RBS 2013 Annual Report Download - page 365
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Business review Risk and balance sheet management
363
Risk management and measurement
The Group seeks to minimise its exposure to business risk, subject to its
wider strategic objectives.
Business risk is identified and managed at product and transaction level.
Estimated revenue and costs, including the potential range of outcomes,
are key elements in the design of any new product or investment
decision. All policies that ultimately seek to manage and control financial
impacts at the product and transaction level are therefore relevant to
business risk management including policies on conduct, treasury and
investment spend.
Business risk is reported, assessed and challenged at every governance
level within the organisation. Revenue and costs are reported within
divisional business line and divisional finance teams maintain a record of
financial performance against plans, reporting this on a regular basis to
divisional CFOs and to Group functions. Group Finance challenges
divisional financial results and reports performance against plan to the
Board and executive committees with a particular focus on revenue
generation, cost management initiatives and risk mitigation.
Business risk is reviewed and assessed through the Group’s planning
cycles and performance management processes.
In the planning cycles, expected and potential scenarios for revenues and
costs are determined, on a bottom-up basis, through plans reflecting
expectations of the external environment and the Group’s strategic
priorities. These scenarios are tested against a range of sensitivities and
stresses to identify the key risk drivers behind any potential volatility,
together with management actions to address and manage them.
Group Risk operates a top-down stress testing process in parallel to the
Group’s planning cycles, considering both severe and extreme stress
scenarios. The stress test outcomes form a core part of the assessment
of earnings and capital adequacy risk appetite and are approved by the
Board. The measurement of change in profit and loss of the divisions
under stress thereby acts as a measure of business risk. Divisions also
conduct their own bottom-up stress testing exercises to assess financial
performance of their businesses under stress.
In 2013, the measurement of business risk was further enhanced through
greater use of downside scenarios, improved granularity of stress testing,
new revenue models in some of the main divisions and the development
of an economic capital related business risk measure.
Business risk is incorporated in the Group’s risk appetite target for
earnings volatility, and an assessment of volatility in revenues and costs
is a key component in determining whether the Group and its underlying
businesses are within risk appetite. Each division is responsible for the
implementation of its business plan and the management of associated
risks within approved risk appetite targets.
*unaudited
Expected profiles for revenues and costs are determined, on a bottom-up
basis, through plans reflecting expectations of the external environment
and the Group’s strategic priorities. These profiles are tested against a
range of sensitivities and stresses to identify the key risk drivers behind
any potential volatility, along with management actions to address and
manage them.
Risk mitigation
The Group operates a forecast process which identifies projected
changes in, or risks to, key financial metrics and ensures appropriate
actions are taken.
During 2013, the Group responded to the business risk challenges that it
continues to face, focusing on the management of net interest margin in
order to sustain and grow revenues. In addition, it introduced cost
management programmes to deliver substantial savings and flexibility in
the cost base.
Strategic risk
Definition
The risk that the Group will make inappropriate strategic choices, or that
there will be changes in the external environment to which the Group fails
to adapt its strategies.
Sources of risk
Strategic risk arises from three principal sources:
• Inadequate or inaccurate analysis of current and prospective
operating conditions in the Group’s markets including
macroeconomic performance, customer and competitor behaviours
and actions, regulatory developments and technological impacts;
• Inadequate or inaccurate understanding of the Group’s existing
capabilities and positioning and ability to implement chosen
strategies; and
• Significant unanticipated changes in the Group’s operating
environment.
Failure to manage strategic risk could have a wide-ranging impact on the
Group. Effects could include damage to the Group’s customer franchises,
and lower revenues, profitability and returns to shareholders. Strategic
risk is viewed as material, given the current uncertain economic climate
and the potential impact of regulatory changes in the medium term.
Governance structure
The Group’s strategic planning process is managed by Group Strategy
and Corporate Finance. As part of that process, each division develops a
strategic plan for its business within a framework set by the Group’s
senior management. Divisional plans are then consolidated at Group
level, and both divisional and Group plans are reviewed, challenged and
assessed against risk appetite. The consolidated plan is reviewed and
formally signed off by the Group Board once a year.