RBS 2013 Annual Report Download - page 344
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Business review Risk and balance sheet management
342
Country risk
Definition
Country risk is the risk of losses occurring as a result of either a country
event or unfavourable country operating conditions. As country events
may simultaneously affect all or many individual exposures to a country,
country event risk is a concentration risk. For other types of concentration
risks such as product, sector or single name concentration, refer to the
Credit risk section.
External environment*
Macroeconomic conditions stabilised in 2013 with signs of improvement
in most mature economies. The US showed the strongest improvement,
with private investment picking up, the housing sector continuing to
strengthen, and unemployment falling. This led the Federal Reserve to
announce in May plans to begin normalising monetary policy. In
December it announced it would start reducing quantitative easing. This
resulted in some volatility in higher-yield asset markets, particularly
emerging markets, where those with the largest external financing needs
saw capital outflows, currency depreciation and stock market losses.
In the second half of the year, investor concerns were heightened by the
risk that the US federal debt ceiling increase would not be passed on time
and that the government might delay debt payments. Short-term political
solutions to these issues were found, though with further progress
needed in 2014.
The eurozone region as a whole remained in recession throughout the
year, but signs of recovery were evident by the second half of the year.
Germany led, but the periphery also showed notable signs of
stabilisation, with Ireland, Spain and Portugal all growing in quarter-on-
quarter terms in the last quarter of 2013. Eurozone monetary policy
support underpinned investor confidence, while progress was made in
developing a banking union that should reduce the risk of a repeat of the
financial crisis over the longer term. Nevertheless, France and Italy
underperformed peers.
In Japan, an economic reform strategy combined with large monetary
stimulus contributed to currency depreciation, a reduction in deflationary
expectations and strong growth in the first half of the year. However,
momentum slowed in the second half of the year.
Many emerging market economies entered 2013 with high growth rates.
While most were in substantially better shape than in previous crises,
some had built up significant imbalances during years of strong capital
inflows. As economic conditions in mature markets, particularly the US,
improved in the course of the year, markets began to anticipate that
monetary policies would normalise.
This led to a sharp round of capital outflows, particularly from equity
markets, in the second quarter of 2013. Currency depreciations in a
number of large emerging economies followed, especially in those with
significant current account deficits. Among the better rated economies,
India, Brazil, Indonesia, South Africa and Turkey, were particularly
affected. To stem the outflow of foreign capital and limit the impact on
domestic asset markets, some countries, including India, started
tightening monetary policy and accelerated financial sector reforms.
Some countries with sizeable accumulated reserve assets, including
China and Russia, were able to use their reserves to ease the pressure
on their currencies.
*unaudited
Outlook
Further strengthening of economic growth in advanced economies is
likely in 2014, but uncertainty over the impact of “tapering” is likely to
contribute to further volatility in asset prices across most regions. The US
is expected to perform quite strongly, with the eurozone also likely to
continue its uneven recovery, although in both cases key areas of the
economy will remain fragile. A more challenging year for emerging
economies is expected as net capital inflows decline, resulting in more
pronounced market volatility and differentiation. Further policy tightening
is likely and growth rates are set to slow, especially in the weakest
markets.
Sources of risk
Country risk has the potential to affect all parts of the Group’s portfolio
across wholesale and retail activities that are directly or indirectly linked
to the country in question.
It arises from possible economic or political events in each country to
which the Group has exposure, and from unfavourable conditions
affecting daily operations in a country.
Country events may include a sovereign default, political conflict, banking
crisis or deep and prolonged recession leading to possible counterparty
defaults. Transfer or convertibility restrictions imposed by a country’s
government to stem the loss of foreign currency reserves may
temporarily prevent counterparties from meeting their payment
obligations. Major currency depreciation may also affect a customer’s
income or debt burden, leading to default.
Unfavourable operating conditions may include the risk that a weak or
creditor unfriendly legal system within a country makes it difficult for the
Group to recover its claims in the event of customer default. An unreliable
or unstable political system may lead to sudden compliance or
reputational issues for the Group, or even expropriation without proper
compensation.
Governance*
The Group’s country risk framework is set by the Executive Risk Forum
(ERF). This body delegates authority to the Group Country Risk
Committee (GCRC) to decide on country risk matters, including risk
appetite, risk management strategy and framework, risk exposure and
policy, as well as sovereign ratings, sovereign loss given default rates
and country Watchlist colours. The GCRC, which is chaired by the Head
of Global Country Risk (GCoR) and includes representatives of divisions
with country risk exposures, can escalate issues when necessary to the
ERF.
For further information on governance, refer to the Risk governance
section on page 175.