RBS 2009 Annual Report Download - page 146

Business review continued
RBS Group Annual Report and Accounts 2009144
Credit risk continued
Impairment loss provision methodology
Provisions for impairment losses are assessed under three categories:
•Individually assessed provisions: provisions required for individually
significant impaired assets which are assessed on a case by case
basis, taking into account the financial condition of the counterparty
and any guarantee and other collateral held after being stressed for
downside risk. This incorporates an estimate of the discounted value
of any recoveries and realisation of security or collateral. The asset
continues to be assessed on an individual basis until it is repaid in
full, transferred to the performing portfolio or written-off;
•Collectively assessed provisions: provisions on impaired credits
below an agreed threshold which are assessed on a portfolio basis,
to reflect the homogeneous nature of the assets, such as credit
cards or personal loans. The provision is determined from a
quantitative review of the relevant portfolio, taking account of the
level of arrears, security and average loss experience over the
recovery period; and
•Latent loss provisions: provisions held against impairments in the
performing portfolio that have been incurred as a result of events
occuring before the balance sheet date but which have not been
identified at the balance sheet date. The Group has developed
methodologies to estimate latent loss provisions that reflect:
– Historical loss experience adjusted where appropriate, in the light
of current economic and credit conditions; and
– The period (‘emergence period’) between an impairment event
occurring and a loan being identified and reported as impaired.
Recoverable cash flows are estimated using two parameters: loss
given default (LGD) – this is the estimated loss amount, expressed as
a percentage, that will be incurred if the borrower defaults; and the
probability that the borrower will default (PD).
Emergence periods are estimated at a portfolio level and reflect the
portfolio product characteristics such as a coupon period and
repayment terms, and the duration of the administrative process
required to report and identify an impaired loan as such. Emergence
periods vary across different portfolios from two to 225 days. They
are based on actual experience within the particular portfolio and are
reviewed regularly.
The Group’s retail business segment their performing loan books into
homogenous portfolios such as mortgages, credit cards or
unsecured loans, to reflect their different credit characteristics. Latent
provisions are computed by applying portfolio-level LGDs, PDs and
emergence periods. The wholesale calculation is based on similar
principles but there is no segmentation into portfolios: PDs and LGDs
are calculated on an individual basis.
Provision analysis
The Group’s consumer portfolios, which consist of high volume, small
value credits, have highly efficient largely automated processes for
identifying problem credits and very short timescales, typically three
months, before resolution or adoption of various recovery methods.
Corporate portfolios consist of higher value, lower volume credits, which
tend to be structured to meet individual customer requirements.
Provisions are assessed on a case by case basis by experienced
specialists with input from professional valuers and accountants. The
Group operates a transparent provisions governance framework, setting
thresholds to trigger enhanced oversight and challenge.