RBS 2012 Annual Report Download - page 510

Risk factors continued
The Group’s business performance could be adversely affected if its
capital is not managed effectively or as a result of changes to capital
adequacy and liquidity requirements
Effective management of the Group’s capital is critical to its ability to
operate its businesses, and to pursue its strategy of returning to
standalone strength. The Group is required by regulators in the UK, the
US and other jurisdictions in which it undertakes regulated activities to
maintain adequate capital resources. The maintenance of adequate
capital is also necessary for the Group’s financial flexibility in the face of
continuing turbulence and uncertainty in the global economy and
specifically in its core UK, US and European markets.
The Basel Committee on Banking Supervision’s package of reforms to
the regulatory capital framework includes a material increase to the
minimum Core Tier 1 (common equity) requirement and the total Tier 1
capital requirement, a capital conservation buffer and a countercyclical
buffer. In addition, a leverage ratio is to be introduced, together with a
liquidity coverage ratio and a net stable funding ratio. Further measures
may include bail-in debt which may impact existing as well as future
issues of debt and expose them to the risk of conversion into equity
and/or write-down of principal amount. Such measures would be in
addition to proposals for the write-off of Tier 1 and Tier 2 debt (and its
possible conversion into ordinary shares) if a bank becomes non-viable.
The Basel Committee has proposed that global systemically important
financial institutions (GSIFIs) be subject to an additional common equity
Tier 1 capital requirement, depending on a bank’s systemic importance.
The Group has been identified by the Financial Stability Board as a
GSIFI. As a result the Group was required to meet resolution planning
requirements by the end of 2012 as well as have additional loss
absorption capacity. In addition, GSIFIs will be subjected to more
intensive and effective supervision. The additional capital requirements
are to be applied to GSIFIs identified in 2014 (the Financial Stability
Board will update its list every three years) and phased in beginning in
2016.
The Basel III rules are due to be phased in between 1 January 2013 and
2019 but have not yet been approved by the EU and their incorporation
into European and national law has, accordingly, not yet taken place. On
20 July 2011, the European Commission published a legislative package
of proposals to implement the changes with a new Directive and
Regulation (collectively known as CRD IV). The final form of CRD IV is
still under negotiation and the start-date for its implementation is still not
known with full implementation still planned by 1 January 2019. The
current proposals would allow the UK to implement more stringent
prudential requirements than envisaged under Basel III.
The ICB recommendations and the UK Government’s response
supporting such recommendations include proposals to increase capital
and loss absorbency to levels that exceed the proposals under Basel
III/CRD IV. These requirements, as well as the other recommendations of
the ICB, are expected to be phased in between 2015 and 2019. The US
Federal Reserve has also proposed changes in how it will regulate the
US operations of foreign banking operations such as the Group that may
affect the capital requirements of the Group’s operations in the US. As
the implementation of the ICB recommendations are the subject of draft
legislation not yet adopted and the Federal Reserve’s recent proposals
are in a comment period, the Group cannot predict the impact such rules
will have on the Group’s overall capital requirements or how they will
affect the Group’s compliance with applicable capital and loss
absorbency requirements.
To the extent the Group has estimated the indicative impact that Basel III
reforms may have on its risk-weighted assets and capital ratios, such
estimates are preliminary and subject to uncertainties and may change.
In particular, the estimates assume mitigating actions will be taken by the
Group (such as deleveraging of legacy positions and securitisations,
including Non-Core, as well as other actions being taken to de-risk
market and counterparty exposures), which may not occur as anticipated,
in a timely manner, or at all.
The Basel Committee changes and other future changes to capital
adequacy and liquidity requirements in the UK, the US and in other
jurisdictions in which the Group operates, including any application of
increasingly stringent stress case scenarios by the regulators in the UK,
the US and other jurisdictions in which the Group undertakes regulated
activities, may require the Group to raise additional Tier 1 (including Core
Tier 1) and Tier 2 capital by way of further issuances of securities, and
will result in existing Tier 1 and Tier 2 securities issued by the Group
ceasing to count towards the Group’s regulatory capital, either at the
same level as present or at all. The requirement to raise additional Core
Tier 1 capital, which could be mandated by the Group’s regulators, could
have a number of negative consequences for the Group and its
shareholders, including impairing the Group’s ability to pay dividends on,
or make other distributions in respect of, ordinary shares and diluting the
ownership of existing shareholders of the Group. If the Group is unable to
raise the requisite Tier 1 and Tier 2 capital, it may be required to reduce
further the amount of its risk-weighted assets and engage in the disposal
of core and other non-core businesses, which may not occur on a timely
basis or achieve prices which would otherwise be attractive to the Group.
Pursuant to the acquisition and contingent capital agreement entered into
between the Royal Bank and HM Treasury on 29 November 2009, the
Group will be subject to restrictions on payments on its hybrid capital
instruments should its Core Tier 1 ratio fall below 6% or if it would fall
below 6% as a result of such payment. At 31 December 2012, the
Group’s Tier 1 and Core Tier 1 capital ratios were 12.4% and 10.3%,
respectively, calculated in accordance with FSA requirements. Any
change that limits the Group’s ability to manage effectively its balance
sheet and capital resources going forward (including, for example,
reductions in profits and retained earnings as a result of write-downs or
otherwise, increases in risk-weighted assets, regulatory changes, actions
by regulators, delays in the disposal of certain assets or the inability to
syndicate loans as a result of market conditions, a growth in unfunded
pension exposures or otherwise) or to access funding sources, could
have a material adverse impact on its financial condition and regulatory
capital position.
508
Additional information continued