RBS 2012 Annual Report Download - page 130

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Business review Risk and balance sheet management continued
Capital management
Introduction*
The Group aims to maintain an appropriate level of capital to meet its
business needs and regulatory requirements, and the Group operates
within an agreed risk appetite.
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.
2012 achievements*
The Group’s Core Tier 1 ratio of 10.3% is higher than at the end of 2011
(after adjusting for Asset Protection Scheme effects) despite absorbing
regulatory changes equivalent to 109 basis points and in the face of
challenging economic headwinds and continuing costs of de-risking. This
has been achieved through a continued focus on reshaping the Group’s
use of capital.
The Group has developed its stress testing capability to identify the
impact of a wider set of potential scenarios. The stress outcomes show
that the de-risking in the Group has been effective in reducing the
impacts of stress scenarios and at the same time the capital ratios have
been improving, resulting in increased capital buffers. The changes to the
risk profiles as a result of de-risking include run-down of Non-Core,
reduction in concentrations, and revising the strategic footprint of the
Markets division.
The capital allocation approaches used in the Group will be developed to
become increasingly risk sensitive and align risk management and
resource allocation more fully.
Governance and approach
The Group Asset and Liability Management Committee (GALCO) is
responsible for ensuring the Group maintains adequate capital at all
times. The Capital and Stress Testing Committee (CAST) is a cross-
functional body driving and directing integrated risk capital activities
including determination of the amount of capital the Group should hold,
how and where capital is allocated and planning for actions that would
ensure that an adequate capital position would be maintained in a
stressed environment. 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, risk appetite and reflects the
current and emerging regulatory requirements of the Group. It is
evaluated through the application of both internally and externally defined
stress tests that identify potential changes in capital ratios to a range of
scenarios.
The Group identifies the management and recovery actions that could be
applied to stress environments. These form an important part of the
capital management approach and the contingency planning
arrangements, complementing the established buffers.
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 might deteriorate 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 expects to remain adequately capitalised.
Capital allocation*
Capital resources are 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,
the intensity of regulatory capital use and the usage of other key Group
resources such as balance sheet funding and liquidity.
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 to ensure customer activity is appropriately
aligned with Group and divisional targets and allocations.
The Financial Services Authority (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