RBS 2012 Annual Report Download - page 112

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Business review Risk and balance sheet management continued
Strategic risk objectives* continued
Top and emerging risk scenarios*
As part of its risk management process, the Group identifies and monitors
its top and emerging risk scenarios. Such risk scenarios are those the
materialisation of which would lead to a significant unexpected negative
outcome, thereby causing the Group as a whole or a particular division to
fail to meet one or more strategic risk objectives. In assessing the
potential impact of risk materialisation, the Group takes into account both
financial and reputational considerations.
Although management is concerned with a range of risk scenarios, a
relatively small number attracted particular attention from senior
management during the past year. These can be grouped into three
broad categories:
x Macro-economic risks.
x Regulatory and legal risks.
x Risks related to the Group’s operations.
In addition, further information on these and other risks facing the Group
appears in the discussion of Risk Factors on pages 503 to 515.
Descriptions of top and emerging risks are provided below:
Macro-economics risks
(i) Increased defaults in sectors to which the Group has concentrated
exposure, particularly commercial real estate
The Group has concentrated lending exposure to several sectors, most
notably commercial real estate, giving rise to the risk of losses and
reputational damage from unexpectedly high defaults. Another sector to
which the Group has concentrated lending exposure is shipping. Several
of the Group’s businesses are exposed to these sectors, principally Non-
Core, Ulster Bank and UK Corporate.
Impact on the Group
x If borrowers are unable to refinance existing debt, they may default.
Further, if the value of collateral they have provided continues to
decline, the resulting impairments may be larger than expected. In
addition, as other lenders seek to sell assets, the Group may find it
more difficult to meet its own targets for a reduction in its exposure
to certain sectors.
Mitigants
x The Group is mitigating its risks by monitoring exposures carefully
and achieving reductions through a combination of repayments, roll-
offs and asset sales whenever possible. In addition, it has placed
limits on the origination of new business of this type.
(ii) The risk of a eurozone event
Europe was of concern throughout the year owing to a combination of
slow growth in major economies and negative growth in peripheral
countries labouring under high public debt burdens. As a result, several
risks might materialise, including the default of one or more eurozone
sovereigns, the exit from the eurozone of one or more member countries
or the redenomination of the currency of a eurozone country followed by
the devaluation of that country’s currency. Although the Group’s direct
exposure to most peripheral eurozone countries is modest, it has material
exposure to Ireland through its ownership of Ulster Bank. In addition, it
has material exposure to core eurozone countries such as Germany, the
Netherlands, France and, to a lesser extent, Italy. Details of the Group’s
eurozone exposures appear on pages 256 to 280. All divisions are
affected by this risk.
Impact on the Group
x If a peripheral eurozone sovereign defaults on its debt, the Group
could experience unexpected impairments, either as a result of its
exposure to the sovereign or as a result of its exposure to financial
institutions or corporations located in that country.
x If one or more sovereigns exit the eurozone, credit ratings for
eurozone borrowers more broadly may be downgraded, resulting in
increases in credit spreads and decreases in security values, giving
rise to market value losses.
x If one or more peripheral eurozone sovereigns redenominates its
currency, resulting in a devaluation, the Group could experience
losses to the extent that its exposures to these sovereigns are not
funded by liabilities that similarly redenominate.
Mitigants
The Group has taken a number of steps to mitigate the impact of these
risks.
x To mitigate the impact of a eurozone sovereign default, the Group
has reduced its exposures to peripheral eurozone countries. To
mitigate the impact of the exit from the eurozone of one or more
countries, and the sovereign ratings downgrade that would likely
result, the Group has extended its limit control framework to include
all eurozone countries.
x Finally, to mitigate the impact of redenomination, the Group has
reduced exposures and sought where possible to reduce
mismatches between the currencies in which assets and liabilities
are denominated.
(iii) The risk of a more severe or protracted economic downturn
Following the financial crisis of 2007, economies in the UK, Europe and
the US have struggled to recover and return to growth. An unexpectedly
severe downturn could result from economic weakness in the emerging
markets of Asia, spreading to the US, the UK and Europe. A slowdown in
or reversal of economic growth could undermine the austerity plans of the
UK and other countries in Europe. The risk to the UK is of particular
concern. While all divisions are potentially affected, those most at risk
include UK Corporate, UK Retail, Markets, Non-Core and Ulster Bank.
*unaudited