Royal Bk Scot.Grp. RBS Interim Management Statement - Part 6 of 7

  Royal Bk Scot.Grp. (RBS) - Interim Management Statement - Part 6 of 7

RNS Number : 1671Q
Royal Bank of Scotland Group PLC
02 November 2012






Risk and balance sheet management (continued)



Market risk

Market risk arises from  changes in interest  rates, foreign currency,  credit 
spreads, equity prices and risk  related factors such as market  volatilities. 
The Group manages  market risk  centrally within its  trading and  non-trading 
portfolios through  a comprehensive  market  risk management  framework.  This 
control framework includes qualitative and  quantitative guidance in the  form 
of comprehensive policy statements, dealing authorities, limits based on,  but 
not limited to, value-at-risk (VaR), stress testing, and sensitivity analyses.



For a description of the Group's basis of measurement and methodologies, refer
to pages 229 to 231 of the Group's 2011 Annual Report and Accounts.



CRD III capital charges

Following the implementation  of CRD  III in 2011,  the Group  is required  to 
calculate: (i) Stressed VaR (SVaR) -  an additional capital charge based on  a 
stressed calibration of the VaR model;  (ii) an Incremental Risk Charge  (IRC) 
to capture the  default and migration  risk for credit  risk positions in  the 
trading book;  and (iii)  an  All Price  Risk  (APR) measure  for  correlation 
trading positions, subject to  a capital floor that  is based on  standardised 
securitisation charges. The capital charges  associated with these models  are 
shown in the table below:



                        30 September 31 December

                               2012        2011
                                 £m          £m
                                               
Stressed VaR                   1,407       1,682
Incremental Risk Charge          519         469
All Price Risk                    34         297



Key points

· The decrease  in  SVaR and  APR  over the  first  nine months  of  2012  was 
  primarily due to the  restructuring of certain  trades in Non-Core.  General 
  de-risking in sovereign and agency positions in Markets also contributed  to 
  the decrease.
 
· The increase in IRC due to the implementation of a new IRC model at the  end 
  of Q2 2012 was partially offset by the general de-risking.



Risk and balance sheet management (continued)



Market risk (continued)



Daily distribution of Markets trading revenues

The graph below shows trading revenues  for Markets for the nine months  ended 
30 September 2012 and the corresponding period in 2011.



http://www.rns-pdf.londonstockexchange.com/rns/1671Q_-2012-11-1.pdf



Note:

(1) The effect of any  month end adjustments, not  attributable to a  specific 
    daily market move, is spread evenly over the trading days in that specific
    month.



Key points

· The average daily revenue earned by Markets trading activities in the  first 
  nine months  of 2012  was £18  million,  compared with  £20 million  in  the 
  corresponding period in 2011. The  standard deviation of the daily  revenues 
  decreased from £20 million to £14 million.
 
· The number of days with negative revenue decreased to 18 from 27. During  Q3 
  2011 the credit environment deteriorated  rapidly causing credit spreads  to 
  widen following a heightened period of uncertainty in the eurozone.
 
· The most frequent  daily revenue was  between £15 million  and £20  million, 
  which occurred  32times.  In the  prior  period, the  most  frequent  daily 
  revenue was between £25 million and £30million, which occurred 24 times.



Risk and balance sheet management (continued)



Market risk (continued)

Counterparty Exposure Management (CEM) manages the over-the-counter derivative
counterparty credit  and  funding  risk  on behalf  of  Markets,  by  actively 
controlling risk  concentrations and  reducing  unwanted risk  exposures.  The 
hedging transactions that CEM enters into  are booked in the trading book  and 
therefore contribute  to  the market  risk  VaR  exposure of  the  Group.  The 
counterparty exposures  themselves  are not  captured  in VaR  for  regulatory 
capital. In the interest  of transparency and to  more properly represent  the 
exposure, CEM exposure and total VaR excluding CEM are disclosed separately.



The table below details  VaR for the Group's  trading portfolios, analysed  by 
type of market risk exposure, and between Core, Non-Core, CEM and the  Group's 
total trading VaR excluding CEM.



                                                                                             31
                                          Nine months ended                           December

                       30 September 2012                  30 September 2011             2011
                         Period                              Period                      Period
               Average   end Maximum Minimum  Average   end Maximum Minimum      end
Trading VaR          £m    £m      £m      £m       £m    £m      £m      £m       £m
                                                                                    
Interest rate      63.7  44.8    95.7    43.6     50.3  73.0    79.2    27.5     68.1
Credit spread      69.4  67.2    94.9    44.9     87.4  69.8   151.1    47.4     74.3
Currency           11.4   8.9    21.3     5.3     10.1   6.5    18.0     5.2     16.2
Equity              6.3   8.2    12.5     3.3      9.8   7.7    17.3     4.6      8.0
Commodity           1.9   2.7     6.0     0.9      0.4   3.6     3.6       -      2.3
Diversification
(1)                     (40.8)                          (54.3)                    (52.3)
                                                                                    
Total              99.0  91.0   137.0    66.5    104.1 106.3   181.3    59.7    116.6
                                                                                    
Core               74.2  69.4   118.0    47.4     75.3  83.1   133.9    41.7     89.1
Non-Core           32.3  26.5    41.9    22.1     74.2  38.7   128.6    33.2     34.6
                                                                                    
CEM                77.7  74.3    84.2    73.3     44.1  54.1    58.2    30.3     75.8
                                                                                    
Total
(excluding CEM)    46.4  46.6    76.4    32.2     82.6  66.6   150.0    43.1     49.7



Note:

(1) The Group benefits from diversification, which reflects the risk reduction
    achieved by  allocating investments  across various  financial  instrument 
    types, currencies  and  markets.  The extent  of  diversification  benefit 
    depends on the  correlation between  the assets  and risk  factors in  the 
    portfolio at a particular time.



Key points

· The Group's average and maximum credit spread VaR for the first nine  months 
  of 2012 were lower than for the corresponding period of 2011. This reflected
  the credit spread  volatility experienced during  the 2008 financial  crisis 
  dropping out of  the time series  window, combined with  a reduction in  the 
  asset-backed securities trading inventory in  Core and the restructuring  of 
  some monoline hedges relating to the Non-Core banking book.
· Towards the end of September 2012,  the credit spread VaR increased,  driven 
  by credit  spreads widening  on  the back  of  a deterioration  in  eurozone 
  sentiment and by an  increase in bought protection  on credit indices.  This 
  caused both the Group's period end  total and credit spread VaR to  increase 
  in the third quarter of 2012, compared with the first half of the year.
· The period end interest rate VaR for the first nine months of 2012 was lower
  than  that  for  the  same  period  in  2011,  largely  driven  by  position 
  reductions. However,  the  average interest  rate  VaR was  higher,  due  to 
  pre-hedging and positioning ahead of government bond auctions.
· Since late  2011,  CEM started  to  centrally  manage the  funding  risk  on 
  over-the-counter derivative contracts. The CEM trading VaR was  considerably 
  higher in the first  nine months of  2012 than in the  same period in  2011, 
  primarily due to  the transfer  of funding risk  management from  individual 
  desks to CEM.



Risk and balance sheet management (continued)



Market risk (continued)

The table below details VaR  for the Group's non-trading portfolio,  excluding 
the structured credit portfolio and loans and receivables.



                                                                                             31
                                          Nine months ended                           December

                       30 September 2012                  30 September 2011             2011
                         Period                              Period                      Period
               Average   end Maximum Minimum  Average   end Maximum Minimum      end
Non-trading VaR      £m    £m      £m      £m       £m    £m      £m      £m       £m
                                                                                    
Interest rate       7.6   5.5    10.7     5.3      8.6  10.3    11.1     5.7      9.9
Credit spread      11.1   8.6    15.4     7.3     19.6  14.8    39.3    14.1     13.6
Currency            3.4   1.5     4.5     1.3      1.8   4.1     5.9     0.1      4.0
Equity              1.7   1.7     1.9     1.6      2.2   1.8     3.1     1.6      1.9
Diversification
(1)                      (8.0)                          (13.5)                    (13.6)
                                                                                    
Total              12.6   9.3    18.3     8.6     20.9  17.5    41.6    13.4     15.8
                                                                                    
Core               12.4   9.2    19.0     8.3     20.4  18.6    38.9    13.5     15.1
Non-Core            2.1   3.6     3.6     1.6      3.4   3.7     4.3     2.2      2.5
                                                                                    
CEM                 1.0   1.0     1.1     0.9      0.3   0.4     0.4     0.3      0.9
                                                                                    
Total
(excluding CEM)    12.4   9.3    17.8     8.2     20.9  17.5    41.4    13.7     15.5



Note:

(1) The Group benefits from diversification, which reflects the risk reduction
    achieved by  allocating investments  across various  financial  instrument 
    types, currencies  and  markets.  The extent  of  diversification  benefit 
    depends on the  correlation between  the assets  and risk  factors in  the 
    portfolio at a particular time.



Key points

· The average and  period end total  and credit spread  VaR were  considerably 
  lower for the first nine  months of 2012, due  to reduced volatility in  the 
  market data time series, position reductions  and a decrease in the size  of 
  the collateral  portfolio. The  reduction in  collateral was  driven by  the 
  restructuring of certain Dutch residential mortgage-backed securities during
  H1 2012 permitting  their eligibility as  European Central Bank  collateral. 
  This allowed the disposal during the first nine months of 2012 of additional
  collateral purchased during the corresponding period in 2011.
 
· The Non-Core period  end VaR  was higher  at 30  September 2012  than at  31 
  December 2011, due  to improvements in  the time series  mapping on  certain 
  Australian bonds and the purchase of additional hedges.



Risk and balance sheet management (continued)



Market risk (continued)



Structured Credit Portfolio

The Structured Credit Portfolio is within Non-Core. The risk in this portfolio
is not measured or disclosed using VaR,  as the Group believes this is not  an 
appropriate tool for the banking book portfolio, which comprises illiquid debt
securities. These  assets are  reported on  a drawn  notional and  fair  value 
basis, and managed on a third party asset and risk-weighted assets basis.  The 
table below shows the open market risk in the structured credit portfolio.



                     Drawn notional                     Fair value
                                Other                           Other

              CDOs CLOs MBS  ABS Total  CDOs CLOs MBS  ABS Total
30 September
2012             £m   £m  £m    £m    £m    £m   £m  £m    £m    £m
                                                                  
1-2 years         -    -   -   128   128     -    -   -   120   120
2-3 years         -    -   6    28    34     -    -   5    27    32
3-4 years         -    -   -    45    45     -    -   -    43    43
4-5 years         -    - 161   218   379     -    - 136   198   334
5-10 years        -  298 110     -   408     -  278  53     -   331
>10 years       317  313 436   553 1,619   127  285 267   314   993
                                                                  
               317  611 713   972 2,613   127  563 461   702 1,853
                                                                  
31 December
2011                                                               
                                                                  
1-2 years         -    -   -    27    27     -    -   -    22    22
2-3 years         -    -  10   196   206     -    -   9   182   191
4-5 years         -   37  37    95   169     -   34  30    88   152
5-10 years       32  503 270   268 1,073    30  455 184   229   898
>10 years     2,180  442 464   593 3,679   766  371 291   347 1,775
                                                                  
             2,212  982 781 1,179 5,154   796  860 514   868 3,038



Key point

· The Structured  Credit Portfolio  drawn notional  and fair  values  declined 
  across all asset  classes from 31  December 2011 to  30 September 2012.  Key 
  drivers were: (i) during H1 2012, the liquidation of legacy trust  preferred 
  securities and  commercial  real estate  CDOs  and subsequent  sale  of  the 
  underlying assets, and (ii)  during Q3 2012, the  sale of underlying  assets 
  from CDO collateral pools and legacy conduits.





Risk and balance sheet management (continued)



Risk management: Country risk



Introduction

Country  risk  is  the  risk  of  material  losses  arising  from  significant 
country-specific events such as  sovereign events (default or  restructuring); 
economic events (contagion of sovereign default to other parts of the economy,
cyclical  economic  shock);  political  events  (transfer  or   convertibility 
restrictions, expropriation  or  nationalisation);  and  natural  disaster  or 
conflict. Such events  have the potential  to affect elements  of the  Group's 
credit portfolio that  are directly  or indirectly  linked to  the country  in 
question and  can  also  give  rise  to  market,  liquidity,  operational  and 
franchise risk related losses.



The global picture  remains mixed,  with advanced  economies, particularly  in 
Europe, overall much  weaker than  emerging markets. The  economic outlook  in 
Asia is  weakening but  remains comparatively  positive. Although  the US  and 
Japanese central  banks  have both  announced  additional asset  purchases  to 
counteract  economic  weakness,  market   confidence  will  remain   primarily 
influenced by developments in eurozone  crisis management and a resolution  of 
the US fiscal deadlock.  The Latin American  outlook remains positive  despite 
rising external risks.



Markets continue to benefit from the European Central Bank's Outright Monetary
Transactions (OMT)  announcement and  the European  Stability Mechanism  (ESM) 
approval by the German Constitutional  Court, but disagreements over the  next 
steps to eurozone integration highlight the length of the road ahead. Overall,
the Group still sees  a gradual resolution  of the crisis  as the most  likely 
outcome. In  the  short-term,  a  clearer  roadmap  towards  a  joint  banking 
regulator is needed, a prerequisite  for the ESM being  able to lend to  banks 
directly. Dir

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