RBS 2011 Annual Report Download - page 119

RBS Group 2011 117
Stress testing
The strength of a bank’s liquidity risk management can only be evaluated
based on its ability to survive under stress. The Group evaluates the
survivability of the major legal entities and legal entity groups when
subjected to simulated stress conditions.
Simulated liquidity stress testing is periodically performed for each
business as well as the major operating subsidiaries. A variety of firm-
specific and market-related scenarios are used at the consolidated level
and in individual countries. These scenarios include assumptions about
significant changes in key funding sources, credit ratings, contingent uses
of funding, and political and economic conditions in certain countries.
The Group’s actual experiences from the 2008 and 2009 period factor
heavily into the liquidity analysis. This systemic and name-specific crisis
provides important data points in estimating stress severity.
Stress scenarios are applied to both on-balance sheet and off-balance
sheet commitments, to provide a comprehensive view of potential cash
flows.
Contingency planning
The Group has a Contingency Funding Plan (CFP), which is updated as
the balance sheet evolves. The CFP is linked to stress test results and
forms the foundation for liquidity risk limits. Limits in the business-as-
usual environment are bounded by capacity to satisfy the Group’s
liquidity needs in the stress environments. The CFP provides a detailed
description of the availability, size and timing of all sources of contingent
liquidity available to the Group in a stress event. These are ranked in
order of economic impact and effectiveness to meet the anticipated
stress requirement. The CFP includes documented procedures and sign-
offs for actions that may require businesses to provide access to
customer assets for collateralised borrowing, securitisation or sale. Roles
and responsibilities for the effective implementation of the CFP are also
documented.
Liquidity reserves
The Group maintains liquidity reserves sufficient to satisfy cash
requirements, in the event of a severe disruption in its access to funding
sources. The reserves consist of cash held on deposit at central banks,
high quality unencumbered government securities and other
unencumbered collateral. Government securities vary by type and
jurisdiction based on local regulatory considerations. The currency mix of
the reserves reflects the underlying balance sheet composition.
Regulatory oversight
The Group operates in multiple jurisdictions and is subject to a number of
regulatory regimes.
The Group’s lead regulator is the UK Financial Services Authority (FSA).
The FSA implemented a new liquidity regime on 1 June 2010. The new
rules provide a standardised approach applied to all UK banks. At RBS
Group, the rules focus on the UK Defined Liquidity Group (a subset
comprising the Group’s five UK banks, The Royal Bank of Scotland plc,
National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co and
Adam & Co) and cover adequacy of liquidity resources, controls, stress
testing and the Individual Liquidity Adequacy Assessment (ILAA). The
ILAA informs the Group Board and the FSA of the assessment and
quantification of the Group’s liquidity risks and their mitigation, and how
much current and future liquidity is required.
In the US, the Group’s operations must meet liquidity requirements set
out by the US Federal Reserve Bank, the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation and the Financial
Industry Regulatory Authority. In the Netherlands, the Group is subject to
the De Nederlandsche Bank liquidity oversight regime.
Regulatory developments*
There have been a number of significant developments in the regulation
of liquidity risk.
In December 2010, the Basel Committee on Banking Supervision issued
the ‘International framework for liquidity risk measurement, standards and
monitoring’ which confirmed the introduction of two liquidity ratios: the
liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).
The introduction of both of these ratios will be subject to an observation
period, which includes review clauses to identify and address any
unintended consequences.
After an observation period beginning in 2011, the LCR, including any
revisions, will be introduced on 1 January 2015. The NSFR, including any
revisions, will move to a minimum standard by 1 January 2018.