RBS 2013 Annual Report Download - page 369
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Independent auditor’s report to the members of The Royal Bank of Scotland Group plc
367
Our assessment of risks of material misstatement
The assessed risks of material misstatement described below are those that had the greatest effect on our audit strategy, the allocation of resources in
the audit and directing the efforts of the engagement team:
Our assessment of the risks of material misstatement Our response to those risks
The calculation of the Group’s loan impairment provisions requires
management to make significant judgements on whether impairment
events have occurred which result in the need for a provision, on the
amount of these provisions, and on the estimate of loan losses that have
been incurred but not yet specifically identified.
A number of the loans held in GRG and in Ulster Bank require particularly
judgemental estimates to be made of the value of collateral assets in
illiquid markets.
In November 2013 the Group announced the transfer of approximately
£38 billion of assets, predominantly loans, held in Ulster Bank, Non-Core,
UK Corporate and International Banking into the RBS Capital
Restructuring Group (“RCR”) on 1 January 2014 in order to manage the
run-down of those assets on an accelerated timescale. The faster run-
down of such loans led to revisions to expected cash flows and an
increased impairment charge for the year.
We undertook an assessment of loan impairment provisioning practices
across the Group to compare them with the requirements of IFRS and
tested the key controls over the processes used to calculate impairment
provisions, including testing the controls over the information used in the
provisioning processes.
For the collective and latent loan impairment provisions we tested
samples of the data used in the models together with the calculations in
and the output from the models. We also challenged management on the
level of specific provisions by assessing for a sample of loans (including a
sample of those being transferred into RCR) whether or not provisions
booked had been recognised in accordance with IFRS.
Where appropriate, our work involved assessing third party valuations of
collateral and external expert reports on borrowers’ business plans and
enterprise valuations to determine whether appropriate valuation
methodologies and assumptions were employed and to assess the
objectivity of the external experts used, including assessing whether any
inappropriate restrictions had been placed on their work.
The valuation of the Group’s financial instruments, held at fair value, is
based on a combination of market data and financial models which often
require a considerable number of inputs. Many of these inputs are
obtained from readily available data for liquid markets. Where such
observable data are not readily available, such as in the case of level 3
assets, then estimates need to be developed which can involve significant
judgement.
We tested the key controls over the Group’s financial instrument valuation
processes. Our work included testing a sample of the underlying models
and assumptions used, by reference to trade data as well as peer group
comparison, where available.
In addition for a sample of transactions the year end valuations were
recalculated by our valuation specialists using our own independent
models.
The estimation of the provisions held in relation to the ongoing regulatory
investigations and litigation affecting the Group, including the mortgage-
backed securities and securities related litigation, payment protection
insurance and interest rate hedging products mis-selling, is highly
judgemental given the uncertainties in relation to future regulatory and
legal judgements, as well the uncertainties around key assumptions used
to calculate these provisions such as average redress costs and the
volumes of future complaints.
For certain claims it is not possible reliably to estimate whether and what
amounts will be paid out and in those situations disclosures are provided
on the status of these claims and the possible outcomes as set out in Note
32 to the financial statements.
We assessed the legal advice and correspondence with regulators
received in connection with legal proceedings, investigations and
regulatory matters which the Group is party to. Where appropriate we
additionally engaged in direct enquiry with the Group’s external legal
counsel.
For redress costs we challenged the adequacy of provisions recognised
by critically assessing the key assumptions used in the provision models,
where possible comparing the assumptions to available peer and historic
data.
We also challenged the appropriateness of the disclosures provided in
relation to these matters, including those where a reliable estimate of the
liability could not be calculated.
Identified deficiencies in the privileged access controls over a number of
significant applications that run on the Group’s information technology
systems, could have had a negative impact on the Group’s controls and
financial reporting systems at a number of divisions.
Where these deficiencies affected specific applications within our audit
scope we extended our control testing to provide assurance over both
compensating controls and the completeness and accuracy of
management information used in key controls. In addition and where
appropriate we extended the scope of our substantive procedures over
the year-end balance sheet.