RBS 2013 Annual Report Download - page 230
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Business review Risk and balance sheet management
228
Credit risk
Definition
Credit risk is the risk of financial loss due to the failure of a customer or
counterparty to meet its obligation to settle outstanding amounts.
Sources of credit risk
The Group is exposed to credit risk as a result of a wide range of
business activities. The most significant source of credit risk is lending.
The second most significant source is counterparty credit risk, which
results from the Group’s activities in the derivatives and securities
financing transaction markets.
The Group offers a number of lending products where it has an
irrevocable obligation to provide credit facilities to a customer. Security
may be obtained to mitigate the risk of loss in the form of physical
collateral, such as commercial real estate assets and residential property,
or financial collateral such as cash or bonds. Also included in the Group’s
lending are exposures arising from leasing activities.
Derivatives and securities financing transactions expose the Group to
counterparty credit risk, which is the risk of loss arising from a failure of a
customer to meet obligations which vary in value by reference to a
market factor.
The Group holds debt securities with the intention of selling them and so
is exposed to market risk. However, it also holds some debt securities
generally for liquidity management purposes, and is exposed to credit risk
as a result.
The Group is exposed to credit risk from off-balance sheet products such
as trade finance activities and guarantees.
Credit risk governance
A strong credit risk management function is vital to support the ongoing
profitability of the Group. The potential for loss is mitigated through a
robust credit risk culture in the business units and through a focus on
sustainable lending practices. The Group’s credit risk management
function is responsible for credit approval and managing concentration
risk, as well as credit risk control frameworks and acts as the ultimate
authority for the approval of credit. This, together with strong independent
oversight and challenge, enables the business to maintain a sound credit
environment.
The Group Chief Credit Officer (GCCO), through the Group Credit Risk
(GCR) function, is responsible for the development of, and ensuring
compliance with, Group-wide policies and credit risk frameworks as well
as Group-wide assessment of provision adequacy. The risk management
functions, located in the Group’s business divisions, are responsible for
the execution of these policies.
The divisional credit risk management functions work together with GCR
to ensure that the risk appetite set by the Group Board is met. The credit
risk function in each division is managed by a Chief Credit Officer, who
reports jointly to a divisional Chief Risk Officer and to the GCCO.
Divisional credit risk management activities include transaction analysis,
credit approval, ongoing credit risk stewardship, and early problem
identification and management.
The Executive Risk Forum (ERF) considers and approves material
aspects of the Group’s credit risk management framework, such as credit
risk appetite and limits for portfolios of strategic significance. The ERF
has delegated approval authority to the Group Credit Risk Committee, a
functional sub-committee of the Group Risk Committee, to act on credit
risk matters. These include, but are not limited to, credit risk appetite and
limits (within the overall risk appetite set by the Board and the ERF),
credit risk strategy and frameworks, credit risk policy and the oversight of
the credit profile across the Group. There are separate Group Credit Risk
Committees for the retail and wholesale portfolios and these are chaired
by the GCCO.
The Group Audit Committee (GAC) provides oversight of the Group’s
provision adequacy. The GCCO is accountable to the GAC for the
adequacy of the Group’s provisions, both individual and collective.
The Group Provisions Committee, which is chaired by either the Group
Chief Risk Officer or the GCCO, approves recommendations from the
divisional provisions committees.
Key trends in the credit risk profile of the Group, performance against
limits and emerging risks are set out in the RBS Risk Management
Monthly Report provided to the Executive Committee, the Board Risk
Committee and the Group Board.
Risk appetite and concentration framework
Risk appetite is set using specific quantitative targets under stress,
including earnings volatility and capital adequacy. The Group’s credit risk
framework has therefore been designed around the factors that influence
the Group’s ability to meet those targets. These include product and
asset class, industry sector, single name and country concentrations. Any
of these factors could generate higher earnings volatility under stress
and, if not adequately controlled, could undermine capital adequacy.
Tools such as stress testing and economic capital are used to measure
credit risk volatility and develop links between Group risk appetite targets
and the credit risk control framework. The frameworks are supported by a
suite of Group-wide and divisional policies that set out the risk
parameters within which divisions must operate. The Group also
manages its exposures to counterparty credit risk closely, using portfolio
limits and specific tools to control more volatile or capital intensive
business areas.
Wholesale
Four formal frameworks are used to manage wholesale credit
concentration risk. The Group continually reassesses its frameworks to
ensure that they remain appropriate for its varied business franchises and
current economic conditions, as well as to reflect further refinements in
the Group’s risk measurement models.