RBS 2006 Annual Report Download - page 181
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RBS Group • Annual Report and Accounts 2006
180
Notes on the accounts continued
34 Risk management
Financial risk management policies and objectives
The Board establishes the overall governance framework for
risk management and sets the risk appetite and philosophy for
the Group.
The principal financial risks that the Group manages are
as follows:
•Credit risk: is the risk arising from the possibility that the
Group will incur losses from the failure of customers to meet
their obligations.
•Liquidity risk: is the risk that the Group is unable to meet its
obligations as they fall due.
•Market risk: the Group is exposed to market risk because of
positions held in its trading portfolios and its non-trading
businesses.
•Insurance risk: the Group is exposed to insurance risk, either
directly through its businesses or through using insurance as
a tool to mitigate other risk exposures.
Credit risk
The objective of credit risk management is to enable the Group
to achieve appropriate risk versus reward performance
whilst maintaining credit risk exposure in line with approved
risk appetite.
The key principles for credit risk management as defined in the
Group’s Credit Risk Management Framework are set out below.
•Approval of all credit exposure is granted prior to any
advance or extension of credit.
•An appropriate credit risk assessment of the customer and
credit facilities is undertaken prior to approval of credit
exposure. This includes a review of, amongst other things,
the purpose of the credit and sources of repayment,
compliance with affordability tests, repayment history,
capacity to repay, sensitivity to economic and market
developments and risk-adjusted return.
•The Board delegates authority to Advances Committee,
Group Credit Committee and divisional credit committees.
•Credit risk authority must be specifically granted in writing to
all individuals involved in the granting of credit approval,
whether this is exercised personally or collectively as part of
a credit committee. In exercising credit authority, the
individuals act independently.
•Where credit authority is exercised personally, the individual
has no responsibility or accountability for related business
revenue origination.
•All credit exposures, once approved, are effectively
monitored and managed and reviewed periodically against
approved limits. Lower quality exposures are subject to a
greater frequency of analysis and assessment.
•Customers with emerging credit problems are identified
early and classified accordingly. Remedial actions
are implemented promptly to minimise the potential loss
to the Group.
•Portfolio analysis and reporting is used to identify
and manage credit risk concentrations and credit risk
quality migration.
Credit approval process
Different credit approval processes exist for each customer
type in order to ensure appropriate skills and resources are
employed in credit assessment and approval. Credit authority
is not extended to relationship management.
Credit risk models
Credit risk models are used throughout the Group to support
the analytical elements of the credit risk management framework,
in particular the risk assessment part of the credit approval
process, ongoing monitoring as well as portfolio analysis and
reporting. Credit risk models used by the Group can be
broadly grouped into four categories.
•Probability of default (“PD”)/customer credit grade – these
models assess the probability that the customer will fail to
make full and timely repayment of credit obligations over a
one year time horizon. Each customer is assigned an
internal credit grade which corresponds to a probability of
default. There are a number of different credit grading
models in use across the Group, each of which considers
particular characteristics of customer types in that portfolio.
The credit grading models use a combination of quantitative
inputs, such as recent financial performance and customer
behaviour, and qualitative inputs, such as company
management performance or sector outlook.
Every customer credit grade across all grading scales in the
Group can be mapped to a Group level credit grade which
uses a five band scale from AQ1 to AQ5.
•Exposure at default (“EAD”) – these models estimate the
expected level of utilisation of a credit facility at the time of
a borrower’s default. The EAD will typically be higher than
the current utilisation (e.g. in the case where further
drawings are made on a revolving credit facility prior to
default) but will not normally exceed the total facility limit.
The methodologies used in EAD modelling recognise that
customers may make more use of their existing credit
facilities in the run up to a default.