RBS 2012 Annual Report Download - page 160

158
Business review Risk and balance sheet management continued
Credit risk
Introduction
Credit risk is the risk of financial loss due to the failure of a customer or
counterparty to meet its obligation to settle outstanding amounts. The
credit risk that the Group faces arises mainly from wholesale and retail
lending, provision of contingent obligations (such as letters of credit and
guarantees) and counterparty credit risk arising from derivative contracts
and securities financing transactions entered into with customers. Other
material risks covered by the Group’s credit risk management framework
are:
x Concentration risk - the risk of an outsized loss due to the
concentration of credit risk to a specific asset class or product,
industry sector, customer or counterparty, or country.
x Settlement risk - the intra-day risk that arises when the Group
releases funds prior to confirmed receipt of value from a third party.
x Issuer risk - the risk of loss on a tradable instrument (e.g. a bond)
due to default by the issuer.
x Wrong way risk - the risk of loss that arises when the risk factors
driving the exposure to a counterparty are positively correlated with
the probability of default for that counterparty.
x Credit mitigation risk - the risk that credit risk mitigation (for example,
taking a legal charge over property to secure a customer loan) is not
enforceable or that the value of such mitigation decreases, thus
leading to unanticipated losses.
Top and emerging credit risks*
The quantum and nature of credit risk assumed across the Group’s
different businesses vary considerably, while the overall credit risk
outcome usually exhibits a high degree of correlation with the
macroeconomic environment. The Group therefore remains sensitive to
the economic conditions within the geographies in which it operates, in
particular the UK, Ireland, the US and the eurozone.
The following credit risks continue to be the focus of management
attention.
Irish property market
The continuing challenging economic climate within Ireland has resulted
in impairment levels for Irish portfolios remaining at elevated levels. In
particular, high unemployment, austerity measures and general economic
uncertainty have reduced real estate lease rentals. This, together with
limited liquidity, has depressed asset values and reduced consumer
spending with a consequent downward impact on the commercial real
estate portfolio as well as broader impacts on Ulster Bank Group’s
mortgage and small and medium enterprise (SME) lending portfolios.
Further details on Ulster Bank Group’s credit risk profile can be found on
pages 190 to 193.
Commercial real estate
While progress has been made in reducing the overall exposure and
rebalancing the portfolio, commercial real estate remains a key credit
concentration risk for the Group. The Group has continued to strengthen
its approach to managing sector concentration risk, with a particular focus
on additional controls for the commercial real estate portfolio.
However, the credit performance remains sensitive to the economic
environment in the UK and Ireland. Although some improvements have
been seen in commercial real estate values across prime locations,
secondary and tertiary values remain subdued.
Refinancing risk remains a focus of management attention and is
assessed throughout the credit risk management life cycle. In particular, it
is considered as part of the early problem recognition and impairment
assessment processes.
Further details on the Group’s exposure to commercial real estate can be
found on pages 181 to 185.
Eurozone troubles
The ongoing impact of the troubles in the eurozone continued to be felt
most significantly in the banking sector, where widening credit spreads
and regulatory demand for increases in Tier 1 capital and liquidity
exacerbated the risk management challenges already posed by the
sector’s continued weakness, as provisions and write-downs remain
elevated.
A material percentage of global banking activity in risk mitigation now
passes through the balance sheets of the top global players, increasing
the systemic risks to the banking sector. The Group’s exposures to these
banks continue to be closely managed. In particular, the Group has
intensified its management of settlement risk through ongoing review of
the level of risk and the operational controls in place to manage it,
together with proactive actions to reduce limits. The weaker banks in the
eurozone also remained subject to heightened scrutiny and the Group’s
risk appetite for these banks was adjusted throughout 2012.
The Group has continued to focus on operational preparations for
possible sovereign defaults and/or eurozone exits. The Group has also
considered initiatives to determine and reduce redenomination risk.
Further actions to mitigate risks and strengthen control in the eurozone
typically included taking guarantees or insurance, updating collateral
agreements, and tightening certain credit pre-approval processes.
The Group has a material exposure to Spanish AFS debt securities
issued by banks and other financial institutions of £4.8 billion at 31
December, predominately comprised of covered bonds backed by
mortgages. Whilst the exposure was reduced by £1.6 billion during 2012,
largely as a result of sales, the portfolio continues to be subject to
heightened scrutiny, including undertaking stress analysis.
Further details on the Group’s approach to managing country risk and the
risks faced within the eurozone can be found on pages 252 to 280.
*unaudited