RBS 2011 Annual Report Download - page 133

RBS Group 2011 131
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. When aggregated, they form portfolios of
assets and liabilities with varying degrees of sensitivity to changes in
market rates.
However, mismatches in these sensitivities give rise to net interest
income (NII) volatility as 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, varied interest rate repricing
characteristics and maturities, it is likely the NII will vary from period to
period, even if interest rates remain the same. New business volumes
originated in any period will alter the interest rate sensitivity of a bank if
the resulting portfolio differs from portfolios originated in prior periods.
The Group assesses interest rate risk in the banking book (IRRBB) using
aset 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 measures used to
evaluate IRRBB are subjected to approval of divisional Asset and Liability
Management Committees (ALCOs) and the Group Asset and Liability
Management Committee (GALCO).
Limits on IRRBB are proposed by the Group Treasurer for approval by
the Executive Risk Forum annually.
The Group uses a variety of approaches to quantify its interest rate risk.
IRRBB is measured using a version of the same value-at-risk (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.
With the exception of Citizens and GBM, divisions are required to
manage IRRBB through internal transactions with Group Treasury, to the
greatest extent possible. Residual risks in divisions must be measured
and reported as described below.
Group Treasury aggregates exposures arising from its own external
activities and positions transferred to it from divisions. Where appropriate,
Group Treasury nets off-setting risk exposures to determine a residual
exposure to interest rate movements. Hedging transactions using cash
and derivative instruments are executed to manage IRRBB exposures,
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% a confidence level was as follows:
Average Period end Maximum Minimum
£m £m £m £m
2011 63 51 80 44
2010 58 96 96 30
2009 86 101 123 53
Abreakdown of the Group’s IRRBB VaR by currency is shown below.
Currency 2011
£m
2010
£m
2009
£m
Euro 26 33 32
Sterling 57 79 111
US dollar 61 121 42
Other 510 9
Key points
xInterest rate exposure at 31 December 2011 was considerably
lower than at 31 December 2010 but average exposure was 9%
higher in 2011 than in 2010.
xThe reduction in US dollar VaR reflects, in part, changes in
holding period assumptions following changes in Non-Core
assets.*