RBS 2011 Annual Report Download - page 112

110 RBS Group 2011
Business review Risk and balance sheet management continued
Balance sheet management
All disclosures in this section (pages 110 to 133) are audited unless
otherwise indicated by an asterisk (*).
Two of the Group’s four key strategic risk objectives relate to the
maintenance of capital adequacy and ensuring stable and efficient
access to liquidity and funding. This section on balance sheet
management explains how the Group is performing on achieving these
objectives.
Capital management
Introduction*
The Group aims to maintain an appropriate level of capital to meet its
business needs and regulatory requirements as capital adequacy and
risk management are closely aligned. The Group operates within an
agreed risk appetite whilst optimising the use of shareholders’ funds to
deliver sustainable returns.
The appropriate level of capital is determined based on the dual aims of:
(i) meeting minimum regulatory capital requirements; and (ii) ensuring the
Group maintains sufficient capital to uphold investor and rating agency
confidence in the organisation, thereby supporting the business franchise
and funding capacity.
Governance*
The Group Asset and Liability Management Committee (GALCO) is
responsible for ensuring the Group maintains adequate capital at all
times. The newly established Capital and Stress Testing Committee
(CAST) is a cross-functional body driving and directing integrated risk
capital activities including stress testing economic capital and capital
allocation. These activities have linkages to capital planning, risk appetite
and regulatory change. CAST reports through GALCO and comprises
senior representatives from Risk Management, Group Finance and
Group Treasury.
Determining appropriate capital*
The minimum regulatory capital requirements are identified by the Group
through the Internal Capital Adequacy Assessment Process and then
agreed between the Group Board and the appropriate supervisory
authority.
The Group’s own determination of how much capital is sufficient is
derived from the desired credit rating level and the application of both
internally and externally defined stress tests that identify potential
changes in capital ratios over time.
Monitoring and maintenance*
Based on these determinations, which are continually reassessed, the
Group aims to maintain capital adequacy both at Group level and in each
regulated entity.
The Group operates a rigorous capital planning process aimed at
ensuring the capital position is controlled within the agreed parameters.
This incorporates regular re-forecasts of the capital positions of the
regulated entities and the overall Group. In the event that the projected
position deteriorates beyond acceptable levels, the Group would issue
further capital and/or revise business plans accordingly.
Stress testing approaches are used to determine the level of capital
required to ensure the Group remains adequately capitalised.
Capital allocation*
Capital resourcesare allocated to the Group’s businesses based on key
performance parameters agreed by the Group Board in the annual
strategic planning process. Principal among these is a profitability metric
which assesses the effective use of the capital allocated to the business.
Projected and actual return on equity is assessed against target returns
set by the Group Board. The allocations also reflect strategic priorities
and balance sheet and funding metrics.
Economic profit is also planned and measured for each division during
the annual planning process. It is calculated by deducting the cost of
equity utilised in the particular business from its operating profit and
measures the value added over and above the cost of equity.
The Group aims to deliver sustainable returns across the portfolio of
businesses with projected business returns stressed to test key
vulnerabilities.
The divisions use return on capital metrics when making pricing decisions
on products and transactions with a view to ensuring customer activity is
appropriately aligned with Group and divisional targets and allocations.
The FSA uses the risk asset ratio as a measure of capital adequacy in
the UK banking sector, comparing a bank’s capital resources with its
RWAs (the assets and off-balance sheet exposures are weighted to
reflect the inherent credit and other risks); by international agreement the
risk asset ratios should not be less than 8% with a Tier 1 component of
not less than 4%.
*unaudited