RBS 2009 Annual Report Download - page 127

Business review
Risk, capital and liquidity management
In addition to the calculation of minimum capital requirements for credit,
market and operational risk, banks are required to undertake an
Individual Capital Adequacy Assessment Process (ICAAP) for other
risks. The Group’s ICAAP, in particular, focuses on pension fund risk,
interest rate risk in the banking book together with stress tests to assess
the adequacy of capital over one year and the economic cycle.
The Group publishes its Pillar 3 (Market disclosures) on its website,
providing a range of additional information relating to Basel II and risk
and capital management across the Group. The disclosures focus on
Group level capital resources and adequacy, discuss a range of credit
risk approaches and their associated RWAs under various Basel II
approaches such as credit risk mitigation, counterparty credit risk and
provisions. Detailed disclosures are also made on equity, securitisation,
operational and market risk, as well as providing Interest Rate Risk in
the Banking Book disclosures.
Stress and scenario testing
Stress testing forms part of the Group’s risk and capital framework and
an integral component of Basel II. As a key risk management tool,
stress testing highlights to senior management potential adverse
unexpected outcomes related to a mixture of risks and provides an
indication of how much capital might be required to absorb losses,
should adverse scenarios occur. Stress testing is used at both a
divisional and Group level to assess risk concentrations, estimate the
impact of stressed earnings, impairments and write-downs on capital. It
determines the overall capital adequacy under a variety of adverse
scenarios. The principal business benefits of the stress testing
framework include: understanding the impact of recessionary
scenarios; assessing material risk concentrations; forecasting the
impact of market stress and scenarios on the Group’s balance sheet
liquidity.
At Group level, a series of stress events are monitored on a regular
basis to assess the potential impact of an extreme yet plausible event
on the Group. There are four core elements of scenario stress testing:
•Macroeconomic stress testing considers the impact on both
earnings and capital for a range of scenarios. They entail multi-year
systemic shocks to assess the Group’s ability to meet its capital
requirements and liabilities as they fall due under a downturn in the
business cycle and/or macroeconomic environment;
•Enterprise wide stress testing considers scenarios that are not
macroeconomic in nature but are sufficiently broad in nature to
impact across multiple risks or divisions and are likely to impact
earnings, capital and funding;
•Cross-divisional stress testing includes scenarios which have
impacts across divisions relating to sensitivity to a common risk
factor(s). This would include sector based stress testing across
corporate portfolios and sensitivity analysis to stress in market
factors. These stress tests are discussed with senior divisional
management and are reported to senior committees across the
Group; and
•Divisional and risk specific stress testing is undertaken to support
risk identification and management. Current examples include the
daily product based stress testing using a hybrid of hypothetical and
historical scenarios within market risk.
Portfolio analysis, using historic performance and forward looking
indicators of change, uses stress testing to facilitate the measurement
of potential exposure to events and seeks to quantify the impact of an
adverse change in factors which drive the performance and profitability
of a portfolio.
125RBS Group Annual Report and Accounts 2009