RBS 2012 Annual Report Download - page 142

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Business review Risk and balance sheet management continued
Liquidity risk: Policy, framework and governance continued
The ILAA is the cornerstone of the Group’s assessment process and
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 to manage those risks.
The Group has identified ten specific liquidity risk factors which range
from the risk associated with both behavioural and contractual customer
deposit outflows, through to firm-specific reputational factors that could
impact the Group’s liquidity position from time to time.
In addition, the Group follows the broader market developments in
respect of the ongoing evolution of industry and regulatory liquidity risk
policies that are currently being debated at an international level and
adjusts its policies and processes where appropriate.
Finally, external stakeholders such as market counterparties, debt and
equity investors and credit rating agencies actively review and challenge
the Group’s approach, their views being reflected through their ongoing
support of the Group.
The Group actively monitors ongoing regulatory developments in the
international arena. Whilst most individual country regulators have
implemented or refined specific country liquidity regulations, much work
continues at an international level to agree common standards.
The majority of this work is conducted under the auspices of the Basel
Committee on Bank Supervision and includes discussion on important
measures such as the liquidity coverage ratio (LCR) and the net stable
funding ratio (NSFR). The Group will always look to proactively adopt
such measures into its reporting capabilities provided that there is an
alignment and agreement between domestic and international regulators
on these issues and specific country regulatory rules are updated to
reflect these agreements.
In January 2013, the Basel Committee on Banking Supervision issued its
revised draft guidance for calculating the LCR, which is currently
expected to come into force from 1 January 2015 on a phased basis.
Pending the finalisation of the definitions, the Group monitors the LCR
and the NSFR in its internal reporting framework based on its
interpretation and expectation of the final rules. On this basis, as of 31
December 2012, the Groups LCR was over 100% and the NSFR 117%.
At present there is a broad range of interpretations on how to calculate
the NSFR and, especially, the LCR due to the lack of a commonly agreed
market standard. There are also inconsistencies between the current
regulatory approach of the FSA and that being proposed in the LCR with
respect to the treatment of unencumbered assets that could be pledged
to central banks via a discount window facility. This makes meaningful
comparisons of the LCR between institutions difficult. The Group will
continue to work with regulators and industry groups to measure and
report the impact of the rules as they are finalised. Assumptions will be
refined as regulatory interpretations evolve.
Liquidity measurement and monitoring
Liquidity risk is measured and assessed on a daily basis at Group level.
The Group uses a set of internal and regulatory metrics and analysis to
assess liquidity risk.
The Group uses limits to manage and control the overall extent of liquidity
risk within the balance sheet. Limits focus on the aggregate risk, the
amount and composition of particular sources of liabilities, asset liability
mismatches and third party counterparty concentrations. Reported
balance sheet metrics such as loan:deposit ratio targets or the
percentage of short-term wholesale funding are examples of these limits.
The Group also uses appropriate transfer pricing of liquidity costs to
foster appropriate pricing behaviour and decision making. The Group’s
internal transfer pricing policy helps to manage the balance sheet mix
and composition of contingent and actual liabilities and to ensure that
liquidity risk is reflected in product pricing and divisional business
performance measurement. This also ensures that divisions are being
correctly incentivised to source the most appropriate mix of funding.
Stress and scenario testing is used to help inform a broader
understanding of liquidity risk as well as to model specific liquidity risks
events, for example the secession of a country from the euro.
The Group actively monitors a range of market and firm-specific early
warning indicators of emerging liquidity stresses. Some of these
indicators will be actual performance of the business against pre-agreed
limits, for example customer deposit outflows. Others will be based
around general or specific market movements such as movements in the
Group’s credit default swap spreads.
Liquidity risks are reviewed at legal entity daily, and performance
reported to Divisional and Group Asset and Liability Committees. Any
breach or material deterioration of these metrics will set in motion a
series of actions and escalations that could lead to activation of the
contingency funding plan. Any breach of these metrics that subsequently
means that the Group can no longer comply with its ILG will necessitate
notification to the FSA and the eventual submission of a liquidity
remediation plan.
The Group’s liquidity risk framework is subject to internal oversight,
challenge and governance both at Board level and via internal control
functions such as Internal Audit. The Group is also subject to regulatory
review and challenge from the FSA through its supervisory programme.