RBS 2012 Annual Report Download - page 508

Risk factors continued
Concerns about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other financial
institutions, as the commercial and financial soundness of many financial
institutions may be closely related as a result of credit, trading, clearing
and other relationships. Even the perceived lack of creditworthiness of, or
questions about, a counterparty may lead to market-wide liquidity
problems and losses for, or defaults by, the Group. This systemic risk
may adversely affect financial intermediaries, such as clearing agencies,
clearing houses, banks, securities firms and exchanges with which the
Group interacts on a daily basis, all of which could have a material
adverse effect on the Group’s access to liquidity or could result in losses
which could have a material adverse effect on the Group’s financial
condition, results of operations and prospects.
In certain jurisdictions in which the Group does business, particularly
Ireland, there has been disruption during recent years in the ability of
certain financial institutions to complete foreclosure proceedings in a
timely manner (or at all), including as a result of interventions by certain
states and local governments. This disruption has lengthened the time to
complete foreclosures, increased the backlog of repossessed properties
and, in certain cases, has resulted in the invalidation of purported
foreclosures.
The trends and risks affecting borrower and counterparty credit quality
have caused, and in the future may cause, the Group to experience
further and accelerated impairment charges, increased repurchase
demands, higher costs, additional write-downs and losses for the Group
and an inability to engage in routine funding transactions.
The value or effectiveness of any credit protection that the Group has
purchased depends on the value of the underlying assets and the
financial condition of the insurers and counterparties
The Group has credit exposure arising from over-the-counter derivative
contracts, mainly credit default swaps (CDSs), and other credit
derivatives, each of which are carried at fair value. The fair value of these
CDSs, as well as the Group’s exposure to the risk of default by the
underlying counterparties, depends on the valuation and the perceived
credit risk of the instrument against which protection has been bought.
Many market counterparties have been adversely affected by their
exposure to residential mortgage linked and corporate credit products,
whether synthetic or otherwise, and their actual and perceived
creditworthiness may deteriorate rapidly. If the financial condition of these
counterparties or their actual or perceived creditworthiness deteriorates,
the Group may record further credit valuation adjustments on the credit
protection bought from these counterparties under the CDSs. The Group
also recognises any fluctuations in the fair value of other credit
derivatives. Any such adjustments or fair value changes may have a
material adverse impact on the Group’s financial condition and results of
operations.
Changes in interest rates, foreign exchange rates, credit spreads, bond,
equity and commodity prices, basis, volatility and correlation risks and
other market factors have significantly affected and will continue to affect
the Group’s business and results of operations
Some of the most significant market risks the Group faces are interest
rate, foreign exchange, credit spread, bond, equity and commodity prices
and basis, volatility and correlation risks. Changes in interest rate levels
(or extended periods of low interest rates), yield curves (which remain
depressed) and spreads may affect the interest rate margin realised
between lending and borrowing costs, the effect of which may be
heightened during periods of liquidity stress. Changes in currency rates,
particularly in the sterling-US dollar and sterling-euro exchange rates,
affect the value of assets, liabilities, income and expenses denominated
in foreign currencies and the reported earnings of the Group’s non-UK
subsidiaries and may affect the Group’s reported consolidated financial
condition or its income from foreign exchange dealing. For accounting
purposes, the Group values some of its issued debt, such as debt
securities, at the current market price. Factors affecting the current
market price for such debt, such as the credit spreads of the Group, may
result in a change to the fair value of such debt, which is recognised in
the income statement as a profit or loss.
The performance of financial markets affects bond, equity and commodity
prices, which has caused, and may in the future cause, changes in the
value of the Group’s investment and trading portfolios. As part of its
ongoing derivatives operations, the Group also faces significant basis,
volatility and correlation risks, the occurrence of which are also impacted
by the factors noted above.
While the Group has implemented risk management methods to mitigate
and control these and other market risks to which it is exposed, it is
difficult, particularly in the current environment, to predict with accuracy
changes in economic or market conditions and to anticipate the effects
that such changes could have on the Group’s financial performance and
business operations.
In the UK and in other jurisdictions, the Group is responsible for
contributing to compensation schemes in respect of banks and other
authorised financial services firms that are unable to meet their
obligations to customers
In the UK, the Financial Services Compensation Scheme (FSCS) was
established under the FSMA and is the UK’s statutory fund of last resort
for customers of authorised financial services firms. The FSCS can pay
compensation to customers if a firm is unable or likely to be unable, to
pay claims against it and may be required to make payments either in
connection with the exercise of a stabilisation power or in exercise of the
bank insolvency procedures under the Banking Act. The FSCS is funded
by levies on firms authorised by the FSA, including the Group. In the
event that the FSCS raises funds from the authorised firms, raises those
funds more frequently or significantly increases the levies to be paid by
such firms, the associated costs to the Group may have an adverse
impact on its results of operations and financial condition. At 31
December 2012, the Group had accrued £119 million for its share of
estimated FSCS levies for the 2012/2013 and 2013/2014 FSCS years.
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Additional information continued