RBS 2012 Annual Report Download - page 155

RBS GROUP 2012
153
Non-traded interest rate risk
Introduction and methodology
Non-traded interest rate risk impacts earnings arising from the Group’s
banking activities. This excludes positions in financial instruments which
are classified as held-for-trading, or hedging items.
The Group provides a range of financial products to meet a variety of
customer requirements. These products differ with regard to repricing
frequency, tenor, indexation, prepayments, optionality and other features.
When aggregated, they form portfolios of assets and liabilities with
varying degrees of sensitivity to changes in market rates.
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 net interest
income 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 policy is to manage interest rate sensitivity in banking book
portfolios within defined risk limits. With the exception of CFG and
Markets, interest rate risk is transferred from the divisions to Group
Treasury. Aggregate positions are then hedged externally using cash and
derivative instruments, primarily interest rate swaps, to manage
exposures within Group Asset and Liability Management Committee
(GALCO) approved limits.
The Group assesses interest rate risk in the banking book (IRRBB) using
a set of standards to define, measure and report the risk. These
standards incorporate the expected divergence between contractual
terms and the actual behaviour of fixed rate loan portfolios due to
refinancing incentives and the risks associated with structural hedges of
interest rate insensitive balances, which relates to the stability of the
underlying portfolio.
Key measures used to evaluate IRRBB are subject to approval by
divisional Asset and Liability Management Committees (ALCOs) and
GALCO. Limits on IRRBB are proposed by the Group Treasurer for
approval by the Executive Risk Forum annually. Residual risk positions
are reported on a regular basis to divisional ALCOs and monthly to the
Group Balance Sheet Management Committee, GALCO, the Executive
Risk Forum and the Group Board.
The Group uses a variety of approaches to quantify its interest rate risk
encompassing both earnings and value metrics. 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 earnings sensitivity over time against movements in
interest rates.
Analyses
Value-at-risk
VaR metrics are based on interest rate repricing gap reports as at the
reporting date. These incorporate customer products and associated
funding and hedging transactions as well as non-financial assets and
liabilities such as property, plant and equipment, capital and reserves.
Behavioural assumptions are applied as appropriate.
The VaR does not provide a dynamic measurement of interest rate risk
since static underlying repricing gap positions are assumed. Changes in
customer behaviour under varying interest rate scenarios are captured by
way of earnings risk measures. IRRBB VaR for the Group’s Retail and
Commercial banking activities at 99% confidence level and currency
analysis of period end VaR were as follows:
Average Period end Maximum Minimum
£m £m £m £m
2012 46 21 65 20
2011 63 51 80 44
2010 58 96 96 30
2012
£m
2011
£m
2010
£m
Euro 19 26 33
Sterling 17 57 79
US dollar 15 61 121
Other 4 5 10
Key points
x Interest rate exposure at 31 December 2012 was considerably lower
than at 31 December 2011 and average exposure was 27% lower in
2012 than in 2011.
x The reduction in VaR seen across all currencies reflects closer
matching of the Group’s structural interest rate hedges to the
behavioural maturity profile of the hedged liabilities as well as
changes to the VaR methodology (refer to page 244 for more details
on VaR methodology improvement).
x It is estimated that the change in methodology reduced VaR by
£13.8 million (33%) on implementation.