RBS 2006 Annual Report Download - page 83
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Please find page 83 of the 2006 RBS annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.RBS Group • Annual Report and Accounts 2006
82
Operating and financial review continued
Operating and financial review
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 quantitative risk assessment part
of the credit approval process, ongoing credit monitoring as
well as portfolio level analysis and reporting.
Credit risk modelling governance
The Group’s ‘Principles for Managing Credit Risk’ outline the
governance structure under which all credit risk models must
be developed, reviewed and approved. GRM is responsible for:
•Establishing high level standards to which all credit risk
models across the Group must adhere and thus ensuring a
consistency of approach to credit risk modelling across the
Group.
•Approving all credit risk models prior to implementation and
reviewing existing models on at least an annual basis.
Divisional credit risk departments own the particular models
and are responsible for:
•Developing credit risk models appropriate for the types of
borrower and facilities in their credit portfolios and obtaining
approval from GRM for their implementation.
•Validating the models and submitting documentation of
these validations to GRM with appropriate recommendations
on recalibration, where applicable.
•Obtaining approval from GRM for any new methodology or
parameter estimates used in existing credit risk models prior
to implementation.
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 probability of
default. There are a number of different credit grading
models in use across the Group, each of which considers
particular customer characteristics 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
(see page 83).
•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 typically 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.
•Loss given default (“LGD”) – these models estimate the
economic loss that may be suffered by the Group on a credit
facility in the event of default. The LGD of a facility represents
the amount of debt which cannot be recovered and is
typically expressed as a percentage of the EAD. The Group’s
LGD models take into account the type of borrower, facility
and any risk mitigation such as security or collateral held.
The LGD may also be affected by the industry sector of the
borrower, the legal jurisdiction in which the borrower operates
as well as general economic conditions which may impact the
value of any assets held as security.
•Credit risk exposure measurement – these models calculate
the credit risk exposure for products where the exposure is
not 100% of the gross nominal amount of the credit
obligation. These models are most commonly used for
derivative and other traded instruments where the amount of
credit risk exposure may be dependent on external variables
such as interest rates or foreign exchange rates.
Credit risk stress testing
Credit risk stress testing measures the potential vulnerability to
exceptional but plausible economic and geopolitical events,
and seeks to quantify the impact of an adverse change in
factors which drive the performance and profitability of a
portfolio. Stress testing is used within the Group’s CRMF to
estimate and manage potential loss in the portfolio and to
support the Board’s internal assessment of adequacy of
regulatory capital.
At the Group level, a series of stress events are monitored on a
regular basis to assess the potential impact on the Group’s
income statement, through the credit impairment charge. The
primary objective of this analysis is to support the Group’s
framework for managing industry and geographical sector
concentrations. This is done through the identification of
scenarios which are likely to affect groups of inter-related
sectors. These stress tests are discussed with senior divisional
management and are reported to GRC, GEMC and the GAC.
The Group manages to a trigger limit on the stressed
impairment charge for an individual scenario.
In addition, the Group calculates the potential impact of a
range of macroeconomic scenarios on both the Group’s
income statement and balance sheet. This analysis is
discussed by GEMC and reported to the Board.