Governance at a glance 20 Chairman’s statement 22 Chief Executive’s review 24 Economic and monetary environment 28 Risk overview 29 Sustainability 31 Approval of Strategic Report 34
Following the conclusion of a £600 million preIPO investment by a consortium of investors led by global financial services specialists Corsair Capital and Centerbridge Partners, and including the Church Commissioners for England and RIT Capital Partners plc, the
An additional £465 million provision for Payment Protection Insurance (PPI) redress and related costs was booked in Q4 2013, making a total of £900 million for the full year
Serving our customers Investment of £700 million has been committed over the next 3-5 years to build the best retail and commercial bank in the UK. Investment in digital channels continued, with 50% of eligible customers now banking online or on mobile.
At the beginning of 2013, a personalised letter launching the new purpose and values was signed by the members of our Executive Committee and sent to all of our employees. Employees were invited to engage in an open debate online to discuss the new values – 25,000 joined that conversation.
New Leadership Standards were developed to align them directly with our values. These standards support Our Code and provide us with a clear view of what is expected from leaders and is being built into how we recruit, develop and reward them.
Each of the three businesses is built on franchises that have the potential to be the number one bank for their respective customer groups. Each is designed to: • Serve customer needs better than the existing operating divisions.
• We will move from 50 core banking systems to around 10.
At the swipe of a smartphone customers can check their balance, move money, view their transaction history, pay a contact or even take cash out without a debit card. With over £30 million transferred every day, it’s actually the bank’s busiest branch: over a 30 day period, we had around 78 million logins which is equal to each customer visiting a physical branch around 30 times a month. By contrast, people tend to visit an actual branch less than once a month.
• Operating profit increased 3% from £1,891 million to £1,943 million, driven by a decline in impairment losses.
• Excluding the impact of increased impairment losses related to the creation of RCR, return on equity was 11%.
We provide private banking and investment services in the UK through Coutts & Co and Adam & Company; offshore banking through RBS International, NatWest Offshore and Isle of Man Bank; and international private banking through Coutts & Co Ltd.
BIC supports our goal of becoming our customers’ primary banking partner through greater convenience, more privacy and fewer errors. Now we have a truly functional tool that delivers efficiency and security for our customers.
As one of their most important sites, this investment in growth will assist the UK’s shipping industry to remain globally competitive as well as acting as a catalyst for future development. It’s believed Liverpool2 will help create around 5,000 jobs in Merseyside, including additional apprenticeships – a great boost for the local economy.
Our Board The Board has 11 directors comprising the Chairman, two executive directors and eight independent non-executive directors, one of whom is the Senior Independent Director. Biographies for each director and details of which Board Committees they are members of can be found in the Corporate governance report on pages 39 to 42.
For more detail of the operation of the committee please refer to the full committee report on pages 64 and 65.
RCR and conduct issues can properly be described as legacy costs, arising from events and actions in the run-up to the financial crisis.
These skills now need to be deployed on a task of equal magnitude: creating a stepchange in the customer service and financial performance of RBS. The hardest part of our financial restructuring is now complete, and we now need to use our strengths and capabilities to make RBS an example for everything that should be right with banking.
Quality service leads to repeat business and customer advocacy. Repeat business and higher advocacy leads to sustainable income. We won’t compromise on this logic.
We will collapse seven operating divisions into three customer businesses that can understand our customers’ needs and provide appropriate, consistent services far better than we can across current silos.
Measure 4: Capital strength We will target a CET1 capital ratio, on a fully loaded Basel III basis, of 12% or greater by the end of 2016. Our targeted leverage ratio, on the same basis, will be 3.5-4% in the medium term and 4% or above in the long term.
The Group’s liquidity position continued to strengthen and at the end of the year, the liquidity portfolio of £146 billion was more than four times greater than its short-term wholesale funding of £32 billion. The loan:deposit ratio continued to improve and was 94% at the end of the year.
Sustainability at RBS means building our future on long term thinking that focuses on our customers and supporting the communities in which they live. We are committed to being open and transparent regarding the challenges faced by our business, so our stakeholders can see what we are doing to become a more sustainable bank. You can read more about the issues raised here, as well as about our wider sustainability agenda, at rbs.com/sustainable.
Total Scope 1 CO2e emissions (tonnes) 73,117 61,880 79,855 +9.2% +29%
With the launch of our new values and programme of cultural change, the Group Performance and Remuneration Committee has played a vital role in ensuring that our remuneration policy supports the desired behaviours. Remuneration decisions are considered in the context of performance on a range of issues, including customer service, and reward behaviours and outcomes that are aligned with our values.
• Non-executive director and chair of the audit committee at Gamefly, Inc
External appointment(s): • Non-executive director and chairman of the audit committee of BP plc • Member of the Financial Reporting Review
Ross McEwan, Group Chief Executive Nathan Bostock, Group Finance Director For biographies see page 39
Non-executive directors Along with the Chairman and executive directors, the non-executive directors are responsible for ensuring the Board fulfils its responsibilities under its terms of reference. The non-executive directors combine broad business and commercial experience with independent and objective judgement and they provide independent challenge to the executive directors and the leadership team. The balance between non-executive and executive directors enables the Board to provide clear and effective leadership across the Group’s business activities.
Brendan Nelson (Chairman) 7/7 Tony Di Iorio 7/7 Baroness Noakes 7/7 Philip Scott 7/7
Executive Committee and other senior executives to provide confirmation following their review of the Annual Report and Accounts that they consider them to be fair, balanced and understandable; and
Oversight of the Group’s relationship with its regulators The Group Audit Committee has a responsibility to monitor the Group’s relationship with the Prudential Regulatory Authority (PRA), Financial Conduct Authority (FCA) and other regulators. During 2013, it received regular reports on the Group’s relationship with all its regulators highlighting significant developments. It received reports on regulatory actions and investigations. Over the course of the year the Chairmen of the Group’s senior Board committees met with the PRA and the FCA on an individual basis and also participated in Regulatory College meetings with the Group’s primary regulators. The Chairman of the Group Audit Committee also met with the PRA and with the External Auditor on a trilateral basis.
In addition, the External Auditor is engaged from time to time by the Group to perform services in relation to the restructuring of loans and other financing. The Group is not liable for these fees, and often has a limited role in the selection process. As an additional governance control, these engagements are subject to the ad hoc approval process. Information on fees paid in respect of audit and non-audit services carried out by the External Auditor can be found in Note 5 to the consolidated accounts on page 403.
• the Committee has overseen the refinement and further embedding of the Group’s risk appetite framework into the business divisions; • the Committee considered the outputs of stress testing and approved a reverse stress test trigger framework to further assist the risk management team in assessing how the business is positioned to respond to various potential scenarios; and
More detailed information on each of these areas is set out in the Board Risk Committee report that follows.
Membership of the Board Risk Committee The Board Risk Committee comprises at least three independent nonexecutive directors. The Chairman and members of the Committee, together with their attendance at meetings, are shown below.
The Committee made recommendations to the Board concerning the Individual Liquidity Adequacy Assessment, the Internal Capital Adequacy Assessment Process (ICAAP) and the Contingency Funding Plan, in line with the Group’s commitments to its regulators.
During the course of two separate visits to Risk Management, the Committee reviewed the risk management operating model to ensure the function had the appropriate structure and resources in place to deliver its strategic plan. Bench-strength of the risk function was reviewed and consideration was give to succession-planning, resource and budget.
Other areas supported by the Committee included the adoption of a number of internationally accepted voluntary codes notably the Equator Principles, United Nations Global Compact and Natural Capital Declaration (see pages 31 to 33 for more detail).
Operating in markets where absolute and relative levels of pay are still high, RBS has been a back-marker. But we do not and cannot operate in a vacuum. Many of our employees have done good work this year to help rebuild the company for the future. While pay in aggregate will continue to remain at the lower end of current market practice, I firmly believe our pay levels must remain competitive to attract and retain a high calibre of staff. This is essential if we are to build a business of value for our customers and our shareholders.
Any future salary increases will be considered against peer companies and will not normally be greater than the average salary increase for RBS employees over the period of the policy.
As a minimum, shares will be subject to deferral and retention periods as required under the PRA Remuneration Code.
The award will have an overall five year vest period, vesting in equal tranches in years four and five.
The award will be delivered under the RBS 2014 Employee Share Plan, subject to shareholder approval at the 2014 AGM.
Reimbursement of reasonable out-of-pocket expenses incurred in performance of duties. The Chairman also receives private medical cover in line with the scheme rules.
• Fixed share allowance = an allowance of 100% of salary, paid in shares and released in equal tranches over a five year period.
The reaction to the consultation process was positive and allowed the Committee to gain valuable insight into areas that shareholders were likely to support and those areas of concern. There was general support for the possible use of role-based allowances for the small number of employees impacted by the cap imposed under CRD IV. Payment of any allowances in arrears, with delivery in shares for more senior roles and with deferral, were viewed as positive features. Many shareholders also welcomed the discontinuation of annual bonus arrangements for executive directors but stressed the need to ensure sufficient variable pay was available for performance adjustment and clawback. The move to a five year overall timeframe for future long-term incentive awards was also viewed favourably. Overall, there was continuing support for simple and transparent pay structures.
Notes: The number of shares awarded is based on a multiple of salary and the award price is calculated based on the average share price over five business days prior to the grant date of £3.092 In addition to performance conditions, all awards are subject to clawback provisions prior to vesting and a six month retention period post vesting in line with the PRA Remuneration Code. The treatment of outstanding LTIP awards held by Stephen Hester is detailed under the Payments for loss of office section. The LTIP award held by Nathan Bostock has been lapsed following notification that he will be leaving the Group.
Performance conditions for outstanding LTIP awards granted to executive directors in 2011, 2012 and 2013 – current assessment Awards are due to vest in 2014 to 2016. An assessment of performance of each relevant element is provided by the control functions and PwC assesses relative TSR performance. The Committee determines overall vesting based on these assessments including consideration of the drivers of performance and the context against which it was delivered. The assessment is analytical and if any discretion is used in the final assessment, it will be explained. The table below represents an early indication of potential vesting outcomes only.
Threshold: 20% vesting if TSR is at median of the comparator group. Maximum: 100% vesting if TSR is at upper quartile of the comparator group.
Ensure alignment with the advancement of the strategic position and capability of the organisation and the building of a sustainable business.
Awards held at 1 January 2013 (or date of appointment if later) Awards granted in 2013 Award price £ Awards lapsed in 2013
Other payments made by the Group - Irrecoverable VAT and other indirect taxes suffered by the Group (3) 714 830 (14%)
The amounts included above have been calculated in accordance with applicable accounting standards and reflect the amounts included in the Group Income statement and related Notes. Notes: (1) Remuneration paid to all employees represents total staff expenses per Note 3 to the Financial statements, exclusive of social security and other staff costs. (2) Income statement charge for social security costs per Note 3 to the Financial Statements. (3) Input VAT and other indirect taxes unable to be recovered by the Group due to it being partially exempt.
• Review of the Committee’s agenda planner, Terms of Reference and delegated authorities for individual remuneration governance.
Variable remuneration for 2013 performance Consisted of deferred awards payable over a three year period. Cash awards were limited to a maximum of £2,000 per employee.
Notes: (1) Total remuneration includes fixed pay, pension and benefit funding and variable pay
The Group assessed the effectiveness of its internal control over financial reporting as of 31 December 2013 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘Internal Control - Integrated Framework'.
Disclosure controls and procedures As required by US regulations, management have conducted an evaluation of the effectiveness and design of the Group’s disclosure controls and procedures (as defined in the Exchange Act rules) as at 31 December 2013. Based on this evaluation, management concluded that the Group’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Changes in internal control There was no change in the company's internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting.
The company did not pay a dividend on ordinary shares in 2012 or 2013.
The Group has now resumed payments on all discretionary non-equity capital instruments. Future coupons and dividends on hybrid capital instruments will only be paid subject to, and in accordance with, the terms of the relevant instruments.
For 2014, the Board has decided to continue partially neutralising the Core Tier 1 impact of Group hybrid capital instruments. It is expected that £300 million of new equity will be issued during the course of 2014 to achieve this aim.
This commitment to inclusion extends to supporting and participating in positive action programmes outside of the Group aimed at cultivating future leaders, including ‘An Inspirational Journey’ and FTSE-100 crosscompany mentoring programmes. The Group continues to maintain its involvement with external charitable networks and events such as Manchester Pride.
Going concern The Group’s business activities and financial position, the factors likely to affect its future development and performance and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Business review. The risk factors which could materially affect the Group’s future results are set out on pages 523 to 536. The Group’s regulatory capital resources and significant developments in 2013 and anticipated future developments are detailed on pages 192 to 208. The liquidity and funding section on pages 209 to 226 describes the Group’s funding and liquidity profile, including changes in key metrics, the build up of liquidity reserves and the outlook for 2014.
Managed results The financial information on a managed basis, prepared using the Group’s accounting policies, shows the underlying performance of the Group which excludes certain one-off and other items. This information is provided in this form to give a better understanding of the results of the Group’s operations. Consistent with the manner in which the Group is managed, Group operating profit on a managed basis excludes: • own credit adjustments; • Payment Protection Insurance (PPI) costs; • Interest Rate Hedging Products redress and related costs; • regulatory and legal actions; • sovereign debt impairment and interest rate hedge adjustments; • amortisation of purchased intangible assets; • integration and restructuring costs; • gain on redemption of own debt; • write-down of goodwill and other intangible assets; • Asset Protection Scheme (APS); • strategic disposals; • bank levy; • bonus tax; and • RFS Holdings minority interest (RFS MI)
Ulster Bank is a leading retail and commercial bank in Northern Ireland and the Republic of Ireland. It provides a comprehensive range of financial services through both its Retail Banking division, which provides loan and deposit products through a network of branches and direct channels, and its Corporate Banking division, which provides services to businesses and corporate customers.
RCR became fully operational on 1 January 2014 with a pool of c.£29 billion of assets, down from the forecast of c.£38 billion due to accelerated disposals and increased impairments. Whilst RCR is of a similar size to the Non-Core division, the assets have been selected on a different basis and no direct comparisons can be drawn.
• The Group’s business performance, financial condition and capital and liquidity ratios could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements, including those arising out of Basel III implementation (globally or by European, UK or US authorities) as well as structural changes that may result from the implementation of ring-fencing under the Financial Services (Banking Reform) Act 2013 or proposed changes of the US Federal Reserve with respect to the Group’s US operations. The Group’s ability to reach its target capital ratios in the medium term will turn on a number of factors including a significant downsizing of the Group in part through the sale of RBS Citizens.
• The actual or perceived failure or worsening credit of the Group’s counterparties or borrowers, including sovereigns in the Eurozone, and depressed asset valuations resulting from poor market conditions have led the Group to realise and recognise significant impairment charges and write-downs which have adversely affected the Group and could continue to adversely affect the Group if, due to a deterioration in economic and financial market conditions or continuing weak economic growth, it were to recognise or realise further write-downs or impairment charges.
(5) Adjusted (loss)/earnings per ordinary and equivalent B share is based on earnings from continuing operations adjusted for own credit adjustments, PPI costs, Interest Rate Hedging Products redress and related costs, regulatory and legal actions, sovereign debt impairment and related interest rate hedge adjustments, integration and restructuring costs, gain on redemption of own debt, writedown of goodwill and other intangible assets, Asset Protection Scheme, amortisation of purchased intangible assets, strategic disposals, bank levy and bonus tax. Adjusted earnings per ordinary and equivalent B share excludes the participation rights of the dividend access share.
Movement in net interest income UK 566 (1,028) (462) 566 (1,028) (462)
2012 compared with 2011 - statutory Non-interest income was down 47% at £6,539 million primarily due to the accounting charge for improved own credit of £4,649 million compared with a credit of £1,914 million in 2011, offset by a lower fair value charge of £44 million compared with £906 million in 2011 on the Asset Protection Scheme.
Net interest income 3,979 3,990 4,302 Net fees and commissions 919 884 1,066 Other non-interest income 39 95 140 Non-interest income 958 979 1,206
Wholesale and retail trade, repairs 74 112 85 Asset and invoice finance 32 40 38
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) 0.6% 0.3% 0.3%
Impairment losses remained elevated, as weak underlying credit metrics prevailed. Falling asset values throughout most of 2012 and high levels of unemployment coupled with weak domestic demand continued to depress the property market. The impairment charge for 2012 was driven by a combination of new defaulting customers and deteriorating security values. Risk elements in lending increased by £2 billion during the year reflecting continued difficult conditions in both the commercial and residential property sectors.
2013 compared with 2012 Operating profit of £647 million ($1,012 million) was down £107 million ($184 million), or 14%. The operating environment and market conditions remained challenging, with intense competition for loans. An extended period of low short-term rates limited net interest margin expansion and the rise in long-term rates dramatically slowed mortgage refinance volumes.
Of which: Ongoing businesses (2) 655 1,431 523 Run-off and recovery businesses (35) 78 376
Memo - fixed income and currencies Total income ongoing businesses 3,695 4,754 4,270 Less: primary credit markets (561) (574) (683) Total fixed income and currencies 3,134 4,180 3,587
Ulster Bank Mortgages Commercial real estate - investment 837 288 609
Notes (1) Performing assets are those with an internal asset quality (AQ) of 1-9; and non-performing assets are in AQ 10 with a probability of default being 100%. (2) The negative capital deductions are a result of the latent loss provisions held in respect of the performing portfolio.
Commentary on consolidated balance sheet continued 2012 compared with 2011 Total assets of £1,312.3 billion at 31 December 2012 were down £194.6 billion, 13%, compared with 31 December 2011. This was principally driven by a decrease in loans and advances to banks and customers led by Non-Core disposals and run off, decreases in debt securities and the continuing reduction in the mark-to-market value of derivatives.
Non-controlling interests increased by £1.1 billion, 158%, to £1.8 billion, predominantly due to the sale of 34.7% of the Group’s investment in Direct Line Group during the fourth quarter.
2013 The major factors contributing to the net cash outflow from operating activities of £30,631 million were the decrease of £28,780 million in operating assets and liabilities, the net operating loss before tax of £8,066 million from continuing and discontinued operations, loans and advances written-off net of recoveries of £4,090 million and other provisions utilised of £2,066 million. These were partially offset by provisions for impairment losses of £8,432 million and other provisions charged net of releases £4,422 million.
Profit from discontinued operations, net of tax 148 — 148 Loss for the year (8,477) — (8,477) Non-controlling interests (120) — (120) Preference share and other dividends (398) — (398) Loss attributable to ordinary and B shareholders (8,995) — (8,995)
Notes: (1) Primarily investment in associate (Direct Line Group) and Illinois branches of RBS Citizens. (2) Primarily Direct Line Group. (3) Primarily UK branch-based businesses, RBS Aviation Capital which was sold in 2012, and the remainder of RBS Sempra Commodities JV. (4) Excludes reverse repos.
Risk governance* Governance structure The Group is committed to achieving the highest standards of corporate governance in every aspect of the business, including risk management.
A key aspect of the Group Board’s responsibility as the main decisionmaking body at Group level is the setting of Group risk appetite to ensure that the levels of risk the Group is willing to accept in the attainment of its strategic business and financial objectives are clearly understood.
In addition, functional risk committees ensure that effective risk control frameworks are in place and that limits are consistent with the Group’s risk appetite. Divisional executive committees develop, own and manage divisional risk appetites, ensuring that these are consistent with the Group’s targets.
This involves ensuring: • All activities undertaken by the individual divisions are consistent with the Group’s risk appetite targets; • Group policies and resulting operating frameworks, including delegated authorities and limits, are complied with through effective monitoring and exception reporting; and
Payment Protection Insurance Since the judicial review decision in 2011, the Group has worked closely with both the Financial Conduct Authority and the Financial Ombudsman Service. It has invested considerable resources in ensuring that all Payment Protection Insurance (PPI) complaints are handled in a fair manner in line with regulatory requirements. The Group stopped selling PPI in 2010 and has since then made a number of changes to ensure fair customer outcomes and to ensure that the appropriate lessons are learned from PPI. These include substantially simplifying our retail product offering and sales processes (including, but not limited to, protection products), enhancing training for, and controls in relation to, customer advisers and improving management information on products sales. Our product design and approval processes are now also radically different from the time when PPI products were available to customers.
Impact on the Group If borrowers default, the value of the Group’s collateral may prove inadequate to repay the associated debt, leading to increased impairments. UK Corporate is likely to be most affected.
Under one of them, there is a severe recession in the UK in 2013/2014, a sharp rise in unemployment and a marked fall in equity prices. There are downgrades of UK sovereign debt by two notches, and corresponding downgrades for UK banks, including the Group, leading to increased funding costs and lower levels of lending. As the economic environment deteriorates, there is market concern about losses in the banking sector.
It has the potential to affect parts of the Group’s credit portfolio that are directly or indirectly linked to the country in question.
In 2013, various pension risk stress testing initiatives were undertaken, focused both on internally defined scenarios and on scenarios designed to meet integrated PRA stress testing requirements.
It has the potential to directly affect the Group’s profitability and capital requirements, as well as stakeholder confidence.
The Prudential Regulatory Authority (PRA) announced the acceleration of the end state rules for CET1 capital, whereby from 1 January 2014 the calculation is now closely aligned with the fully loaded definition. There will be no transitional arrangements applied to the prudential filters or regulatory deductions with the exception of unrealised gains on available for sale debt and equity which will be incorporated from 1 January 2015.
The Group identifies the management and recovery actions that could be applied in stress environments. These form an important part of the capital management approach and the contingency planning arrangements, complementing the established buffers.
The ‘year 1 transitional basis’ applies the rules as if 2013 was year 1 of the transition period. The full basis shows the same calculation based on a complete implementation of CRR. This is based on the Group’s interpretation of the current rules and guidance.
The actual impact of CRD IV on capital ratios may be different as the requirements and related technical standards have not yet been finalised and will ultimately be subject to application by local regulators. The actual impact will also be dependent on required regulatory approvals and the extent to which further management action is taken prior to implementation.
Note: (1) The PRA issued its consultative paper on implementing CRD IV (PS7/13) in December 2013. Under the draft proposals, there would be no transition in respect of the changes to the prudential filters and deductions from CET1. These proposals came into effect from 1 January 2014.
Accruals, deferred income and other liabilities 16,017 (33) 139 16,123 14,801 (100) 253 14,954
The table below shows the currency split of the liquidity portfolio. GBP USD EUR Other Total
The table below shows the Group’s principal funding sources excluding repurchase agreements.
2013 2012 2011 Less than More than Less than More than Less than More than 1 year 1 year Total 1 year 1 year Total 1 year 1 year Total £m £m £m £m £m £m £m £m £m
• Short-term wholesale funding has decreased by £9.2 billion to £32.4 billion reflecting the reduced funding requirement and ongoing liability management.
Deposits and repos The table below shows the composition of the Group’s deposits and repos. 2013 2012 2011 Deposits Repos Deposits Repos Deposits Repos £m £m £m £m £m £m
Financial institutions - central and other banks 35,329 28,650 57,074 44,332 69,114 39,691 - other financial institutions 53,607 52,945 64,237 86,968 66,009 86,032 Personal and corporate deposits 364,062 3,539 369,755 1,072 370,744 2,780 452,998 85,134 491,066 132,372 505,867 128,503 £161 billion (or 39%) of the customer deposits included above are insured through the UK Financial Services Compensation Scheme, US Federal Deposit Insurance Corporation scheme and other similar schemes. Of the personal and corporate deposits above, 53% relate to personal customers.
The following table shows the Groups gross repos by quality and maturity.
Liabilities secured Intra-Group - used for secondary liquidity (22.6) — — — — (22.6) Intra-Group - other (23.9) — — — — (23.9) Third-party (1) (12.0) (10.1) (60.4) (132.4) (15.3) (230.2) (58.5) (10.1) (60.4) (132.4) (15.3) (276.7)
Key point • Of the £464.1 billion collateral available, £166.8 billion is in the Group’s liquidity portfolio. The remainder is available to support for general funding and collateral needs.
The Group Audit Committee (GAC) provides oversight of the Group’s provision adequacy. The GCCO is accountable to the GAC for the adequacy of the Group’s provisions, both individual and collective. The Group Provisions Committee, which is chaired by either the Group Chief Risk Officer or the GCCO, approves recommendations from the divisional provisions committees.
Wholesale Four formal frameworks are used to manage wholesale credit concentration risk. The Group continually reassesses its frameworks to ensure that they remain appropriate for its varied business franchises and current economic conditions, as well as to reflect further refinements in the Group’s risk measurement models.
Credit risk assessment Wholesale The credit risk function assesses, approves and manages the credit risk associated with a borrower or group of related borrowers.
(6) Other assets: includes intangible assets, property, plant and equipment, deferred tax, prepayments and accrued income and assets of disposal groups. (7) Includes documentary credits (commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents), classified as commitments for financial reporting.
• The reduction in the Core portfolio was mostly driven by the implementation of a risk reduction strategy in Markets. CRA in Markets fell by 24% during the year, affected by a contraction in lending and rate risk management activities. Markets represented 15% of Core CRA (2012 - 19%). CRA decreased in all Core divisions with the exception of ‘other’.
• Exposure to banks and financial institutions declined by 20%. This was primarily as a result of limited lending and interbank money market activity which fell by 8% and a reduction in derivative exposures which fell by 27%. The declining trend in interbank activity was largely attributable to increased bank liquidity including access to liquidity via schemes put in place via central banks and governments. The reduction in derivative exposure was due to the Group exiting certain products and the benefits of regulatory netting derived from the implementation of new modelling methodology. The Group has a suite of control frameworks and policies for managing the derivatives portfolio, particularly uncollateralised derivatives with long tenors. During the year the control framework for this segment of the portfolio was further tightened.
The table below analyses the incidence of the main types of wholesale forbearance arrangements by loan value. 2013 2012 2011
• Although the forbearance stock increased by 40% during the year, the number of customers approaching Ulster Bank for assistance for the first time remained broadly stable. This can be attributed to more mortgages being put on to longer-term arrangements, and therefore not exiting forbearance.
Credit risk continued Key loan portfolios* Commercial real estate The commercial real estate sector comprised exposures to entities involved in the development of, or investment in, commercial and residential properties (including house builders). The analysis of lending utilisations below is gross of impairment provisions and excludes rate risk management and contingent obligations.
US Retail & International UK Corporate Ulster Bank Commercial Banking Markets Total
Key points • The overall maturity profile remained relatively unchanged during
Key point • CRE lending net of impairment provisions decreased by £13.5 billion or 26% in the year to £39.4 billion in part due to the increased impairment provisions recorded in the fourth quarter of 2013 in Ulster Bank Non-Core, as part of RCR creation and related strategy. Provision coverage on CRE REIL was 66% compared to 46% at the end of 2012.
Credit risk continued Key loan portfolios* continued Residential mortgages The table below analyses the mortgage portfolios and includes both Core and Non-Core. Total gross mortgage lending comprises 35% of the Group’s gross lending of £418 billion. 2013 2012 2011 £m £m £m
• The impairment charge for mortgage loans was £30 million for 2013 compared to £92 million in 2012, reflecting a lower level of defaults and reduced loss rates as valuations improved on properties held as security on defaulted debt.
• The weighted average LTV of the portfolio decreased from 75% at 31 December 2012 to 67% at 31 December 2013, driven by increases in the Case-Shiller Home Price Index from the third quarter of 2012 to the fourth quarter of 2013. The weighted average LTV of the portfolio, excluding SBO, was 64%.
Core The impairment charge for the year of £1,774 million (2012 - £1,364 million; 2011 - £1,384 million) reflected the difficult economic climate in Ireland, and most particularly the RCR deleverage strategy across the corporate portfolios. The mortgage portfolio improved notably in 2013, accounting for £235 million (13%) of the total 2013 impairment charge (2012 - £646 million; 2011 - £570 million) due to lower debt flows driven by improved collections performance and stabilising residential property prices.
Note: (1) Of which £3.2 billion was due to RCR and the related change of strategy.
Securities Clearing Corporation. (2) This reflects the amounts by which the Group’s credit risk is reduced through master netting and cash management pooling arrangements. Derivative master netting agreements include cash pledged with counterparties in respect of net derivative liability positions and are included in lending in the table above. (3) Includes cash collateral received against derivative assets of £24.3 billion (2012 - £34.1 billion; 2011 - £37.2 billion).
Sector and geographic concentration The following tables analyse financial assets by sector and geography. Geographical regions are based on the location of the lending or issuer.
• Within lending: ° UK Retail unsecured lending decreased by £0.6 billion, partially offset by an increase of £0.2 billion in mortgage lending. ° UK Corporate lending decreased by £4.5 billion, as business demand for credit remains weak. ° Non-Core continued to make significant progress on its balance sheet strategy by reducing lending by £19.8 billion across all sectors, principally property and construction, where commercial real estate lending decreased by £7.1 billion.
UK Central and local government — 6,950 13,210 — 3,856 122 24,138 (4,351) 19,787 Financial institutions - banks 18,462 17,597 3,153 449 132,076 55,720 227,457 (142,018) 85,439 - other (2) 19,293 28,937 11,915 2,015 56,441 2,248 120,849 (69,890) 50,959 Personal - mortgages — 110,515 — — — — 110,515 — 110,515 - unsecured — 17,098 — — — 3 17,101 — 17,101 Property — 44,252 86 292 2,728 — 47,358 (676) 46,682 Construction — 4,691 22 101 414 7 5,235 (1,346) 3,889 Manufacturing 466 8,740 409 2,147 979 21 12,762 (2,414) 10,348 Finance leases and instalment credit — 10,567 3 5 11 — 10,586 (16) 10,570 Retail, wholesale and repairs — 10,804 154 423 724 11 12,116 (1,908) 10,208 Transport and storage — 9,059 141 69 1,646 — 10,915 (703) 10,212 Health, education and leisure — 11,757 39 79 618 14 12,507 (847) 11,660 Hotels and restaurants — 5,333 1 50 217 — 5,601 (161) 5,440 Utilities — 2,117 123 281 2,900 — 5,421 (1,027) 4,394 Other 18 16,202 115 1,971 1,514 47 19,867 (2,625) 17,242 Total gross of provisions 38,239 304,619 29,371 7,882 204,124 58,193 642,428 (227,982) 414,446 Provisions — (11,005) (229) (82) — — (11,316) n/a (11,316)
Key points • Underlying the balance sheet reduction in the year the overall asset quality in the upper bands (AQ1-AQ5) remained broadly similar.
Balance sheet analysis continued Debt securities continued Ratings The table below summarises the ratings of asset-backed securities on the balance sheet.
Countries £m £m £m £m £m £m £m £m £m £m £m
US 208 619 2,645 3,472 (132) 307 419 18 744 4,216 7 UK 372 144 2,483 2,999 (35) 35 70 320 425 3,424 73 Japan 24 67 973 1,064 (1) — 2 — 2 1,066 — China 331 147 357 835 (3) — 14 3 17 852 7 Australia 77 45 159 281 (17) — — — — 281 — Switzerland 4 — 71 75 (13) — 34 — 34 109 31 Hong Kong 2 81 97 180 — — — 4 4 184 2 Russia 16 4 158 178 — — — — — 178 — Other 147 367 2,051 2,565 (291) — 5 180 185 2,750 (1)
France 12 15 90 117 (62) 3 2 124 129 246 20 Luxembourg — 201 88 289 — 383 3 2 388 677 17 Germany 23 4 114 141 (186) — — — — 141 — Other 20 22 106 148 (68) — 16 1 17 165 10 Total eurozone 122 320 1,315 1,757 (445) 386 87 294 767 2,524 (33)
reflecting increased interest rate yields and continued use of trade compression cycles, partially offset by increased trade volumes.
Credit derivative product companies (CDPCs) The table below summarises the Group's exposures to CDPCs, all of which are in Non-Core.
Credit metrics REIL Provisions Provisions Gross as a % of as a % as a % of Impairment Amounts loans REIL Provisions gross loans of REIL gross loans charge written-off
Balance sheet analysis continued REIL, provisions and AFS reserves continued 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.
At 1 January 2013 2,629 2,432 109 391 3,910 285 9,756 305 1 10,062 11,200 21,262 Currency translation and other adjustments 1 8 — (15) 51 31 76 5 — 81 28 109 Disposal of subsidiaries — — — — — — — — — — (77) (77)
Individually assessed - banks — — — 6 — — 6 107 — 113 1 — 114 - customers — 1,024 96 270 1,213 46 2,649 189 1 2,839 9,805 — 12,644 Collectively assessed 2,439 1,111 — — 2,110 125 5,785 — — 5,785 757 — 6,542 Latent 190 297 13 115 587 114 1,316 9 — 1,325 637 — 1,962
UK UK International Ulster US Total Total Retail Corporate Wealth Banking Bank R&C (1) R&C (1) Markets Core Non-Core RFS MI Group £m £m £m £m £m £m £m £m £m £m £m £m
• GRA quantifies the model risk by comparing front office model outputs with those of alternative models independently developed by GRA.
Counterparty Exposure Management Management of the over-the-counter derivative counterparty credit risk and funding risk is carried out by the Counterparty Exposure Management (CEM) desk in Markets. CEM actively manages risk exposures and concentrations on behalf of both Markets and Non-Core. The hedging transactions CEM enters into are booked in the trading book and therefore contribute to the Group’s market risk VaR exposure and capital.
Market risk continued Traded market risk continued VaR validation* In addition to the independent VaR model reviews carried out by GRA (discussed on page 323), a dedicated model-testing team within Market Risk works with the risk managers to: • Test the accuracy of the valuation methods used in the VaR model on appropriately chosen test portfolios and trades.
• Identify and give early warning of any market or portfolio weakness that may become significant.
VaR back-testing* The table below shows regulatory back-testing exceptions for a period of 250 days for 1-day 99% traded regulatory VaR vs. Clean and Hypo P&L for the legal entities approved by the PRA and De Nederlandsche Bank.
Asset Backed Products — — Treasury Markets — — Emerging Markets — — Equities — — Currency Options 1 1 Interest Rate Options North America — — Non Linear Trading 2 2 Delta Flow (flow rates) 1 1 CEM Funding (derivative funding risk) — — Flow Credit — — Currencies — 6
The top ten RNIVs represent approximately two thirds of the total RNIV capital requirement.
While internal VaR provides a measure of the economic risk, regulatory VaR is one of the measures of regulatory capital by legal entity.
Risks not in VaR (RNIVs)* As discussed earlier, the Group has an established RNIV framework that ensures that the risks not captured in VaR are adequately covered by its capital.
The model is mainly driven by three-month transition, default and correlation parameters. The portfolio impact of correlated defaults and rating changes is assessed with reference to the resulting change in the market value of positions, which is determined using stressed recovery rates and modelled credit spread changes. Individual instrument revaluation vectors are used to capture non-linear behaviour.
• Specific interest rate risk of securitisation positions: This charge decreased due to the disposal of assets, primarily in the AAA and BB rating categories, during the year.
Market risk continued Non-traded market risk Risk management The governance framework, risk management principles and appetite and limit framework applicable to the Group’s management of market risk are covered by the discussion on pages 176. More specific information on the Group’s management of non-traded market risk is provided below.
Value-at-risk The Group’s standard VaR metrics - which assume a time horizon of one trading day and a confidence level of 99% - are based on interest rate repricing gaps at the reporting date. Daily rate moves are modelled using observations over the last 500 business days. These incorporate customer products plus associated funding and hedging transactions as well as non-financial assets and liabilities such as property, plant and equipment, capital and reserves. Behavioural assumptions are applied as appropriate.
VaR for selected AFS non-trading portfolios Available-for-sale portfolios in Markets and Non-Core, other than the structured credit portfolio, do not typically form part of the structural interest rate framework due to the short-term nature of the interest rate risks they carry. They are thus monitored and managed through the same framework and using the same metrics as portfolios in the trading book.
Country risk 342 Definition 342 External environment 342 Outlook 342 Sources of risk 342 Governance 343 Risk management 343 Risk measurement 343 Risk mitigation 344 Basis of reporting 344 Definitions 345 Country exposure
Country risk Definition Country risk is the risk of losses occurring as a result of either a country event or unfavourable country operating conditions. As country events may simultaneously affect all or many individual exposures to a country, country event risk is a concentration risk. For other types of concentration risks such as product, sector or single name concentration, refer to the Credit risk section.
Many emerging market economies entered 2013 with high growth rates. While most were in substantially better shape than in previous crises, some had built up significant imbalances during years of strong capital inflows. As economic conditions in mature markets, particularly the US, improved in the course of the year, markets began to anticipate that monetary policies would normalise.
Country events may include a sovereign default, political conflict, banking crisis or deep and prolonged recession leading to possible counterparty defaults. Transfer or convertibility restrictions imposed by a country’s government to stem the loss of foreign currency reserves may temporarily prevent counterparties from meeting their payment obligations. Major currency depreciation may also affect a customer’s income or debt burden, leading to default.
• Balance sheet and off-balance sheet exposures to nearly all countries declined across all broad product categories. This was because the Group maintained a cautious stance and many clients reduced debt levels. Non-Core lending declined in most countries, particularly in Spain, the Netherlands, France and Romania, reflecting the Group’s risk reduction strategy.
The Pension Risk Committee, acting as a sub-committee of the Group Asset and Liability Management Committee (GALCO), considers the Group’s view of pension risk. The Pension Risk Committee considers mechanisms that could potentially be used for managing risk within the funds as well as financial strategy and employee welfare implications, It also reviews actuarial assumptions from a sponsor perspective as appropriate. The Pension Risk Committee is a key component of pension risk management and 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, where risk management, asset strategy and financing issues are discussed. The Investment Executive also consults with the Group to obtain its view on the appropriate level of risk within the pension fund.
A “Centres of Excellence” model was adopted in July 2013. This has brought together divisional and functional resources to manage issues more efficiently, using specialisms in existing teams and managing issues cross-divisionally.
Quarterly reporting to the Group Audit Committee captures all material regulatory reviews and investigations as well as other regulatory developments worldwide. The reporting also tracks the status of, and trends in, key regulatory relationships.
Sources of risk Reputational risk can arise across a range of actions taken (or, in some cases, not taken) by the Group and individuals, as well as its wider conduct, policies and practices.
The Group has put the focus on “serving customers well” at the heart of its strategic objectives that, combined with a safe and sound bank, will build a culture and reputation in line with the Group’s stakeholder expectations. By serving customers well, RBS aims to be trusted, respected and valued – a sustainable model of how banks serve society. Legacy issues remain to be worked through, but dealing with them in a transparent manner is a necessary part of the ability to move forward.
The financial statements comprise the accounting policies, the consolidated and company balance sheets as at 31 December 2013, the consolidated income statement, the consolidated statement of comprehensive income, the consolidated and company statements of changes in equity and the consolidated and company cash flow statements for the year ended 31 December 2013, the related Notes 1 to 42 on the consolidated financial statements, the related Notes 1 to 16 on the company financial statements and the information identified as “audited” in the Risk and balance sheet management section of the Business review. The financial reporting framework that has been applied in their preparation is applicable law and IFRSs as adopted by the European Union and, as regards the parent company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
The Audit Committee’s consideration of these risks is set out on page 54.
Basic and diluted loss from continuing and discontinued operations 9 (80.3p) (55.0p) (19.9p)
17. Financial liabilities On initial recognition, financial liabilities are classified into held-fortrading; designated as at fair value through profit or loss; or amortised cost. Issues of financial liabilities measured at amortised cost are recognised on settlement date; all other regular way transactions in financial liabilities are recognised on trade date.
Goodwill The Group capitalises goodwill arising on the acquisition of businesses, as discussed in Accounting policy 6. The carrying value of goodwill as at 31 December 2013 was £10,139 million (2012 - £11,266 million; 2011 - £12,424 million).
Effective after 2014 IAS 19 ‘Defined Benefit Plans: Employee Contributions’ was issued in November 2013. This amendment distinguishes the accounting for employee contributions that are related to service from those that are independent of service. It is effective for annual periods beginning on or after 1 July 2014.
(2) In January 2013, the Group redeemed certain senior unsecured securities for cash resulting in losses of £51 million. In June 2013, the Group redeemed certain mortgage backed debt securities in exchange for cash resulting in gains totalling £242 million. In July 2013, the Group redeemed certain unsecured subordinated debt securities resulting in a gain of £13 million. In December 2013, the Group redeemed £987 million of senior unsecured debt resulting in a loss of £29 million. In March 2012 and September 2012, the Group redeemed certain notes resulting in net gains totalling £454 million being credited to profit or loss. In June 2011, the Group redeemed certain mortgage backed debt securities in exchange for cash, resulting in gains totalling £255 million being credited to profit or loss.
Non-deferred share awards — 27 (100) — 17 (100) Total non-deferred variable compensation 67 100 (33) 9 27 (67)
Curtailment gains of £4 million were recognised in 2013 arising from changes to pension benefits in a subsidiary’s scheme (2012 - £9 million; 2011 - nil). Settlement gains of £3 million were recognised in 2013 in respect of subsidiaries’ schemes (2012 - £32 million; 2011 - nil).
The defined benefit obligation is attributable to the different classes of scheme members in the following proportions (Main scheme): Following the legal separation of ABN AMRO Bank N.V. on 1 April 2010, ABN AMRO’s principal pension scheme in the Netherlands was transferred to the State of the Netherlands. At 31 December 2009, this scheme had fair value of plan assets of £8,118 million and present value of defined benefit obligations of £8,298 million. The principal actuarial assumptions at 31 December 2009 were: discount rate 5.25%; expected return on plan assets (weighted average) 5.25%; rate of increase in salaries 2.5%; rate of increase in pensions in payment 2.0%; and inflation assumption 2.0%.
The Group and the Trustees of the Main scheme agreed the funding valuation as at 31 March 2010 in 2011. It showed that the value of liabilities exceeded the value of assets by £3.5 billion as 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. 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. These contributions are in addition to the regular annual contributions of around £250 million for future accrual of benefits.
A funding valuation as at 31 March 2013 is currently in progress and is expected to be concluded by 30 June 2014.
Main scheme All schemes 2013 2012* 2011* 2010* 2009* 2013 2012* 2011* 2010* 2009*
Notes: (1) Comprises fees of £0.9 million (2012 - £1.0 million) in relation to reviews of interim financial information, £2.3 million (2012 - £2.9 million) in respect of reports to the Group’s regulators in the UK and overseas, £0.3 million (2012 - £0.5 million) in respect of internal controls assurance and £0.3 million (2012 - £0.2 million) in relation to non-statutory audit opinions. (2) Comprises fees of £0.8 million (2012 - £1.6 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations. The figure for 2012 includes £4.1 million in respect of reporting accountant services in connection with divestments by the Group, which was not repeated in 2013.
The actual tax charge differs from the expected tax credit computed by applying the standard rate of UK corporation tax of 23.25% (2012 - 24.5%; 2011 - 26.5%) as follows: Expected tax credit 1,916 1,293 370 Sovereign debt impairment where no deferred tax asset recognised — — (275) Other losses in year where no deferred tax asset recognised (879) (511) (530) Foreign profits taxed at other rates (196) (383) (417) UK tax rate change impact (1) (313) (149) (112) Unrecognised timing differences (8) 59 (20) Non-deductible goodwill impairment (247) — — Items not allowed for tax - losses on disposals and write-downs (20) (49) (72)
Held-for- through profit Hedging Available- Loans and instruments Finance assets/ trading or loss derivatives for-sale receivables (amortised cost) leases liabilities Total 2011 £m £m £m £m £m £m £m £m £m
Derivatives 1,051,670 (544,491) 507,179 (441,626) (37,222) (5,312) 23,019 Reverse repurchase agreements 128,447 (37,605) 90,842 (15,246) — (75,596) — Settlement balances 2,087 (1,359) 728 (728) — — — 1,182,204 (583,455) 598,749 (457,600) (37,222) (80,908) 23,019
In 2013, the Group made a significant and ongoing investment into further enhancing its control environment. This included continuing investment in global IPV and reserving tools which partly automated the IPV and reserves process into a single central portal. System developments included implementing a rules based approach which ensures consistency across portfolios and the use of hierarchy of independent data inputs.
Inputs to valuation models Values between and beyond available data points are obtained by interpolation and extrapolation. When utilising valuation techniques, the fair value can be significantly affected by the choice of valuation model and by underlying assumptions concerning factors such as the amounts and timing of cash flows, discount rates and credit risk. The principal inputs to these valuation techniques are as follows: • Bond prices - quoted prices are generally available for government bonds, certain corporate securities and some mortgage-related products.
• Counterparty credit spreads - adjustments are made to market prices (or parameters) when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price (or parameters).
In order to determine a reliable fair value, where appropriate, management applies valuation adjustments to the pricing information gathered from the above sources. The sources of independent data are reviewed for quality and are applied in the IPV processes using a formalised input quality hierarchy. These adjustments reflect the Group's assessment of factors that market participants would consider in setting a price. Furthermore, on an ongoing basis, the Group assesses the appropriateness of any model used. To the extent that the price provided by internal models does not represent the fair value of the instrument, for instance in highly stressed market conditions, the Group makes adjustments to the model valuation to calibrate to other available pricing sources.
Key points • Monoline and CDPC: reduced exposures during the year, tighter credit spreads and exchange rate movements contributed to the decrease in CVA.
HFT DFV Total liabilities DFV Total Derivatives Total Cumulative own credit adjustment (CR)/DR (1) £m £m £m £m £m £m £m
Equity shares 0.2 0.6 0.4 1.2 0.3 0.7 0.4 1.4 0.3 1.3 0.4 2.0 Total AFS assets 21.0 31.7 1.6 54.3 35.0 36.7 3.4 75.1 53.6 49.6 6.1 109.3
Liabilities Deposits by banks Repos — 23.1 — 23.1 — 36.4 — 36.4 — 23.3 — 23.3 Derivative collateral — 19.1 — 19.1 — 28.6 — 28.6 — 31.8 — 31.8 Other — 0.6 0.1 0.7 — 1.9 0.1 2.0 — 2.4 — 2.4 — 42.8 0.1 42.9 — 66.9 0.1 67.0 — 57.5 — 57.5 Customer accounts Repos — 52.3 — 52.3 — 82.2 — 82.2 — 65.5 — 65.5 Derivative collateral — 7.1 — 7.1 — 8.0 — 8.0 — 9.2 — 9.2 Other — 8.8 0.2 9.0 — 10.3 0.1 10.4 — 10.8 — 10.8 — 68.2 0.2 68.4 — 100.5 0.1 100.6 — 85.5 — 85.5 Debt securities in issue — 23.1 1.3 24.4 — 33.1 1.4 34.5 — 45.0 2.2 47.2 Short positions 23.9 4.1 — 28.0 23.6 4.0 — 27.6 34.4 6.3 0.3 41.0 Derivatives Foreign exchange — 65.0 0.7 65.7 — 69.3 1.2 70.5 — 80.6 0.4 81.0 Interest rate 0.1 208.0 0.6 208.7 0.1 345.0 0.4 345.5 0.4 405.2 1.1 406.7 Credit — 4.5 0.9 5.4 — 9.6 0.8 10.4 — 24.9 1.8 26.7 Equities and commodities — 4.9 0.8 5.7 — 7.0 0.9 7.9 — 9.1 0.5 9.6 0.1 282.4 3.0 285.5 0.1 430.9 3.3 434.3 0.4 519.8 3.8 524.0 Subordinated liabilities — 0.9 — 0.9 — 1.1 — 1.1 — 0.9 — 0.9 24.0 421.5 4.6 450.1 23.7 636.5 4.9 665.1 34.8 715.0 6.3 756.1
Notes: (1) Residential mortgage-backed securities. (2) Commercial mortgage-backed securities. (3) Collateralised debt obligations. (4) Collateralised loan obligations. (5) Sensitivity represents the favourable and unfavourable effect on the income statement or the statement of comprehensive income due to reasonably possible changes to valuations using reasonably possible alternative inputs in the Group’s valuation techniques or models. Level 3 sensitivities are calculated at a sub-portfolio level and hence these aggregated figures do not reflect the correlation between some of the sensitivities. In particular, for some portfolios, the sensitivities may be negatively correlated where a downward movement in one asset would produce an upward movement in another, but due to the additive presentation above, this correlation cannot be shown.
11 Financial instruments - valuation continued Valuation techniques The table below shows a breakdown of valuation techniques and the ranges for those unobservable inputs used in valuation models and techniques that have a material impact on the valuation of Level 3 financial instruments. The table excludes unobservable inputs where the impact on valuation is less significant. Movements in the underlying input may have a favourable or unfavourable impact on the valuation depending on the particular terms of the contract and the exposure. For example an increase in the credit spread of a bond would be favourable for the issuer and unfavourable for the note holder. Whilst we indicate where we consider that there are significant relationships between the inputs, these inter-relationships will be affected by macro economic factors including interest rates, foreign exchange rates or equity index levels.
Non-modelled products Non-modelled products are generally quoted on a price basis and can therefore be considered for each of the 3 levels. This is determined by the market activity, liquidity and valuation uncertainty of the instruments which is in turn measured from the availability of independent data used by the IPV process to allocate positions to IPV quality levels.
AFS Debt securities 4,379 2 3 2,097 (21) 98 — (817) (47) 3 5,697 2 Equity shares 279 2 59 82 — 7 — (1) (29) (4) 395 (4)
Guarantees and commitments notional amount Guarantees (1) 20,179 — — — — — Commitments (2) 213,046 — — — — — 233,225 — — — — —
Forecast receivable cash flows 407 415 360 306 200 280 — — 1,968 Forecast payable cash flows (120) (106) (73) (70) (71) (344) (568) (160) (1,512)
At 1 January 4,468 2,855 273 1,823 4,479 3,892 17,790 Transfers (to)/from disposal groups (129) 101 11 95 (135) — (57) Currency translation and other adjustments (51) 21 13 (124) (182) (53) (376) Reclassifications 24 (47) 21 (6) 8 — — Additions 372 153 8 121 519 402 1,575 Expenditure on investment properties 10 — — — — — 10 Change in fair value of investment properties - continuing operations (153) — — — — — (153)
Other discontinued operations reflect the results of RFS Holdings attributable to the State of the Netherlands and Santander following the legal separation of ABN AMRO Bank N.V. on 1 April 2010. The profit from discontinued operations includes a gain of £37 million (2012 - £112 million loss; 2011 - £42 million profit) attributable to non-controlling interests.
(c) Assets and liabilities of disposal groups 2013 2012 2011 £m £m £m
At 31 December 2011, disposal groups comprised the RBS Aviation Capital business which was sold in the second half of 2012 and the RBS England and Wales and NatWest Scotland branch-based businesses, along with certain SME and corporate activities across the UK (‘UK branch-based businesses’).
Loans and advances to banks — 2,036 2,579 Loans and advances to customers — 881 893 Debt securities and equity shares — 7,156 7,992 Derivatives — 12 — Intangible assets — 750 1,065 Property, plant and equipment — 222 132 Interests in associates 879 — — Prepayments, accrued income and other assets — 1,640 1,200 Assets of disposal group 879 12,697 —
The Royal Bank of Scotland plc - the deferred tax asset in respect of tax losses brought forward at 1 January 2013 related mainly to trading losses that arose in the UK branch of RBS N.V. These were transferred following the transfer of the majority of the activities of the UK branch of RBS N.V. to The Royal Bank of Scotland plc. The UK branch tax losses attributable to credit market write-downs during the financial crisis were principally incurred between 2007 and 2009.
Sterling 45 608 60 366 — 785 1,864 US dollar 706 961 1,386 4,735 91 4,486 12,365 Euro 200 1,005 2,985 1,946 166 823 7,125 Other 399 617 531 813 — 298 2,658 1,350 3,191 4,962 7,860 257 6,392 24,012
Sterling 73 158 648 453 — 823 2,155 US dollar 302 555 3,903 1,793 190 4,619 11,362 Euro 220 1,299 2,389 4,296 513 832 9,549 Other 29 — 1,618 1,261 — 345 3,253 624 2,012 8,558 7,803 703 6,619 26,319
Dated loan capital continued Capital 2013 2012 2011 treatment £m £m £m
Non-cumulative preference shares of US$0.01 Series F US$156 million 7.65% (callable any time from March 2007) Tier 1 95 97 101 Series H US$242 million 7.25% (callable any time from March 2004) Tier 1 146 150 157 Series L US$751 million 5.75% (callable any time from October 2009) Tier 1 454 465 485
At 1 January 2012 — 283 403 686 Currency translation and other adjustments — (12) (6) (18) (Loss)/profit attributable to non-controlling interests - continuing operations — (43) 19 (24)
In July 2013, the company allotted and issued 43.0 million new ordinary shares of £1 each at a subscription price of 314.188 pence each, the gross proceeds being £135 million.
In September 2013, the company allotted and issued 20.5 million new ordinary shares of £1 each at a subscription price of 341.898 pence each the gross proceeds being £70 million.
The B shares do not generally carry voting rights at general meetings of ordinary shareholders. Following the subdivision and consolidation of ordinary shares in 2012 and subject to anti-dilution adjustments, each B share is entitled to one tenth of the cash dividend of an ordinary share and may be converted at any time at the option of the holder into ordinary shares at the rate of ten B shares for each ordinary share.
Own shares held - at 31 December 2013, 34 million ordinary shares of £1 each of the company (2012 - 51 million; 2011 - 164 million) were held by Employee Share Trusts in respect of share awards and options granted to employees. The 17 million reduction during the year relates to the sale of surplus shares to help neutralise any impact on Core Tier 1 capital as a result of the recommencement of capital and dividend payments on the Group’s hybrid capital instruments, together with ordinary shares delivered in satisfaction of the exercise of options, the vesting of share awards and for equity funding of employee incentive awards under the employee share plans.
Regulatory adjustments and deductions Own credit 726 691 (2,634) Defined benefit pension fund adjustment 362 913 — Net unrealised AFS losses 308 346 957 Cash flow hedging reserve 84 (1,666) (879) Other regulatory adjustments (103) (197) 571 Goodwill and other intangible assets (12,368) (13,545) (14,858) 50% of expected losses less impairment provisions (19) (1,904) (2,536)
Trustee and other fiduciary activities In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group's financial statements. The Group earned fee income of £462 million (2012 - £476 million; 2011 - £502 million) from these activities.
Card Protection Plan Limited On 22 August 2013, the FCA announced that Card Protection Plan Limited (“CPP”) and 13 banks and credit card issuers, including the Group, had agreed to a compensation scheme in relation to the sale of card and/or identity protection insurance to certain retail customers. CPP has now written to affected policyholders to confirm the details of the proposed scheme, which requires approval by a policyholder vote and by the High Court of England and Wales. A creditors’ meeting was held on 7 January 2014, at which the creditors voted in favour of the proposed scheme. The Group has made appropriate levels of provision based on its estimate of ultimate exposure.
In addition, RBS Citizens, N.A. agreed to take certain remedial actions to improve its compliance risk management systems and to create a comprehensive action plan designed to achieve compliance with the Consent Order. Restitution plans have been prepared and submitted for approval, and RBS Citizens, N.A. has submitted for approval and is in the process of implementing its action plan for compliance with the Consent Order, as well as updated policies, procedures and programmes related to its compliance risk management systems. In addition to the above, the bank subsidiaries could face further formal administrative enforcement actions from their federal supervisory agencies, including the assessment of civil monetary penalties and restitution, relating to issues arising from other consumer products.
Governance and risk management consent order On 27 July 2011, the Group agreed with the Board of Governors of the Federal Reserve System, the New York State Banking Department, the Connecticut Department of Banking, and the Illinois Department of Financial and Professional Regulation to enter into a consent Cease and Desist Order (the Order) to address deficiencies related to governance, risk management and compliance systems and controls in RBS plc and RBS N.V. branches. In the Order, the Group agreed to create the following written plans or programmes: • a plan to strengthen board and senior management oversight of the corporate governance, management, risk management, and operations of the Group’s U.S. operations on an enterprise-wide and business line basis,
33 Net cash (outflow)/inflow from operating activities 2013 2012* 2011* £m £m £m
38 Segmental analysis (a) Divisions The directors manage the Group primarily by class of business and present the segmental analysis on that basis. This includes the review of net interest income for each class of business - interest receivable and payable for all reportable segments is therefore presented net. Segments charge market prices for services rendered to other parts of the Group; funding charges between segments are determined by Group Treasury, having regard to commercial demands. The segment measure is operating profit/(loss).
Non-Core managed separately assets that the Group intended to run off or dispose of. The division contained a range of businesses and asset portfolios primarily from the legacy GBM businesses, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also included a number of other portfolios and businesses including regional markets businesses that the Group had concluded were no longer strategic.
UK Retail 3,990 979 4,969 (2,549) — (529) 1,891 UK Corporate 2,974 1,749 4,723 (1,916) (173) (838) 1,796 Wealth 720 450 1,170 (882) 1 (46) 243 International Banking 913 1,209 2,122 (1,417) — (111) 594 Ulster Bank 649 196 845 (521) — (1,364) (1,040) US Retail & Commercial 1,932 1,159 3,091 (2,050) (196) (91) 754 Markets 111 4,372 4,483 (2,707) (230) (37) 1,509 Central items (116) 510 394 364 (634) (40) 84 Core 11,173 10,624 21,797 (11,678) (1,232) (3,056) 5,831 Non-Core 244 44 288 (694) (250) (2,223) (2,879)
Write-down of other intangible assets — — — (106) — — (106)
Transfer to disposal groups — — — — — — (15) — (15) Currency translation and other adjustments — — — (28) 12 1 — (1) (16)
Loans and advances to banks 3 24,574 24,066 18,368 Loans and advances to customers 3 153 1,266 4,056 Debt securities 7 1,517 1,522 1,568 Investments in Group undertakings 8 54,813 54,995 53,871 Derivatives 6 164 511 1,502 Prepayments, accrued income and other assets 36 20 25 Assets of disposal groups 842 — — Total assets 82,099 82,380 79,390
Liabilities Deposits by banks 3 1,490 1,455 1,091 Customer accounts 3 740 838 977 Debt securities in issue 3 7,015 9,310 8,373 Derivatives 6 62 7 79 Accruals, deferred income and other liabilities 9 49 491 704 Subordinated liabilities 10 12,426 11,305 8,777 Total liabilities 21,782 23,406 20,001 Owners’ equity 60,317 58,974 59,389 Total liabilities and equity 82,099 82,380 79,390
Investing activities Investment in subsidiaries — (2,900) (4,568) Disposal of subsidiaries and associates 1,206 892 — Net cash flows from investing activities 1,206 (2,008) (4,568)
Profit/(loss) for the year 964 (684) (107) Other comprehensive income — — — Total comprehensive income/(loss) for the year 964 (684) (107)
Included in the table above are derivatives held for hedging purposes as follows: 2013 2012 2011 Assets Liabilities Assets Liabilities Assets Liabilities
Finance leases and instalment credit 3,671 4,321 2,532 10,524 10,532 11,216 13,374 16,186
UK 9,754 8,222 8,537 7,004 4,634 Overseas 11,496 11,661 9,645 10,279 6,382 21,250 19,883 18,182 17,283 11,016 Transfer (to)/from disposal groups UK — 764 (773) (25) — Overseas (9) — — (47) (324)
Financial summary continued Forbearance The table below shows loans granted forbearance during the year. These loans are unimpaired: either the loan was performing before and after the granting of forbearance or the loan was non-performing before but subsequently transferred to the performing book. Loans with impairment provisions subject to forbearance continue to be reported as impaired loans.
The Group’s ability to dispose of businesses, including RBS Citizens and the EC mandated branch divestment now known as Williams & Glyn, and assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which remain volatile. As a result there is no assurance that the Group will be able to sell or run down (as applicable) the businesses it has planned to sell or exit or asset portfolios it is seeking to sell either on favourable economic terms to the Group or at all. Material tax or other contingent liabilities could arise on the disposal or run-down of assets or businesses and there is no assurance that any conditions precedent agreed will be satisfied, or consents and approvals required will be obtained in a timely manner, or at all. There is consequently a risk that the Group may fail to complete such disposals within time frames envisaged by the Group, its regulators and the EC.
Furthermore, if the Group is unable to comply with the terms of the State Aid approval, it could constitute a misuse of aid. In circumstances where the EC doubts that the Group is complying with the terms of the State Aid approval, it may open a formal investigation. At the conclusion of any such investigation, if the EC decided that there had been misuse of aid, it could issue a decision requiring HM Treasury to recover the misused aid, which could have a material adverse impact on the Group.
Rating agencies continue to evaluate the rating methodologies applicable to UK and European financial institutions and any change in such rating agencies’ methodologies could materially adversely affect the credit ratings of Group companies. Any further reductions in the long-term or short-term credit ratings of RBSG or one of its principal subsidiaries (particularly the Royal Bank) would increase its borrowing costs, require the Group to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the Group’s access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements. At 31 December 2013, a simultaneous one notch longterm and associated short-term downgrade in the credit ratings of RBSG and the Royal Bank by the three main ratings agencies would have required the Group to post estimated additional collateral of £10 billion, without taking account of mitigating action by management.
Any downgrade in the UK Government’s credit ratings could adversely affect the credit ratings of Group companies and may have the effects noted above. In December 2012, Standard & Poor’s placed the UK’s AAA credit rating on credit watch, with negative outlook and, in February 2013, Moody’s downgraded the UK’s credit rating one notch to Aa1. Credit ratings of RBSG, the Royal Bank, The Royal Bank of Scotland N.V. (RBS N.V.), Ulster Bank Limited and RBS Citizens are also important to the Group when competing in certain markets, such as over-the-counter derivatives. As a result, any further reductions in RBSG’s long-term or short-term credit ratings or those of its principal subsidiaries could adversely affect the Group’s access to liquidity and its competitive position, increase its funding costs and have a material adverse impact on the Group’s earnings, cash flow and financial condition.
Risk factors continued The market perception of bank credit risk has changed significantly as a result of the financial crisis and banks that are deemed by the market to be riskier have had to issue debt at a premium. Any uncertainty regarding the perception of credit risk across financial institutions may lead to reductions in levels of interbank lending and associated term maturities and may restrict the Group’s access to traditional sources of funding or increase the costs of accessing such funding. The ability of the Group’s regulator to bail-in senior debt which may be exercised as soon as either the provisions of the Banking Reform Act 2013 are implemented through secondary legislation or the RRD comes into effect, may also increase investors’ perception of risk and hence affect the availability and cost of funding for the Group.
The Group may be required to make further contributions to its pension schemes if the value of pension fund assets is not sufficient to cover potential obligations The Group maintains a number of defined benefit pension schemes for past and a number of current employees. Pension risk is the risk that the assets of the Group’s various defined benefit pension schemes which are long-term in nature do not fully match the timing and amount of the schemes’ liabilities, as a result of which the Group is required or chooses to make additional contributions to the schemes. Pension scheme liabilities vary with changes to long-term interest rates, inflation, pensionable salaries and the longevity of scheme members as well as changes in applicable legislation. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios, returns from them and any additional future contributions to the schemes, may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities.
The Banking Reform Act 2013 will require banks to ring-fence specific activities (principally retail and small business deposits) from certain other activities. Ring-fencing is likely to entail changes to the structure of the Group’s existing defined benefit pension schemes, which could affect assessments of the schemes’ deficits. Such assessments may also be affected by other measures introduced in the Banking Reform Act 2013, including the categorisation of deposits eligible for compensation under the Financial Services Compensation Scheme as preferential debts.
EU Directive on taxation of savings income Under the European Union Council Directive 2003/48/EC on the taxation of savings income, member states of the European Union are required to provide to the tax authorities of other member states details of payments of interest and other similar income paid by a person to an individual or certain other persons resident in another member state, except that Luxembourg and Austria may instead impose a withholding system for a transitional period unless during such period they elect otherwise. On April 10, 2013, the Luxembourg Ministry of Finance announced that Luxembourg’s transitional period will end with effect from January 1, 2015.
Position risk requirement - a capital requirement applied to a position treated under BIPRU 7 (Market risk) as part of the calculation of the market risk capital requirement.
Residential mortgage backed securities (RMBS) - asset-backed securities for which the underlying asset portfolios are residential mortgages.
The Group implemented the majority of the EDTF recommendations in its 2012 Annual Report and Accounts and Pillar 3 Report and the remainder in its 2013 reports.
The table below sets out the EDTF recommendations and the related locations in the 2013 Annual Report and Accounts and Pillar 3 Report.
Financial instruments Accounting policies 381 Critical accounting policies 388 Notes on the consolidated accounts 406 Parent company notes 502
Property, plant and equipment Accounting policies 379 Notes on the consolidated accounts 446