RBS 2013 Annual Report Download - page 537
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Additional information
535
A further deterioration in economic and market conditions or changes to
legal or regulatory landscapes could worsen borrower and counterparty
credit quality and also impact the Group’s ability to enforce contractual
security rights. In addition, the Group’s credit risk is exacerbated when
the collateral it holds cannot be realised or is liquidated at prices not
sufficient to recover the full amount of the loan or derivative exposure that
is due to the Group, which is most likely to occur during periods of
illiquidity and depressed asset valuations, such as those experienced in
recent years. This has been particularly the case with respect to large
parts of the Group’s commercial real estate portfolio. Any such losses
could have an adverse effect on the Group’s results of operations and
financial condition.
Concerns about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other financial
institutions, as the commercial and financial soundness of many financial
institutions may be closely related as a result of credit, trading, clearing
and other relationships. Even the perceived lack of creditworthiness of, or
questions about, a counterparty may lead to market-wide liquidity
problems and losses for, or defaults by, the Group. This systemic risk
may adversely affect financial intermediaries, such as clearing agencies,
clearing houses, banks, securities firms and exchanges with which the
Group interacts on a daily basis, all of which could have a material
adverse effect on the Group’s access to liquidity or could result in losses
which could have a material adverse effect on the Group’s financial
condition, results of operations and prospects.
In certain jurisdictions in which the Group does business, particularly
Ireland, additional constraints have been imposed in recent years on the
ability of certain financial institutions to complete foreclosure proceedings
in a timely manner (or at all), including as a result of interventions by
certain states and local and national governments.
These constraints have lengthened the time to complete foreclosures,
increased the backlog of repossessed properties and, in certain cases,
have resulted in the invalidation of purported foreclosures.
The EU, the ECB, the International Monetary Fund and various national
authorities have proposed and implemented certain measures intended
to address systemic financial stresses in the Eurozone, including the
creation of a European Banking Union which, through a Single Resolution
Mechanism (SRM) will apply the substantive rules of bank recovery and
resolution set out in the RRD. Current expectations are that the RRD,
which is intended to provide supervisory authorities with common tools
and powers to address banking crises pre-emptively in order to safeguard
financial stability and minimise taxpayers’ exposure to losses, will be
finalised early in 2014. The effectiveness of these and other actions
proposed and implemented at both the EU and national level to address
systemic stresses in the Eurozone is not assured.
The trends and risks affecting borrower and counterparty credit quality
have caused, and in the future may cause, the Group to experience
further and accelerated impairment charges, increased repurchase
demands, higher costs, additional write-downs and losses for the Group
and an inability to engage in routine funding transactions.
Changes in interest rates, foreign exchange rates, credit spreads, bond,
equity and commodity prices, basis, volatility and correlation risks and
other market factors have significantly affected and will continue to affect
the Group’s business and results of operations
Some of the most significant market risks the Group faces are interest
rate, foreign exchange, credit spread, bond, equity and commodity prices
and basis, volatility and correlation risks. Changes in interest rate levels
(or extended periods of low interest rates such as experienced over the
past several years), yield curves (which remain depressed) and spreads
may affect the interest rate margin realised between lending and
borrowing costs, the effect of which may be heightened during periods of
liquidity stress. Changes in currency rates, particularly in the sterling-US
dollar and sterling-euro exchange rates, affect the value of assets,
liabilities, income and expenses denominated in foreign currencies and
the reported earnings of the Group’s non-UK subsidiaries and may affect
the Group’s reported consolidated financial condition or its income from
foreign exchange dealing. For accounting purposes, the Group values
some of its issued debt, such as debt securities, at the current market
price. Factors affecting the current market price for such debt, such as
the credit spreads of the Group, may result in a change to the fair value
of such debt, which is recognised in the income statement as a profit or
loss.
The performance of financial markets affects bond, equity and commodity
prices, which has caused, and may in the future cause, changes in the
value of the Group’s investment and trading portfolios. As part of its on-
going derivatives operations, the Group also faces significant basis,
volatility and correlation risks, the occurrence of which are also impacted
by the factors noted above.
While the Group has implemented risk management methods to mitigate
and control these and other market risks to which it is exposed, it is
difficult to predict with accuracy changes in economic or market
conditions and to anticipate the effects that such changes could have on
the Group’s financial performance and business operations.
The value or effectiveness of any credit protection that the Group has
purchased depends on the value of the underlying assets and the
financial condition of the insurers and counterparties
The Group has credit exposure arising from over-the-counter derivative
contracts, mainly credit default swaps (CDSs), and other credit
derivatives, each of which are carried at fair value. The fair value of these
CDSs, as well as the Group’s exposure to the risk of default by the
underlying counterparties, depends on the valuation and the perceived
credit risk of the instrument against which protection has been bought.
Many market counterparties have been adversely affected by their
exposure to residential mortgage linked and corporate credit products,
whether synthetic or otherwise, and their actual and perceived
creditworthiness may deteriorate rapidly. If the financial condition of these
counterparties or their actual or perceived creditworthiness deteriorates,
the Group may record further credit valuation adjustments on the credit
protection bought from these counterparties under the CDSs. The Group
also recognises any fluctuations in the fair value of other credit
derivatives. Any such adjustments or fair value changes may have a
material adverse impact on the Group’s financial condition and results of
operations.