RBS 2013 Annual Report Download - page 214
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Business review Risk and balance sheet management
212
Liquidity risk continued
Stress testing and contingency planning*
Liquidity stress tests apply scenario-based behavioural and contractual
assumptions to cash inflows and outflows to assess the level of liquidity
reserves required under a particular scenario.
A stress event can occur when either firm-specific or market-wide factors
or a combination of both lead to depositors and investors to withdraw or
not to renew funding on maturity. This could be caused by many factors
including fears over the viability of the firm. Additionally, liquidity stress
can be brought on by customers choosing to draw down on loan
agreements and facilities.
Simulated liquidity stress testing is performed at least quarterly for each
division as well as the major operating subsidiaries in order to evaluate
the strength of the Group’s liquidity risk management.
Stress tests are designed to examine the impact of a variety of firm-
specific and market-wide scenarios on the future adequacy of the
Group’s liquidity reserves. Stress test scenarios are designed to take into
account the Group’s experiences during the financial crisis, recent market
conditions and events. These scenarios can be run at any time in
response to the emergence of firm-specific or market-wide risks that
could have a material impact on the Group’s liquidity position. In the past
these have included credit rating changes and political and economic
conditions changing in particular countries.
In determining the adequacy of the Group’s liquidity resources the Group
focuses on the outflows it anticipates as a result of any stress scenario
occurring. These outflows are measured over certain time periods which
extend from two weeks to three months. The Group is expected to be
able to withstand these stressed outflows through its own resources
(primarily through the use of the liquidity portfolio) without having to resort
to extraordinary central bank or governmental assistance.
The Group’s liquidity risk appetite is measured by reference to the
liquidity portfolio as a percentage of stressed contractual and behavioural
outflows under the worst of three severe stress scenarios, as prescribed
by the PRA. These are a market-wide stress, an idiosyncratic stress and
a combination of both. At 31 December 2013, the Group’s liquidity
portfolio was 145% of the worst case stress requirements.
*unaudited
Key liquidity risk stress testing assumptions
• Net wholesale funding - Outflows at contractual maturity of
wholesale funding, with no rollover/new issuance, prime brokerage,
100% loss of excess client derivative margin and 100% loss of
excess client cash.
• Secured financing and increased haircuts - Loss of secured funding
capacity at contractual maturity date and incremental haircut
widening, depending upon collateral type.
• Retail and commercial bank deposits - Substantial outflows as the
Group could be seen as a greater credit risk than competitors.
• Intra-day cash flows - Liquid collateral held against intra-day
requirement at clearing and payment systems is regarded as
encumbered with no liquidity value assumed. Liquid collateral is held
against withdrawal of unsecured intra-day lines provided by third
parties.
• Intra-group commitments and support - Risk of cash within
subsidiaries becoming unavailable to the wider Group and
contingent calls for funding on Group Treasury from subsidiaries and
affiliates.
• Funding concentrations - Additional outflows recognised against
concentration of providers of wholesale secured financing.
• Off-balance sheet activities - Collateral outflows due to market
movements, and all collateral owed by the Group to counterparties
but not yet called; anticipated increase in firm’s derivative initial
margin requirement in stress scenarios; collateral outflows
contingent upon a multi-notch credit rating downgrade of Group
firms; drawdown on committed facilities provided to corporates,
based on counterparty type, creditworthiness and facility type; and
drawdown on retail commitments.
• Franchise viability - Group liquidity stress testing includes additional
liquidity in order to meet outflows that are non-contractual in nature,
but are necessary in order to support valuable franchise businesses.
• Management action - Unencumbered marketable assets that are
held outside of the Core liquidity portfolio and are of verifiable
liquidity value to the firm, are assumed to be monetised (subject to
haircut/valuation adjustment).
The Group has a Contingency Funding Plan (CFP), which is updated at
least annually and as the balance sheet evolves and forms the basis of
analysis and actions to remediate adverse events as and if they arise.
The CFP provides a detailed description of the availability, size and
timing of all sources of contingent liquidity available to the Group in a
stress event. These are ranked in order of economic impact and
effectiveness to meet the anticipated stress requirement. The CFP
includes documented processes for actions that may be required to meet
the outflows and specifies roles and responsibilities for the effective
implementation of the CFP.