RBS 2007 Annual Report Download - page 88

RBS Group • Annual Report and Accounts 2007
86
Business review continued
Business review
Treasury
The Group’s treasury activities include its money market
business and the management of internal funds flow within the
Group’s businesses. Money market portfolios include cash
instruments (principally debt securities, loans and deposits)
and related hedging derivatives. VaR for the Group’s treasury
portfolios, which relates mainly to interest rate risk including
credit spreads, was £5.5 million at 31 December 2007 (2006 –
£1.5 million). During the year the maximum VaR was £6.4
million (2006 – £4.4 million), the minimum £1.3 million (2006 –
£0.6 million) and the average £3.7 million (2006 – £2.4 million).
Retail and commercial banking
Non-trading interest rate risk can arise in these activities from a
variety of sources, including where assets, liabilities and off-
balance sheet instruments have different repricing dates.
Non-trading interest rate risk is calculated in each business on
the basis of establishing the repricing behaviour of each asset,
liability and off-balance sheet product. For many products, the
actual interest rate repricing characteristics differ from the
contractual repricing. In most cases, the repricing maturity is
determined by the market interest rate that most closely fits the
historical behaviour of the product interest rate. For non
interest bearing current accounts, the repricing maturity is
determined by the stability of the portfolio. The repricing
maturities used are approved by Group Treasury and divisional
asset and liability committees at least annually. Key
conventions are reviewed annually by GALCO.
A static maturity gap report is produced as at the month-end
for each business, in each functional currency based on the
behaviouralised repricing for each product. It is Group policy
to include in the gap report, non-financial assets and liabilities,
mainly property, plant and equipment and the Group’s capital
and reserves, spread over medium and longer term maturities.
This report also includes hedge transactions, principally
derivatives.
Any residual non-trading interest rate exposures are controlled
by limiting repricing mismatches in the individual business
balance sheets. Potential exposures to interest rate movements
in the medium to long term are measured and controlled using
a version of the same VaR methodology that is used for the
Group’s trading portfolios but without discount factors. Net
accrual income exposures are measured and controlled in
terms of sensitivity over time to movements in interest rates.
Risk is managed within VaR limits approved by GALCO,
through the execution of cash and derivative instruments.
Execution of the hedging is carried out by the relevant division
through the Group’s treasury functions. The residual risk
position is reported to divisional asset and liability committees,
GALCO and the Board.
Non-trading interest rate VaR
Non-trading interest rate VaR for the Group’s treasury and retail
and commercial banking activities, including ABN AMRO on a
fully consolidates basis, was £42.9 million at 31 December
2007 (2006 – £40.2 million) with the major exposure being to
changes in longer term US dollar interest rates. During the
year, the maximum VaR was £53.6 million (2006 – £98.7
million), the minimum £32.9 million (2006 – £40.2 million) and
the average £43.2 million (2006 – £76.6 million).
Citizens was the main contributor to overall non-trading interest
rate VaR. It invests in portfolios of highly rated and liquid
investments, principally mortgage-backed securities issued
by US Government-backed entities. This balance sheet
management approach is common for US retail banks where
mortgages are originated and then sold to Federal agencies
for funding through the capital markets.
VaR, like all interest rate risk measures, has limitations when
applied to retail banking books and the management of
Citizens Financial Group’s interest rate exposures involves a
number of other interest rate risk measures and related limits.
Two measures that are reported both to Citizens ALCO and the
Board are:
•The sensitivity of net accrual earnings to a series of parallel
movements in interest rates; and
•Economic value of equity (“EVE”) sensitivity to a series of
parallel movements in interest rates.