RBS 2012 Annual Report Download - page 143

RBS GROUP 2012
141
Stress testing*
The strength of any bank’s liquidity risk management can only be
evaluated on the Group’s ability to survive under stress.
Simulated liquidity stress testing is regularly performed for each business
as well as the major operating subsidiaries. Stress tests are designed to
look at the impact of a variety of firm-specific and market-related
scenarios on the future adequacy of the Group’s liquidity resources.
Stress tests can be run at any time in response to the emergence of one
of these risks.
Scenarios include assumptions about significant changes in key funding
sources, external credit ratings, contingent uses of funding, and political
and economic conditions or events in particular countries. For example,
during 2012 the Group undertook a specific series of stress tests to
assess the likely worst case impact associated with a one notch
downgrade to the Group’s credit rating by Moody’s. Stress scenarios are
applied to both on-balance sheet instruments and off-balance sheet
activities, to provide a comprehensive view of potential cash flows.
In determining the adequacy of the Group’s liquidity resources the Group
focuses on the stressed outflows it could be anticipated to experience as
a result of any stress scenario occurring. These outflows are measured
as occurring over certain time periods which extend from any given day
out to two weeks, to as long as three months. The Group is expected to
be able to withstand these stressed outflows through its own resources
(principally the use of the liquidity buffer) over these time horizons without
having to revert to extraordinary central bank or governmental
assistance.
The Group’s actual experiences from the 2008 and 2009 period have
factored heavily into the liquidity analysis in the past, although more
recent market conditions and events provide more up-to-date data for
scenario modelling. Stress tests are augmented from time to time to
reflect firm-specific or emerging market risks that could have a material
impact on the Group’s liquidity position.
The Group’s liquidity risk appetite is measured by reference to the
liquidity buffer as a percentage of stressed contractual and behavioural
outflows under the worst of three severe stress scenarios as envisaged
under the FSA regime. Liquidity risk is expressed as a surplus of liquid
assets over three months’ stressed outflows under the worst of a market-
wide stress, an idiosyncratic stress and a combination of both. At 31
December 2012, the Group’s holding of liquid assets was 128% of the
worst case stress requirements.
The results of stress testing are an active part of management and
strategy in balance sheet management and inform allocation, target and
limit discussions. In short, limits in the business-as-usual environment are
bounded by capacity to satisfy the Group’s liquidity needs in the stress
environments.
Key liquidity risk stress testing assumptions
x Net wholesale funding - Outflows at contractual maturity of
wholesale funding and conduit commercial paper, with no
rollover/new issuance. Prime Brokerage, 100% loss of excess client
derivative margin and 100% loss of excess client cash.
x Secured financing and increased haircuts - Loss of secured funding
capacity at contractual maturity date and incremental haircut
widening, depending upon collateral type.
x Retail and commercial bank deposits - Substantial outflows as the
Group could be seen as a greater credit risk than competitors.
x Intra-day cashflows - Liquid collateral held against intra-day
requirement at clearing and payment systems is regarded as
encumbered with no liquidity value assumed. Liquid collateral is held
against withdrawal of unsecured intra-day lines provided by third
parties.
x Intra-group commitments and support - Risk of cash within
subsidiaries becoming unavailable to the wider Group and
contingent calls for funding on Group Treasury from subsidiaries and
affiliates.
x Funding concentrations - Additional outflows recognised against
concentration of providers of wholesale secured financing.
x Off-balance sheet activities - Collateral outflows due to market
movements, and all collateral owed by the Group to counterparties
but not yet called; anticipated increase in firm’s derivative initial
margin requirement in stress scenarios; collateral outflows
contingent upon a multi-notch credit rating downgrade of Group
firms; drawdown on committed facilities provided to corporates,
based on counterparty type, creditworthiness and facility type; and
drawdown on retail commitments.
x Franchise viability - Group liquidity stress testing includes additional
liquidity in order to meet outflows that are non-contractual in nature,
but are necessary in order to support valuable franchise businesses.
x Management action - Unencumbered marketable assets that are
held outside of the Core liquidity buffer and are of verifiable liquidity
value to the firm, are assumed to be monetised (subject to
haircut/valuation adjustment).
*unaudited