RBS 2012 Annual Report Download - page 170

Credit risk mitigation
Approaches and methodologies*
The Group employs a number of structures and techniques to mitigate
credit risk. Netting of debtor and creditor balances is undertaken in
accordance with relevant regulatory and internal policies. Exposure on
OTC derivative and secured financing transactions is further mitigated
by the exchange of financial collateral and the use of market standard
documentation. Further mitigation may occur in a range of
transactions, from retail mortgage lending to large wholesale financing.
This can include: structuring a security interest in a physical or
financial asset; use of credit derivatives, including credit default swaps,
credit-linked debt instruments and securitisation structures; and use of
guarantees and similar instruments (for example, credit insurance)
from related and third parties. Such techniques are used in the
management of credit portfolios, typically to mitigate credit
concentrations in relation to an individual obligor, a borrower group or
a collection of related borrowers.
The use and approach to credit risk mitigation varies by product type,
customer and business strategy. Minimum standards applied across
the Group cover:
x The suitability of qualifying credit risk mitigation types and any
conditions or restrictions applicable to those mitigants;
x The means by which legal certainty is to be established, including
required documentation, supportive independent legal opinions
and all necessary steps required to establish legal rights;
x Acceptable methodologies for initial and any subsequent
valuations of collateral and the frequency with which collateral is
to be revalued and the use of collateral haircuts;
x Actions to be taken in the event that the value of mitigation falls
below required levels;
x Management of the risk of correlation between changes in the
credit risk of the customer and the value of credit risk mitigation;
x Management of concentration risks, for example, by setting
thresholds and controls on the acceptability of credit risk mitigants
and on lines of business that are characterised by a specific
collateral type or structure; and
x Collateral management to ensure that credit risk mitigation
remains legally effective and enforceable.
Secured portfolios
Within its secured portfolios, the Group has recourse to various types
of collateral and other credit enhancements to mitigate credit risk and
reduce the loss to the Group arising from the failure of a customer to
meet its obligations. These include: cash deposits; charges over
residential and commercial property, debt securities and equity shares;
and third-party guarantees. The existence of collateral may affect the
pricing of a facility and its regulatory capital requirement. When a
collateralised financial asset becomes impaired, the impairment charge
directly reflects the realisable value of collateral and any other credit
enhancements.
Corporate exposures
The type of collateral taken by the Group’s commercial and corporate
businesses and the manner in which it is taken will vary according to
the activity and assets of the customer.
x Physical assets - These include business assets such as stock,
plant and machinery, vehicles, ships and aircraft. In general,
physical assets qualify as collateral only if they can be
unambiguously identified, located or traced, and segregated from
uncharged assets. Assets are valued on a number of bases
according to the type of security that is granted.
x Real estate - The Group takes collateral in the form of real estate,
which includes residential and commercial properties. The market
value of the collateral will typically exceed the loan amount at
origination date. The market value is defined as the estimated
amount for which the asset could be sold in an arms length
transaction by a willing seller to a willing buyer.
x Receivables - When taking a charge over receivables, the Group
assesses their nature and quality and the borrower’s
management and collection processes. The value of the
receivables offered as collateral will typically be adjusted to
exclude receivables that are past their due dates.
The security charges may be floating or fixed, with the type of security
likely to impact: (i) the credit decision; and (ii) the potential loss upon
default. In the case of a general charge such as a mortgage
debenture, balance sheet information may be used as a proxy for
market value if the information is deemed reliable.
The Group does not recognise certain asset classes as collateral: for
example, short leasehold property and equity shares of the borrowing
company. Collateral whose value is correlated to that of the obligor is
assessed on a case-by-case basis and, where necessary, over-
collateralisation may be required.
The Group uses industry-standard loan and security documentation
wherever possible. Non-standard documentation is typically prepared
by external lawyers on a case-by-case basis. The Group’s business
and credit teams are supported by in-house specialist documentation
teams.
The existence of collateral has an impact on provisioning. Where the
Group no longer expects to recover the principal and interest due on a
loan in full or in accordance with the original terms and conditions, it is
assessed for impairment. If exposures are secured, the current net
realisable value of the collateral will be taken into account when
assessing the need for a provision. No impairment provision is
recognised in cases where all amounts due are expected to be settled
in full on realisation of the security.
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Business review Risk and balance sheet management continued
*unaudited