account when assessing the need for a provision. No impairment provision is recognised in cases where all amounts due are expected to be settled in full on realisation of the security.
Bank. Total portfolio average LTV is quoted net of loans with minimal security given that the anticipated recovery rate is less than 10%. Provisions are marked against these loans where required to reflect asset quality and recovery profile. 2011 presentation has been revised.
(2) Other performing loans of £6.6 billion (2011 - £9.2 billion) include general corporate lending, typically unsecured, to commercial real estate companies, and major UK homebuilders. The credit quality of these exposures is consistent with that of the performing portfolio overall. Other non-performing loans of £1.9 billion (2011 - £2.5 billion) are subject to the Group’s standard provisioning policies.
Other corporate 2012 2011 2010 Corporate risk elements in lending and potential problem loans (excluding commercial real estate)
Reverse repurchase agreements 104.8 100.9 95.1 Securities received as collateral (1) (104.7) (98.9) (94.3)
Derivative assets gross exposure 441.9 530.1 432.2 Counterparty netting (373.9) (441.6) (330.4) Cash collateral held (34.1) (37.2) (31.1) Securities received as collateral (5.6) (5.3) (2.9)
Retail Within the Group’s retail book, mortgage and home equity lending portfolios are secured by residential property. The Group’s portfolio of US automobile loans is secured by motor cars or other vehicles. Student loans and credit card lending are all unsecured. The vast majority of personal loans are also unsecured.
The value of a property intended to secure a mortgage is assessed during the loan underwriting process using industry-standard methodologies. Property values supporting home equity lending reflect either an individual appraisal or valuations generated by statistically valid automated valuation models. Property values are updated each quarter using the relevant house price index (the Halifax Quarterly Regional House Price Index in the UK, the Case-Shiller Home Value Index in the
US, and the Central Statistics Office Residential Property Price Index in ROI (monthly) and the Nationwide House Price Index in Northern Ireland).
For automobile lending in the US, new vehicles are valued at cost and used vehicles at the average trade-in value. At 31 December 2012, this portfolio amounted to £5.4 billion (2011 - £4.8 billion; 2010 - £5.1 billion).
Notes: (1) Includes residential mortgages and home equity loans and lines (refer to page 188 for a breakdown of balances). (2) Where no indexed LTV is held. (3) Average LTV weighted by value is arrived at by calculating the LTV on each individual mortgage and applying a weighting based on the value of each mortgage. (4) Excludes mortgage lending in Wealth. This portfolio totalled £8.8 billion (2011 - £8.3 billion; 2010 - £7.8 billion) and continues to perform in line with expectations with minimal provisions of
Wholesale customers The controls and processes for managing wholesale problem debts are embedded within the divisions’ credit approval frameworks and form an essential part of the ongoing credit assessment of customers. Any necessary approvals will be required in accordance with the delegated authority grid governing the extension of credit.
Early problem recognition Each division has established Early Warning Indicators (EWIs) designed to identify those performing exposures that require close attention due to financial stress or heightened operational issues. Such identification may also take place as part of the annual review cycle. EWIs vary from division to division and comprise both internal parameters (such as account level information) and external parameters (such as the share price of publicly listed customers).
Watchlist * There are three Watchlist ratings - amber, red and black - reflecting progressively deteriorating conditions. Watchlist Amber loans are performing loans where the counterparty or sector shows early signs of potential stress or has other characteristics such that they warrant closer monitoring. Watchlist Red loans are performing loans where indications of the borrower’s declining creditworthiness are such that the exposure requires active management, usually by the Global Restructuring Group (GRG). Watchlist Black loans comprise risk elements in lending and potential problem loans.
For all Watchlist Red cases, the division is required to consult with GRG on whether the relationship should be transferred to GRG (see more on GRG below). Relationships managed by the divisions tend to be with companies operating in niche sectors, such as airlines or products such as securitisation special purpose vehicles. The divisions may also manage those exposures when subject matter expertise is available in the divisions rather than within GRG.
Global Restructuring Group (GRG) In cases where the Group’s exposure to the customer exceeds £1 million, the relationship may be transferred to GRG following consultation with the originating division. The primary function of GRG is active management of the exposures to minimise loss for the Group and where feasible return the exposure to the Group’s mainstream loan book following an assessment by GRG that no further losses are expected.
At 31 December 2012, credit risk assets relating to exposures under GRG management (excluding those placed under GRG stewardship for operational reasons rather than concerns over credit quality and those in the AQ10 internal asset quality (AQ) band) totalled £19.9 billion. Credit risk assets are defined on page 163. The internal asset quality bands are defined on page 166.
Wholesale renegotiations Loan modifications take place in a variety of circumstances including but not limited to a customer’s current or potential credit deterioration. Where the contractual payment terms of a loan have been changed because of the customer’s financial difficulties, it is classified as ‘renegotiated’ in the wholesale portfolio.
Loans modified in the normal course of business where there is no evidence of financial difficulties and any changes to terms and conditions are within acceptable credit parameters, within credit risk appetite and/or reflective of improving conditions for the customer in the credit markets, are not considered to have been renegotiated.
A number of options are available to the Group when a wholesale customer is facing financial difficulties and corrective action is deemed necessary. Such actions are tailored to the individual circumstances of the customer. The aim of such actions is to assist the customer in restoring its financial health and to minimise risk to the Group. To ensure that the renegotiations are appropriate for the needs and financial profile of the customer, the Group requires minimum standards to be applied when assessing, recording, monitoring and reporting this type of activity.
In addition, the Group may offer a temporary covenant waiver, a recalibration of covenants and/or a covenant amendment to cure a potential or actual covenant breach. Such relief is usually granted in exchange for fees, increased margin, additional security, or a reduction in maturity profile of the original loan. These financial covenant concessions are monitored internally, but are not included in the renegotiated loans data (when this is the sole concession granted to a customer) as we believe that such concessions are qualitatively different from other renegotiations: The loan’s payment terms are unchanged. Covenant concessions provide an early warning indicator rather than firm evidence of a significant deterioration in credit quality.
Early problem identification and problem debt management: Wholesale renegotiations continued The data presented in the tables below include loans renegotiated during 2011 and 2012 which individually exceed thresholds set at divisional level, ranging from nil to £10 million. This population captures approximately 68% of that proportion of the wholesale portfolio which is either on Watchlist or under GRG stewardship. We continue to refine our reporting processes relating to renegotiated loans and as part of the 2012 review, the amounts inprogress and completed renegotiations relating to 2011 have been revised.
The table below shows the value of loans (excluding loans where the Group has initiated recovery procedures) where renegotiations were completed during the year by sector and renegotiation types.
Wholesale renegotiations during the year by sector Performing £m Non-performing £m
Property 1,954 3,288 18 2,166 3,215 25 Transport 832 99 23 771 670 10 Telecommunications, media and technology 237 341 46 57 33 30 Retail and leisure 487 111 34 331 433 10 Other (1) 792 245 28 893 792 42 Total 4,302 4,084 22 4,218 5,143 25
Variation in margin 9 12 Payment concessions and loan rescheduling 69 92 Forgiveness of all or part of the outstanding debt 29 33 Other (2) 20 9
Notes: (1) The total above exceeds 100% as an individual case can involve more than one type of arrangement. (2) Main types of “other” concessions include formal “standstill” agreements, release of security and amendments to negative pledge. 2012 saw the completion of a small number of material standstill agreements, accounting for the higher proportion of the “Other” modification type.
Provisions for renegotiated wholesale loans are assessed in accordance with the Group’s normal provisioning policies (refer to Impairment loss provision methodology on page 179). For the non-performing population, provisions on exposures greater than £1 million are individually assessed by GRG. The provision required is calculated based on the difference between the debt outstanding and the present value of the estimated future cash flows. Exposures smaller than £1 million are deemed not to be individually significant and are assessed collectively by the originating division. Within the performing book, latent loss provisions are held for those losses that are incurred, but not yet identified.
In the case of non-performing loans that are renegotiated, the loan impairment provision assessment almost invariably takes place prior to the renegotiation. The quantum of the loan impairment provision may change once the terms of the renegotiation are known, resulting in an additional provision charge or a release of the provision in the period the renegotiation takes place.
Performing loans that are renegotiated will be included in the calculation of the latent loss provisions. To the extent that the renegotiation event has affected the customer’s estimated probably of default or loss given default, this will be reflected in the underlying calculation.
Where the Group holds collateral or other security interest and is entitled to enforce its rights, it may take ownership or control of the assets. The Group’s preferred strategy is to consider other possible options prior to exercising these rights.
Insolvency - Where there is no suitable renegotiation option or the business is no longer regarded as sustainable, insolvency will be considered. Insolvency may be the only option that ensures that the assets of the business are properly and efficiently distributed to relevant creditors.
Retail forbearance Within the Group’s retail businesses, forbearance generally occurs when the business, for reasons relating to the actual or potential financial stress of a borrower, grants a permanent or temporary concession to that borrower. Forbearance is granted following an assessment of the customer’s ability to pay. It is granted principally to customers with mortgages. Granting of forbearance to unsecured customers is less extensive.
In payment concession arrangements a temporary reduction in, or elimination of, the periodic (usually monthly) loan repayment is agreed with the customer. At the end of the concessionary period, forborne principal and accrued interest outstanding is scheduled for repayment over an agreed period.
As a result of the economic difficulties in the Republic of Ireland market and responding to regulatory intervention in the Irish mortgage market, Ulster Bank has developed additional treatment options to support customers in overcoming financial difficulties, over an extended period of time.
The principal types of forbearance granted in RBS Citizens’ mortgage portfolio are the US government mandated HAMP (Home Affordable Modification Program) and RBS Citizens’ proprietary modification programme. Both programmes typically feature a combination of term extensions, capitalisations of arrears, temporary interest rate reductions and conversions from interest only to amortising. These tend to be permanent changes to contractual terms. Borrowers seeking a modification must meet government-specified qualifications for HAMP and internal qualifications for RBS Citizens’ modification programme. Both are designed to evidence that the borrower is in financial difficulty as well as demonstrating willingness to pay.
For forbearance loans that are performing, the aim is to enable the customer to continue to service the loan. For forbearance loans classified as non-performing only those for which capitalisation of arrears has been agreed can qualify for return to the performing book. Transfer of such loans takes place currently once the customer has met the revised payment terms for at least six months and is expected to continue to do so.
The mortgage forbearance population is reviewed regularly to ensure that customers are meeting the agreed terms of the arrangement. Key metrics have been developed to record the proportion of customers who fail to meet the agreed terms over time, as well as the proportion of customers who return to a performing state with no arrears.
Notes: (1) Includes all forbearance arrangements whether relating to the customer’s lifestyle changes or financial difficulty. (2) Includes the current stock position of forbearance deals agreed since early 2008 for UK Retail and early 2009 for Ulster Bank. (3) Forbearance stock reported at 31 December 2012 now includes home equity loans and lines as well as the residential mortgage portfolio. (4) SME business within Wealth is now reported within Wholesale forbearance.
The table below shows forbearance agreed during 2012 analysed between performing and non-performing.
UK Retail Ulster Bank RBS Citizens (1) Wealth (2) Total (3)
Performing forbearance in the year 1,809 2,111 88 18 4,026 Non-performing forbearance in the year 184 1,009 71 2 1,266 Total forbearance in the year (4) 1,993 3,120 159 20 5,292
Notes: (1) Forbearance stock reported at 31 December 2012 now includes home equity loans and lines as well as the residential mortgage portfolio. (2) SME business within Wealth is now reported within Wholesale forbearance. (3) As an individual case can include more than one type of arrangement, the analysis in the table on forbearance arrangements exceeds the total value of cases subject to forbearance. (4) Includes all deals agreed during the year (new customers and renewals) regardless of whether they remain active at the year end.
At 31 December 2012, stock levels of £4.8 billion represent 4.9% of the total mortgage assets; this represents a 9.2% increase in forbearance stock since 31 December 2011. Of these, approximately 83% were up-to-date with payments (compared with approximately 97% of the mortgage population not subject to forbearance activity). The flow of forbearance arrangements has remained stable year on year.
The provision cover on performing assets subject to forbearance was about five times that on assets not subject to forbearance.
December 2012 was interest only conversions, which accounted for 46% of total assets subject to forbearance. The other categories of temporary forbearance were payment concessions: reduced repayments (36%); and payment holidays (3%).
The flow by forbearance type remained stable when compared with 2011 and there was a modest reduction, 3%, in customers seeking assistance for the first time year on year.
The provision cover on performing assets subject to forbearance is approximately eight times higher than that on performing assets not subject to forbearance.
Unsecured portfolios For unsecured portfolios in UK Retail and Ulster Bank, forbearance treatments comprise either debt consolidation loans provided to customers subject to collections activity who do not meet the Group’s standard underwriting criteria, longer-term financial hardship plans, or repayment arrangements to facilitate the repayment of overdraft excesses. Additionally, support is provided to customers experiencing financial difficulties through breathing space initiatives on all unsecured products, including credit cards, whereby the Group suspends collections activity for a 30-day period to allow customers to establish a debt repayment plan. Arrears continue to accrue for customer loans benefiting from breathing space.
(1.1% of the total unsecured balances) were subject to forbearance at 2012 year end.
For unsecured portfolios in Ulster Bank, £20 million (3.4% by value) of the population was subject to forbearance at 31 December 2012.
Within RBS Citizens, granting of forbearance is significantly less extensive for non real-estate portfolios, as it is predominantly restricted to the granting of short-term (1-3 months) loan extensions to customers to alleviate the financial burden caused by temporary hardship. Such extensions are offered only if a customer has demonstrated a capacity and willingness to pay following the extension term. The number and frequency of extensions available to a given customer are limited per customer. Additionally, in the case of loans secured by vehicles and credit cards, RBS Citizens may offer temporary interest rate modifications, but no principal reduction. RBS Citizens may also provide forbearance to student loan borrowers consistent with the policy guidelines of the US Office of the Comptroller of the Currency.
For corporate portfolios, given their complexity and nature, the Group relies not only on time-based measures, but also on management judgement to identify evidence of impairment. Other factors considered may include: significant financial difficulty of the borrower; a breach of contract; a loan restructuring; a probable bankruptcy; and any observable data indicating a measurable decrease in estimated future cash flows.
Early problem identification and problem debt management: Impairment loss provision methodology continued Depending on various factors as explained below, the Group uses one of the following three different methods to assess the amount of provision required: individual; collective; and latent.
Individually assessed provisions - Provisions required for individually significant impaired assets are assessed on a case-by-case basis. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the assets carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. Future cash flows are estimated through a case-by-case analysis of individually assessed assets.
Refer to pages 224 to 241 for analysis of impaired loans, related provisions and impairments.
By geography (1) Commercial £m Residential £m Commercial £m Residential £m Total £m Core £m Non-Core £m Core £m Non-Core £m Total £m
Key points In line with the Group’s strategy, the overall exposure to commercial real estate fell during 2012, across all geographies. The overall mix in terms of geography, sub-sector and investment versus development remained broadly unchanged.
Most of the decrease was in Non-Core and was due to repayments, asset sales, and write-offs. The Non-Core portfolio totalled £26.4 billion (42% of the portfolio) at 31 December 2012 (2011 - £34.3 billion or 46% of the portfolio).
The growth in Markets was caused by an increase in the inventory of US commercial real estate loans earmarked for securitisation as commercial mortgage-backed securities (CMBS). CMBS warehouse activity is tightly controlled with limits on maximum portfolio size and holding period, and marked-to-market on a daily basis.
With the exception of exposure in Spain and Ireland, the Group had minimal commercial real estate exposure in the peripheral eurozone countries. Exposure in Spain was predominantly in the Non-Core portfolio and totalled £1.6 billion (2011 - £2.3 billion), of which 31% (2011 - 55%) was in default. The majority of the portfolio is managed by GRG. The Spanish portfolio has already been subject to material provisions, which are regularly assessed by reference to reappraised asset values. Asset values vary significantly by type and geographic location. Refer to the Ulster Bank Group (Core and NonCore ) section on page 192 for details on the exposure in Ireland.
Speculative lending, defined by the Group as short-term lending to property developers without sufficient pre-let revenue at origination to support investment financing after practical completion, represented less than 1% of the portfolio at 31 December 2012. The Group’s appetite for originating speculative commercial real estate lending is very limited and any such business requires senior management approval.
Maturity profile of portfolio £m £m £m £m £m £m 1-2 years 508 692 163 3,064 — 4,427 2-3 years 312 177 152 1,738 — 2,379 > 3 years 1,636 392 321 3,126 — 5,475 Not classified (2) 297 — — 4 — 301
Notes: (1) Includes on demand and past due assets. (2) Predominantly comprises overdrafts and multi-option facilities for which there is no single maturity date.
Key credit portfolios*: Commercial real estate continued Key points The overall maturity profile has remained relatively unchanged over the last 12 months.
Refinancing risk remains a focus of management attention and is assessed throughout the credit risk management lifecycle.
Of the total portfolio of £63.0 billion at 31 December 2012, £28.1 billion (2011 - £34.7 billion) was managed within the Group’s standard credit processes and £5.1 billion (2011 - £5.9 billion) was receiving varying degrees of heightened credit management under the Group’s Watchlist process. A further £29.8 billion (2011 - £34.3 billion) was managed within GRG and included Watchlist and non-performing exposures. The decrease in the portfolio managed by GRG was driven by Non-Core reductions.
The table below analyses commercial real estate (Core and Non-Core) lending by loan-to-value (LTV) which represents loan value before provisions. Due to market conditions in Ireland and to a lesser extent in the UK, there is a shortage of market-based data. In the absence of external valuations, the Group deploys a range of alternative approaches to assess property values, including internal expert judgement and indexation.
UK Retail 99,062 96,388 92,592 Ulster Bank 19,162 20,020 21,162 RBS Citizens (1) 21,538 24,153 25,028 139,762 140,561 138,782
Note: (1) 2011 and 2010 have been revised to include the legacy serviced by others portfolio.
<= 50% 21,537 285 21,822 2,568 222 2,790 4,745 49 4,794 > 50% and <= 70% 25,598 390 25,988 1,877 157 2,034 4,713 78 4,791 > 70% and <= 90% 33,738 671 34,409 2,280 223 2,503 6,893 125 7,018 > 90% and <= 100% 7,365 343 7,708 1,377 128 1,505 2,352 66 2,418 > 100% and <= 110% 3,817 276 4,093 1,462 130 1,592 1,517 53 1,570 > 110% and <= 130% 1,514 199 1,713 2,752 322 3,074 1,536 53 1,589 > 130% and <= 150% 60 15 75 2,607 369 2,976 626 28 654 > 150% — — — 2,798 748 3,546 588 27 615 Total with LTVs 93,629 2,179 95,808 17,721 2,299 20,020 22,970 479 23,449 Other (2) 567 13 580 — — — 681 23 704 Total 94,196 2,192 96,388 17,721 2,299 20,020 23,651 502 24,153
Average LTV on new originations during the year 63% 74% 63%
<= 50% 19,568 246 19,814 3,385 186 3,571 5,193 45 5,238 > 50% and <= 70% 24,363 345 24,708 2,534 152 2,686 4,902 79 4,981 > 70% and <= 90% 31,711 588 32,299 3,113 179 3,292 7,029 137 7,166 > 90% and <= 100% 7,998 319 8,317 1,958 121 2,079 2,459 67 2,526 > 100% and <= 110% 4,083 260 4,343 2,049 137 2,186 1,534 53 1,587 > 110% and <= 130% 1,722 202 1,924 4,033 358 4,391 1,425 61 1,486 > 130% and <= 150% 57 16 73 2,174 297 2,471 599 28 627 > 150% — — — 355 131 486 589 36 625 Total with LTVs 89,502 1,976 91,478 19,601 1,561 21,162 23,730 506 24,236 Other (2) 1,090 24 1,114 — — — 762 30 792 Total 90,592 2,000 92,592 19,601 1,561 21,162 24,492 536 25,028
Gross new mortgage lending remained strong at £14 billion. The average of individual LTV on new originations was 65.2% weighted by value of lending (2011 - 63.0%) and 61.3% by volume (2011 - 58.4%). The ratio of total lending to total property valuations was 56.3% (2011 - 52.9%). Average LTV by volume is arrived at by calculating the LTV on each individual mortgage with no weighting applied in the calculation of the average. The ratio approach is the sum of all lending divided by the value of all properties held as security against the lending.
Based on the Halifax Price Index at September 2012, the portfolio average indexed LTV by weighted value of debt outstanding was 66.8% (2011 - 67.2%) and 58.1% by volume (2011 - 57.8%). The ratio of total outstanding balances to total indexed property valuations is 48.5% (2011 - 48.4%).
25.6% of the residential owner occupied UK Retail mortgage book is on interest only terms down from 27.3% in 2011. A further 9.1% are on mixed repayments split between a combination of interest only and capital repayments (2011 - 9.6%). UK Retail withdrew interest only repayment products from sale to residential owner occupied customers with effect from 1 December 2012. Interest only repayment remains an option on buy-to-let mortgages. At 1.6%, the percentage of accounts more than 3 payments in arrears was similar to the 1.4% observed on capital repayment mortgages.
Key credit portfolios*: Residential mortgages: Key points continued Ulster Bank Ulster Bank’s residential mortgage portfolio totalled £19.2 billion at 31 December 2012, with 88% in the Republic of Ireland and 12% in Northern Ireland. At constant exchange rates, the portfolio decreased 2% from 31 December 2011 as a result of natural amortisation and limited growth due to low market demand.
The assets include £2.3 billion of exposure (12%) of residential buyto -let loans. The interest rate product mix is approximately 91% on a variable rate product (including tracker products) and 9% on a fixed rate.
16% of the total portfolio is on interest only which reflects legacy policy and is no longer available to residential mortgage customers on a permanent basis. Interest only is permitted on a temporary basis under the suite of forbearance treatments available within Ulster Bank (refer to page 178 for further information). Interest only repayment remains an option for private customers within Northern Ireland on an exception basis.
Average LTVs increased from 31 December 2011 to 31 December 2012, on a value basis, as a result of decreases in the Central Statistics Office house price index (4%) impacting the Ulster Bank portfolio. The average of individual LTV on new originations was stable in 2012 at 74% (weighted by value of lending) and 69.4% by volume (2011 - 67.3%). The volume of business remains very low. The maximum LTV available to Ulster Bank customers is 90% with the exception of a specific Northern Ireland scheme which permits LTVs of up to 95%, in which Ulster Bank’s exposure is capped at 85% LTV.
The portfolio comprises £6.2 billion (Core - £5.8 billion; Non-Core - £0.4 billion) of residential mortgages, of which 1% are in second lien position. There is also £15.3 billion (Core - £13.3 billion; Non-Core - £2.0 billion) of home equity loans and lines. Home equity Core consists of 47% in first lien position while Non-Core consists of 95% in second lien position.
The Non-Core portfolio comprises 11% of the mortgage portfolio with the serviced by others (SBO) portfolio being the largest component (75%). The SBO portfolio consists of purchased pools of home equity loans and lines. The full year charge-off rate was 7.4% for 2012 (excluding one-time events, the charge-off rate was 6.8%), which represents a year-on-year improvement (2011 - 8.6%). It is characterised by out-of-footprint geographies, high (95%) second lien concentration, and high LTV exposure (111% weighted average LTV at 31 December 2012). The SBO book has been closed to new purchases since the third quarter of 2007 and is in run-off, with exposure down from £2.3 billion at 31 December 2011 to £1.8 billion at 31 December 2012. The arrears rate of the SBO portfolio has decreased from 2.3% at 31 December 2011 to 1.9% at 31 December 2012 due primarily to portfolio liquidation (highest risk borrowers have been charged-off), as well as more effective account servicing and collections.
Key points UK Retail The UK personal lending portfolio, comprises credit cards, unsecured loans and overdrafts, and totalled £14.7 billion at 31 December 2012 (2011 - £16.0 billion).
The decrease in portfolio size of 8.1% was driven by continued subdued loan recruitment activity and a continuing general market trend of customers repaying unsecured debt.
RBS Citizens RBS Citizens' credit card portfolio totalled £948 million at 31
Core Mortgages 19,162 3,147 1,525 16.4 48 8.0 646 22 Commercial real estate - investment 3,575 1,551 593 43.4 38 16.6 221 — - development 729 369 197 50.6 53 27.0 55 2 Other corporate 7,772 2,259 1,394 29.1 62 17.9 389 15 Other lending 1,414 207 201 14.6 97 14.2 53 33 32,652 7,533 3,910 23.1 52 12.0 1,364 72
Non-Core Commercial real estate - investment 3,383 2,800 1,433 82.8 51 42.4 288 15 - development 7,607 7,286 4,720 95.8 65 62.0 611 103 Other corporate 1,570 1,230 711 78.3 58 45.3 77 23 12,560 11,316 6,864 90.1 61 54.6 976 141
Ulster Bank Group Mortgages 19,162 3,147 1,525 16.4 48 8.0 646 22 Commercial real estate - investment 6,958 4,351 2,026 62.5 47 29.1 509 15 - development 8,336 7,655 4,917 91.8 64 59.0 666 105 Other corporate 9,342 3,489 2,105 37.3 60 22.5 466 38 Other lending 1,414 207 201 14.6 97 14.2 53 33 *unaudited
Non-Core Mortgages — — — — — — 42 — Commercial real estate - investment 3,854 2,391 1,000 62.0 42 25.9 630 — - development 8,760 6,341 2,783 72.4 44 31.8 1,759 — Other corporate 1,970 1,310 561 66.5 43 28.5 251 — 14,584 10,042 4,344 68.9 43 29.8 2,682 —
Ulster Bank Group Mortgages 21,162 1,566 439 7.4 28 2.1 336 7 Commercial real estate - investment 8,138 2,989 1,332 36.7 45 16.4 889 — - development 9,850 6,406 2,820 65.0 44 28.6 1,875 — Other corporate 11,009 2,515 1,228 22.8 49 11.2 695 11 Other lending 1,282 185 158 14.4 85 12.3 48 30 51,441 13,661 5,977 26.6 44 11.6 3,843 48
Key credit portfolios*: Ulster Bank Group (Core and Non-Core) continued Key points Core REIL increased by £2.0 billion during the year, which reflects continued difficult conditions in both the commercial and residential property sectors in Ireland.
At 31 December 2012, 60% of REIL was in Non-Core (2011 - 68%).
Geographical analysis Commercial real estate The commercial real estate lending portfolio for Ulster Bank Group (Core and Non-Core) totalled £15.3 billion at 31 December 2012, of which £11.0 billion or 72% was in Non-Core. The geographic split of the total Ulster Bank Group commercial real estate portfolio, based on the location of the underlying security, remained similar to 2011, with 63% in the Republic of Ireland, 26% in Northern Ireland and 11% in the UK (excluding Northern Ireland).
Exposure by geography Commercial £m Residential £m Commercial £m Residential £m Total
ROI 3,546 779 1,603 3,653 9,581 NI 1,083 210 631 2,059 3,983 UK (excluding NI) 1,239 86 82 290 1,697 RoW 14 1 8 10 33 5,882 1,076 2,324 6,012 15,294
ROI 3,775 853 1,911 4,095 10,634 NI 1,322 279 680 2,222 4,503 UK (excluding NI) 1,371 111 95 336 1,913 RoW 27 4 — 32 63 6,495 1,247 2,686 6,685 17,113
Ireland (ROI and NI) 5,032 1,098 2,785 6,578 15,493 UK (excluding NI) 1,869 115 110 359 2,453 RoW 23 1 — 18 42 6,924 1,214 2,895 6,955 17,988 *unaudited
The outlook for the property sector remains challenging. While there may be some signs of stabilisation in main urban centres, the outlook continues to be negative for secondary property locations on the island of Ireland.
During the year, Ulster Bank experienced further migration of commercial real estate exposures to its problem management framework, where various measures may be agreed to assist customers whose loans are performing but who are experiencing temporary financial difficulties. For further details on Wholesale renegotiations refer to page 173.
Residential mortgages The mortgage lending portfolio analysis by country of location of the underlying security is set out below.
Financial assets 195 – Exposure summary 195 – Sector and geographic concentration 196
Debt securities 209 IFRS measurement classification and issuer 209 Ratings 210 – Asset-backed securities 213
Introduction 213 Product, geography and IFRS measurement classification 214 Ratings 217
Notes: (1) Relates to offset arrangements that comply with IFRS criteria and to transactions cleared through and novated to central clearing houses, primarily London Clearing House and US Government
Balance sheet analysis: Financial assets continued Sector and geographic concentration The following tables provide an analysis of credit concentration of financial assets by sector and geography. Geographical regions are based on the location of the lending or issuer.
2011 Government (2) 2,247 8,359 1,383 9,742 125,543 — 5,541 641 143,714 (1,098) 142,616 Financial institutions - banks (3) 39,345 43,374 706 44,080 16,940 2,218 400,261 79,396 582,240 (407,457) 174,783 - other (4) 58,478 48,598 3,272 51,870 60,628 2,501 98,255 7,451 279,183 (119,717) 159,466 Personal - mortgages — 144,171 5,102 149,273 — — — — 149,273 — 149,273 - unsecured — 32,868 1,556 34,424 — — — 52 34,476 (7) 34,469 Property — 42,994 38,064 81,058 573 175 4,599 1 86,406 (1,274) 85,132 Construction — 7,197 2,672 9,869 50 53 946 — 10,918 (1,139) 9,779 Manufacturing 254 23,708 4,931 28,639 664 1,938 3,786 306 35,587 (2,214) 33,373 Finance leases (5) — 8,440 6,059 14,499 145 2 75 — 14,721 (16) 14,705 Retail, wholesale and repairs — 22,039 2,339 24,378 645 2,652 1,134 18 28,827 (1,671) 27,156 Transport and storage 436 16,581 5,477 22,058 539 74 3,759 — 26,866 (241) 26,625 Health, education and leisure — 16,073 1,419 17,492 310 21 885 — 18,708 (973) 17,735 Hotels and restaurants — 7,709 1,161 8,870 116 5 671 — 9,662 (184) 9,478 Utilities — 6,557 1,849 8,406 1,530 554 3,708 30 14,228 (450) 13,778 Other 174 28,769 4,721 33,490 3,785 5,136 6,437 595 49,617 (1,003) 48,614 Total gross of provisions 100,934 457,437 80,711 538,148 211,468 15,329 530,057 88,490 1,484,426 (537,444) 946,982 Provisions — (9,187) (11,487) (20,674) (2,388) (141) — — (23,203) n/a (23,203)
Lending Securities Reverse repos Core Non-Core Total Debt Equity Derivatives Other Balance sheet value Non-IFRS
offset (1) Exposure post offset 2010 £m £m £m £m £m £m £m £m £m £m £m
Key points Financial asset exposures after offset including disposal groups decreased by £110 billion or 12% to £814 billion, reflecting the Group’s focus on reducing its funded balance sheet, primarily in Non-Core, Markets and International Banking.
(£54 billion), debt securities (£44 billion) and derivatives (£88 billion). Conditions in the financial markets and the Group’s focus on risk appetite and sector concentration had a direct impact on the composition of its portfolio during the year.
The banking sector is one of the largest in the Group’s portfolio. The sector is well diversified geographically and by exposure with derivative exposures being largely collateralised. The sector is tightly controlled through the combination of the single name concentration framework, a suite of credit policies specifically tailored to the sector and country limits. Exposures to the banking sector decreased by £22 billion during the period, primarily due to reduced interbank lending and derivative activity, and a reduction in limits to banks in countries under stress, such as the peripheral eurozone countries.
Retail, wholesale and repairs sector decreased by £4 billion, reflecting de-leveraging of customers in the retail sector.
Transport and storage includes the Group’s shipping exposures of £11 billion which comprises asset-backed exposures to ocean-going vessels. Conditions remained poor across the major shipping market segments in 2012, with low charter rates and vessel values. A key protection for the Group is the minimum security covenant. This covenant is tested each quarter on an individual vessel basis to ensure prompt remedial action is taken if values fall significantly below agreed loan coverage ratios. There was an increase in the number of clients suffering liquidity issues or failing to meet their minimum security covenant and a commensurate rise in referrals to the Watchlist and the GRG. At 31 December 2012, 20% of the Group’s exposure to this sector was in Watchlist Red. The Group’s exposure to the shipping sector (including shipping related infrastructure) declined by 3.5% in 2012 as a result of amortisation and foreign exchange movements. At 31 December 2012, £0.7 billion of loans were included in risk elements in lending with an associated provision of £0.2 billion and impairment charge of £0.1 billion for 2012.
UK Government (2) 441 8,079 8 8,087 62,722 — 5,582 47 76,879 (5,028) 71,851 Financial institutions - banks (3) 24,856 22,551 100 22,651 6,110 1,175 193,892 40,851 289,535 (202,189) 87,346 - other (4) 42,203 32,024 1,931 33,955 16,834 2,069 62,810 2,946 160,817 (78,976) 81,841 Personal - mortgages — 109,511 19 109,530 — — — — 109,530 — 109,530 - unsecured — 20,443 55 20,498 — — — 4 20,502 — 20,502 Property — 35,532 18,198 53,730 547 282 3,954 — 58,513 (1,328) 57,185 Construction — 5,101 1,406 6,507 14 248 789 — 7,558 (1,666) 5,892 Manufacturing 326 9,416 642 10,058 579 1,553 1,286 111 13,913 (3,542) 10,371 Finance leases (5) — 6,349 4,183 10,532 81 1 — — 10,614 — 10,614 Retail, wholesale and repairs — 11,103 428 11,531 397 1,634 701 41 14,304 (1,590) 12,714 Transport and storage — 7,958 2,619 10,577 527 361 2,049 2 13,516 (2,279) 11,237 Health, education and leisure — 11,530 371 11,901 144 548 818 59 13,470 (888) 12,582 Hotels and restaurants — 5,505 484 5,989 121 51 493 11 6,665 (344) 6,321 Utilities — 2,780 776 3,556 1,178 492 2,654 30 7,910 (2,515) 5,395 Other 19 13,969 1,874 15,843 1,085 4,757 2,647 140 24,491 (1,885) 22,606 Total gross of provisions 67,845 301,851 33,094 334,945 90,339 13,171 277,675 44,242 828,217 (302,230) 525,987 Provisions — (5,637) (4,124) (9,761) (420) (112) — — (10,293) n/a (10,293)
RoW Government (2) — 31 693 724 6,849 — 132 42 7,747 (91) 7,656 Financial institutions - banks (3) 4,528 4,110 140 4,250 961 111 24,639 1,210 35,699 (23,453) 12,246 - other (4) 4,226 2,221 75 2,296 565 84 4,515 425 12,111 (3,893) 8,218 Personal - mortgages — 330 — 330 — — — — 330 — 330 - unsecured — 1,055 6 1,061 — — — — 1,061 — 1,061 Property — 327 185 512 219 8 53 — 792 — 792 Construction — 22 — 22 — 8 22 — 52 — 52 Manufacturing — 2,043 234 2,277 7 45 183 32 2,544 (9) 2,535 Finance leases (5) — 89 53 142 1 — 13 — 156 — 156 Retail, wholesale and repairs — 1,745 6 1,751 6 63 137 — 1,957 (121) 1,836 Transport and storage — 259 127 386 94 11 481 — 972 (156) 816 Health, education and leisure — 248 139 387 — 4 13 — 404 — 404 Hotels and restaurants — 19 — 19 — — — — 19 — 19 Utilities — 429 188 617 27 19 178 — 841 — 841 Other 1 2,835 753 3,588 88 98 416 — 4,191 (188) 4,003 Total gross of provisions 8,755 15,763 2,599 18,362 8,817 451 30,782 1,709 68,876 (27,911) 40,965 Provisions — (147) (171) (318) — — — — (318) n/a (318)
offset (1) Exposure post offset 2011 £m £m £m £m £m £m £m £m £m £m £m
Europe Government (2) — 365 1,017 1,382 18,648 — 66 — 20,096 — 20,096 Financial institutions - banks (3) 94 10,219 313 10,532 11,843 322 — 7,974 30,765 — 30,765 - other (4) — 2,642 1,019 3,661 4,886 64 746 53 9,410 (1) 9,409 Personal - mortgages — 19,473 621 20,094 — — — — 20,094 (5) 20,089 - unsecured — 2,270 600 2,870 — — — 25 2,895 — 2,895 Property — 5,139 12,636 17,775 — 43 — — 17,818 (5) 17,813 Construction — 1,014 873 1,887 — 27 1 — 1,915 (14) 1,901 Manufacturing — 5,853 4,440 10,293 18 87 39 — 10,437 (6) 10,431 Finance leases (5) — 370 744 1,114 — — — — 1,114 — 1,114 Retail, wholesale and repairs — 4,126 999 5,125 32 2 33 — 5,192 (15) 5,177 Transport and storage — 5,625 1,369 6,994 141 22 2 — 7,159 (5) 7,154 Health, education and leisure — 1,442 496 1,938 27 9 — — 1,974 — 1,974 Hotels and restaurants — 1,055 535 1,590 — 120 — — 1,710 (4) 1,706 Utilities — 1,412 683 2,095 74 188 10 — 2,367 — 2,367 Other 28 4,869 2,219 7,088 746 138 54 — 8,054 (45) 8,009 Total gross of provisions 122 65,874 28,564 94,438 36,415 1,022 951 8,052 141,000 (100) 140,900 Provisions — (1,984) (5,243) (7,227) — — — — (7,227) n/a (7,227) Total including disposal groups before RFS MI 122 63,890 23,321 87,211 36,415 1,022 951 8,052 133,773 (100) 133,673 RFS Minority Interest — — 2 2 — — — — 2 — 2 Total 122 63,890 23,323 87,213 36,415 1,022 951 8,052 133,775 (100) 133,675
RoW Government (2) 34 425 428 853 14,073 — 189 6 15,155 — 15,155 Financial institutions - banks (3) 5,129 4,453 219 4,672 3,299 548 24,183 1,641 39,472 (22,063) 17,409 - other (4) 2,088 6,751 93 6,844 145 160 3,354 1,792 14,383 (512) 13,871 Personal - mortgages — 410 203 613 — — — — 613 — 613 - unsecured — 1,460 2 1,462 — — — — 1,462 — 1,462 Property — 735 1,205 1,940 303 15 68 — 2,326 — 2,326 Construction — 183 91 274 12 4 22 — 312 — 312 Manufacturing — 2,185 686 2,871 — 4 448 — 3,323 — 3,323 Finance leases (5) — 47 — 47 — — — — 47 — 47 Retail, wholesale and repairs — 1,030 102 1,132 13 28 149 — 1,322 (1) 1,321 Transport and storage — 430 403 833 398 27 199 — 1,457 — 1,457 Health, education and leisure — 132 17 149 — 8 29 — 186 — 186 Hotels and restaurants — 90 13 103 — 3 4 — 110 — 110 Utilities — 1,468 480 1,948 33 34 97 — 2,112 — 2,112 Other 1 2,196 2,596 4,792 167 6 1,006 9 5,981 (1) 5,980 Total gross of provisions 7,252 21,995 6,538 28,533 18,443 837 29,748 3,448 88,261 (22,577) 65,684 Provisions — (121) (549) (670) — — — — (670) n/a (670)
Notes: (1) This reflects the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities relating to reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
Settlement balances and other financial assets Derivatives Commitments Contingent liabilities Total 2012 £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Total AQ1 56,655 92,494 128,817 7,757 411,375 78,728 9,745 785,571 AQ2 14 598 13,282 1,411 3,704 26,128 1,980 47,117 AQ3 48 2,197 26,232 156 3,317 25,731 4,337 62,018 AQ4 372 748 95,777 577 3,391 41,027 6,522 148,414 AQ5 99 2,322 115,982 259 5,399 38,612 5,169 167,842 AQ6 3 159 66,683 34 1,070 25,991 2,230 96,170 AQ7 2 178 46,072 150 1,464 18,752 2,456 69,074 AQ8 — 15 16,573 14 403 9,289 9,545 35,839 AQ9 — 115 14,263 85 521 3,889 932 19,805 AQ10 5 355 5,644 2 1,581 2,829 407 10,823 Past due — 10 13,430 2,675 — — — 16,115 Impaired — 145 35,609 375 — — — 36,129 Impairment provision — (127) (18,091) (29) — — — (18,247) Group before RFS MI 57,198 99,209 560,273 13,466 432,225 270,976 43,323 1,476,670 RFS MI — 2 — — — — 32 34 Group 57,198 99,211 560,273 13,466 432,225 270,976 43,355 1,476,704
Core AQ1 56,637 91,298 103,645 7,180 396,419 71,091 9,651 735,921 AQ2 14 550 10,534 1,274 2,243 24,923 1,728 41,266 AQ3 48 2,165 23,102 155 3,132 23,546 4,268 56,416 AQ4 10 539 85,779 577 3,017 36,909 5,070 131,901 AQ5 99 2,247 100,051 79 3,988 35,302 4,924 146,690 AQ6 3 138 53,498 34 805 24,050 2,140 80,668 AQ7 2 154 38,438 70 595 17,605 2,309 59,173 AQ8 — 15 13,290 14 257 8,617 9,434 31,627 AQ9 — 107 9,898 52 237 3,442 886 14,622 AQ10 5 300 2,777 2 368 1,500 250 5,202 Past due — 3 10,744 2,629 — — — 13,376 Impaired — 144 13,367 375 — — — 13,886 Impairment provision — (126) (7,740) (29) — — — (7,895)
Settlement balances and other financial assets Derivatives Commitments Contingent liabilities Total 2010 £m £m £m £m £m £m £m £m
Note: (1) Excludes items in the course of collection from other banks (2011 - £1,470 million; 2010 - £1,958 million).
Loans and advances to banks: AQ1 balances decreased by £41.8 billion reflecting the balance sheet reduction, mainly in Markets and also the impact of model changes which resulted in certain counterparties moving to lower AQ bands, primarily to AQ2AQ4, which increased by £6.8 billion, £8.7 billion and £9.1 billion respectively.
Held-for-trading (HFT) 7,692 17,349 27,195 2,243 21,876 2,015 78,370 18,619 Designated as at fair value — — 123 86 610 54 873 516 Available-for-sale 9,774 19,046 16,155 8,861 23,890 3,167 80,893 30,743 Loans and receivables 5 — — 365 3,728 390 4,488 3,707 Long positions 17,471 36,395 43,473 11,555 50,104 5,626 164,624 53,585
Balance sheet analysis: Debt securities continued Key points Debt securities decreased by £44.5 billion or 21% during the year, principally due to a reduction of £26.4 billion in available-for-sale (AFS) across the Group and £16.7 billion of HFT positions within Markets reflecting a combination of de-risking strategies and active balance sheet management.
HFT The £16.7 billion decrease comprised £13.3 billion of central and local government, £1.3 billion financial institutions, £1.2 billion of banks and £0.9 billion of corporate: Decrease in UK and US government bonds of £1.3 billion and £2.3 billion respectively reflected maturities and disposals in line with Markets balance sheet management strategy and unwinding of positions.
Reduction in other government bonds principally French, Italian, Swiss and Japanese, was partially offset by moves to German and Belgian bonds.
Japanese government bonds fell by £2.2 billion as lower collateral was required following a change in clearing status from direct (self- clearing) to agency.
Ratings The table below analyses debt securities by issuer and external ratings. Ratings are based on the lower of Standard and Poor’s, Moody’s and Fitch.
Total AAA 17,471 31 17,167 2,304 11,502 174 48,649 30 10,758 AA to AA+ — 36,357 7,424 1,144 26,403 750 72,078 44 28,775 A to AA- — 6 11,707 2,930 3,338 1,976 19,957 12 2,897 BBB- to A- — — 6,245 4,430 4,217 1,643 16,535 10 7,394 Non-investment grade — — 928 439 3,103 614 5,084 3 2,674 Unrated — 1 2 308 1,541 469 2,321 1 1,087 17,471 36,395 43,473 11,555 50,104 5,626 164,624 100 53,585
Core AAA 17,471 31 17,161 2,296 10,023 172 47,154 30 9,319 AA to AA+ — 36,283 7,419 1,137 24,879 748 70,466 45 27,255 A to AA- — 6 11,707 2,920 2,019 1,968 18,620 12 1,603 BBB- to A- — — 6,245 4,430 3,701 1,602 15,978 10 6,812 Non-investment grade — — 682 439 2,361 496 3,978 2 2,176 Unrated — 1 2 294 1,297 338 1,932 1 859 17,471 36,321 43,216 11,516 44,280 5,324 158,128 100 48,024
Non-Core AAA — — 6 8 1,479 2 1,495 23 1,439 AA to AA+ — 74 5 7 1,524 2 1,612 25 1,520 A to AA- — — — 10 1,319 8 1,337 21 1,294 BBB- to A- — — — — 516 41 557 8 582 Non-investment grade — — 246 — 742 118 1,106 17 498 Unrated — — — 14 244 131 389 6 228 — 74 257 39 5,824 302 6,496 100 5,561
The Group RMBS classifications include sub-prime and non-conforming. Non-conforming RMBS include Alt-A RMBS. Classification as sub-prime or Alt-A is based on Fair Isaac Corporation scores (FICO), level of documentation and loan-to-value (LTV) ratios of the underlying mortgage loans. RMBS are classified as sub-prime if the mortgage portfolio comprises loans with FICO scores between 500 and 650 with full or limited documentation. Mortgages in Alt-A RMBS portfolios have FICO scores of 640 to 720, limited documentation and an original LTV of 70% to 100%.
Balance sheet analysis: Debt securities continued Product, geography and IFRS measurement classification
US UK Europe RoW Total HFT DFV AFS LAR 2010 £m £m £m £m £m £m £m £m £m
Ratings The table below summarises the rating levels of ABS carrying values.
AAA 2,454 2,854 1,487 11 639 396 92 1,181 165 1,479 10,758 AA to AA+ 23,692 613 88 26 102 2,551 7 887 340 469 28,775 A to AA- 201 302 275 33 155 808 74 146 20 883 2,897 BBB- to A- 990 53 141 86 4,698 441 32 291 8 654 7,394 Non-investment grade (2) 20 641 454 330 136 304 421 133 — 235 2,674 Unrated (3) — 108 8 298 — 23 94 388 — 168 1,087 27,357 4,571 2,453 784 5,730 4,523 720 3,026 533 3,888 53,585
AAA 4,169 3,599 1,488 105 2,595 647 135 2,171 625 1,622 17,156 AA to AA+ 29,252 669 106 60 379 710 35 1,533 321 550 33,615 A to AA- 131 506 110 104 2,567 1,230 161 697 100 725 6,331 BBB- to A- — 39 288 93 1,979 333 86 341 — 1,321 4,480 Non-investment grade (2) 21 784 658 396 — 415 1,370 176 — 672 4,492 Unrated (3) — 148 29 146 — 56 170 423 — 263 1,235 33,573 5,745 2,679 904 7,520 3,391 1,957 5,341 1,046 5,153 67,309
Of which in Non-Core — 81 336 379 — 1,278 3,159 5,094 — 2,386 12,713
Notes: (1) Includes US agency and Dutch government guaranteed securities. (2) Includes HFT £1,177 million (2011 - £1,682 million; 2010 - £2,456 million), DFV £7 million (2011 and 2010 - nil), AFS £1,173 million (2011 - £2,056 million; 2010 - £2,160 million) and LAR £317 million (2011 - £754 million; 2010 - £307 million). (3) Includes HFT £808 million (2011 - £804 million; 2010 - £867 million), AFS £149 million (2011 - £249 million; 2010 - £491 million) and LAR £130 million (2011 - £182 million; 2010 - £345 million).
Balance sheet analysis continued Equity shares The table below analyses holdings of equity shares for eurozone countries and other countries with balances more than £100 million by country, issuer and measurement classification. The HFT portfolios in Markets comprise positions in the Markets Derivative Products Solutions business primarily for economic hedging of liabilities including debt issuances and equity derivatives. The AFS portfolios include capital stock in the Federal Home Loans Bank (a government sponsored entity, included in Other financial institutions) and the Federal Reserve Bank together £0.7 billion, that US Retail & Commercial are required to hold and a number a number of individually small holdings in unlisted companies, mainly acquired through loan renegotiations in GRG.
Notes: (1) Exchange traded contracts were £2,497 billion, principally interest rate. Trades are generally closed out daily hence mark-to-market was insignificant (assets - £41 million; liabilities - £255 million). (2) Interest rate notional includes £15,864 billion (2011 - £16,377 billion) relating to contracts with central clearing houses. (3) Comprises equity and commodity derivatives.
Derivative fair values are driven by complex factors such as changes in foreign exchange rates, interest rates, credit default swap spreads and other underlying rates. At 31 December 2012, derivative fair values were in a net asset position of £7.6 billion. More specifically: Group Treasury issues long term fixed rate debt that is hedged with floating rate interest rate swaps and also uses swaps to hedge fixed rate indefinite maturity liabilities such as equity and customer accounts. As interest rates have fallen over recent years the fair value of these swaps has increased. This net asset position mirrored by the net liability position relating to the difference between the fair value and carrying value on fixed rate loans and current accounts.
Within Markets the hedging of issued notes, more exotic derivatives and long dated zero coupon inflation structures have led to a positive fair value which is not offset by other derivatives or hedges.
Credit derivatives The Group trades credit derivatives as part of its client led business and to mitigate credit risk. The Group’s credit derivative exposures relating to proprietary trading are minimal. The table below analyses the Group’s bought and sold protection.
Non-Core Residual risk 19.3 12.3 0.4 0.4 30.0 21.1 2.4 2.5 39.2 19.5 3.2 2.3 Credit hedging - banking book (1) 3.7 0.4 0.1 — 13.4 3.7 0.1 — 15.2 20.8 0.2 0.1 Credit hedging - trading book - rates 1.6 1.2 — — 1.3 0.9 — — 0.2 0.1 (0.1) — - credit and mortgage markets 8.5 2.4 0.7 0.5 38.3 24.4 2.0 1.5 163.7 168.4 3.3 2.8 - other 0.1 0.1 — — 0.2 — — — 0.1 — — —
Credit valuation adjustment as a % of gross exposure 34% 63% 61%
The table below summarises monoline exposures by rating. Credit ratings are based on those from rating agencies Standard and Poor’s and Moody's. Where the ratings differ, the lower of the two is taken.
A to AA- 3,388 2,944 444 128 — 316 Non-investment grade 1,194 1,077 117 64 12 41 4,582 4,021 561 192 12 357
Of which: CMBS 183 170 13 3 CLOs 2,777 2,563 214 47 Other ABS 1,202 999 203 95 Other 420 289 131 47 4,582 4,021 561 192
Of which: CMBS 946 674 272 247 CDOs 500 57 443 351 CLOs 4,616 4,166 450 177 Other ABS 1,998 1,455 543 334 Other 502 322 180 89 8,562 6,674 1,888 1,198
The credit valuation adjustment decreased on a total basis reflecting reduction in exposure and on a relative basis due to restructurings and tighter credit spreads.
Credit derivative product companies (CDPCs) A summary of the Group's exposure to CDPCs, all of which are in Non-Core, is detailed below.
Gross exposure to CDPCs 554 1,896 1,244 Valuation adjustment (314) (1,034) (490) Net exposure to CDPCs 240 862 754
Valuation adjustment as a % of gross exposure 57% 55% 39%
Key points The exposure to CDPCs decreased during the year primarily driven by tighter credit spreads of the underlying reference loans and bonds together with a decrease in the relative value of senior tranches compared with the underlying reference portfolio and the impact of restructuring certain exposures in the first half of the year.
The valuation adjustment decreased on an absolute basis in line with the decrease in exposure while remaining stable on a relative basis.
UK Retail 628 110,659 4,599 2,679 4.2 58 788 823 UK Corporate 806 110,729 5,001 2,061 4.5 41 790 658 Wealth 2,422 16,913 211 81 1.2 38 25 11 International Banking 3,411 57,729 1,632 851 2.8 52 168 125 Ulster Bank 2,079 34,052 5,523 2,749 16.2 50 1,384 124 US Retail & Commercial 208 51,562 1,007 455 2.0 45 248 373 Retail & Commercial 9,554 381,644 17,973 8,876 4.7 49 3,403 2,114 Markets 29,991 31,490 414 311 1.3 75 — 23 Direct Line Group and other 3,829 929 — — — — — — Core 43,374 414,063 18,387 9,187 4.4 50 3,403 2,137 Non-Core 706 80,005 24,007 11,487 30.0 48 3,838 2,390 Group 44,080 494,068 42,394 20,674 8.6 49 7,241 4,527
UK Retail 408 108,405 4,620 2,741 4.3 59 1,160 1,135 UK Corporate 126 113,782 3,981 1,746 3.5 44 768 357 Wealth 2,220 16,130 223 66 1.4 30 18 9 International Banking 3,982 63,173 1,484 855 2.3 58 125 92 Ulster Bank 2,928 36,858 3,619 1,633 9.8 45 1,161 48 US Retail & Commercial 145 48,602 914 509 1.9 56 485 550 Retail & Commercial 9,809 386,950 14,841 7,550 3.8 51 3,717 2,191 Markets 45,084 25,300 366 316 1.4 86 20 33 Direct Line Group and other 2,140 601 — — — — — — Core 57,033 412,851 15,207 7,866 3.7 52 3,737 2,224 Non-Core 1,656 113,001 23,444 10,352 20.7 44 5,407 3,818 Group 58,689 525,852 38,651 18,218 7.4 47 9,144 6,042
Key points Total REIL decreased by £1.3 billion to £41.1 billion compared with
Non-Core REIL decreased by £2.6 billion or 11% reflecting a mixture of repayments and write-offs within UK Corporate, Markets and International Banking corporate portfolios.
Conditions in Ireland remain difficult and economic indicators continue to be weak, this is reflected in the Ulster Bank credit metrics with Core REIL increasing by £2.0 billion since 31 December 2011, primarily within mortgage and commercial real estate portfolios, to £7.5 billion and is now 23% of loans and advances to customers. Impairments continue to outpace write-offs.
The provision coverage increased to 52% at 31 December 2012 from 49% at 31 December 2011 as the economic conditions remain challenging particularly in relation to Ulster Bank and commercial real estate portfolios.
The impairment charge for 2012 of £5.3 billion was 26% lower than in 2011. The main drivers were lower impairment across Non-Core portfolios (down £1.5 billion or 40%) mainly as a result of lower impairments across Ulster Bank’s commercial real estate portfolio (down £1.3 billion or 58%) and continued improvement across Core UK portfolios.
Balance sheet analysis: REIL, provisions and AFS reserves continued Sector and geographical regional analyses: Group continued
Government (1) 8,359 — — — — — — — Finance 48,598 745 579 1.5 78 1.2 207 44 Personal - mortgages 144,171 4,890 1,216 3.4 25 0.8 776 198 - unsecured 32,868 2,960 2,364 9.0 80 7.2 715 935 Property 42,994 4,132 1,133 9.6 27 2.6 469 167 Construction 7,197 841 286 11.7 34 4.0 179 143 Manufacturing 23,708 490 242 2.1 49 1.0 106 125 Finance leases (2) 8,440 172 110 2.0 64 1.3 31 68 Retail, wholesale and repairs 22,039 679 345 3.1 51 1.6 208 119 Transport and storage 16,581 342 60 2.1 18 0.4 47 29 Health, education and leisure 16,073 691 257 4.3 37 1.6 170 55 Hotels and restaurants 7,709 1,005 386 13.0 38 5.0 209 60 Utilities 6,557 22 1 0.3 5 — — — Other 28,769 1,282 668 4.5 52 2.3 538 194 Latent — — 1,418 — — — (252) — 414,063 18,251 9,065 4.4 50 2.2 3,403 2,137 of which: UK - residential mortgages 104,965 2,210 420 2.1 19 0.4 174 24 - personal lending 21,881 2,680 2,179 12.2 81 10.0 657 828 - property 35,431 2,984 744 8.4 25 2.1 378 114 - construction 5,707 655 236 11.5 36 4.1 160 138 - other 114,878 2,571 1,648 2.2 64 1.4 366 398 Europe - residential mortgages 18,393 2,121 664 11.5 31 3.6 437 10 - personal lending 1,972 143 125 7.3 87 6.3 (8) 22 - property 4,846 1,037 365 21.4 35 7.5 162 10 - construction 1,019 72 43 7.1 60 4.2 13 — - other 24,414 2,430 1,806 10.0 74 7.4 915 183 US - residential mortgages 20,311 526 120 2.6 23 0.6 162 164 - personal lending 7,505 136 59 1.8 43 0.8 66 85 - property 2,413 111 24 4.6 22 1.0 16 43 - construction 412 98 1 23.8 1 0.2 — 5 - other 34,971 345 583 1.0 169 1.7 26 96 RoW - residential mortgages 502 33 12 6.6 36 2.4 3 — - personal lending 1,510 1 1 0.1 100 0.1 — — - property 304 — — — — — (87) — - construction 59 16 6 27.1 38 10.2 6 — - other 12,570 82 29 0.7 35 0.2 (43) 17 Group 414,063 18,251 9,065 4.4 50 2.2 3,403 2,137
Government (1) 1,671 — — — — — — — Finance 7,791 562 193 7.2 34 2.5 7 88 Personal - mortgages 6,142 277 184 4.5 66 3.0 436 426 - unsecured 3,891 413 349 10.6 85 9.0 213 306 Property 47,948 16,297 5,918 34.0 36 12.3 3,943 911 Construction 3,425 1,854 653 54.1 35 19.1 341 108 Manufacturing 7,688 644 237 8.4 37 3.1 (211) 1,423 Finance leases (2) 8,529 603 414 7.1 69 4.9 189 71 Retail, wholesale and repairs 3,191 546 313 17.1 57 9.8 135 58 Transport and storage 8,195 136 78 1.7 57 1.0 47 4 Health, education and leisure 1,975 548 185 27.7 34 9.4 14 135 Hotels and restaurants 1,492 528 268 35.4 51 18.0 156 57 Utilities 2,948 69 20 2.3 29 0.7 13 7 Other 8,115 966 534 11.9 55 6.6 248 213 Latent — — 1,005 — — — (116) — 113,001 23,443 10,351 20.7 44 9.2 5,415 3,807 of which: UK - residential mortgages 1,665 52 7 3.1 13 0.4 5 1 - personal lending 585 195 177 33.3 91 30.3 13 11 - property 30,789 5,532 1,719 18.0 31 5.6 1,152 354 - construction 2,383 1,211 422 50.8 35 17.7 223 81 - other 29,236 1,784 1,415 6.1 79 4.8 285 305 Europe - residential mortgages 621 45 21 7.2 47 3.4 37 — - personal lending 600 198 152 33.0 77 25.3 23 5 - property 12,636 9,903 3,959 78.4 40 31.3 2,587 209 - construction 873 600 223 68.7 37 25.5 103 3 - other 13,521 1,785 888 13.2 50 6.6 195 1,329 US - residential mortgages 3,653 180 156 4.9 87 4.3 390 424 - personal lending 2,704 20 20 0.7 100 0.7 79 161 - property 3,318 621 159 18.7 26 4.8 237 166 - construction 78 43 8 55.1 19 10.3 20 24 - other 4,020 439 476 10.9 108 11.8 (131) 329 RoW - residential mortgages 203 — — — — — 4 1 - personal lending 2 — — — — — 98 129 - property 1,205 241 81 20.0 34 6.7 (33) 182 - construction 91 — — — — — (5) — - other 4,818 594 468 12.3 79 9.7 133 93 Group 113,001 23,443 10,351 20.7 44 9.2 5,415 3,807
The Group reviews its portfolios of available-for-sale financial assets for evidence of impairment, which includes: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and it becoming probable that the issuer will enter bankruptcy or other financial reorganisation. However, the disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not evidence of impairment. Furthermore, a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment. Determining whether objective evidence of impairment exists requires the exercise of management judgement. The unrecognised losses on the Group’s available-for-sale debt securities are concentrated in its portfolios of mortgage-backed securities. The losses reflect the widening of credit spreads as a result of the reduced market liquidity in these securities and the current uncertain macroeconomic outlook in the US and Europe. The underlying securities remain unimpaired.
US Retail & Commercial Markets Core Non-Core Total £m £m £m £m £m £m £m £m £m £m
At 1 January 2012 3,685 8,051 11,675 486 110 24,007 Currency translation and other adjustments (57) (104) (231) (20) (75) (487) Additions 1,542 2,210 1,713 323 12 5,800 Transfers 11 59 — — — 70 Transfer to performing book (171) (863) — — (1) (1,035)
Balance sheet analysis: REIL, provisions and AFS reserves continued REIL and PPLs summary The table below analyses REIL between UK and overseas, based on the location of the lending office.
Accruing loans past due 90 days or more - UK 1,759 248 2,007 1,430 508 1,938 1,434 939 2,373 - overseas 456 178 634 364 34 398 262 262 524 2,215 426 2,641 1,794 542 2,336 1,696 1,201 2,897 Total REIL 19,766 21,374 41,140 18,387 24,007 42,394 15,207 23,444 38,651
2012 2011 2010 Core Non-Core Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m
Past due 1-29 days 5,349 250 5,599 5,722 724 6,446 6,401 822 7,223 Past due 30-59 days 1,062 55 1,117 1,556 171 1,727 1,725 392 2,117 Past due 60-89 days 1,151 26 1,177 975 107 1,082 922 271 1,193 Past due 90 days or more 2,215 426 2,641 1,794 542 2,336 1,696 1,201 2,897 9,777 757 10,534 10,047 1,544 11,591 10,744 2,686 13,430
US R&C (1) Other Total £m £m £m £m £m £m
At 1 January 2012 1,633 3,027 6,363 416 48 11,487 Currency translation and other adjustments (100) (58) (107) (89) (15) (369) Disposal of subsidiaries — — — (1) — (1)
At 1 January 2011 2,741 1,746 66 855 1,633 509 7,550 316 7,866 10,352 — 18,218 Intra-group transfers — 177 — — — — 177 — 177 (177) — — Currency translation and other adjustments — 25 3 (37) (79) (5) (93) 17 (76) (225) — (301) Disposal of subsidiaries — — — — — — — — — — 8 8 Amounts written-off (823) (658) (11) (125) (124) (373) (2,114) (23) (2,137) (2,390) — (4,527) Recoveries of amounts previously written-off 69 17 — 3 1 76 166 1 167 360 — 527 Charged to income statement - continuing operations 788 790 25 168 1,384 248 3,403 — 3,403 3,838 — 7,241 - discontinued operations — — — — — — — — — — (8) (8)
Total Core Non-Core RFS MI Group £m £m £m £m £m £m £m £m £m £m £m £m
Recoveries of amounts previously written-off 128 8 — 2 1 72 211 2 213 198 — 411 Charged to income statement - continuing operations 1,160 768 18 125 1,161 485 3,717 20 3,737 5,407 — 9,144 - discontinued operations — — — — — — — — — — 42 42 Unwind of discount (2) (89) (31) (2) (4) (70) — (196) (1) (197) (258) — (455)
Individually assessed - banks — — 2 46 — — 48 78 126 1 — 127 - customers — 546 57 572 502 56 1,733 215 1,948 8,176 — 10,124 Collectively assessed 2,526 703 — — 733 177 4,139 — 4,139 1,170 — 5,309 Latent 215 497 7 237 398 276 1,630 23 1,653 1,005 — 2,658
Core Non-Core Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m
Provisions as a % of REIL 51% 52% 52% 50% 48% 49% 52% 44% 47% Customer provisions as a % of customer loans (1) 2.5% 20.0% 4.7% 2.2% 14.4% 4.2% 1.9% 9.1% 3.4%
Key points Within Core, the increase in collectively assessed provisions related primarily to Ulster Bank’s mortgage and corporate portfolio reflecting a continuation of difficult conditions in Ireland.
Non-Core individually assessed provisions decreased by £0.2 billion, principally reflecting write-offs in Markets and UK Corporate.
Individually assessed — 612 24 233 637 64 1,570 10 — 1,580 3,615 5,195 Collectively assessed 798 392 — — 655 230 2,075 — — 2,075 516 2,591 Latent loss (10) (213) 1 (65) 92 (46) (241) (11) — (252) (293) (545) Loans to customers 788 791 25 168 1,384 248 3,404 (1) — 3,403 3,838 7,241 Securities - sovereign debt (2) — — — — — — — — 1,268 1,268 — 1,268 - other — 2 — — — 78 80 39 (2) 117 83 200 Charge to income statement 788 793 25 168 1,384 326 3,484 38 1,266 4,788 3,921 8,709
Notes: (1) Retail & Commercial. (2) Includes related interest rate hedge instruments.
Individually assessed 1,233 1,936 3,169 1,580 3,615 5,195 1,489 4,719 6,208 Collectively assessed 1,884 312 2,196 2,075 516 2,591 2,258 812 3,070 Latent loss (145) 72 (73) (252) (293) (545) (5) (116) (121) Loans to customers 2,972 2,320 5,292 3,403 3,838 7,241 3,742 5,415 9,157 Loans to banks 23 — 23 — — — (5) (8) (13) Securities - sovereign debt (1) — — — 1,268 — 1,268 — — — - other 61 (97) (36) 117 83 200 44 68 112 Charge to income statement 3,056 2,223 5,279 4,788 3,921 8,709 3,781 5,475 9,256
Charge as a % of gross loans (1) 0.7% 4.2% 1.2% 0.8% 4.8% 1.5% 0.9% 4.8% 1.7%
Potential problem loans Potential problem loans (PPL) are loans for which an impairment event has taken place but no impairment loss is expected. This category is used for advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.
2012 2011 2010 UK US Other (1) Total UK US Other (1) Total UK US Other (1) Total £m £m £m £m £m £m £m £m £m £m £m £m
Note: (1) Includes eurozone countries as detailed in the Country risk section (page 252).
Refer to Country risk section for additional analysis on eurozone country by country AFS reserves.
Risk measurement 243 Key principles 243 Risk appetite 244 Risk models 244 Stress testing 246 Pricing models 246
In 2011, RBS Group announced plans to transfer a substantial part of its business from RBS N.V. to RBS plc, in an effort to simplify the structure and reduce risk. During 2012, a substantial part of the business was transferred to RBS plc. A key element of this was the Financial Services Authority (FSA) approval of the Netherlands trading branch location into the scope of the regulatory models.
A product approval process that requires market risk teams to assess and quantify market risk associated with proposed new products.
Market risk: Risk measurement continued Risk appetite* The Executive Risk Forum (ERF) approves the quantitative market risk appetite for trading and non-trading activities. The Global Head of Market & Insurance Risk, under delegated authority from the ERF, sets and populates a limit framework, which is cascaded down through legal entity, division, business and desk level market risk limits.
At the Group level, the risk appetite is expressed in the form of a combination of VaR, SVaR, sensitivity and stress testing limits.
A daily report summarises the Group’s market risk exposures against the agreed limits. This daily report is sent to the Head of Restructuring & Risk, Global Head of Market & Insurance Risk, divisional Chief Risk Officers and appropriate divisional market risk managers.
Legal entities, divisions and lower levels in the business also have an appropriate market risk framework of controls and limits in place to cover all material market risk exposures.
The market risk control framework has been enhanced further during 2012 with the implementation of SVaR and portfolio gap risk limits. The portfolio gap risk takes into consideration the possibility of the joint occurrence of losses across different gap risk products.
In line with the overall business strategy to reduce risk exposures, the Group’s market risk limits were adjusted down during 2012. The majority of the Group’s market risk exposure were in the Markets, International Banking and Non-Core divisions and Group Treasury. The Group is also exposed to market risk through interest rate risk and foreign exchange risk on its non-trading activities in the retail and commercial businesses. These aspects are discussed in more detail in Non-traded interest rate risk on page 153 and Structural foreign currency exposures on page 155.
The VaR model has been approved by the FSA to calculate regulatory capital for the trading book for those legal entities under its jurisdiction. These legal entities are The Royal Bank of Scotland plc; National Westminster Bank Plc; RBS Financial Products Inc; and RBS Securities Inc. Regulatory VaR differs from the internal VaR as it is based on a tenday holding period. The approval covers general market risk in interest rate, foreign exchange, equity and specified commodity products and specific risk in interest rate and equity products.
The VaR model is an important market risk measurement and control tool. It is used for determining a significant component of the market risk capital and, as such, it is regularly assessed. The main approach employed to asses the ongoing model performance is back-testing, which counts the number of days when a loss (as defined by the FSA) exceeds the corresponding daily VaR estimate, measured at a 99% confidence level. The FSA categorises a VaR model as green, amber or red. A green model status is consistent with a good working model and is achieved for models that have four or fewer back-testing exceptions in a 12-month period. For the Group’s trading book, a green model status was maintained throughout 2012.
The use of a one-day time horizon will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day.
During 2012, an improved methodology was implemented for interest rates, to more realistically represent the distribution of rate changes. The enhanced model introduces a level-dependent scaling methodology for interest rates, which removes the overestimation of rate fluctuations in regimes of declining rates and leads to a swifter adaptation to changing circumstances in times of increasing rates. At the point of implementation the impact on the trading VaR was a decrease of £3.9 million, while the interest rate VaR saw an increase of £1.4 million. The non-trading total and interest rate VaR decreased by £0.5 million and £1.9 million respectively.
The Group adopts two approaches to the quantification of risks not in VaR (RNIVs): Some RNIVs are quantified using a (standalone) VaR approach. For these RNIVs, two values are calculated: (i) the VaR RNIV; and (ii) the SVaR RNIV.
For each legal entity covered by the FSA VaR model waiver, all RNIVs are aggregated to obtain the following three measures: (i) Total VaR RNIV; (ii) Total SVaR RNIV; and (iii) Total stressed RNIV.
In each case, no allowance is made for potential diversification in respect of material RNIVs.
All price risk (APR) - The APR model is applied to the corporate credit correlation trading portfolio, subject to certain eligibility constraints (principally that the underlying names are liquid corporate CDS positions). The measure is calibrated to a 99.9% confidence level over a one year time horizon. All material price risks, including defaults and credit rating changes, are within the scope of the model. Of these, the most significant are credit spread risk, credit correlation risk, index basis risk, default risk, and recovery rate risk. In addition, losses due to both hedging costs and hedge slippage are modelled. The overall APR capital charge is floored at 8% of the corresponding standard rules charge for the same portfolio. The average liquidity horizon at the year end was 12 months.
Identify all risks not adequately captured in VaR, and ensure that such risks are captured via the risks not in VaR process.
Perform impact assessment. Estimate the impact on total one-day and ten-day 99% VaR at the total legal entity level and the major business level, and individual risk factor level one-day and ten-day 99% VaR at the total legal entity level.
Market risk: Risk measurement continued Additionally, Group Risk Analytics (GRA) assess the appropriateness of all new or amended models prior to their introduction. Existing approved models are re-assessed on a periodic basis to ensure they remain fit-forpurpose, for example, following significant market developments or portfolio changes. The models required to be reviewed by GRA (in relation to market risk) include VaR, SVaR, IRC, APR and economic capital. The independent validation review process will consider some or all of the following areas as appropriate: Test and challenge the logical and conceptual soundness of the methodology; The assumptions underlying the model will be tested, where feasible against actual behaviour. The validation report will judge the reasonableness and stability of the assumptions and specify which assumptions, if any, should be routinely monitored in production; Compare model results with independent model replication; Compare outcome with results from alternative methods; Test parameter selection and calibration; Ensure that model outputs are sufficiently conservative in areas where there is significant model uncertainty; Confirm applicability of tests for accuracy, and stability; recalculate; and ensure that results are robust; and
Bottom-up stress testing requires analysis of the market risk exposures by risk factors and different liquidity horizons, to identify the key risks. Stresses for these risks are then designed following consultation with risk managers, economists and front office. The tests may be based on an economic scenario that is translated into risk factor shocks by an economist or by risk managers and front office as a means of assessing the vulnerabilities of their book.
Reverse stress testing is designed to assess the plausibility of scenarios derived by stressing market risk factors until the loss reaches a given threshold. Market Risk contributes to the firm wide, cross risk reverse stress tests.
Pricing models* 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 subject to oversight and approval by asset level modelled product review committees. These committees prioritise models for independent validation by GRA taking into consideration both the materiality of risk booked against the model and an assessment of the degree of model risk (i.e. valuation uncertainty arising from choice of modelling assumptions). GRA review aims to quantify model risk by comparing model outputs against those of alternative independently developed models, the results of which are used by Market Risk to inform risk limits and by Finance to inform model reserves.
The 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 ‘Financial Instruments: Recognition and Measurement’ 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 must be approved by all stakeholders (trading, finance, market risk, model development and model review) prior to use for profit and loss and risk management purposes.
Traders are responsible for marking-to-market their trading book positions on a daily basis. Traders can either: directly mark a position with a price (e.g. spot foreign exchange); or indirectly mark a position through the marking of inputs to an approved model, which will in turn generate a price. *unaudited
Independent price verification Independent price verification is a key additional control over front office marking of positions.
Key elements of the independent price verification framework include: Appropriate financial controls - business unit controllers are responsible for ensuring that independent price verification processes are in place covering all trading book positions held by their business. The independent pricing verification policy requires that daily independent price verification is performed for positions where prices/model inputs are readily available on a daily basis. For positions where prices/model inputs are available on a less regular basis, verification may occur on a frequency that is less than daily.
Where practical, verification is performed to a frequency that matches the availability of this independent price information.
Market risk analyses Trading revenues* The graph below shows the daily distribution of trading and related revenues for Markets for the years ended 31 December 2012 and 31 December 2011.
Note: (1) The effect of any month end adjustments, not attributable to a specific daily market move, is spread evenly over the trading days in that specific month.
Trading book The table below analyses the VaR for the Group’s trading portfolios, segregated by type of market risk exposure, and between Core, Non-Core, counterparty exposure management (CEM) and the Group’s total trading VaR excluding CEM.
Interest rate 62.6 75.6 95.7 40.8 53.4 68.1 79.2 27.5 51.6 57.0 83.0 32.5 Credit spread 69.2 74.1 94.9 44.9 82.7 74.3 151.1 47.4 166.3 133.4 243.2 110.2 Currency 10.3 7.6 21.3 2.6 10.3 16.2 19.2 5.2 17.9 14.8 28.0 8.4 Equity 6.0 3.9 12.5 1.7 9.4 8.0 17.3 4.6 9.5 10.9 17.9 2.7 Commodity 2.0 1.5 6.0 0.9 1.4 2.3 7.0 — 9.5 0.5 18.1 0.5 Diversification (1) (55.4) (52.3) (75.6)
Core 74.6 88.1 118.0 47.4 75.8 89.1 133.9 41.7 103.6 101.2 153.4 58.3 Non-Core 30.1 22.8 41.9 22.0 64.4 34.6 128.6 30.0 105.7 101.4 169.4 63.2 CEM 78.5 84.9 86.0 71.7 50.1 75.8 78.8 30.3 Total (excluding CEM) 47.1 57.6 76.4 32.2 75.5 49.9 150.0 41.6
January February March April May June July August September October November December £ m
VaR non-trading portfolios VaR The table below details VaR for the Group’s non-trading portfolios, excluding the structured credit portfolio and loans and receivables.
In order to better represent the risk of the non-trading portfolios, the table below analyses the VaR for the non-trading portfolios but excludes the Non-Core structured credit portfolio. These assets are shown separately on a drawn notional and fair value basis by maturity profile and asset class. The risk in this portfolio is managed on both a third party asset and RWA basis.
Also excluded from the non-trading VaR portfolios are the loans and receivable products that are managed within the credit risk management framework.
Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m
Interest rate 6.9 4.5 10.7 4.1 8.8 9.9 11.1 5.7 8.7 10.4 20.5 4.4 Credit spread 10.5 8.8 15.4 7.3 18.2 13.6 39.3 12.1 32.0 16.1 101.2 15.4 Currency 3.0 1.3 4.5 1.3 2.1 4.0 5.9 0.1 2.1 3.0 7.6 0.3 Equity 1.7 0.3 1.9 0.3 2.1 1.9 3.1 1.6 1.2 3.1 4.6 0.2 Diversification (1) (5.4) (13.6) (15.9)
Note: (1) The Group benefits from diversification, which reflects the risk reduction achieved by allocating investments across various financial instrument types, currencies and markets. The extent of diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time.
The average and period end interest rate VaR were lower in 2012, due to the implementation of an enhanced rates re-scaling methodology.
Drawn notional Fair value CDOs (1) CLOs (2) MBS (3) Other ABS (4) Total CDOs (1) CLOs (2) MBS (3) Other ABS (4) Total 1-2 years — — — 80 80 — — — 74 74 3-4 years — — 27 82 109 — — 24 76 100 4-5 years — — 95 — 95 — — 86 — 86 5-10 years — 310 92 — 402 — 295 44 — 339 >10 years 289 279 380 398 1,346 116 256 253 254 879 289 589 594 560 2,032 116 551 407 404 1,478 1-2 years — — — 27 27 — — — 22 22 2-3 years — — 10 196 206 — — 9 182 191 4-5 years — 37 37 95 169 — 34 30 88 152 5-10 years 32 503 270 268 1,073 30 455 184 229 898 >10 years 2,180 442 464 593 3,679 766 371 291 347 1,775 2,212 982 781 1,179 5,154 796 860 514 868 3,038 1-2 years — — — 47 47 — — — 42 42 2-3 years 85 19 44 98 246 81 18 37 91 227 3-4 years — 41 20 205 266 — 37 19 191 247 4-5 years 16 — — — 16 15 — — — 15 5-10 years 98 466 311 437 1,312 87 422 220 384 1,113 >10 years 412 663 584 550 2,209 161 515 397 367 1,440 611 1,189 959 1,337 4,096 344 992 673 1,075 3,084
Key point The structured credit portfolio drawn notional and fair values declined across all asset classes from 31 December 2011 to 31 December 2012. Key drivers were: (i) during the first half of 2012, the liquidation of legacy trust preferred securities and commercial real estate CDOs and subsequent sale of the underlying assets; and (ii) during the second half of 2012, the sale of underlying assets from CDO collateral pools and legacy conduits.
Interest rate position risk requirement 254 1,107 Equity position risk requirement 1 3 Option position risk requirement 26 26 Commodity position risk requirement 2 2 Foreign currency position risk requirement 12 10 Specific interest rate risk of securitisation positions 156 250 Total (standard method) 451 1,398 Pillar 1 model based position risk requirement 2,959 3,725 Total position risk requirement 3,410 5,123 *unaudited
The principal contributors to the Pillar 1 model based position risk requirement (PRR) are: 2012 Average (1) Maximum (1) Minimum (1) Period end 2011 £m £m £m £m £m
IRC by rating and product category The following table analyses the IRC by rating and product. Internal ratings £m AA £m
Note: (1) The figures presented are based on the spot IRC charge at 31 December 2012 and will therefore not agree with the IRC position risk requirement, as this is based on the 60 day average. The figures presented above are in capital terms.
Securitisation positions in the trading book The following table analyses the trading book securitised exposures, by rating, subject to a market risk capital requirement.
Notes: (1) Based on S&P ratings. (2) Excludes the capital deductions. (3) Percentage of total standardised position risk requirement.
Country risk exposure 255 Definitions 255 Summary 256 Total eurozone 260 Eurozone periphery – total 261 Eurozone periphery – by country 262 Eurozone non-periphery – total 273 Eurozone non-periphery – by country 274
Country risk Introduction* Country risk is the risk of material losses arising from significant countryspecific events such as sovereign events (default or restructuring); economic events (contagion of sovereign default to other parts of the economy, cyclical economic shock); political events (transfer or convertibility restrictions, expropriation or nationalisation); and conflict. Such events have the potential to affect elements of the Group’s credit portfolio that are directly or indirectly linked to the country in question and can also give rise to market, liquidity, operational and franchise riskrelated losses.
Eurozone risks Eurozone risks continued to dominate, as concerns about the impact of banking sector problems on government balance sheets led to further capital flight from periphery countries and a rise in sovereign bond yields until August, particularly for Spain. To break the feedback loop between banks and their sovereigns, eurozone leaders agreed at their June summit that the European Stability Mechanism (ESM), the eurozone’s permanent crisis fund, could lend to banks directly once a single eurozone-wide banking regulator had been established. They also approved the provision by the ESM of significant financial support to Spain to recapitalise its banks.
Meanwhile, in Greece, private sector claims on the government were restructured in early 2012, but political risks remained acute as two successive parliamentary elections eventually resulted in a narrow victory for the pro-bailout New Democracy party. As the electoral process delayed policy implementation and the recession, contrary to earlier expectations, deepened further, additional reforms became necessary and the European Commission, the IMF and the ECB (known collectively as the Troika) further eased Greece’s targets.
Elsewhere, Ireland continued to make progress towards targets set out in its Troika programme, notably allowing the government to resume a degree of market financing. Talks with the European authorities on ways to relieve the government of some of the costs of past banking sector support continued, resulting in a favourable restructuring of the Anglo Irish promissory note in early 2013, reducing related fiscal costs somewhat. Notwithstanding these developments, Irish growth remained very weak and reliant on external demand. Portugal also made progress in a number of areas, though had greater structural constraints to address to boost longer-term growth prospects. Towards the end of the year, Cyprus also entered negotiations with the EU and IMF on a support programme. The eurozone as a whole entered recession in the second half of the year, although divergence within the currency union continued, with the core considerably stronger than the periphery.
Emerging countries in Europe started to be affected by very weak growth in the eurozone, with the most export-focused economies being worst hit. However, countries that took significant action in the wake of the financial crisis to stabilise their banking sectors, saw an easing of risk. Turkey was upgraded by one rating agency to investment grade.
During 2012, in addition to all emerging markets and the vulnerable eurozone countries, the Group brought nearly all advanced countries under country limits. The exceptions were the UK (and related European special territories of Guernsey, Jersey, the Isle of Man and Gibraltar) and the US, given their home country status.
Also in 2012, an enhanced country risk appetite framework was introduced. The Group’s risk appetite for a particular country is now guided by global risk appetite, the country’s internal rating and strategic importance to the Group, the portfolio composition by tenors and clients, an assessment of the potential for losses arising from a number of possible key country risk events, and other country-specific considerations such as funding profile, risk/return analysis, business opportunities and reputational risk. The actual country limits continue to be set by GCRC (or the ERF above certain benchmark levels).
Further enhancements included improved divisional country risk operating models and the implementation of a new sovereign rating model.
Eurozone crisis preparedness A Group executive steering group is driving eurozone crisis preparedness. Its agenda in 2012 included operational preparations for possible sovereign defaults and/or eurozone exits. The steering group also considered initiatives to determine and reduce redenomination risk. Further actions to mitigate risks and strengthen control in the eurozone typically included taking guarantees or insurance, updating collateral agreements, and tightening certain credit pre-approval processes.
Redenomination risk The overall impact of redenomination risk on the Group is difficult to determine with certainty, but would be shaped by: the scope and reach of any new legislation introduced by an exiting country; its applicability to the facility documentation; and whether there are any appropriate offsets to the exposures. For the purposes of estimating funding mismatches at risk of redenomination (detailed below), the Group takes, as its starting point balance sheet exposure as defined on page 255 and excludes exposures at low risk of redenomination. The latter are identified through consideration of the relevant documentation, particularly the currency of exposure, governing law, court of jurisdiction, precise definition of the contract currency (for euro facilities), and location of payment. The Group also deducts offsets for provisions taken and liabilities that would be expected to redenominate at the same time.
A redenomination event would also be accompanied by increased credit risk, for two reasons. First, capital controls would likely be introduced in the affected country, resulting in any non-redenominated assets, including non-euro assets, potentially becoming harder to service. Second, a sharp devaluation could imply payment difficulties for counterparties with large debts denominated in foreign currency and counterparties that are heavily dependent on imports.
The Group's focus continues to be on reducing its asset exposures and funding mismatches in the eurozone periphery countries. During 2012, total asset exposures to these countries decreased by 13% to £59.1 billion. The estimated funding mismatch at risk of redenomination was £9.0 billion for Ireland, £4.5 billion for Spain, and £1.0 billion for Italy at 31 December 2012. These mismatches can fluctuate due to volatility in trading book positions and changes in bond prices. The net positions for Greece, Portugal and Cyprus were all minimal.
Refer to pages 256 to 280 for discussion on the Group’s exposure to banks, financial institutions and other sectors in a number of eurozone countries.
Credit default swaps The Group uses credit default swap (CDS) contracts to service customer activity as well as to manage counterparty and country exposure. The latter is done to hedge portfolios or specific exposures. This may give rise to maturity mismatches between the underlying exposure and the CDS contract, as well as between bought and sold CDS contracts on the same reference entity. CDS positions are monitored on a daily basis as part of regular market risk management.
The terms of the Group’s CDS contracts are covered by standard International Swaps and Derivatives Association (ISDA) documentation, which determines if a contract is triggered due to a credit event. Such events may include bankruptcy or restructuring of the reference entity or a failure of the reference entity to repay its debt or interest. Under the terms of a CDS contract, one of the regional Credit Derivatives Determinations Committees of the ISDA is empowered to decide whether or not a credit event has occurred.
The Group transacts CDS contracts primarily on a collateralised basis with investment-grade global financial institutions who are active participants in the CDS market. These transactions are subject to regular margining, which usually takes the form of cash collateral. For European peripheral sovereigns, credit protection has been purchased from a number of major European banks, predominantly outside the country of the reference entity. In a few cases where protection was bought from banks in the country of the reference entity, giving rise to wrong-way risk, this risk is mitigated through specific collateralisation and monitored on a weekly basis.
The tables that follow show the Group’s exposure by country of incorporation of the counterparty at 31 December 2012. Countries shown are those where the Group’s balance sheet exposure (as defined in this section) to counterparties incorporated in the country exceeded £1 billion and the country had an external rating of A+ or below from Standard and Poor’s, Moody’s or Fitch at 31 December 2012, as well as selected eurozone countries. The exposures are stated before taking into account mitigants, such as collateral (with the exception of reverse repos), insurance or guarantees, which may have been taken to reduce or eliminate exposure to country risk events. Exposures relating to oceangoing vessels are not included due to their multinational nature.
Risk elements in lending (REIL) - Comprises impaired loans and accruing past due 90 days or more as to principal or interest. Impaired loans are all loans (including renegotiated) for which an impairment provision has been established. Accruing past due 90 days or more comprise loans past due 90 days where no impairment loss is expected and those awaiting individual assessment. A latent provision is established for the latter.
Debt securities - Comprise securities classified as available-for-sale (AFS), loans and receivables (LAR), held-for-trading (HFT) and designated as at fair value through profit or loss (DFV). All debt securities other than LAR securities are carried at fair value. LAR debt securities are carried at amortised cost less impairment. HFT debt securities are presented as gross long positions (including DFV securities) and short positions per country. Impairment losses and exchange differences relating to AFS debt securities, together with interest, are recognised in the income statement. Other changes in the fair value of AFS securities are reported within AFS reserves, which are presented gross of tax.
Derivatives (net) - Comprise the mark-to-market (mtm) value of such contracts after the effect of legally enforceable netting agreements but before the effect of collateral. Figures shown include the effect of counterparty netting used within the regulatory capital model.
Repos (net) - Comprises the mtm value of repo and reverse repo contracts after the effect of legally enforceable netting agreements and collateral. Counterparty netting is applied within the regulatory capital model used.
The column CDS notional less fair value represents the instantaneous increase in exposure arising from sold positions netted against the decrease arising from bought positions should the CDS contracts be triggered by a credit event and assuming there is a zero recovery rate on the reference exposure. For a sold position, the change in exposure equals the notional less fair value amount and represents the amount the Group would owe to its CDS counterparties. Positive recovery rates would tend to reduce the gross components (increases and decreases) of those numbers.
Other eurozone - Comprises Austria, Estonia, Finland, Malta, Slovakia and Slovenia.
CDS notional less fair value Derivatives Repos 2010 £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Reported exposures are affected by currency movements. Over 2012, sterling appreciated 4.4% against the US dollar and 2.6% against the euro, resulting in exposures denominated in these currencies (and in other currencies linked to the same) decreasing in sterling terms.
Key points* Balance sheet and off-balance sheet exposures to nearly all countries shown in the table declined during 2012, as the Group maintained a cautious stance and many clients reduced debt levels. The reductions were seen in all broad product categories and in all client groups. Non-Core lending exposure declined as the strategy for disposal progressed, particularly in Germany, Spain and Ireland. Most of the Group’s country risk exposure was in International Banking (primarily lending and off-balance sheet exposure to corporates), Markets (mostly derivatives and repos with financial institutions), Ulster Bank (mostly lending exposure to corporates and consumers in Ireland) and Group Treasury (largely AFS debt securities and liquidity with central banks).
Japan - Exposure decreased during 2012, principally in the first half of the year, reflecting a reduction in International Banking’s cash management business and a change in Japanese yen clearing status from direct (self-clearing) membership to agency. The Group no longer needs to hold positions resulting in a £2.2 billion reduction in AFS Japanese government bonds.
protection on most countries shown in the table. A £0.4 billion net sold CDS position on Brazil was primarily hedging bought nth-todefault CDS contracts with Brazilian reference entities (these latter contracts are not included in the reported numbers by country - refer to the Definitions section on page 255).
Government 51 — — 644 (132) 3,686 2,698 1,632 134 — 1,817 16 1,833 361 — Central bank 107 — — — — — — — — — 107 — 107 — — Other banks 299 — — 3,551 (660) 165 131 3,585 4,093 476 8,453 75 8,528 29,706 4,186 Other FI 812 — — 2,065 (541) 466 40 2,491 746 103 4,152 1,414 5,566 1,557 4,136 Corporate 24,362 12,146 6,757 192 2 128 40 280 1,678 — 26,320 5,414 31,734 2,027 326 Personal 18,292 3,347 1,713 — — — — — 1 — 18,293 611 18,904 1 — 43,923 15,493 8,470 6,452 (1,331) 4,445 2,909 7,988 6,652 579 59,142 7,530 66,672 33,652 8,648
Government 225 — — 2,085 (871) 6,564 4,672 3,977 180 — 4,382 226 4,608 304 — Central bank 2,238 — — — — 7 — 7 1 125 2,371 1 2,372 1 1,160 Other banks 1,003 — — 6,003 (920) 356 181 6,178 4,013 261 11,455 293 11,748 29,469 4,238 Other FI 1,392 — — 2,708 (480) 295 7 2,996 1,618 25 6,031 2,558 8,589 3,006 3,476 Corporate 30,447 10,726 4,899 120 37 226 22 324 1,482 4 32,257 8,441 40,698 2,004 4 Personal 20,697 1,639 534 — — — — — — — 20,697 647 21,344 1 — 56,002 12,365 5,433 10,916 (2,234) 7,448 4,882 13,482 7,294 415 77,193 12,166 89,359 34,785 8,878
Key points* Ulster Bank Group’s (UBG) Irish exposure comprises personal lending (largely mortgages) and corporate lending and commitments, plus some lending to financial institutions (refer to the Ulster Bank Group (Core and Non-Core) section on page 190 for further details). In addition, International Banking has lending exposure and commitments, and Markets has derivative and repo exposure to financial institutions and large international clients with funding subsidiaries based in Ireland.
Group exposure decreased further during 2012, principally lending, which fell £3.3 billion as a result of de-risking of the portfolio and currency movements.
Personal Overall lending exposure fell by £1.0 billion as a result of exchange rate movements, amortisation, maturities, a small amount of writeoffs, low new business volumes and active risk management. Residential mortgage loans amounted to £16.9 billion at 31 December 2012, including REIL of £3.0 billion and loan provisions of £1.5 billion. The housing market continues to suffer from weak domestic demand, with house prices that stabilised in the course of 2012 at approximately 50% below their 2007 peak.
Non-Core (included above) Non-Core lending exposure was £9.5 billion at 31 December 2012, down £0.7 billion since 31 December 2011. The lending portfolio largely consisted of exposures to commercial real estate (82%), retail (4%) and leisure (4%).
Lending to financial institutions decreased to less than £0.1 billion at 31 December 2012 from £0.3 billion at 31 December 2011.
Corporate Lending decreased by £1.5 billion and off-balance sheet exposure by £0.9 billion, due to reductions primarily in the commercial real estate and electricity sectors. Commercial real estate lending amounted to £1.6 billion at 31 December 2012, predominantly in Non-Core. The majority of REIL and loan provisions relates to commercial real estate lending and further decreased during 2012, reflecting disposals and restructurings.
Government and central bank The Group is an active market-maker in Italian government bonds and has an active CDS portfolio, resulting in large and fluctuating gross long and short positions in HFT debt securities.
The Group’s product offering consists largely of collateralised trading products and to a lesser extent, short-term uncommitted lending lines for liquidity purposes. During 2012, derivative exposure decreased by £0.2 billion due to market movements. Risk is mitigated since most facilities are fully collateralised. Lending declined by £0.1 billion to £0.4 billion.
The AFS bond exposure was reduced by £0.3 billion due to sales.
Non-Core (included above) Non-Core lending exposure was £0.9 billion at 31 December 2012, a £0.3 billion or 22% reduction since 31 December 2011, primarily due to a fall in exposure to investment funds and industrials. The remaining lending exposure was mainly to the commercial real estate (29%), leisure (25%) and electricity (16%) sectors.
Exposure declined further during 2012, with continued reductions in lending and off-balance sheet exposure, and sales of Group Treasury’s AFS bonds.
Government and central bank The Group’s exposure to the Portuguese government at 31
December 2012 was £102 million, comprising a very small derivative exposure and a small net long debt securities position, an increase from the net short debt securities position at 31 December 2011.
Non-Core (included above) Non-Core lending exposure to Portugal decreased by £0.1 billion during 2012, to £0.3 billion. The portfolio largely comprised lending exposure to the land transport and logistics (40%), electricity (37%) and commercial real estate (18%) sectors.
Government — — — — — 9 — 9 17 — 26 — 26 151 — Central bank 7 — — — — — — — — — 7 — 7 — — Other banks — — — — — — — — 299 — 299 — 299 411 — Other FI 1 — — — — — 8 (8) — — (7) — (7) — — Corporate 179 38 38 — — — — — 44 — 223 18 241 61 — Personal 14 — — — — — — — — — 14 9 23 — — 201 38 38 — — 9 8 1 360 — 562 27 589 623 —
2010 Government 14 — — 895 (694) 118 39 974 7 — 995 7 1,002 23 — Central bank 36 — — — — — — — — — 36 — 36 — — Other banks 18 — — — — — — — 167 — 185 1 186 284 181 Other FI 31 — — — — — — — 3 — 34 3 37 3 — Corporate 191 48 48 — — — — — 50 — 241 143 384 50 — Personal 16 — — — — — — — — — 16 10 26 — — 306 48 48 895 (694) 118 39 974 227 — 1,507 164 1,671 360 181
Key points* The Group’s exposure to Greece decreased further in 2012, largely as a result of the restructuring and sale of Greek government debt and a corporate write-off. The remainder of the exposure is actively managed, in line with the Group’s de-risking strategy that has been in place since early 2010. Much of the remaining exposure is collateralised or guaranteed. The remaining Greek exposure at 31 December 2012 was £0.6 billion. The majority of this was derivative exposure to banks (itself in part collateralised). The rest was mostly corporate lending including exposure to local subsidiaries of international companies.
Government and central bank The Group participated in the restructuring of Greek government debt in March 2012, which resulted in the issuance of new bonds that were sold in March and April, and £0.3 billion of AFS bonds issued by the European Financial Stability Facility incorporated in Luxembourg. The Group no longer holds any AFS bonds issued by the Greek government. A small HFT position, resulting from the sovereign debt restructuring in March, has been retained to enable the Group to quote prices and stay relevant to key clients.
Corporate Lending exposure fell by £0.2 billion to £0.2 billion, largely due to a single name write-off in the first half of 2012.
Non-Core (included above) Non-Core lending exposure to Greece was £0.1 billion at 31
Government — — — 8,103 453 5,070 1,592 11,581 533 — 12,114 735 12,849 1,656 — Central bank 20,018 — — — — — — — — — 20,018 — 20,018 — — Other banks 660 — — 668 10 280 332 616 5,558 183 7,017 139 7,156 50,998 4,935 Other FI 460 — — 285 (23) 95 30 350 3,046 116 3,972 933 4,905 3,911 3,066 Corporate 3,756 460 152 207 14 11 2 216 339 24 4,335 5,462 9,797 637 406 Personal 83 1 — — — — — — — — 83 25 108 — — 24,977 461 152 9,263 454 5,456 1,956 12,763 9,476 323 47,539 7,294 54,833 57,202 8,407 2011 Government — — — 12,035 523 4,136 2,084 14,087 423 — 14,510 2 14,512 1,284 164 Central bank 18,068 — — — — — — — 2 — 18,070 — 18,070 2 — Other banks 653 — — 1,376 5 294 761 909 5,886 117 7,565 284 7,849 62,744 4,277 Other FI 305 — — 563 (33) 187 95 655 3,272 49 4,281 1,116 5,397 3,657 1,659 Corporate 6,608 191 80 109 9 14 7 116 586 — 7,310 6,103 13,413 963 42 Personal 155 19 19 — — — — — — — 155 22 177 — — 25,789 210 99 14,083 504 4,631 2,947 15,767 10,169 166 51,891 7,527 59,418 68,650 6,142 2010 Government — — — 10,648 1 5,964 4,124 12,488 160 — 12,648 — 12,648 805 18 Central bank 10,894 — — — — — — — 4 6,229 17,127 — 17,127 4 6,229 Other banks 1,060 — — 1,291 3 567 481 1,377 5,943 346 8,726 250 8,976 52,483 2,854 Other FI 422 — — 494 (47) 195 17 672 1,860 91 3,045 740 3,785 2,478 3,006 Corporate 7,519 163 44 219 4 44 53 210 633 — 8,362 7,905 16,267 1,368 — Personal 162 — — — — — — — — — 162 22 184 — — 20,057 163 44 12,652 (39) 6,770 4,675 14,747 8,600 6,666 50,070 8,917 58,987 57,138 12,107
Government 7 — — 1,052 57 1,248 993 1,307 36 — 1,350 29 1,379 1,662 — Central bank 1,822 — — — — — — — 2 — 1,824 — 1,824 2 4,648 Other banks 496 — — 575 136 252 86 741 6,667 309 8,213 3,471 11,684 16,558 3,074 Other FI 1,785 — — 6,107 (508) 242 17 6,332 1,908 45 10,070 1,311 11,381 5,087 2,335 Corporate 3,720 508 156 66 2 29 28 67 476 — 4,263 6,650 10,913 648 — Personal 26 — — — — — — — — — 26 12 38 — — 7,856 508 156 7,800 (313) 1,771 1,124 8,447 9,089 354 25,746 11,473 37,219 23,957 10,057 2011 Government 8 — — 1,447 74 849 591 1,705 40 — 1,753 — 1,753 1,521 — Central bank 7,654 — — — — 6 — 6 7 — 7,667 — 7,667 10 15,103 Other banks 623 — — 802 217 365 278 889 7,410 164 9,086 3,566 12,652 17,425 2,615 Other FI 1,557 — — 6,804 (386) 290 108 6,986 1,806 108 10,457 3,388 13,845 5,082 5,792 Corporate 4,827 621 209 199 6 113 5 307 747 3 5,884 6,596 12,480 1,820 416 Personal 20 3 2 — — — — — — — 20 11 31 — — 14,689 624 211 9,252 (89) 1,623 982 9,893 10,010 275 34,867 13,561 48,428 25,858 23,926 2010 Government 914 — — 3,469 16 1,426 607 4,288 46 — 5,248 46 5,294 1,682 — Central bank 6,484 — — — — — — — — — 6,484 — 6,484 12 22,167 Other banks 554 — — 984 2 223 275 932 4,819 202 6,507 3,813 10,320 13,199 837 Other FI 1,801 — — 6,612 (185) 344 12 6,944 2,944 172 11,861 4,734 16,595 5,630 1,084 Corporate 6,170 388 149 264 3 152 57 359 875 — 7,404 9,537 16,941 1,178 — Personal 81 3 3 — — — — — — — 81 11 92 — — 16,004 391 152 11,329 (164) 2,145 951 12,523 8,684 374 37,585 18,141 55,726 21,701 24,088
AQ1 AQ2-AQ3 AQ4-AQ9 AQ10 Total Notional Fair value Notional Fair value Notional Fair value Notional Fair value Notional Fair value 2012 £m £m £m £m £m £m £m £m £m £m
Government 494 — — 537 (41) 5,186 2,064 3,659 257 — 4,410 3 4,413 270 — Central bank 9 — — — — — — — — — 9 — 9 — — Other banks 2,498 — — 730 5 184 27 887 5,608 58 9,051 591 9,642 41,782 11,581 Other FI 124 — — 757 (4) 252 51 958 833 392 2,307 1,106 3,413 1,721 2,743 Corporate 2,426 116 71 218 16 116 15 319 724 — 3,469 7,685 11,154 1,147 — Personal 71 — — — — — — — — — 71 75 146 — — 5,622 116 71 2,242 (24) 5,738 2,157 5,823 7,422 450 19,317 9,460 28,777 44,920 14,324 2011 Government 481 — — 2,648 (14) 8,705 5,669 5,684 357 — 6,522 911 7,433 372 — Central bank 3 — — 20 — — — 20 — — 23 — 23 — — Other banks 1,273 — — 889 (17) 157 75 971 7,009 262 9,515 474 9,989 42,922 17,689 Other FI 282 — — 642 (40) 325 126 841 592 83 1,798 928 2,726 1,763 4,541 Corporate 3,761 128 74 240 9 72 34 278 743 — 4,782 7,829 12,611 1,148 — Personal 79 — — — — — — — — — 79 75 154 — — 5,879 128 74 4,439 (62) 9,259 5,904 7,794 8,701 345 22,719 10,217 32,936 46,205 22,230 2010 Government 511 — — 5,912 40 10,266 3,968 12,210 362 — 13,083 15 13,098 399 — Central bank 3 — — — — — — — — 15 18 — 18 — 727 Other banks 1,095 — — 774 — 410 204 980 6,554 629 9,258 954 10,212 35,028 16,002 Other FI 470 — — 666 (22) 42 23 685 361 14 1,530 1,310 2,840 740 1,255 Corporate 4,376 230 46 71 1 185 90 166 672 — 5,214 9,285 14,499 1,074 — Personal 102 — — — — — — — — — 102 76 178 — — 6,557 230 46 7,423 19 10,903 4,285 14,041 7,949 658 29,205 11,640 40,845 37,241 17,984
Off- balance sheet Total Derivatives Repos 2012 £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Government and central bank The Group holds significant short-term surplus liquidity with central banks for liquidity, credit risk and capital considerations as well as due to limited alternative investment opportunities. This exposure also fluctuates as part of the Group’s asset and liability management. In the third quarter of 2012 the Group transferred part of its euro payment activity from the RBS N.V. account with the Dutch central bank to the RBS plc account with the German central bank, as part of strategic plans to migrate most of the RBS N.V. balance sheet, activities and exposures to RBS plc.
Germany - Net long HFT positions in German bonds in Markets increased during 2012, driven by market opportunities. Concurrently, German AFS bond positions in Group Treasury were reduced in the first half of the year, in line with internal liquidity management strategies.
Markets throughout 2012 while reducing its net long HFT position in the first half of the year and increasing it again in the second half of the year, in anticipation of changes in credit spreads. AFS bond positions in Group Treasury were gradually reduced as part of general risk management and in line with internal liquidity management strategies.
Financial institutions France - Lending exposure to banks increased as a result of a transfer of bank account services for Group Treasury secured funding transactions from in-house to an external bank, for £1.7 billion. Derivatives exposure to banks decreased by £1.4 billion, spread over a number of banks.
Non-Core (included above) Germany - Non-Core lending exposure was £2.8 billion at 31
December 2012, down £0.5 billion since 31 December 2011. Most of the lending was in the commercial real estate (56%) and securitisations (21%) sectors.
December 2012, a decline of £0.7 billion since 31 December 2011. The lending portfolio mainly comprised public sector (30%), commercial real estate (23%) and construction (13%) exposures.
Other risks Operational risk* Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. It is an integral and unavoidable part of the Group’s business as it is inherent in the processes it operates to provide services to customers and meet strategic objectives.
In 2012, the Group continued to make good progress in enhancing its operational risk framework and risk management capabilities. Details of developments undertaken and planned are set out below along with the key processes through which the Group manages operational risk.
Governance, structure and risk appetite Governance and structure Group Operational Risk is an independent function reporting to the Head of Restructuring & Risk. It is responsible for the design and maintenance of the operational risk policy standards.
The standards, which are incorporated in the Group Policy Framework (GPF), provide the direction for delivering effective operational risk management and are designed to allow the consistent identification, assessment, management, monitoring and reporting of operational risk across the Group.
The Operational Risk Executive Committee acts upon all operational risk matters, and reviews and monitors the operational risk profile across the Group, in line with risk appetite. It oversees, manages and monitors operational risk strategies and frameworks, and reviews operational risk policy. It escalates and reports necessary items to the Group Risk Committee.
Operational risk appetite, policy and frameworks are reviewed regularly at the Executive Risk Forum to satisfy oversight responsibilities and, as appropriate, other senior committees.
Risk appetite The Group’s operational risk appetite statement is agreed by the Group Board. It comprises a number of specific measures of risk, such as: The maximum operational risk losses the Group is prepared to accept. For 2012, this was expressed as a percentage of the Group’s estimated gross income but will transition to a more forward-looking expected loss measure during 2013 following the development of the operational risk model; and
To confirm that the Group operates within the set risk appetite, the highlevel statement is supplemented by specific tolerances for different types of operational risk. The GPF sets out how to manage risk within acceptable limits, which in turn enables the Group to operate within the overall risk appetite and the specific tolerances.
The process is designed to confirm that risks are effectively managed in line with stated risk appetite, prioritised and documented. Controls are tested frequently to verify and validate that they remain fit for purpose and operate effectively.
New product risk assessment process The Group’s new product risk assessment process is designed to identify, assess and approve the risks associated with new products prior to launch.
Scenario analysis Scenario analysis is used to assess the possible impact of extreme but plausible operational risk loss events. It provides a forward-looking basis for managing exposures beyond the Group's risk appetite. The methodology provides a structured and consistent approach to scenario scoping and measurement. During 2012, the portfolio of scenarios was further enhanced to increase coverage of the material risks to which the Group is exposed.
Scenario analysis is an important component in the operational risk framework, providing senior management with valuable insight into systemic risk that could significantly impact the Group’s financial performance or reputation if these events were to occur. Using its forward-looking nature, senior management cross-examines various risk topics against a range of circumstances and assumptions, including consideration of single points of failure.
Operational risk impacts are also assessed based on additional economic stress scenarios developed internally.
Management, monitoring and reporting Issues management The objective of the operational risk issues management framework is the adoption of a consistent approach to the identification, capture, classification, monitoring, closure and acceptance of operational risk issues and associated actions across the Group.
This element of the operational risk framework continues to be enhanced in areas such as analysis of common issues on an aggregated basis across the Group to identify emerging trends and improvements to the quality of data captured.
Event and loss data management Event and loss data management covers the discovery, escalation, capture, investigation, approval and closure, and reporting and analysis of operational risk events and loss data. It also provides for clear, simple, quick and consistent communication of operational risk events that meet defined threshold criteria to those members of the Group’s senior management and executives who need to know of these events.
The Group has continued to focus on the timely, accurate capture of operational risk losses; the use of a single Group-wide repository; and the escalation of material operational risk events. This has resulted in enhanced completeness and accuracy of the Group’s internal loss data, and transparency of operational risk events, which allows the Group to manage its operational risk profile more effectively.
The event and loss data process will continue to evolve to keep apace with changing regulatory and industry standards regarding the collection of internal loss data.
Insurance The Group purchases insurance to provide the business with financial protection against specific losses and to comply with statutory or contractual requirements. Insurance is used to help manage the Group’s exposures, providing protection against financial loss once a risk has crystallised.
Monitoring and reporting Monitoring and reporting forms an integral part of all of the Group’s operational risk management processes, which are designed to ensure that risks and issues are identified, escalated and managed on a timely basis. Exposures for each division are reported through monthly risk and control reports, which provide detail on the risk exposures and action plans.
Code; effectiveness of the risk frameworks, culture and governance structures of each division or function to help ensure the Group operates within risk appetite; and reporting on the material risks for the business against appetite.
Operational risk metrics Operational risk events (net loss greater than £10,000) by event category All losses and recoveries associated with an event are reported based on the date of each financial impact. A single event can have multiple losses (or recoveries), which may take a period of time to crystallise. Losses and recoveries will also have been booked during 2012 on events which occurred or were identified in prior years.
Number of events At 31 December 2012, two categories accounted for around 60% of all operational risk events: (i) clients, products and business practices; and (ii) execution, delivery and process management. This proportion was unchanged from 31 December 2011.
The regulatory agenda, largely framed by the G20 but with many instances of European Union (EU) and national initiatives, constitutes the most sweeping set of changes seen in many decades. At 31 December 2012, the Group was managing some 105 major regulatory or legislative policy initiatives. During the year as a whole, it had also reviewed over 320 consultations in its core markets. In addition to these changes, many supervisory authorities also continued to intensify their ongoing level of scrutiny and intervention.
These trends have posed multiple challenges for banking groups, including the Group, namely: tracking, analysing and engaging with policymakers on proposed changes; implementing change programmes to ensure compliance with new requirements; revisiting strategy, business and operating models in response to the new environment; and driving through cultural and other changes to promote good business practice and to minimise enforcement risks.
Final rules amending the liquidity coverage ratio (LCR), including revised definitions of high quality liquid assets and net cash outflows. The LCR will now be phased in from 2015 to 2019 and it was also re-confirmed that a stock of liquid assets would be available for use by banks in stress situations (January 2013).
The Basel Committee also turned its attention increasingly to developments beyond Basel III. In particular, it published an initial consultation paper to launch its fundamental review of the trading book (May 2012). Here, the Committee is seeking to improve the coherence of market risk capital requirements and to enhance the consistency of implementation across jurisdictions and convergence of requirements across the industry.
Systemic financial institutions With the G20-mandated target of agreeing a framework for dealing with global systemically important financial institutions having been met in 2011, much work in 2012 was at the EU level, with discussions on incorporating a general approach into CRD IV.
Globally, Financial Stability Board (FSB) workstreams under relevant bodies including the International Organization of Securities Commissions and the Basel Committee continued in five key areas: banks’ interactions with shadow banking entities; ways to reduce the susceptibility of money market funds to runs; the regulation of other shadow banking entities on prudential grounds; retention requirements and transparency in securitisation; and the possible regulation of margins and haircuts in securities lending and repos. The FSB issued an update and a further series of consultation papers on certain workshops in November 2012 and revised recommendations are expected by the G20 St Petersburg leaders’ summit in September 2013.
EU regulatory developments The EU regulatory agenda in 2012 continued to focus mainly on prudential and market structure measures. Retail issues also came under increased focus. Key highlights were as follows: The Liikanen Review In November 2011, the EU Commissioner for Internal Market and Services, Michel Barnier, announced the establishment of a High-Level Expert Group to consider structural reform of EU banks and in early 2012 it was convened under the chairmanship of Erkki Liikanen, the Governor of the Bank of Finland. The group was mandated to consider measures to improve EU banks’ stability and efficiency. In addition to any new measures, it was tasked to look at ongoing structural reforms, including the UK Independent Commission on Banking and the US ‘Volcker Rule’.
Crisis management and banking union proposals In June 2012, the EU Commission published proposals for an EU-wide recovery and resolution regime, providing for banks and authorities to maintain plans for each firm, setting out measures to set right or resolve businesses should they face difficulties. Authorities would receive a number of powers to intervene in banks for these purposes, including early intervention powers ahead of problems coming to light, and a minimum set of tools to restructure or wind up a failed firm.
Among the new tools is the power to ‘bail in’ senior creditors when resolving a firm, to ensure losses are spread among shareholders and creditors, without recourse to tax-payer funding. Bailed-in creditors take a loss and become shareholders in the new entity created.
These proposals are likely to be agreed in 2013, with member states and banks in compliance from 2015, and bail-in provisions from 2018. Notwithstanding these developments, the euro-area crisis continued to develop and in July 2012, the President of the European Council, Herman Van Rompuy, set out a road-map for further euro-area financial integration. This aims to both resolve the current crisis and tackle longstanding structural problems in the single-currency zone. Fundamental to these proposals are banking and fiscal union and further economic integration. The President’s banking union proposal comprises: a Single Supervisory Mechanism; and mutualisation of bank losses through common deposit guarantee and resolution funding arrangements. The latter two elements are planned to follow agreement of the recovery and resolution regime in 2013.
The European Parliament is now considering the proposals, with agreement expected in early 2013. The ECB will not acquire full supervisory authority until March 2014 and there is scope to delay this. Operational elements, such as how the ECB will be staffed, how it will interact with national supervisors and how it will implement its new macro-prudential responsibilities, remain to be seen. More detail should emerge during 2013.
Progress of the legislation was slower than hoped and did not conclude before the Basel III start date of 1 January 2013. Nevertheless, the European Banking Authority did press ahead with proposals for a number of the technical standards mandated by CRD IV, including: reporting of own funds, liquidity, leverage and large exposures; gain on sale of associated with future margin income in a securitisation context; credit valuation adjustment; and prudent valuation.
Other prudential initiatives have included, notably: continued work on developing the Solvency II framework for insurers; capital requirements for central counterparties; corporate governance in financial institutions; and supervision of financial conglomerates.
Other initiatives - these have included proposals to revise the Data
EU retail market reforms Notwithstanding the focus on prudential and market reforms in response to the financial crisis, the EU Commission during 2012 also continued to work on a wide range of retail agenda initiatives. These included: bank account transparency, switching and the potential for making basic bank accounts a legal right for EU citizens; the Insurance Mediation Directive II, which could have implications for packaged accounts with inbuilt insurance products; multilateral interchange fees; and the Mortgage Credit Directive, which is still progressing through the legislative process and which covers areas including responsible lending and pre-contract disclosure.
Regulatory architecture reforms The Financial Services Act to introduce the “twin peaks” model of financial regulation received Royal Assent in December 2012 and so the formal split of the FSA into the Prudential Regulation Authority and the Financial Conduct Authority will take place on 1 April 2013 as expected. In the meantime, the FSA continued to alter its structure in anticipation of the split. The Group has been closely involved in work with trade associations to respond to a number of related consultations, notably to the ‘Journey to the FCA’ document.
UK regulatory developments UK regulatory developments during 2012 continued to be extensively determined by global and EU developments, with UK regulators working to implement requirements coming into force and actively participating in policy development at the EU and global levels. There was less focus on prudential reviews issued by UK authorities in 2012 but nevertheless a number of papers were published, including consultations on macroprudential tools and large exposures. In addition, there were a number of other developments specific to the UK.
Other risks: Regulatory risk* continued Retail conduct issues In addition to EU retail initiatives, the UK authorities continued to pursue additional issues during 2012. These included initiatives relating to Universal Credit, a review into the personal current account market and continuing work on the Retail Distribution Review ahead of its implementation on 31 December 2012. Work also continues on the Mortgage Market Review, Packaged Accounts and Simple Financial Products. Preparation for the new Financial Conduct Authority (FCA) stepped up, including papers on its powers, regulatory approach and the desire for transparency in areas such as product intervention and publication of Ombudsman decisions. The Group expects significant implementation and ongoing costs to arise from changes to documentation, structure and processes as well as increased regulatory fees.
Front-end supervisory resources have been increased and existing tools have been used more frequently and robustly evidenced, for instance, in terms of the heightened number of information requests, the increased deployment by the FSA of skilled person reports as well as the increased fines charged against the industry. Across the industry, fines for 2012 totalled £311.6 million, compared with £66.1 million in 2011, and £5.3 million as the financial crisis began in 2007.
Key final rules were issued on a range of issues, including prudential standards for systemically important financial institutions, removal of certain references to credit rating agencies, Basel 2.5 market risk standards and final definitions of swap dealers, major swap participants and swaps. Requirements for the registration of entities as swap dealers took effect from 12 October 2012, with registration commencing from 31 December 2012 once firms reach certain activity thresholds. RBS plc was one of 65 global entities which registered with effect from 31 December 2012.
Other proposals included Basel III capital and leverage standards and disclosures and other rules relating to mortgages. The Volcker Rule, which restricts proprietary trading and investments in private equity/hedge funds, was not finalised by its effective date of 21 July 2012 but in April 2012 the Federal Reserve Board issued an interpretation which provided some guidance to the effect that banks should demonstrate their ‘good faith’ planning efforts in the two-year conformance period to July 2014.
Group Regulatory Affairs maintains a well-established policy and supporting processes for the identification and management of such changes across the Group. Group Board and Executive Committee oversight is supported by a Prudential Regulatory Developments Executive Steering Group, which was formed in early 2010 to provide a specific focus on a range of key regulatory changes augmented by more specialised groups which cover capital, liquidity, prudential and wholesale market and retail conduct issues. In addition, there is a divisional Heads of Regulatory Developments forum and an RBS Americas regional forum.
Reporting and internal communications activity expanded in 2012 in response to the growing regulatory change agenda. This included: monthly reporting of key developments to the Group Risk Committee; substantial enhancements to the suite of tools used to monitor and react to regulatory developments; and increased communications, such as staff seminars, publication of additional information such as house views on key issues on internal websites and the weekly Regulatory Affairs Flash Report, circulated widely across the Group, which captures key regulatory developments and relationship topics.
Key regulatory policies - ‘Group Relationships with Regulators’ and ‘Political, Legislative and Regulatory Environment’, are kept under annual review. Each incorporates a new risk appetite statement, relevant benchmarking activity against the Group's peer banks and, for the latter, an end-to-end review and mapping of the upstream risk management process.
The Group intends to continue its activities aimed at producing robust and effective plans and to proactively influence policy makers regarding the most practical approach to implementing the regulations. It will also be important to consider how individual regulations might be implemented in a manner that takes advantage of any potential synergies and avoids unnecessary re-work. The potential overlaps between recovery and resolution planning and the proposals arising from the Independent Commission on Banking, the US and the EU will provide an area of focus in this regard.
Other risks continued Conduct risk* Conduct risk is the risk that the conduct of the Group and its staff towards its customers, or within the markets in which it operates, leads to reputational damage and/or financial loss by breaching regulatory rules or laws, or failing to meet customers’ or regulators’ expectations of the Group. Activities through which conduct risk may arise include: personal account dealing; privacy and data protection; conflicts of interest; money laundering; and bribery and corruption.
The Group’s compliance functions are responsible for monitoring the management of conduct risk, including anti-money laundering (AML); sanctions and terrorist financing; and anti-bribery and corruption. In doing so, they design, implement and maintain an effective management framework to enable consistent identification, assessment, monitoring and reporting of conduct risk.
Policy design and implementation Placing conduct risk at the centre of the Group’s philosophy promotes a customer-oriented culture that informs and challenges business strategy, delivers fair outcomes and promotes behaviours consistent with regulatory and legal standards across its retail and wholesale markets.
Completion by the separate AML Change Programme of its Groupwide gap analysis and benchmarking against enhanced policies, including recording identified issues, establishing a new AML organisational reporting and accountability hierarchy, initiating comprehensive and continuing tailored staff training; and establishing a global AML assurance programme.
A comprehensive and progressive training programme supports the professional development of the Group’s compliance teams. All members of these teams are engaged in compliance eLearning, including a mandatory ‘essentials’ course, and RBS Risk Academy, through which all staff are required to complete foundation courses in other risk disciplines, such as operational risk, market risk and retail credit risk. Formal training is supplemented by regulatory familiarisation, designed to share knowledge and support both personal development and technical training across the Group’s wider risk community.
During 2012, as well as providing thematic process reviews and assurance over specific compliance topics, the Group Compliance assurance teams, working with its divisional counterparts, validated the closure of issues it identified during the 2011 programme of Group-wide assurance reviews, and identified common issues between divisions.
Stakeholders include customers, investors, rating agencies, employees, suppliers, government, politicians, regulators, special interest groups, consumer groups, media and the general public. Brand damage can be detrimental to the business in a number of ways, including an inability to build or sustain business relationships with customers, low staff morale, regulatory censure or reduced access to funding sources.
One of the most fundamental stakeholder expectations is that a bank is financially prudent, safe and sound. The Group has made significant progress in meeting this expectation through the execution of its Strategic Plan in restructuring its balance sheet and improving its capital and funding position. Major reforms have also been made to strengthen its risk identification, evaluation and management processes. Further work remains, but the Group is now in a much stronger financial position to face challenges and uncertainties in its economic and operating environment.
The Group’s reputational risk management framework is aligned with its strategic objectives and its risk appetite goal of maintaining stakeholder confidence. It is designed to embed, at different points of decision-making processes, a series of reputational filters and controls that examine products, services and activities through the lenses of sustainability, transparency and fairness.
This approach recognises that reputational risk can arise across a range of actions taken (or not taken) by the Group, as well as its wider conduct, policies and practices. Therefore, it is aligned with the management of a range of risk types that have a high reputational sensitivity.
The Group Board risk report contains a ‘top slice’ view of key embedded risks, including a reputational risk impact assessment of each key risk. In addition, the divisions report to their own committees and Boards on relevant barometers of reputational risk and actions to manage reputational events according to the source.
For example, an Environmental, Social and Ethical (ESE) risk management function assesses the ESE risks associated with business engagements and business divisions, while the Group Policy Framework includes a range of policies relating to conduct and reputational matters.
Business risk* Business risk is the risk that the Group suffers losses as a result of adverse variance in its revenues and/or costs relative to its business plan and strategy. Such variance may be caused by internal factors such as volatility in pricing, sales volumes and input costs and/or by external factors such as the Group’s exposure to macroeconomic, regulatory and industry risks.
The Group seeks to minimise its exposure to business risk, subject to its wider strategic objectives. Business risk is identified, measured and managed through the Group’s planning cycles and performance management processes. Expected profiles for revenues and costs are determined, on a bottom-up basis, through plans reflecting expectations of the external environment and the Group’s strategic priorities. These profiles are tested against a range of stress scenarios and factors to identify the key risk drivers behind any potential volatility, along with management actions to address and manage them.
The management of business risk lies primarily with divisions, with oversight at the Group level led by Finance. Divisions are responsible for delivery of their business plans and management of such factors as pricing, sales volumes, marketing spend and other factors that can introduce volatility into earnings.
Other risks continued Pension risk* The Group is exposed to risk from its defined benefit pension schemes to the extent that the assets of the schemes do not fully match the timing and amount of the schemes’ liabilities. Pension scheme liabilities vary with changes in long-term interest rates and inflation in particular, as well as pensionable salaries, the longevity of scheme members and changes in legislation. The Group is exposed to the risk that the market value of the schemes’ assets, together with future returns and any additional future contributions could be considered insufficient to meet the liabilities as they fall due. In such circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes or be required to hold additional capital to mitigate such risk.
The RBS Group Pension Fund (‘Main scheme’) is the largest of the schemes and the main source of pension risk. The Main scheme operates under a trust deed under which the corporate trustee, RBS Pension Trustee Limited, is a wholly owned subsidiary of The Royal Bank of Scotland plc. The trustee board comprises six directors selected by the Group and four directors nominated by members.
In October 2006, the Main scheme was closed to new employees. In November 2009, the Group confirmed that it was making changes to the Main scheme and a number of other defined benefit schemes including the introduction of a limit of 2% per annum (or the annual change in the Consumer Price Index, if lower) to the amount of any salary increase that will count for pensionable purposes. In October 2012, the Group confirmed that it was increasing the charge made through its flexible benefits programme for membership of the Main scheme by 5% of salaries, with employees having the alternative of accepting an increase in their Normal Pension Age from 60 to 65 in respect of service from October 2012 at no additional cost.
Risk management framework The Group manages the risk it faces as a sponsor of its defined benefit pension schemes using a pension risk management framework that encompasses risk reporting and monitoring, stress testing, modelling and an associated governance structure that helps ensure the Group is able to fulfil its obligation to support the defined benefit pension schemes to which it has exposure.
Stress testing and modelling Throughout 2012, various pension risk stress testing initiatives were undertaken, focused both on internally defined scenarios and on scenarios to meet integrated FSA stress testing requirements. On an annual basis, the Internal Capital Adequacy Assessment Process is also modelled. This entails assessing changes in pension asset and liability values over a 12-month horizon under various stresses and scenarios.
Governance A key component of the pension risk framework is the Pension Risk Committee. This committee also serves as a formal link between the Group and the Investment Executive, which acts on behalf of the trustee of the Group’s largest pension schemes, on risk management, asset strategy and financing issues and has facilitated an agreement between the two on mechanisms for reducing risk within the RBS Group Pension Fund.
As part of the continuing development of the pension risk management framework within the Group, key achievements in 2012 focused on developing an improved pension risk reporting, monitoring, modelling and stress testing capability for the Group. The focus for 2013 will revolve around extending and embedding these improvements across the Group.
Main scheme The most recent funding valuation, at 31 March 2010, was agreed during 2011. It showed that the value of liabilities exceeded the value of assets by £3.5 billion at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the Group agreed to pay additional contributions each year over the period 2011 to 2018. These contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. Further details are provided in Note 4 of the consolidated accounts. The next funding valuation is due at 31 March 2013.
The assets of the Main scheme, which represent 85% of Group pension plan assets at 31 December 2012, are invested in a diversified portfolio of quoted and private equity, government and corporate fixed interest and index-linked bonds, and other assets including property and hedge funds. The trustee has taken measures to partially mitigate inflation and interest rate risks both by investing in suitable physical assets and by entering into inflation and interest rate swaps. The Main scheme also uses derivatives within its portfolio to manage the allocation to asset classes and to manage risk within asset classes.
At 31 December 2012 Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields 76 255 (179) Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields 578 995 (417) Fall in credit spreads of 0.25% at all durations with no change in nominal or real swap yields 71 1,261 (1,190) Fall in equity values of 10% (862) — (862)
It has been a challenging year for the Group, and the banking sector as a whole, against a backdrop of difficult market conditions and a fast moving regulatory environment. We are fortunate to have engaged and dedicated Board members willing to commit extensive time, individually and collectively, to work towards the recovery of the Group and to build a sustainable business.
Further details on the role and principal activities of the Board are contained within the Corporate governance report on pages 294 to 342. Individual reports from the Group Audit Committee, Board Risk Committee and Group Performance and Remuneration Committee are also contained within the Corporate governance report.
Our statement of compliance with the UK Corporate Governance Code (the “Code”) dated June 2010 is set out on page 343. Our Corporate governance report also includes additional disclosures representing early compliance with a number of the new provisions introduced by the UK Corporate Governance Code dated September 2012 (the “2012 Code”). Reporting under the 2012 Code will take effect for our 2013 financial year.
Whilst no new directors were appointed in 2012, the composition of the Board has been kept under review by the Group Nominations Committee during the year and we will continue to ensure that there is an appropriate balance of skills, experience and knowledge on the Board. The Board operates a formal boardroom diversity policy which aims to promote diversity in the composition of the Board. Under this policy, all Board appointments will be made on the basis of individual competence, skills and expertise measured against identified objective criteria and we already meet the target of 25 per cent female board representation. Further details on the boardroom diversity policy can be found on page 307.
Leadership and Board Effectiveness As Chairman, I am responsible for ensuring we have an effective Board and for leading the Board. I am supported by the Group Nominations Committee in reviewing Board composition and the recruitment of new directors and by the Group Secretary on induction, continuing professional development, Board process (including information flows) and evaluation.
We conduct an annual evaluation of the effectiveness of the Board and this year’s evaluation was facilitated externally. I also evaluate the individual performance of each of the non-executive directors and all directors stand for re-election annually. This year’s evaluation has concluded that the Board is operating effectively and has suggested some further improvements that could be made to the operation of the Board and we will be acting upon these suggestions during 2013. Further details on performance evaluation are set out on page 305.
Group Performance and Remuneration Committee (formerly Group Remuneration Committee) has oversight of the Group’s policy on remuneration. It also considers senior executive remuneration and makes recommendations to the Board on remuneration of executive directors.
Group Nominations Committee assists the Board in the selection and appointment of directors. It reviews the structure, size and composition of the Board, and membership and chairmanship of Board committees.
Group Sustainability Committee is responsible for overseeing and challenging how management is addressing sustainability and reputation issues relating to all stakeholder groups, except where such issues have already been dealt with by other Board committees.
Philip Hampton (age 59) Date of appointment: appointed to the Board on 19 January 2009 and to the position of Chairman on 3 February 2009
Sandy Crombie (age 64) Senior Independent Director Date of appointment: 1 June 2009
Previously group chief executive of Standard Life plc. He was also previously a director of the Association of British Insurers, a member of the former Chancellor of the Exchequer’s High Level Group on Financial Services and Chairman of the Edinburgh World City of Literature Trust. In 2007 he was the Prince of Wales’ Ambassador for Corporate Social Responsibility in Scotland.
External appointments Chairman of Creative Scotland Member and vice-chairman of the Board of
Board Committee membership Group Sustainability Committee (Chair) Board Risk Committee Group Nominations Committee Group Performance and Remuneration
Former director of City National Bank, First Data Corporation and chair of the board of LECG Corporation. She previously worked at McKinsey & Company, AT Kearney, as chief financial officer at Barclays Global Investors (now BlackRock) and managing partner of Belvedere Capital, a private equity firm focused on buyouts in the financial services sector.
Non-executive director, chair of audit committee and member of compliance committee of Xoom Corporation
Chair of the Governing Board of Women’s Initiative for Self Employment
Tony Di Iorio (age 69) Date of appointment: 1 September 2011
Board Committee membership Board Risk Committee Group Audit Committee Group Nominations Committee
External appointments Non-executive director, chair of corporate compliance and responsibility committee and member of audit, nomination and remuneration committees of Wm Morrison Supermarkets plc
External appointments Chairman of Prytania Holdings LLP Chairman of the Brendoncare Foundation Non-executive director of Huntsworth plc
Former global chairman, financial services for KPMG. Previously held senior leadership roles within KPMG including as a member of the KPMG UK board from 1999 to 2006 and as vice chairman from 2006. Chairman of the Audit Committee of the Institute of Chartered Accountants of Scotland from 2005 to 2008.
Board Committee membership Board Risk Committee (Chair) Group Audit Committee Group Nominations Committee
A qualified solicitor, joined RBS in 2000. She was appointed Deputy Group Secretary and Head of Group Secretariat in 2007, and prior to that held various legal, secretariat and risk roles including Head of External Risk, Retail, Head of Regulatory Risk, Retail Direct and Head of Legal and Compliance at Direct Line Financial Services.
On 6 February 2013, the Group announced that John Hourican will leave the Group once he has completed a handover of his responsibilities. With effect from 1 March 2013, Suneel Kamlani and Peter Nielsen will be coheads of the Markets division and John Owen will continue to lead the International Banking division and all will report directly to the Group Chief Executive.
Chris Sullivan (age 55) Chief Executive, Corporate Banking Chris Sullivan was appointed Chief Executive of the Corporate Banking Division in August 2009 and also has responsibility for Ulster Bank Group. Chris’ previous role was as Chief Executive of RBS Insurance. Prior to this, Chris was Chief Executive of Retail and Deputy Chief Executive of Retail Markets. Chris is the Group sponsor for Gender Diversity and the Group’s internal Women’s Networks and was recognised as the European Diversity Champion of the Year in 2011. He is an active sponsor of professional and leadership development and is a member of the Chartered Banker Professional Standards Board and Governor of both Ashridge College and the ifs School of Finance. Chris holds a number of positions outside the Group including Chairman of both the Global Banking Alliance and the Inter-Alpha Group of Banks. Chris earned his Fellowship of the Chartered Institute of Bankers in Scotland for his services to Scottish Banking.
Ron Teerlink (age 52) Chief Administrative Officer Ron Teerlink joined the RBS Group in April 2008 as Chief Executive of Business Services, becoming the Group Chief Administrative Officer in February 2009. At the same time he was re-appointed to the Managing Board of ABN AMRO to oversee the integration programme. Ron started his career with ABN Bank in 1986 as an IT/Systems analyst and held various functional positions before becoming Chief Operating Officer of the Wholesale Clients Business in 2002. He was appointed Chief Executive Officer of Group Shared Services in 2004 and joined ABN AMRO’s Managing Board in January 2006, where he was responsible for Services and Market Infrastructure. Ron holds a Masters degree in Economics from Amsterdam’s Vrije Universiteit. Ron will step down from his role at RBS in the first half of 2013.
It comprises members of the Executive Committee plus a number of other senior executives. Full details of membership of the Management Committee can be found on the Group’s website www.rbs.com
The Role of the Board The Board is the main decision-making forum for the company. It is collectively responsible for the long-term success of the company and is accountable to shareholders for financial and operational performance.
There are a number of areas where the Board has delegated specific responsibility to management, including to the Group Chief Executive and the Group Finance Director. These include responsibility for the operational management of the Group’s businesses as well as reviewing high level strategic issues and considering risk appetite, risk policies and risk management strategies in advance of these being considered by the Board and/or its Committees. Specific delegated authorities are also in place in relation to business commitments across the Group.
Membership of the Board The Board currently comprises the Chairman, two executive directors and nine independent non-executive directors, one of whom is the Senior Independent Director. The Board functions effectively and efficiently and is considered to be of an appropriate size. The directors provide the Group with the knowledge, mix of skills and experience required. The Board committees comprise directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.
Under the Companies Act 2006, directors have a duty to avoid conflicts of interest unless authorised. The Board has, since this duty was introduced in 2008, operated procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest (as set out in the Articles of Association) are being operated effectively. The Board has therefore considered, and where appropriate authorised, any actual or potential conflicts of interest that directors may have. The Board reviews its conflicts register annually.
Election and re-election of directors In accordance with the provisions of the Code, all directors of the company are required to stand for re-election annually by shareholders at the company’s Annual General Meeting. Further information in relation to the company’s Annual General Meeting can be found in the Chairman’s letter to shareholders that accompanies the notice of meeting.
Board meetings In 2012, nine Board meetings were scheduled and individual attendance by directors at these meetings is shown in the following table. One of the Board meetings took place overseas during the Board’s visit to the Group’s US businesses.
In addition to the nine scheduled meetings, 28 additional meetings of the Board and Committees of the Board were held, including meetings to consider and approve financial statements. The Chairman and the nonexecutive directors meet at least once per year without executive directors present.
Notes: (1) Unable to attend a number of Board meetings during 2012 due to family illness. (2) Retired from the Board on 31 March 2012.
At each Board meeting, the Chairman provided a verbal update on his activities and external engagement and the Group Chief Executive provided a written report on business activities. The Board’s key priorities during 2012 have been conduct risk and culture, regulatory developments and investigations and the continued delivery of the Group’s Strategic Plan. The directors received reports on the Group’s financial performance, capital, funding and liquidity positions and risk management together with regular reports on strategy, risk appetite, litigation and treating customers fairly. Specific strategy sessions were held in January, April and June. Other matters considered by the Board during 2012 included the Independent Commission on Banking reports, Recovery and Resolution Planning and Technology. Strategy, capital, funding and risk are expected to remain key areas of focus for the Board during 2013.
An annual programme of divisional presentations is agreed by the Board each year. During 2012, the Board received in-depth presentations from Direct Line Group, Wealth, Global Restructuring Group, UK Corporate, Non-Core, Ulster Bank Group, RBS Citizens Financial Group, UK Retail, Markets and International Banking. These presentations enhance the Board’s knowledge of the Group’s key divisions and afford directors the opportunity for discussion and debate with divisional senior management.
In line with the recommendations of the Walker Review of Governance in Banks and Financial Institutions (the Walker Review) and the Code, the Group has a comprehensive induction programme for new directors that is kept under review by the Group Secretary. Each new director receives a formal induction on joining the Board, including visits to the Group’s major divisions and meetings with directors and senior management and key stakeholders. Each induction programme includes a mandatory element which comprises 12 meetings, visits and sessions. The remainder of the induction programme is tailored to the new director’s specific requirements and includes meetings with key executives and their teams and visits to divisions, businesses and Group functions, both in the UK and overseas.
As part of their ongoing professional development, directors are advised of appropriate external training and professional development opportunities and undertake the training and professional development they consider necessary to assist them to carry out their duties as directors. Internal training is also provided, tailored to the business of the Group. Continuing professional development logs are maintained by the Group Secretary and are reviewed regularly with directors to ensure training and development opportunities are tailored to individual directors’ requirements.
In 2012, as part of their ongoing development, the directors received briefings on the UK Bribery Act 2010, the new UK regulatory regime, various Financial Reporting Council consultations (including amendments to the Code, audit committee guidelines, the stewardship code and international standards on auditing for the UK and Ireland), a number of government consultations on narrative reporting, executive remuneration and shareholder voting rights and the draft proposals under the Capital Requirements Directive IV, as well as other regulatory consultations.
Business visits are also arranged as part of the Group Audit Committee and Board Risk Committee schedule and all non-executive directors are invited to attend. The Group Audit Committee and the Board Risk Committee undertook a total of six visits in 2012 to RBS Risk Management (2), Group Internal Audit (2), Group Finance and Business Services to review the Change programme.
In 2012, the Board and Committee evaluation process was independently facilitated by IDDAS Limited, a specialist board evaluation consultancy. IDDAS Limited were selected following a competitive tender and the Board is satisfied that IDDAS Limited has no other connection with the Group.
A summary of the key themes arising from 2012 performance evaluation is set out below, together with an overview of the proposed actions: Key themes included Proposed action
The Group Sustainability Committee to be given an expanded remit for customer related sustainability and reputation issues, oversight of cultural and behavioural change, and sustainability aspects of the people agenda.
Philip Hampton (Chairman) 4/4 Sandy Crombie 4/4 Alison Davis 4/4 Tony Di lorio 4/4 Penny Hughes 4/4 Joe MacHale 4/4 Brendan Nelson 4/4 Baroness Noakes 4/4 Art Ryan (1) 3/4 Philip Scott 4/4
Principal activity of the Group Nominations Committee during 2012 Consideration of new non-executive directors During 2012, the Group Nominations Committee kept the structure, size and composition of the Board under review as well as the diversity of skills and experience. Given that Joe MacHale was expected to step down from the Board during 2013, having served as a Non-executive Director since 2004, the Group Nominations Committee agreed to commence a search for a potential additional non-executive director.
Boardroom diversity The Board remains supportive of Lord Davies’ recommendations and currently meets the target of 25 per cent female board representation as set out in Lord Davies’ report. In accordance with the recommendations contained within Lord Davies’ report, the Board operates a boardroom diversity policy and a copy of the Board’s diversity statement is available on www.rbs.com
Further details on the Group’s approach to diversity can be found on pages 346 and 347.
Group Sustainability Committee During 2012, the Group Sustainability Committee focused on reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues. The role, responsibilities and membership of the Committee were reviewed at the end of 2012 as part of the Group’s Purpose, Vision and Values programme. In 2013, the Committee’s scope will widen to include:sustainability and reputational issues related to customer and citizenship activities; oversight of the delivery of the Purpose, Vision and Values cultural and behavioural change; and oversight of the sustainability aspects of the people agenda.
Communication with the company's largest institutional shareholders is undertaken as part of the Investor Relations programme: the Group Chief Executive and Group Finance Director meet regularly with UKFI, the organisation set up to manage the Government’s investments in financial institutions, to discuss the strategy and financial performance of the Group. The Group Chief Executive and Group Finance Director also undertake an extensive annual programme of meetings with the company’s largest institutional shareholders.
the Chairman independently meets with the Group’s largest institutional shareholders annually to hear their feedback on management, strategy, business performance and corporate governance. Additionally, the Chairman, Senior Independent Director and chairs of the Board committees met with the governance representatives of a number of institutional shareholders during the year.
The Group’s Investor Relations programme also includes communications aimed specifically at its fixed income (debt) investors. The Group Finance Director and/or Group Treasurer give regular presentations to fixed income investors to discuss strategy and financial performance. Further information is available on the Group’s website www.rbs.com/ir
External market conditions have continued to be difficult and managing the intensity of the regulatory agenda while remediating existing and certain new issues has inevitably determined the focus of the Group Audit Committee during 2012. However, I am pleased to report that against this challenging backdrop, the Committee continued to meet its key objectives in the period in accordance with its terms of reference.
The Group Audit Committee exercised oversight of the Group’s financial reporting and policy. It monitored the integrity of the financial statements of the Group and reviewed significant financial and accounting judgements. The Committee sought to understand and to challenge management’s accounting judgements and satisfied itself that disclosures in the financial statements about these judgements and estimates were transparent and appropriate. The Group Audit Committee also met the External Auditors in private in advance of key meetings in order to obtain an independent view on the key disclosure issues and risks in relation to the financial statements.
In particular, the Committee has considered: the directors’ going concern disclosure including the Group’s capital, liquidity and funding position; the adequacy of the Group’s loan impairment provisions, focusing particularly on the Ulster Bank loan portfolio and commercial real estate exposures; the impact of the Group’s forbearance policies on provisioning; the Group’s valuation methodologies and assumptions for financial instruments measured at fair value; the adequacy of the Group’s general insurance reserves; valuation of the Group’s defined benefits pension schemes; carrying value of the Group’s goodwill and other intangible assets; the recoverability of the Group’s deferred tax assets; the methodology and assumptions underlying the Group’s provisions for payment protection insurance and interest rate hedging products redress; the Group’s provisions for outstanding litigation and regulatory investigations; and the impact of the announcement that Santander would not complete its planned purchase of certain UK branch-based businesses.
The Group Audit Committee continued to encourage enhancements to the disclosures in the Group’s external financial reports. Revised versions of the UK Corporate Governance Code and related Guidance for Audit Committees were issued by the Financial Reporting Council in September 2012. The Committee considered the new requirements and has endeavoured to comply early, where appropriate to do so. The Committee also considered the recommendations of the Enhanced Disclosure Task Force of the Financial Stability Board and the Group’s plans to meet the recommendations. I am pleased to report that several of the Group’s disclosures were highlighted within the report as examples of best practice.
A key responsibility of the Committee is to monitor and review the scope, nature and effectiveness of Internal Audit. As in previous years, I met regularly with the Head of Group Internal Audit. The Committee also held two in depth sessions with Group Internal Audit. These additional meetings enabled the members of the Committee to be briefed on Group Internal Audit’s strategy under the leadership of Nicholas Crapp, who joined the Group at the start of the year, and to meet the senior management team. The Committee ensured that the Head of Group Internal Audit has appropriate independence and authority; that the scope of Internal Audit is unrestricted; that planning is appropriately risk based; and that the function has the requisite budget and resource strategy. The Head of Group Internal Audit has a direct reporting line to me and I will continue to work closely with him as we seek to strengthen further the function during 2013.
The Committee also monitored and reviewed aspects of the Group’s external audit in the period. It reviewed the scope and planning of the external audit and considered reports and recommendations from the External Auditors. It monitored the External Auditors’ independence and objectivity and ensured effective controls were in place to oversee engagements for the External Auditors to provide non-audit services. The Committee undertook an assessment of the External Auditors’ performance and recommended to the Board that re-appointment of the External Auditors be submitted to shareholders for approval at the Annual General Meeting in 2013.
During 2012, I met with the FSA and with the External Auditors on a trilateral basis as envisaged by the FSA Code of Practice. The purpose of this meeting was to discuss, in the framework of an open and cooperative relationship between the supervisor and the External Auditors, issues considered to be of interest to the parties in meeting their respective responsibilities. This meeting formed part of the Committee’s oversight of the Group’s relationship with its regulators.
The Committee reviewed the Group’s systems of internal controls and the procedures for monitoring their effectiveness. The Committee placed particular focus in 2012 on ensuring that the Group had articulated an appropriate three lines of defence model that clearly stated individuals’ responsibility and accountability for risk and control at all levels. This model is expected to be fully embedded in 2013 and the Group Audit Committee will closely monitor delivery within the divisions and functions.
Litigation and regulatory investigations featured heavily on the agenda of both the Group Audit Committee and Board Risk Committee in the period, highlighting some deficiencies in the control environment. During 2012 the Board asked the Group Audit Committee to monitor progress of the internal and various ongoing regulatory investigations and claims based on allegations that the Group had made inappropriate submissions to influence the setting of interest rates. The Committee met regularly to receive updates on the investigations, including on an ad hoc basis. It worked closely with the Group Performance and Remuneration Committee to make decisions and recommendations in relation to individual accountability.
Brendan Nelson (chairman) 7/7 Tony Di Iorio 7/7 Baroness Noakes 7/7 Philip Scott 7/7
All members of the Group Audit Committee are also members of the Board Risk Committee facilitating effective governance of finance and risk issues. The Group Audit and Board Risk Committees also have strong links with the Group Performance and Remuneration Committee ensuring that levels of compensation reflect relevant finance and risk considerations.
Performance evaluation An external review evaluating the effectiveness of the Group Audit Committee takes place every three to five years with internal reviews by the Board in the intervening years. An external review of the Board and its senior committees took place during 2012. Overall, the review concluded that the Group Audit Committee continued to operate effectively.
Review the arrangements of the Group’s systems of internal controls in relation to financial management, compliance with laws and regulations, safeguarding of assets, and the procedures for monitoring the effectiveness of such controls.
Monitor and review reports prepared by the External Auditors, including their annual management letter; Approve the terms of engagement of the External Auditors; Resolve any disagreements between management and the External Auditors regarding financial reporting; and Asses the performance of the External Auditors annually.
• Review the arrangements of the Group’s systems of internal controls in relation to financial management, compliance with laws and regulations, safeguarding of assets, and the procedures for monitoring the effectiveness of such controls.
• Monitor and review the scope, nature of the work and effectiveness of Internal Audit; and
• Receive and review its reports, findings and recommendations covering the management of key operating risks, the adequacy of any necessary follow up action and any relevant investigation work.
• Monitor the relationship with the Financial Services Authority and other relevant regulatory bodies, including review of the scope and results of work conducted by the Skilled Persons approved by the Financial Services Authority.
A report on the activity of the Group Audit Committee in fulfilling its responsibilities was provided to the Board following each Committee meeting. The key considerations of the Committee during 2012 are explained more fully below.
Financial reporting and policy The Group Audit Committee focused on a number of salient judgments and reporting issues in the preparation of the 2012 accounts, and considered: the directors’ going concern conclusion, including the Group’s capital, liquidity and funding position. Further information is set out on page 347; the adequacy of loan impairment provisions in Ulster Bank. The Irish economy showed some signs of stabilisation but there remained significant uncertainty. The Committee considered the level of provision for loan impairment in light of these uncertainties. It monitored external conditions closely and compared loss experience with forecasts. Loan impairments in the Corporate and Non-core divisions were also carefully reviewed. During 2012, the Committee also revisited the application of IAS 39 to loan impairment rules and concluded that the Group applies them on a neutral and consistent basis; the Group’s forbearance policies. The Committee considered the impact of forbearance on provision levels and monitored emerging trends and reporting capabilities across the Group’s various portfolios; the approach to valuation of the Group’s financial instruments measured at fair value, including its credit market exposures and liabilities carried at fair value; the adequacy of reserves held to meet the claims in the Group’s general insurance business. The Committee considered management’s assessment of the full cost of settling outstanding general insurance claims including claims estimated to have been incurred but not yet reported and for claims handling expenses. It is comfortable that the level of provision is appropriate based on claims experience and on statistical models; valuation of the Group’s defined benefit pension scheme. The
Group’s IT incident in June 2012; the impact of the announcement that Santander would not complete its planned purchase of certain UK branch-based businesses. The Committee considered whether the assets and liabilities should continue to be “held for sale” at 31 December 2012 and concluded that they should no longer be held for sale and that they should be reclassified to the relevant balance sheet captions in the consolidated balance sheet; and the quality and transparency of disclosures bearing in mind regulatory developments and expectations. The Committee received a report on the recommendations of the Financial Stability Board’s Enhanced Disclosure Task Force and the Group’s plans to meet the recommendations.
During the period, the Group Audit Committee reviewed progress against plan for a number of strategic initiatives such as the Finance and Risk Transformation Programme. It also tracked progress in relation to mandatory and remedial projects including the Group’s Anti-Money Laundering Programme and the progress of the Group’s US regulatory initiatives.
The Committee received reports on the operation of the Group Policy Framework. At its request, a policy standard was developed on the management of model risk across the organisation. This standard sets minimum requirements for ownership, design and use of models in the Group. The Committee will review operation of this and other policy standards, and the outputs of assurance activity in early 2013.
The Group Audit Committee considered Group Internal Audit’s annual plan and the adequacy of its resources and budget. Nicholas Crapp joined the function at the beginning of 2012 and the Committee reviewed the strategy for Group Internal Audit under his leadership.
Committee and senior management; the clarity and quality and robustness of written reports presented to the Committee setting out the External Auditors’ findings; the quality of observations provided to the company by the External
Auditors on the Group’s systems of internal control; and the views of management on the performance of the External
The second phase of the review will be conducted following completion of all year end processes and will involve targeted interviews with individuals based on outputs from the initial phase and level of interaction with the External Auditors.
In addition to the annual evaluation performed by the Group Audit Committee, the External Auditors will also conduct their own annual review of audit quality. Twelve service criteria for the audit have been defined by the External Auditors to measure their performance against the quality commitments set out in their annual audit plan, under the headings of ‘quality of audit, approach and conduct’, ‘independence and objectivity’, ‘quality of the team’ and ‘value added’.
The Group Audit Committee is responsible for making recommendations to the Board in relation to the appointment, re-appointment and removal of the External Auditors. In order to make a recommendation to the Board, the Group Audit Committee considers and discusses the performance of the External Auditors, taking account of the outcomes of the annual evaluation carried out. The Board submits the Group Audit Committee's recommendations to shareholders for their approval at the Annual General Meeting. The Board has endorsed the Group Audit Committee's recommendation that shareholders be requested to approve the reappointment of Deloitte LLP as External Auditors at the Annual General Meeting in 2013. The Group Audit Committee also fixes the remuneration of the External Auditors as authorised by shareholders at the Annual General Meeting.
A competitive tender process is required for all proposed non-audit services engagements where the fees are expected to exceed £100,000. Engagements below £100,000 may be approved by the Chairman of the Group Audit Committee; as an additional governance control all engagements have to be approved by the Group Chief Accountant and Group Procurement. Where the engagement is tax related, approval must also be obtained from the Head of Group Taxation. Ad hoc approvals of non-audit services are ratified by the Group Audit Committee each quarter. During 2012, the External Auditors were approved to undertake certain significant engagements which are categorised and explained more fully below: Summary of category of engagement Reason for selection of External Auditors
Provision of advice to management and independent assurance and assessment (one engagement)
The External Auditors were considered to be the most suitable firm to undertake this work given their extensive knowledge of the Group’s systems, end-to-end process and financial reporting framework. The considerable time pressures associated with this project meant that by appointing the External Auditors a number of efficiency savings were ensured.
While 2012 has presented significant challenges, there has also been a great deal of progress on the development and implementation of risk and control throughout the organisation. The Board Risk Committee has been pleased to exercise an oversight role in the development and enhancement of the risk management framework and associated tools that support the Group’s aim of being a safer and more sustainable bank. The Committee has provided input into the Group’s risk strategy and objectives during 2012 and has overseen the refinement and further embedding of the Group’s framework into the business divisions. This has enabled the Committee to gain an improved understanding of the major risks which the Group faces, including market risk, conduct risk, country risk, credit risk (including single name concentrations and sector risk) regulatory risk and operational risk and to ensure robust plans are in place to manage excess exposures. The Group’s stress testing capabilities have been developed and are now being used within business as usual as an effective strategic planning and capital management tool.
The Board Risk Committee has supported the articulation of a conduct risk appetite statement which is being embedded strategically within the Group’s Policy Framework. Conduct Risk standards are being communicated to staff using the four pillars of conduct risk, employee conduct, market conduct, corporate conduct and conduct towards customers. The Committee will monitor implementation of these enhanced standards during 2013.
Enhancements to risk reporting have continued in the period to ensure that reports are insightful and relevant, and provide more metric based information. Data quality is, of course, critical to the accuracy of reporting and the Committee has received in depth updates on the progress of data quality programmes and reporting initiatives ongoing throughout the organisation, most notably the Finance and Risk Transformation Programme.
Report of the Board Risk Committee Meetings and visits The Board Risk Committee held seven scheduled meetings and three additional ad hoc meetings in 2012. Meetings are held alongside Group Audit Committee meetings to ensure that the work of the two Committees is coordinated and consistent. Board Risk Committee meetings are attended by relevant executive directors, risk management, finance and internal audit executives. External advice may be sought by the Board Risk Committee where considered appropriate. During 2012, the members of Board Risk Committee, in conjunction with the members of the Group Audit Committee, took part in an annual programme of visits to the Group’s business divisions and control functions. This programme included two in depth sessions with the Risk Management function to consider key risk areas and the risk strategy and operating model. Full details about the programme of visits is set out in the Report of the Group Audit Committee on page 311.
(1) Missed one meeting owing to travel disruption as a consequence of Hurricane Sandy. (2) Joined the Committee on 1 March 2012; attended all previous meetings as an attendee.
• To review the performance of the Group relative to risk appetite and to review reports relating to any significant issues that require, or are subject to, remedial action or recommendation arising in the period under review.
• To review the Terms of Reference for RBS Risk Management; and
• To provide advice to the Group Performance and Remuneration Committee to enable it to consider adjustments to bonus pools to reflect risk management; • To review year end risk performance of Executive and Management Committee members and the risk weighting of objectives; and
Risk strategy and policy The RBS Group has a clear risk strategy supported by well defined strategic risk objectives. The members of the Board Risk Committee provide input to the overarching strategy for the Group on an ongoing basis. In the first half of 2012, the Committee reviewed and provided direction to the Group’s Resolution submission to the FSA pursuant to its Recovery and Resolution Programme. In conjunction with the Board, the Committee considered the potential implications for the Group of the proposals contained in the UK’s White Paper on Banking Reform and its interaction with potential future regulation in Europe and the US. It will continue to monitor developments throughout 2013.
The Committee also considered conduct risk in the context of product design and regulatory investigations, as referenced below.
Regulatory Reviews and Investigations Regulatory risk featured highly on the agenda of the Board Risk Committee and during 2012 the Committee assumed responsibility for considering certain key areas of risk in a deeper level of granularity. Most significantly, as highlighted above, the Committee played a central role in the oversight and remediation of the Group’s IT incident. In order to ensure appropriate outcomes for customers, members reviewed the remediation plans in detail to ensure that they were fair and robust. On behalf of the Board, the Committee oversaw the independent internal investigation of the incident. Interaction with regulators in relation to their investigation of the incident continues and the Committee has committed to ensuring that the investigation is brought to a close, accountability is fully considered and learnings are addressed across the organisation.
In recognition of the conduct issues under investigation, the Committee reviewed the product approval process. Complex products were reviewed from the perspective of the customer. The Committee intends to look at sales processes and the approvals required for process design in 2013.
Operational risks inherent in the Group’s processes were also considered and the Committee has specifically considered IT continuity, security and data control.
Significant improvements were made to the Group’s integrated stress testing capabilities over the course of 2012 and the Committee reviewed the output of stress tests and considered how these informed risk appetite and key strategic decisions. Reports on reverse stress testing, including key sensitivities and vulnerabilities were reviewed. The Committee monitored progress in the development of an economic capital model and will review how these measures and tools work together in an integrated manner.
As more fully set out in the Group Audit Committee report on page 313, a framework of Divisional Risk and Audit Committees is responsible for reviewing the business of each division and reporting to the Group Audit Committee and Board Risk Committee. During 2012, the risk agenda of these committees continued to evolve alongside the Board Risk Committee agenda. The Material Integrated Risk Assessment process that was introduced in 2011 continued to be refined in 2012 and the Committee received reports on progress.
Risk architecture The Committee reviewed the standards of data quality across the Group and the programmes in place to improve data quality. It monitored the progress of the Finance and Risk Transformation Programme, designed to develop a golden source of data for use in reporting across the Group. Improvements to data quality, management information and reporting have been identified as key areas of focus for the Committee in 2013.
Remuneration The Committee recognises that embedding the correct conduct and culture in the organisation requires an emphasis on performance management and conduct and standards. The Board Risk Committee continued to strengthen its coordination with the Group Performance and Remuneration Committee during the period, with the aim of ensuring that risk was adequately reflected in objectives and compensation arrangements and decisions. The members of the Committee met regularly during 2012, including on an ad hoc basis, to consider specific regulatory and operational issues and to consider accountability and the potential impact upon remuneration.