RBS 2006 Annual Report Download - page 247
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246
Additional information continued
Additional information
Economic and monetary environment
The Group’s earnings are affected by the economic and
monetary environment in its key markets.
The UK interest rate cycle turned in 2006, with the Monetary
Policy Committee (“MPC”) lifting the Bank Rate from 4.5% to
4.75% in August, and to 5% in November. Despite market
expectations that there would be more to come from the MPC
in 2007, longer-term interest rates were below the policy rate at
year-end, as was the case for most of 2006 (e.g. the 10-year
benchmark gilt yield was 4.74%). The Bank Rate was
increased in response to the threat that stronger economic
activity posed to the medium-term inflation outlook, and the risk
that the energy-induced increase in CPI inflation during 2006
would dislodge expectations ahead of the 2007 wage
bargaining round (CPI inflation was 3% in December 2006; the
government-set target is 2%).
Even after 17 interest rate rises over the past two-and-a-half
years, to 5.25%, monetary conditions remain fairly supportive
in the US. A weak dollar and low long-term interest rates have
partially offset the effect of a higher fed funds rate on
economic activity – though 5.25% is not high by historic
standards. The US economy grew by a respectable 3.4% in
2006, though sluggish growth towards the end of the year –
largely attributed to a sharp slowdown in the housing and
auto sectors – led markets to price in rate cuts in 2007. This
helped to exacerbate the yield curve inversion that prevailed
for most of 2006.
The European Central Bank lifted the Refi Rate to 2.25% in
January 2006. Prior to that, the Refi had been on hold at 2% for
two and a half years. Four more quarter-point increases followed,
taking the Refi to 3.25% by year-end. Markets expect this
‘normalisation’ to continue in 2007, as the improved economic
environment meant that ultra-low interest rates were no longer
needed to stimulate demand.
Exchange rates are an important driver of monetary conditions;
they also affect earnings reported by the Group’s non-UK
subsidiaries, and the value of non-sterling denominated assets
and liabilities. The pound rose by 25c against the dollar over the
course of the year, or 14%, in response to the unexpected (at
the start of 2006) increase in UK interest rates. Sluggish growth
in the US towards the end of the year, and the market’s
perception that this would lead to lower interest rates in 2007,
also put downward pressure on the dollar.
Supervision and regulation
1 United Kingdom
1.1 The regulatory regime applying to the UK financial
services industry
The Financial Services and Markets Act 2000 (“FSMA
2000”), containing an integrated legislative framework for
regulating most of the UK financial services industry, came
into force at the end of 2001. This and subsequent
amendments established the Financial Services Authority
(the “FSA”) as the single statutory regulator responsible for
regulating deposit taking, insurance, mortgage and
investment business in the UK.
Under the FSMA 2000, businesses require the FSA's
permission to undertake specified types of activities
including entering into and carrying out contracts of
insurance; managing, dealing in or advising on,
investments; mortgage business; accepting deposits; and
issuing electronic money (‘regulated activities’). The FSA
has published detailed regulatory requirements contained
in a Handbook of Rules and Guidance.
The FSA’s statutory objectives are to maintain confidence
in, and to promote public understanding of, the UK
financial system; to secure an appropriate degree of
consumer protection; and to reduce the scope for financial
crime. In achieving these objectives, the FSA must take
account of certain ‘principles of good regulation’ which
include recognising the responsibilities of authorised firms’
own management, facilitating innovation and competition
and acting proportionately in imposing burdens on the
industry.
1.2 Authorised firms in the Group
As at 31 December 2006, 33 companies in the Group,
spanning a range of financial services sectors (banking,
insurance and investment business), are authorised to
conduct activities regulated by the FSA. These companies
are referred to as 'authorised firms'.
The FSA supervises the banking business of the UK based
banks in the Group, including The Royal Bank of Scotland,
NatWest, Coutts & Co, Ulster Bank Limited and Tesco
Personal Finance Limited.
General insurance business is principally undertaken by
companies in the RBS Insurance division, whilst life
assurance business is undertaken by Royal Scottish
Assurance plc and National Westminster Life Assurance
Limited (with the Group’s partner, the AVIVA Group) and
Direct Line Life Insurance Company Limited. Investment
management business is principally undertaken by
companies in the Retail Markets division, including Adam &
Company Investment Management Limited and Coutts &
Co Investment Management Limited, and in the Corporate
Markets division, RBS Asset Management Limited.