RBS 2012 Annual Report Download - page 373

RBS GROUP 2012
371
Collective component - this is made up of two elements: loan impairment
provisions for impaired loans that are below individual assessment
thresholds (collectively assessed provisions) and for loan losses that
have been incurred but have not been separately identified at the balance
sheet date (latent loss provisions). Collectively assessed provisions are
established on a portfolio basis using a present value methodology taking
into account the level of arrears, security, past loss experience, credit
scores and defaults based on portfolio trends. The most significant
factors in establishing these provisions are the expected loss rates and
the related average life. These portfolios include mortgages, credit card
receivables and other personal lending. The future credit quality of these
portfolios is subject to uncertainties that could cause actual credit losses
to differ materially from reported loan impairment provisions. These
uncertainties include the economic environment, notably interest rates
and their effect on customer spending, the unemployment level, payment
behaviour and bankruptcy trends. Latent loss provisions are held against
estimated impairment losses in the performing portfolio that have yet to
be identified as at the balance sheet date. To assess the latent loss
within its portfolios, the Group has developed methodologies to estimate
the time that an asset can remain impaired within a performing portfolio
before it is identified and reported as such.
Fair value - financial instruments
Financial instruments classified as held-for-trading or designated as at
fair value through profit or loss and financial assets classified as
available-for-sale are recognised in the financial statements at fair value.
All derivatives are measured at fair value. Gains or losses arising from
changes in the fair value of financial instruments classified as held-for-
trading or designated as at fair value through profit or loss are included in
the income statement. Unrealised gains and losses on available-for-sale
financial assets are recognised directly in equity unless an impairment
loss is recognised.
Financial instruments measured at fair value include:
Loans and advances (held-for-trading and designated as at fair value
though profit or loss) - principally comprise reverse repurchase
agreements (reverse repos) and cash collateral.
Debt securities (held-for-trading, designated as at fair value though profit
or loss and available-for-sale) - debt securities include those issued by
governments, municipal bodies, mortgage agencies and financial
institutions as well as corporate bonds, debentures and residual interests
in securitisations.
Equity securities (held-for-trading, designated as at fair value though
profit or loss and available-for-sale) - comprise equity shares of
companies or corporations both listed and unlisted.
Deposits by banks and customer accounts (held-for-trading and
designated as at fair value though profit or loss) - deposits measured at
fair value principally include repurchase agreements (repos) and cash
collateral.
Debt securities in issue (held-for-trading and designated as at fair value
though profit or loss) - principally comprise medium term notes.
Short positions (held-for-trading) - arise in dealing and market making
activities where debt securities and equity shares are sold which the
Group does not currently possess.
Derivatives - these include swaps (currency swaps, interest rate swaps,
credit default swaps, total return swaps and equity and equity index
swaps), forward foreign exchange contracts, forward rate agreements,
futures (currency, interest rate and equity) and options (exchange-traded
options on currencies, interest rates and equities and equity indices and
OTC currency and equity options, interest rate caps and floors and
swaptions).
Fair value is the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm’s length
transaction. Fair values are determined from quoted prices in active
markets for identical financial assets or financial liabilities where these
are available. Fair value for a net open position in a financial instrument
in an active market is the number of units of the instrument held times the
current bid price (for financial assets) or offer price (for financial
liabilities). In determining the fair value of derivative financial instruments
gross long and short positions measured at current mid market prices are
adjusted by bid-offer reserves calculated on a portfolio basis. Credit
valuation adjustments are made when valuing derivative financial assets
to incorporate counterparty credit risk. Adjustments are also made when
valuing financial liabilities to reflect the Group’s own credit standing.
Where the market for a financial instrument is not active, fair value is
established using a valuation technique. These valuation techniques
involve a degree of estimation, the extent of which depends on the
instrument’s complexity and the availability of market-based data. More
details about the Group’s valuation methodologies and the sensitivity to
reasonably possible alternative assumptions of the fair value of financial
instruments valued using techniques where at least one significant input
is unobservable are given in Note 11 on pages 393 to 411.
Accounting developments
International Financial Reporting Standards
A number of IFRSs and amendments to IFRS were in issue at 31
December 2012 that had effective dates of 1 January 2013 or later.
Effective for 2013
The following IFRSs and amendments to IFRS have an effective date of
1 January 2013:
IFRS 10 ‘Consolidated Financial Statements’ replaces SIC-12
‘Consolidation - Special Purpose Entities’ and the consolidation elements
of the existing IAS 27 ‘Consolidated and Separate Financial Statements’.
IFRS 10 adopts a single definition of control: a reporting entity controls
another entity when the reporting entity has the power to direct the
activities of that other entity so as to vary returns for the reporting entity.
IFRS 10 requires retrospective application. The Group continues to
assess aspects of IFRS 10. However implementation is not expected to
have a material effect on the Group’s financial statements.