RBS 2010 Annual Report Download - page 145

Interest rate risk
The banking book consists of interest bearing assets, liabilities and
derivative instruments used to mitigate risks which are accounted for on
an accrual basis, as well as non-interest bearing balance sheet items
which are not subjected to fair value accounting.
The Group provides financial products to satisfy a variety of customer
requirements. Loans and deposits are designed to meet customer
objectives with regard to repricing frequency, tenor, index, prepayment,
optionality and other features. These characteristics are aggregated to
form portfolios of assets and liabilities with varying degrees of sensitivity
to changes in market rates. Mismatches in these sensitivities give rise to
net interest income (NII) volatility as the level of interest rates rise and fall.
For example, a bank with a floating rate loan portfolio and largely fixed
rate deposits will see its NII rise as interest rates rise and fall as rates
decline. Due to the long-term nature of many banking book portfolios,
layered repricing characteristics and maturities, it is likely the NII will vary
from period to period even with no change in market rate level. New
business volumes originated in any period will alter the interest rate
sensitivity of a bank if it differs from portfolios originated in prior periods.
Interest rate risk in the banking book (IRRBB) is assessed using a set of
standards to define, measure and report the market risk. It is the Group’s
policy to minimise interest rate sensitivity in banking book portfolios and
where interest rate risk is retained to ensure that appropriate measures
and limits are applied. Key conventions in evaluating IRRBB are
subjected to approval of divisional ALCOs and GALCO. Limits on IRRBB
are proposed by the Group Treasurer for approval by ERF annually.
IRRBB is measured using a version of the same VaR methodology that is
used for the Group’s trading portfolios. Net interest income exposures are
measured in terms of sensitivity over time to movements in interest rates.
Additionally, Citizens measures the sensitivity of the market value of
equity to changes in forward interest rates.
Divisions with the exception of Citizens and GBM are required to manage
banking book exposures through internal transactions with Group
Treasury to the greatest extent possible. Residual risks in divisions must
be measured and reported as described.
Group Treasury aggregates exposures arising from its own external
activities and positions transferred in from divisions. Where appropriate,
Group Treasury nets offsetting risk exposures to determine a residual
exposure to rate movements. Hedging transactions using cash and
derivative instruments are executed to manage within the GALCO
approved VaR limits.
Citizens and GBM manage their own IRRBB exposures within approved
limits to satisfy their business objectives.
IRRBB VaR for the Group's retail and commercial banking activities at a
99% confidence level was as follows:
Average Period end Maximum Minimum
£m £m £m £m
2010 57.5 96.2 96.2 30.0
2009 85.5 101.3 123.2 53.3
2008 130.0 76.7 197.4 76.7
Abreakdown of the Group's IRRBB VaR by currency is shown below.
Currency 2010
£m
2009
£m
2008
£m
EUR 32.7 32.2 30.9
GBP 79.3 111.2 26.0
USD 120.6 42.1 57.9
Other 9.7 9.0 14.0
Key points
xInterest rate exposure at 31 December 2010 was slightly lower than at the end of 2009. The average exposure in 2010 was 33% below the
average for 2009.
xIn general, actions taken throughout 2010 to mitigate earnings sensitivity from interest rate movements were executed in US dollars, hence the
year on year shift in VaR by currency.
143RBS Group 2010
Business review
Risk and balance sheet management