Tesco 2010 Annual Report Download - page 111

Financial statements
Note 23 Financial risk factors continued
Tesco Bank
Interest rate risk
Interest rate risk arises where assets and liabilities in Tesco Bank’s banking activities have different repricing dates. Tesco Bank policy seeks to minimise
the sensitivity of net interest income to changes in interest rates. Potential exposures to interest rate movements in the medium to long term are
measured and controlled through position and sensitivity limits. Short-term exposures are measured and controlled in terms of net interest income
sensitivity over 12 months to a 1% parallel movement in interest rates. Tesco Bank also use value at risk (VaR) for risk management purposes with a
time horizon of one trading day and a confidence interval of 95%. Interest rate risk is managed using interest rate swaps as the main hedging instrument.
Credit risk
Credit risk is the probability of customers and counterparties failing to meet their obligations to Tesco Bank and arises principally from Tesco Bank’s
lending activities but also from other transactions involving on and off-balance sheet instruments. Limits have been established for all counterparties
based on their respective credit ratings. The limits and proposed counterparties are reviewed and approved by the Risk Management Committee (RMC)
of Tesco Bank.
Internal reporting and oversight of risk assets is principally differentiated by credit ratings. Internal ratings are used to assess the credit quality of
borrowers. Customers are assigned credit ratings, based on various credit grading models that reflect the probability of default.
Liquidity risk
Liquidity risk is managed on a consolidated basis within Tesco Bank’s banking activities and adheres to the liquidity requirements set by the Financial
Services Authority (FSA) from time to time. To meet regulatory requirements a diversified portfolio of high quality liquid and marketable assets is
maintained. Cash flow commitments and marketable asset holdings are measured and managed on a daily basis. Tesco Bank has credit facilities sufficient
to meet all foreseeable outflow requirements as they fall due and its liquidity risk is further mitigated by its well diversified retail deposit base.
Expressed as an annual probability of default, the upper and lower boundaries and the midpoint for each of the asset quality grades are as follows:
At 27 February 2010 and 28 February 2009
Annual probability of default
Minimum Midpoint Maximum S&P
Asset quality grade % % % equivalent
AQ1 0.00 0.10 0.20 AAA to BBB-
AQ2 0.21 0.40 0.60 BB+ to BB
AQ3 0.61 1.05 1.50 BB- to B+
AQ4 1.51 3.25 5.00 B+ to B
AQ5 5.01 52.50 100.00 B and below
Accruing Non- Impairment
AQ1 AQ2 AQ3 AQ4 AQ5 past due accrual provision Total
At 27 February 2010 £m £m £m £m £m £m £m £m £m
Assets:
Other investments 863 – – – – – – – 863
Loans and advances to customers 501 381 762 1,495 838 76 373 (314) 4,112
Loans and advances to banks
and other financial assets 144 – – – – – – – 144
Total assets 1,508 381 762 1,495 838 76 373 (314) 5,119
Commitments (note 33) 3,926 1,329 573 452 184 – – – 6,464
Total off balance sheet 3,926 1,329 573 452 184 – – – 6,464
Accruing Non- Impairment
AQ1 AQ2 AQ3 AQ4 AQ5 past due accrual provision Total
At 28 February 2009 (restated) £m £m £m £m £m £m £m £m £m
Assets:
Other investments 259 – – – – – – – 259
Loans and advances to customers 352 652 828 870 563 82 291 (250) 3,388
Loans and advances to banks
and other financial assets 1,541 – – – – – – – 1,541
Total assets 2,152 652 828 870 563 82 291 (250) 5,188
Commitments (note 33) 3,103 1,451 744 305 129 – – – 5,732
Total off balance sheet 3,103 1,451 744 305 129 – – – 5,732
Tesco PLC Annual Report and Financial Statements 2010 109