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RBS Group • Annual Report and Accounts 2006
Additional information
On 26 October 2001, the President of the United States
signed into law the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the “Patriot Act”). The
Patriot Act was renewed on 2 March 2006 and signed into
law by the President of the United States on 9 March 2006.
The Patriot Act significantly expanded the responsibilities
of financial institutions in preventing the use of the US
financial system to fund terrorist activities. Title III of the
Patriot Act (officially, the “International Money Laundering
Abatement and Anti-Terrorist Financing Act of 2001”) is the
anti-money laundering portion of the Patriot Act. Title III
provided for a sweeping overhaul of the US anti-money
laundering regime. Among other provisions, it requires
financial institutions operating in the United States to (i)
give special attention to correspondent and payable-
through bank accounts, (ii) implement enhanced reporting,
due diligence and “know your customer” standards for
private banking and correspondent banking relationships,
(iii) scrutinise the beneficial ownership and activity of
certain non-US and private banking customers and (iv)
develop new anti-money laundering programmes, due
diligence policies and controls to ensure the detection and
reporting of money laundering. The Patriot Act requires all
US financial institutions to develop anti-money laundering
programmes. Such required compliance programmes are
intended to supplement any existing compliance
programmes for purposes of requirements under the Bank
Secrecy Act and the Office of Foreign Assets Control
Regulations.
4 Other jurisdictions
Through its Corporate Markets and Wealth Management
divisions, the Group conducts business in various other
jurisdictions and is regulated by many financial and other
regulatory bodies around the world. These jurisdictions
include among others China, Hong Kong, Japan,
Singapore and Australia in the Asia Pacific region;
Abu Dhabi, Dubai and Bahrain where the Group has
branches and representative offices; and Switzerland
and the Channel Islands.
5 Regulatory developments for capital and risk
management
The Basel Committee on Banking Supervision issued new
requirements for firms’ risk weighted asset (“RWA”)
calculations in June 2004. These rules are generally
referred to as Basel 2.
In the EU, this new framework became law through the
Capital Requirements Directive and associated changes to
national laws or regulatory guidelines (e.g. the FSA’s
GENPRU and BIPRU). Within the US, regulators have the
flexibility to implement Basel 2 directly, after their final
Notice of Proposed Rulemaking. Full adoption of these
rules comes into force across the EU on 1 January 2008
and the US from 1 January 2009.
Application of Basel 2 differs between jurisdictions. The EU
is applying Basel 2 to all banks and investment firms. The
US is taking a different approach, mandating that the
largest internationally active US banks use the ‘Advanced’
approaches for credit and operational risk calculations;
other US banks will remain on the pre-existing standards or
a modified version thereof (Basel 1 or Basel 1a) or decide
to ‘opt-into’ Basel 2. Our US subsidiary, Citizens Financial
Group, is an ‘opt-in’ firm for these purposes.
The Group has submitted a request to the FSA (generally
referred to as a ‘waiver’) to adopt the Advanced Internal
Ratings-Based approach (“AIRB”) for the majority of the
Group’s EU credit risk exposures from the earliest possible
date, January 2008. In order to satisfy the requirements for
AIRB, which is the most sophisticated option available to
firms, banks are required to have risk grading, scoring and
validation approaches that calculate the Probability of
Default, Exposure at Default and Loss Given Default for
each facility. Outputs from these models, along with other
factors, such as maturity, are then used to calculate
RWAs according to regulatory formulas.
The implications of the new rules are becoming clearer.
Assuming average risk profiles, banks will require less
capital to support lending to residential mortgages and
other retail and small and medium enterprises. Good
quality corporate lending should also see a reduction in
capital requirements. Conversely banks, on average, will be
required to hold more regulatory capital for some
specialised lending and equity exposures, sovereigns and
poorer quality bank and corporate credits, although the
actual capital requirements under Basel 2 depend on a
number of factors, including collateral.
Basel 2 introduces, for the first time, an explicit
requirement to hold capital for operational risk. Of the
available options, the Group is adopting ‘The Standardised
Approach’ initially, with the objective of migrating to the
more sophisticated ‘Advanced Measurement Approach’, in
line with the US implementation. In addition, Basel 2 also
introduces two new elements – a formal supervisory review
process (Pillar 2) and more extensive market disclosures
(Pillar 3). The Group is making good progress in both
areas, in advance of formal implementation in 2008.