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Business review Risk and balance sheet management
211
Regulatory oversight*
The Group operates in multiple jurisdictions and is subject to a number of
regulatory regimes.
The Group’s principal regulator, the PRA, has a comprehensive set of
liquidity policies, the cornerstone of which is Policy Statement (PS) 09/16.
In order to comply with the PRA regulatory process, the Group:
• At least annually, completes and keeps updated an ILAA;
• Undertakes the Focused Liquidity Review process which is a
comprehensive review of the Group’s ILAA, liquidity policies and
operational capacity and capability. This in turn leads to the Group
and the PRA agreeing the parameters of Group’s Individual Liquidity
Guidance (ILG) which influences the overall size of the Group’s
liquidity portfolio.
In addition, the Group’s US operations meet liquidity requirements set out
by the Federal Reserve Board, the Office of the Comptroller of the
Currency, the Federal Deposit Insurance Corporation and the Financial
Industry Regulatory Authority. In the Netherlands, RBS N.V. is subject to
the De Nederlandsche Bank liquidity oversight regime. In the Republic of
Ireland, Ulster Bank Ireland Limited is subject to oversight from the
Central Bank of Ireland.
In January 2013, the Basel Committee on Banking Supervision (BCBS)
issued its revised draft guidance for calculating the liquidity coverage
ratio (LCR), which is currently expected to come into force from 1
January 2015 on a phased basis. Pending the finalisation of the
definitions, the Group monitors the LCR and the net stable funding ratio
(NSFR) in its internal reporting framework based on its interpretation and
expectation of the final rules. On this basis, as of 31 December 2013, the
Group’s LCR was 102% and the NSFR 122%.
At present there is a broad range of interpretations on how to calculate
both the NSFR and the LCR due to the lack of commonly agreed
technical standards. The Group continues to assess the impact of these
consultations and actively communicates with regulators and industry
groups. Assumptions will be refined as regulatory interpretations evolve.
Under the EU Capital Requirements Regulation to implement the
recommended guidance of Basel 3, the European Banking Authority
(EBA) is tasked with issuing a set of technical standards for implementing
the LCR within the EU, to be ratified by the European Commission before
30 June 2014. The LCR metric will come into effect as a minimum
standard from 1 January 2015.
The PRA has issued a statement proposing to retain the existing ILG
framework until 31 December 2014, whilst the EBA’s implementation of
the LCR is finalised.
Several regulatory regimes outside the EU where the Group operates
have also published consultation papers with guidance for
implementation of the LCR, including the Joint Banking Supervisors of
the US. We anticipate further consultations for LCR standards to be
published across other jurisdictions in which the Group operates during
the course of 2014. Additionally, the BCBS has issued a proposal for
revising the guidance on NSFR, expected to be finalised in 2014.
*unaudited
Measurement and monitoring
In implementing the Group’s liquidity risk management framework, a suite
of tools are used to monitor, limit and stress test the risks within the
balance sheet. The limits control the amount and composition of funding
sources, asset and liability mismatches and funding concentrations, in
addition to the level of liquidity risk.
To foster appropriate pricing behaviour, decision making and balance
sheet composition Group Treasury uses transfer pricing of liquidity and
funding costs, limits and parameters. This ensures liquidity and funding
risk is reflected in the measurement of divisional business performance
and ensures divisions are being correctly incentivised to source the most
appropriate mix of funding.
The Board’s determination and quantification of the appetite for liquidity
risk is primarily determined by reference to the ILAA which includes a
comparison of the size of liquidity portfolio to an assessment of stressed
outflows. The ILAA also informs the Board and PRA of the Group’s
liquidity risks, their mitigation and about the current and future liquidity
profile.
Within the liquidity portfolio the Group holds cash at central banks, high
quality government securities and collateral eligible for use in central
bank operations, such as the Bank of England’s Discount Window
Facility.
In determining what assets should be held within the liquidity portfolio, the
liquidity risk management framework dictates minimum internal quality
criteria, level of currency diversification and maturity mix. The liquidity
value of an asset is generally determined by reference to the haircut that
would be applied by a central bank operation or in a private repurchase
agreement.
The Group actively monitors a range of market-wide and firm-specific
early warning indicators of emerging liquidity stresses. Indicators include
such areas as customer deposit outflows, market funding costs and
movements in the Group’s credit default swap premiums. Early warning
indicators and regulatory metrics are reported daily to senior
management, including the CFO and Group Treasurer.
Liquidity risks are reviewed daily at a significant legal entity level and
performance reported at least monthly to legal entity, divisional and
Group Asset and Liability Management Committees. Any breach of
internal metric limits will set in motion a series of actions and escalations
that could lead to activation of the Group’s Contingency Funding Plan.
In November 2013, the Group’s credit rating was downgraded by
Standard & Poor’s. Prior to this event, the Group undertook an intensive
internal review of the magnitude of a rating downgrade on customer and
counterparty behaviours and these included stress testing and scenario
modelling. This analysis was also shared with the PRA. Following the
downgrade by Standard & Poor’s, there was minimal impact on customer
or counterparty behaviour, the primary reason for deposit withdrawals
was due to contractual downgrade triggers or the rating no longer
meeting the customer or counterparty’s investment requirements.