RBS 2013 Annual Report Download - page 321
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Business review Risk and balance sheet management
319
Market risk
Definition
Market risk is the risk of losses arising from fluctuations in interest rates,
credit spreads, foreign currency rates, equity prices, commodity prices
and other factors, such as market volatilities, that may lead to a reduction
in earnings, economic value or both.
Sources of risk
The Group is exposed to traded market risk through its trading activities
and to non-traded market risk as a result of its banking activities. In many
respects, it manages its traded and non-traded market risk exposures
separately, as described in this section, largely in line with the regulatory
definitions of the trading and non-trading books.
Traded market risk
The majority of the Group’s traded market risk exposure arises in Markets
and Non-Core.
The primary objective of the Group’s trading activities is to provide a
range of financing, risk management and investment services to its
customers - including major corporations and financial institutions around
the world. From a market risk perspective, the Group's trading activities
are included within the following markets: currencies; emerging markets;
rates; asset-backed products; and traded credit.
The Group undertakes transactions in financial instruments including debt
securities, loans, deposits and equities, as well as securities financing
and derivatives.
Some of these transactions involve trading or clearing financial
instruments on an exchange, including interest rate swaps, futures and
options. Holders of these instruments provide margin on a daily basis
with cash or other security at the exchange.
Over-the-counter transactions with standard terms are cleared through
central counterparties, while complex transactions are settled directly with
the counterparty. These range from commoditised transactions in
derivative markets to trades tailored to meet specific customer
requirements. Such transactions also give rise to counterparty credit risk,
which the Group manages actively (for more information on how the
Group manages counterparty credit risk, refer to the Credit Risk section,
page 241).
Non-traded market risk
The majority of the Group’s non-traded market risk exposure arises from
retail and commercial banking activities in all divisions from assets and
liabilities that are not classified as held for trading.
The Group’s management of non-traded market risk is largely organised
in line with the following three key categories: non-traded interest rate risk
(NTIRR); non-traded foreign exchange risk; and non-traded equity risk.
Interest rate risk
NTIRR arises from the provision to customers of a range of banking
products that have differing interest rate characteristics. Therefore, when
aggregated, these products form portfolios of assets and liabilities with
varying degrees of sensitivity to changes in market interest rates.
Mismatches in these characteristics can give rise to volatility in net
interest income as interest rates rise and fall.
NTIRR comprises four primary risk factors: repricing risk, yield curve risk,
basis risk and optionality risk. For more information, see page 334.
Foreign exchange risk
Non-traded foreign exchange risk exposures for the Group arise from two
main sources:
• the capital deployed in foreign subsidiaries, branches and
associates and related currency funding where it differs from sterling
(these exposures are known as structural foreign exchange
exposures); and
• customer transactions and profits and losses in a currency that are
not conducted in the functional currency of the transacting operation.
Equity risk
Non-traded equity risk is the potential variation in the Group’s income and
reserves arising from changes in the values of non-trading book equity
positions. Equity exposures arise through strategic acquisitions, venture
capital investments and GRG restructuring arrangements.
Pension risk
The Group’s pension-related activities also give rise to market risk. Refer
to page 356 and 357 for more information on risk related to pensions.