rbs201208036k5.htm
 
FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

 
 
Report of Foreign Private Issuer
 
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
 
For August 3, 2012
 
Commission File Number: 001-10306

 
The Royal Bank of Scotland Group plc

 
RBS, Gogarburn, PO Box 1000
Edinburgh EH12 1HQ

 
(Address of principal executive offices)
 
 
Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.
 
Form 20-F X
  
Form 40-F ___
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):_________

 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):_________


Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.


Yes
   ___
No X
 
 
If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82- ________

 
 
The following information was issued as a Company announcement in London, England and is furnished pursuant to General Instruction B to the General Instructions to Form 6-K:

 
 


Risk and balance sheet management
 
Except as otherwise indicated by an asterisk (*), the information in the Risk and balance sheet management section on pages 129 to 236 is within the scope of the Deloitte LLP's review report.
 
General overview*
The following table defines the main types of risk managed by the Group and presents a summary of the key developments for each risk in the first half of 2012.
 
 
Risk type
Definition
H1 2012 summary
Capital risk
The risk that the Group has insufficient capital.
The Core tier 1 ratio was 11.1%, despite regulatory changes increasing risk-weightings on various asset categories, particularly commercial real estate. The Group reduced RWAs in Markets and successfully restructured a large derivative position in Non-Core. Refer to the Capital section.
Liquidity and funding risk
The risk that the Group is unable to meet its financial liabilities as they fall due.
The Group maintained its trajectory towards a more stable deposit-led balance sheet with the loan:deposit ratio improving from 108% at 31 December 2011 to 104% at 30 June 2012. Short-term wholesale funding declined significantly from £102 billion at 31 December 2011 to £62 billion, covered 2.5 times by the liquidity buffer which was maintained at £156 billion. Refer to the Liquidity and funding risk section.
Credit risk (including counterparty risk)
The risk that the Group will incur losses owing to the failure of a customer to meet its obligation to settle outstanding amounts.
The Group's credit performance improved; the H1 2012 impairment charge of £2.7 billion was 34% lower than the H1 2011 charge. This was despite continued economic stress within the eurozone, including Ireland, and depressed markets elsewhere. Progress continued in reducing key credit concentration risks, with exposure to commercial real estate 7% lower than at 31 December 2011. Refer to the Credit risk section.
Country risk
The risk of material losses arising from significant country-specific events.
Sovereign risk continues to increase, resulting in further rating downgrades for a number of countries, including several eurozone members. Total eurozone exposures decreased by 8% to £218 billion in H1 2012 and within that exposures to the periphery, fell by 10% to £69 billion. The Group participated in the Greek sovereign bond restructuring in March 2012 and sold all resulting new Greek sovereign bonds as well as parts of its Spanish and Portuguese bond holdings. A number of further advanced countries were brought under limit control and exposure to a range of countries was further reduced. Refer to the Country risk section.
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management
 
 
General overview* (continued)
 
 
Risk type
Definition
H1 2012 summary
Market risk
The risk arising from changes in interest rates, foreign currency, credit spreads, equity prices and risk related factors such as market volatilities.
During H1 2012, the Group continued to manage down its market risk exposure in Non-Core through the disposal of assets and unwinding of trades. Refer to the Market risk section.
Insurance risk
The risk of financial loss through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting.
Direct Line Group introduced enhanced claims management systems and processes, improving its ability to handle and understand insured events. In addition, improvements in the Group's insurance risk policy, associated minimum standards and key risk indicators were implemented.
Operational risk
The risk of loss resulting from inadequate or failed processes, people, systems or from external events.
The Group continued to focus on tight management of operational risks, particularly with regard to risk and control assessment (including change risk assessment), scenario analysis and statistical modelling for capital requirements. The level of operational risk remains high due to the continued scale of structural change occurring across the Group, the pace of regulatory change, the economic downturn and other external threats, such as e-crime.
 
During June 2012, the Group's technology incident led to significant payment system disruption. A detailed investigation is underway into the root cause of the problem.
Compliance
risk
The risk arising from non-compliance with national and international laws, rules and regulations.
The Group agreed its conduct risk appetite and made significant progress towards finalising and embedding the associated policy framework and governance. In addition, Group-wide implementation of its Anti Money Laundering Change Programme continued.
 
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management
 
 
General overview* (continued)
 
 
Risk type
Definition
H1 2012 summary
Reputational risk
The risk of brand damage arising from financial and non-financial events arising from the failure to meet stakeholders' expectations of the Group's performance and behaviour.
The Group Sustainability Committee oversaw further development of the Group's policies for environmental, social and ethical risks focusing on the power generation and gambling sectors. As part of the Group's commitment to stakeholder engagement, the Group Sustainability Committee also met with key non-governmental organisations to discuss concerns over high profile issues including tax, oil and gas investment, corporate transparency and agricultural commodity trading.
 
The disruption experienced by customers due to the Group's recent technology incident has presented reputational risks. The Group has informed customers that they will not suffer financially as a result and is undertaking an independent review of the incident.
Business risk
The risk of lower-than-expected revenues and/or higher-than-expected operating costs.
Business risk is fully incorporated within the Group's stress testing process through an analysis of the potential movement in revenues and operating costs under stress scenarios.
Pension risk
The risk that the Group will have to make additional contributions to its defined benefit pension schemes.
The Group continued to focus on improving pension risk management systems and modelling. This included the development of a policy setting out the governance framework for managing the Group's risk as sponsor of its defined pension schemes.
 
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management
 
 
Balance sheet management
 
Capital
The Group aims to maintain an appropriate level of capital to meet its business needs and regulatory requirements. Capital adequacy and risk management are closely aligned. The Group's risk-weighted assets and risk asset ratios, calculated in accordance with Financial Services Authority (FSA) definitions, are set out below.
 
 
 
30 June 
2012 
31 March 
2012 
31 December 
2011 
Risk-weighted assets (RWAs) by risk*
£bn 
£bn 
£bn 
       
Credit risk
334.8 
332.9 
344.3 
Counterparty risk
53.0 
56.8 
61.9 
Market risk
54.0 
61.0 
64.0 
Operational risk
45.8 
45.8 
37.9 
       
 
487.6 
496.5 
508.1 
Asset Protection Scheme relief
(52.9)
(62.2)
(69.1)
       
 
434.7 
434.3 
439.0 
 
 
Risk asset ratios*
% 
% 
% 
       
Core Tier 1
11.1 
10.8 
10.6 
Tier 1
13.4 
13.2 
13.0 
Total
14.6 
14.0 
13.8 
 
Key points*
 
·
The Core Tier 1 ratio improved to 11.1% reflecting reductions in RWAs and capital deductions. Gross RWAs decreased by £20.5 billion in H1 2012, 4%, primarily in Markets and Non-Core.
   
·
Non-Core RWAs decreased by £10.6 billion as a result of sales, run-off, market risk movements and the impact of restructuring a large derivative exposure to a highly leveraged counterparty, which was partly offset by increases to regulatory risk-weightings.
   
·
In Markets, less market risk and a smaller balance sheet led to lower RWAs.
   
·
Market risk RWAs decreased by £10.0 billion in the first half of 2012 and £7.0 billion in Q2 2012 reflecting de-risking of the Non-Core portfolio and a reduction in trading VaR in both Markets and Non-Core.
   
·
The Asset Protection Scheme relief decreased by £16.2 billion in the first half of 2012, £9.3 billion in Q2 2012. This results from the £19.6 billion (Q2 2012 - £8.6 billion) drop in covered assets to £112.2 billion at 30 June 2012.
 
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Capital (continued)
The Group's regulatory capital resources in accordance with FSA definitions were as follows:
 
 
 
30 June 
2012 
31 March 
2012 
31 December 
2011 
 
£m 
£m 
£m 
       
Shareholders' equity (excluding non-controlling interests)
      
 Shareholders' equity per balance sheet
74,016 
73,416 
74,819 
 Preference shares - equity
(4,313)
(4,313)
(4,313)
 Other equity instruments
(431)
(431)
(431)
 
69,272 
68,672 
70,075 
       
Non-controlling interests
      
 Non-controlling interests per balance sheet
1,200 
1,215 
1,234 
 Non-controlling preference shares
(548)
(548)
(548)
 Other adjustments to non-controlling interests for regulatory purposes
(259)
(259)
(259)
 
393 
408 
427 
       
Regulatory adjustments and deductions
      
 Own credit
(402)
(845)
(2,634)
 Unrealised losses on AFS debt securities
520 
547 
1,065 
 Unrealised gains on AFS equity shares
(70)
(108)
(108)
 Cash flow hedging reserve
(1,399)
(921)
(879)
 Other adjustments for regulatory purposes
637 
630 
571 
 Goodwill and other intangible assets
(14,888)
(14,771)
(14,858)
 50% excess of expected losses over impairment provisions (net of tax)
(2,329)
(2,791)
(2,536)
 50% of securitisation positions
(1,461)
(1,530)
(2,019)
 50% of APS first loss
(2,118)
(2,489)
(2,763)
 
(21,510)
(22,278)
(24,161)
       
Core Tier 1 capital
48,155 
46,802 
46,341 
       
Other Tier 1 capital
      
 Preference shares - equity
4,313 
4,313 
4,313 
 Preference shares - debt
1,082 
1,064 
1,094 
 Innovative/hybrid Tier 1 securities
4,466 
4,557 
4,667 
 
9,861 
9,934 
10,074 
       
Tier 1 deductions
      
 50% of material holdings
(313)
(300)
(340)
 Tax on excess of expected losses over impairment provisions
756 
906 
915 
 
443 
606 
575 
       
Total Tier 1 capital
58,459 
57,342 
56,990 
       
Qualifying Tier 2 capital
      
 Undated subordinated debt
1,958 
1,817 
1,838 
 Dated subordinated debt - net of amortisation
13,346 
13,561 
14,527 
 Unrealised gains on AFS equity shares
70 
108 
108 
 Collectively assessed impairment provisions
552 
571 
635 
 Non-controlling Tier 2 capital
11 
11 
11 
 
15,937 
16,068 
17,119 
       
Tier 2 deductions
      
 50% of securitisation positions
(1,461)
(1,530)
(2,019)
 50% excess of expected losses over impairment provisions
(3,085)
(3,697)
(3,451)
 50% of material holdings
(313)
(300)
(340)
 50% of APS first loss
(2,118)
(2,489)
(2,763)
 
(6,977)
(8,016)
(8,573)
       
Total Tier 2 capital
8,960 
8,052 
8,546 


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Capital (continued)
 
 
 
30 June 
2012 
31 March 
2012 
31 December 
2011 
 
£m 
£m 
£m 
       
Supervisory deductions
      
 Unconsolidated Investments
      
   - Direct Line Group
(3,642)
(4,130)
(4,354)
   - Other investments
(141)
(248)
(239)
 Other deductions
(197)
(212)
(235)
       
 
(3,980)
(4,590)
(4,828)
       
Total regulatory capital
63,439 
60,804 
60,708 
 
 
Movement in Core Tier 1 capital
£m 
   
At 1 January 2012
46,341 
Attributable profit net of movements in fair value of own debt
242 
Share capital and reserve movements in respect of employee benefits
659 
Foreign currency reserves
(461)
Decrease in non-controlling interests
(34)
Decrease in capital deductions including APS first loss
1,410 
Decrease in goodwill and intangibles
(30)
Other movements
28 
   
At 30 June 2012
48,155 
 
Risk-weighted assets by division*
Risk-weighted assets by risk category and division are set out below.
 
 
 
Credit 
risk 
Counterparty 
risk 
Market 
risk 
Operational 
risk 
Gross 
RWAs 
30 June 2012
£bn 
£bn 
£bn 
£bn 
£bn 
           
UK Retail
39.6 
- 
- 
7.8 
47.4 
UK Corporate
70.8 
- 
- 
8.6 
79.4 
Wealth
10.3 
- 
0.1 
1.9 
12.3 
International Banking
41.2 
- 
- 
4.8 
46.0 
Ulster Bank
34.7 
0.9 
0.1 
1.7 
37.4 
US Retail & Commercial
52.5 
1.1 
- 
4.9 
58.5 
           
Retail & Commercial
249.1 
2.0 
0.2 
29.7 
281.0 
Markets
15.7 
33.4 
43.1 
15.7 
107.9 
Other
10.5 
0.2 
0.2 
1.8 
12.7 
           
Core
275.3 
35.6 
43.5 
47.2 
401.6 
Non-Core
56.4 
17.4 
10.5 
(1.6)
82.7 
           
Group before RFS Holdings MI
331.7 
53.0 
54.0 
45.6 
484.3 
RFS Holdings MI
3.1 
- 
- 
0.2 
3.3 
           
Group
334.8 
53.0 
54.0 
45.8 
487.6 
APS relief
(46.2)
(6.7)
- 
- 
(52.9)
           
Net RWAs
288.6 
46.3 
54.0 
45.8 
434.7 
 
 
 
 
* not within the scope of Deloitte LLP's review report
 
 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Capital: Risk-weighted assets by division* (continued)
 
 
 
Credit 
risk 
Counterparty 
risk 
Market 
risk 
Operational 
risk 
Gross 
RWAs 
31 March 2012
£bn 
£bn 
£bn 
£bn 
£bn 
           
UK Retail
40.4 
- 
- 
7.8 
48.2 
UK Corporate
68.3 
- 
- 
8.6 
76.9 
Wealth
10.9 
- 
0.1 
1.9 
12.9 
International Banking
37.0 
- 
- 
4.8 
41.8 
Ulster Bank
35.9 
0.7 
0.1 
1.7 
38.4 
US Retail & Commercial
52.8 
0.9 
- 
4.9 
58.6 
           
Retail & Commercial
245.3 
1.6 
0.2 
29.7 
276.8 
Markets
15.0 
36.5 
48.4 
15.7 
115.6 
Other
9.0 
0.2 
- 
1.8 
11.0 
           
Core
269.3 
38.3 
48.6 
47.2 
403.4 
Non-Core
60.6 
18.5 
12.4 
(1.6)
89.9 
           
Group before RFS Holdings MI
329.9 
56.8 
61.0 
45.6 
493.3 
RFS Holdings MI
3.0 
- 
- 
0.2 
3.2 
           
Group
332.9 
56.8 
61.0 
45.8 
496.5 
APS relief
(53.9)
(8.3)
- 
- 
(62.2)
           
Net RWAs
279.0 
48.5 
61.0 
45.8 
434.3 
           
31 December 2011
          
           
UK Retail
41.1 
- 
- 
7.3 
48.4 
UK Corporate
71.2 
- 
- 
8.1 
79.3 
Wealth
10.9 
- 
0.1 
1.9 
12.9 
International Banking
38.9 
- 
- 
4.3 
43.2 
Ulster Bank
33.6 
0.6 
0.3 
1.8 
36.3 
US Retail & Commercial
53.6 
1.0 
- 
4.7 
59.3 
           
Retail & Commercial
249.3 
1.6 
0.4 
28.1 
279.4 
Markets
16.7 
39.9 
50.6 
13.1 
120.3 
Other
9.8 
0.2 
- 
2.0 
12.0 
           
Core
275.8 
41.7 
51.0 
43.2 
411.7 
Non-Core
65.6 
20.2 
13.0 
(5.5)
93.3 
           
Group before RFS Holdings MI
341.4 
61.9 
64.0 
37.7 
505.0 
RFS Holdings MI
2.9 
- 
- 
0.2 
3.1 
           
Group
344.3 
61.9 
64.0 
37.9 
508.1 
APS relief
(59.6)
(9.5)
- 
- 
(69.1)
           
Net RWAs
284.7 
52.4 
64.0 
37.9 
439.0 
 
Regulatory developments*
The regulatory change agenda remains intense, although we are now seeing a change of emphasis. At a global level, the G20 financial sector reform action plan, first developed in 2008, has mostly been addressed, with focus at that forum now shifting to growth and other issues. The G20 is expected to endorse policy proposals on 'shadow banking' by the end of 2012 but its regulation agenda is increasingly geared towards the implementation of agreed standards. Although policy initiation at the G20 level is drawing to an end, there remains a substantial pipeline of policy development, particularly in the EU and US, and RBS does not anticipate any easing of this for some time.
 
* not within the scope of Deloitte LLP's review opinion
 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Regulatory capital developments (continued)
In the H1 2012, there were new regulatory proposals in Europe for data protection and crisis management as well as initial discussions on a banking union and the launch of the Liikanen Group to look at a structural reform of the industry. Negotiations, which are still incomplete, continued throughout the period on the adoption of the Basel III enhanced capital and liquidity standards in Europe. The European Banking Authority published several draft technical standards in anticipation of final agreement.
 
Basel III capital proposals were also issued in the US, as well as final rules for Basel 2.5. These were drawn up to be consistent with the Dodd-Frank Act and several other proposed and final rules were issued under the auspices of that legislation during the period. Significant activity took place in both Europe and the US to finalise rules requiring central clearing, where possible, and other reforms of over-the-counter (OTC) derivatives, as the end of 2012 deadline set by the G20 approaches. Additionally, work continued on the finalisation of recovery and resolution planning frameworks for Europe and the UK.
 
In the UK, the Financial Services Bill to introduce the 'twin peaks' model of financial regulation was published as the FSA continued to alter its structure in anticipation of its formal split into the Prudential Regulation Authority and the Financial Conduct Authority in 2013. The government also published its White Paper on the implementation of the Vickers Report. The Group is evaluating the impact of these developments.
 
CRD IV impacts*
The Group, in conjunction with the FSA, continues to evaluate its models for the assessment of RWAs ascribed to credit risk across various classes. This together with the changes introduced by CRD IV relating primarily to counterparty risk, is expected to increase RWA requirements by the end of 2013 by £50 billion to £65 billion. These estimates are still subject to change; a degree of uncertainty remains around implementation details as the guidelines are not finalised and must still be enacted into EU law. There could be other future changes and associated impacts from these model reviews. See page 115 of the Group's 2011 Annual Report and Accounts on background on Basel III and related proposals. The Group is also in the process of implementing changes to the RWA requirements for commercial real estate portfolios consistent with revised industry guidance from the FSA. This is projected to increase RWA requirements by circa £20 billion by the end of 2013, of which circa £10 billion will apply in 2012. Certain of the changes referred to above have been implemented, adding circa £15 billion to RWAs as of 30 June 2012.
 
The reported Core Tier 1 ratio following the implementation of the above changes is currently projected(1) to be 10.3% at 31 December 2013, while the fully loaded Basel III Core Tier 1 ratio at that date is estimated at 9.0% - 9.5%.
 
CRD IV legislation implementing Basel III proposals was due to be finalised in early July for implementation by 1 January 2013. However there are a number of areas still under consideration. On 1 August 2012, the FSA issued a statement indicating that it was unlikely that the legislation will be adopted earlier than autumn 2012 and enter into force on the envisaged implementation date of 1 January 2013. No alternative implementation date has yet been communicated by the EU institutions.
 
 
(1)
Projected using consensus earnings and company balance sheet forecasts.
 
* not within the scope of Deloitte LLP's review report
 
Risk and balance sheet management (continued)
 
 
Balance sheet management
 
Liquidity and funding risk
Liquidity risk is the risk that the Group is unable to meet its obligations, including financing maturities as they fall due. Liquidity risk is heavily influenced by the maturity profile and mix of the Group's funding base, as well as the quality and liquidity value of its liquidity portfolio.
 
Overview
The Group continues to improve the structure and composition of its balance sheet through persistently difficult market conditions.
 
 
·
The second quarter saw the final maturity of the Group's government guaranteed debt and robust liquidity management through a series of major market-wide credit rating actions. Short-term wholesale funding continued its downward trend to £62 billion and the liquidity coverage of this funding remains strong at 2.5 times. Short-term wholesale funding at 30 June 2012 was 7% of the funded balance sheet and 34% of wholesale funding, compared with 10% and 45% at 31 December 2011.
   
·
Short-term wholesale funding excluding derivative collateral declined by £40.1 billion in H1 2012 (Q2 2012 - £17.4 billion), reflecting the continued downsizing of the Markets balance sheet.
   
·
The Group's customer deposits, excluding derivative collateral, increased by £1.4 billion in the quarter despite headwinds from a credit rating downgrade reflecting the strength of the Group's Retail & Commercial franchise. Deposits now account for 67% of the Group's primary funding sources.
   
·
The deleveraging process being driven by Non-Core and Markets continued, allowing the Group to further reduce wholesale funding requirements. During the second quarter of 2012 the Group did not access the public markets for senior term debt (secured or unsecured).
   
·
Progress against the goals of the Group's strategic plan has resulted in a balance sheet structure which is broadly matched. At 30 June 2012 the Group's loan:deposit ratio improved to 104% with a Core ratio of 92%.
   
·
The Core funding surplus increased from £27 billion at the end of 2011 to £34 billion at 30 June 2012, spread evenly across the first two quarters.
 


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Funding sources
The table below shows the Group's primary funding sources including deposits in disposal groups and excluding repurchase agreements.
 
 
 
30 June 
2012 
31 March 
2012 
31 December 
2011 
 
£m 
£m 
£m 
       
Deposits by banks
      
 derivative cash collateral
32,001 
29,390 
31,807 
 other deposits
35,619 
36,428 
37,307 
       
 
67,620 
65,818 
69,114 
       
Debt securities in issue
      
 conduit asset-backed commercial paper (ABCP)
4,246 
9,354 
11,164 
 other commercial paper (CP)
1,985 
3,253 
5,310 
 certificates of deposits (CDs)
10,397 
14,575 
16,367 
 medium-term notes (MTNs)
81,229 
90,674 
105,709 
 covered bonds
9,987 
10,107 
9,107 
 securitisations
12,011 
14,980 
14,964 
       
 
119,855 
142,943 
162,621 
Subordinated liabilities
25,596 
25,513 
26,319 
       
Notes issued
145,451 
168,456 
188,940 
       
Wholesale funding
213,071 
234,274 
258,054 
       
Customer deposits
      
 cash collateral
10,269 
8,829 
9,242 
 other deposits
425,031 
423,659 
427,511 
       
Total customer deposits
435,300 
432,488 
436,753 
       
Total funding
648,371 
666,762 
694,807 
       
Disposal group deposits included above
      
 banks
1 
83 
1 
 customers
22,531 
22,281 
22,610 
       
 
22,532 
22,364 
22,611 
 
 
The table below shows the Group's wholesale funding source metrics.
 
 
 
Short-term wholesale
funding (1)
  
Total wholesale
funding
  
Net inter-bank
funding (2)
 
Excluding 
 derivative 
collateral 
Including 
 derivative 
 collateral 
  
Excluding 
 derivative 
collateral 
Including 
 derivative 
 collateral 
  
Deposits 
Loans 
Net 
 interbank 
 funding 
 
£bn 
£bn 
  
£bn 
£bn 
  
£bn 
£bn 
£bn 
                   
30 June 2012
62.3 
94.3 
  
181.1 
213.1 
  
35.6 
(22.3)
13.3 
31 March 2012
79.7 
109.1 
  
204.9 
234.3 
  
36.4 
(19.7)
16.7 
31 December 2011
102.4 
134.2 
  
226.2 
258.1 
  
37.3 
(24.3)
13.0 
30 September 2011
141.6 
174.1 
  
267.0 
299.4 
  
46.2 
(33.0)
13.2 
30 June 2011
148.1 
173.6 
  
286.2 
311.7 
  
46.1 
(33.6)
12.5 
 
Notes:
 
(1)
Short-term balances denote those with a residual maturity of less than one year and includes longer-term issuances.
(2)
Excludes derivative collateral.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk: Funding sources (continued)
 
Notes issued
The table below shows the Group's debt securities in issue and subordinated liabilities by remaining maturity.
 
 
Debt securities in issue
      
 
Conduit 
ABCP 
Other 
CP and 
CDs 
MTNs 
Covered 
bonds 
Securit- 
isations 
Total 
Subordinated 
liabilities 
Total 
notes 
issued 
Total 
notes 
issued 
30 June 2012
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
% 
                   
Less than 1 year
4,246 
12,083 
16,845 
1,020 
69 
34,263 
1,631 
35,894 
25 
1-3 years
- 
293 
24,452 
1,681 
1,263 
27,689 
5,401 
33,090 
23 
3-5 years
- 
1 
16,620 
3,619 
- 
20,240 
2,667 
22,907 
15 
More than 5 years
- 
5 
23,312 
3,667 
10,679 
37,663 
15,897 
53,560 
37 
                   
 
4,246 
12,382 
81,229 
9,987 
12,011 
119,855 
25,596 
145,451 
100 
                   
31 March 2012
                  
                   
Less than 1 year
9,354 
17,532 
19,686 
- 
22 
46,594 
454 
47,048 
28 
1-3 years
- 
290 
30,795 
2,787 
1,231 
35,103 
4,693 
39,796 
24 
3-5 years
- 
1 
16,416 
3,666 
- 
20,083 
4,998 
25,081 
15 
More than 5 years
- 
5 
23,777 
3,654 
13,727 
41,163 
15,368 
56,531 
33 
                   
 
9,354 
17,828 
90,674 
10,107 
14,980 
142,943 
25,513 
168,456 
100 
                   
31 December 2011
                  
                   
Less than 1 year
11,164 
21,396 
36,302 
- 
27 
68,889 
624 
69,513 
37 
1-3 years
- 
278 
26,595 
2,760 
479 
30,112 
3,338 
33,450 
18 
3-5 years
- 
2 
16,627 
3,673 
- 
20,302 
7,232 
27,534 
14 
More than 5 years
- 
1 
26,185 
2,674 
14,458 
43,318 
15,125 
58,443 
31 
                   
 
11,164 
21,677 
105,709 
9,107 
14,964 
162,621 
26,319 
188,940 
100 
 
Key point
 
·
Short-term debt securities in issue declined by £34.6 billion (Q2 2012 - £12.3 billion) primarily due to the final tranches of notes issued under the Credit Guarantee Scheme maturing (£21.3 billion in H1 2012 and £5.7 billion in Q2 2012) and the reduction of commercial paper in issue of £10.2 billion (Q2 2012 - £6.4 billion) in line with the Group's strategy.
 
Deposit and repo funding
The table below shows the composition of the Group's deposits excluding repos and repo funding including disposal groups.
 
 
30 June 2012
  
31 March 2012
  
31 December 2011
 
Deposits 
Repos 
  
Deposits 
Repos 
  
Deposits 
Repos 
 
£m 
£m 
  
£m 
£m 
  
£m 
£m 
                 
Financial institutions
                
 - central and other banks
67,620 
39,125 
  
65,818 
41,415 
  
69,114 
39,691 
 - other financial institutions
65,563 
87,789 
  
61,552 
84,743 
  
66,009 
86,032 
Personal and corporate deposits
369,737 
1,161 
  
370,936 
2,560 
  
370,744 
2,780 
                 
 
502,920 
128,075 
  
498,306 
128,718 
  
505,867 
128,503 
 
Key points
 
·
The central and other bank balances include €10 billion in relation to funding accessed through the European Central Banks long-term refinancing operation facility.
   
·
Of the deposits above, about a third are insured through the UK Financial Services Compensation Scheme, US Federal Deposit Insurance Corporation and similar schemes.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk: Funding sources (continued)
 
Customer loan to deposit ratio and funding gap
The table below shows the Group's divisional customer loan:deposit ratio (LDR) and customer funding gap.
 
 
Loans (1)
Deposits (2)
LDR (3)
Funding 
 surplus/ 
(gap) (3)
30 June 2012
£m 
£m 
% 
£m 
         
UK Retail
110,318 
106,571 
104 
(3,747)
UK Corporate
107,775 
127,446 
85 
19,671 
Wealth
16,888 
38,462 
44 
21,574 
International Banking (4)
43,190 
42,238 
102 
(952)
Ulster Bank
29,701 
20,593 
144 
(9,108)
US Retail & Commercial
51,634 
59,229 
87 
7,595 
Conduits (4)
6,295 
- 
- 
(6,295)
         
Retail & Commercial
365,801 
394,539 
93 
28,738 
Markets
30,191 
34,257 
88 
4,066 
Direct Line Group and other
1,320 
2,999 
44 
1,679 
         
Core
397,312 
431,795 
92 
34,483 
Non-Core
57,398 
3,505 
1,638 
(53,893)
         
Group
454,710 
435,300 
104 
(19,410)
 
 
31 March 2012
        
         
UK Retail
109,852 
104,247 
105 
(5,605)
UK Corporate
107,583 
124,256 
87 
16,673 
Wealth
16,881 
38,278 
44 
21,397 
International Banking (4)
42,713 
45,041 
95 
2,328 
Ulster Bank
30,831 
20,981 
147 
(9,850)
US Retail & Commercial
50,298 
58,735 
86 
8,437 
Conduits (4)
9,544 
- 
- 
(9,544)
         
Retail & Commercial
367,702 
391,538 
94 
23,836 
Markets
28,628 
34,638 
83 
6,010 
Direct Line Group and other
1,468 
2,573 
57 
1,105 
         
Core
397,798 
428,749 
93 
30,951 
Non-Core
61,872 
3,739 
1,655 
(58,133)
         
Group
459,670 
432,488 
106 
(27,182)
 
For the notes to this table refer to the following page.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk: Funding sources (continued)
 
Customer loan to deposit ratio and funding gap(continued)
 
 
Loans (1)
Deposits (2)
LDR (3)
Funding 
 surplus/ 
(gap) (3)
31 December 2011
£m 
£m 
% 
£m 
         
UK Retail
107,983 
101,878 
106 
(6,105)
UK Corporate
108,668 
126,309 
86 
17,641 
Wealth
16,834 
38,164 
44 
21,330 
International Banking (4)
46,417 
45,051 
103 
(1,366)
Ulster Bank
31,303 
21,814 
143 
(9,489)
US Retail & Commercial
50,842 
59,984 
85 
9,142 
Conduits (4)
10,504 
- 
- 
(10,504)
         
Retail & Commercial
372,551 
393,200 
95 
20,649 
Markets
31,254 
36,776 
85 
5,522 
Direct Line Group and other
1,196 
2,496 
48 
1,300 
         
Core
405,001 
432,472 
94 
27,471 
Non-Core
68,516 
4,281 
1,600 
(64,235)
         
Group
473,517 
436,753 
108 
(36,764)
 
Notes:
 
(1)
Loans and advances to customers excluding reverse repurchase agreements and stock borrowing but including disposal groups.
(2)
Excluding repurchase agreements and stock lending but including disposal groups.
(3)
Based on loans and advances to customers net of provisions and customer deposits as shown.
(4)
All conduits relate to International Banking and have been extracted and shown separately.
 
Key point
 
·
The Group's customer loan:deposit ratio improved by 400 basis points in the first half 2012 (Q2 2012 - 200 basis points) despite a credit rating downgrade in June 2012, reflecting the growth of Core Retail & Commercial deposits and the ongoing contraction of Non-Core loans.
 
Long-term debt issuance
The table below shows debt securities issued by the Group in the period with an original maturity of one year or more. The Group also executes other long-term funding arrangements (predominantly term repurchase agreements) which are not reflected in the following tables.
 
 
 
Half year ended
 
30 June 
2012 
31 December 
2011 
30 June 
2011 
 
£m 
£m 
£m 
       
Public
      
  - unsecured
- 
- 
5,085 
  - secured
1,784 
4,944 
4,863 
Private
      
  - unsecured
2,585 
4,166 
8,248 
  - secured
- 
500 
- 
       
Gross issuance
4,369 
9,610 
18,196 
Buy backs
(2,859)
(3,656)
(3,236)
       
Net issuance
1,510 
5,954 
14,960 
 
Key point
 
·
Issuance in 2012 has been modest, demonstrating reduced reliance on capital markets for funding.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Securitisations and asset transfers
 
Secured funding
The Group has access to secured funding markets through own-asset securitisation and covered bond funding programme. This complements existing wholesale funding programmes and access to the repo markets. The Group monitors and manages encumbrance levels related to these secured funding programmes including the potential encumbrance of Group assets that could be used in own-asset securitisations and/or covered bonds that could be used as contingent liquidity.
 
Own-asset securitisations
The Group has a programme of own-asset securitisations where assets are transferred to bankruptcy remote special purpose entities (SPEs) funded by the issue of debt securities. The majority of the risks and rewards of the portfolio are retained by the Group and these SPEs are consolidated with all of the transferred assets retained on the Group's balance sheet. In some own-asset securitisations, the Group may purchase all the issued securities which are available to be pledged as collateral for repurchase agreements with major central banks
 
Covered bond programme
Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of covered bonds by the Group. The Group retains all of the risks and rewards of these loans, the partnerships are consolidated, the loans retained on the Group's balance sheet and the related covered bonds included within debt securities in issue.
 
The following table shows:
 
(i)
the asset categories that have been pledged to secured funding structures, including assets backing publicly issued own-asset securitisations and covered bonds; and
   
(ii)
any currently unencumbered assets that could be substituted into those portfolios or used to collateralise debt securities which may be retained by the Group for contingent liquidity purposes.
 
 
     
Debt securities in issue
Asset type (1)
Assets (1)
£m 
  
Held by third 
parties (2)
£m 
Held by the 
Group (3)
£m 
Total 
£m 
           
30 June 2012
          
Mortgages
          
  - UK (RMBS)
21,492 
  
7,461 
16,797 
24,258 
  - UK (covered bonds)
17,303 
  
9,987 
- 
9,987 
  - Irish
11,953 
  
3,278 
8,204 
11,482 
UK credit cards
3,827 
  
1,265 
282 
1,547 
UK personal loans
4,823 
  
- 
4,406 
4,406 
Other
18,730 
  
7 
20,398 
20,405 
           
 
78,128 
  
21,998 
50,087 
72,085 
Cash deposits (4)
5,210 
        
           
 
83,338 
        
 
For the notes relating to this table refer to the following page.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Securitisations and asset transfers (continued)
 
 
     
Debt securities in issue
31 March 2012
Assets (1)
£m 
  
Held by third 
parties (2)
£m 
Held by the 
Group (3)
£m 
Total 
£m 
           
Mortgages
          
  - UK (RMBS)
48,674 
  
10,303 
45,320 
55,623 
  - UK (covered bonds)
17,773 
  
10,107 
- 
10,107 
  - Irish
12,496 
  
3,419 
8,532 
11,951 
UK credit cards
3,869 
  
1,251 
282 
1,533 
UK personal loans
4,948 
  
- 
4,543 
4,543 
Other
18,505 
  
7 
18,462 
18,469 
           
 
106,265 
  
25,087 
77,139 
102,226 
Cash deposits (4)
11,198 
        
           
 
117,463 
        
 
 
31 December 2011
          
           
Mortgages
          
  - UK (RMBS)
49,549 
  
10,988 
47,324 
58,312 
  - UK (covered bonds)
15,441 
  
9,107 
- 
9,107 
  - Irish
12,660 
  
3,472 
8,670 
12,142 
UK credit cards
4,037 
  
500 
110 
610 
UK personal loans
5,168 
  
- 
4,706 
4,706 
Other
19,778 
  
4 
20,577 
20,581 
           
 
106,633 
  
24,071 
81,387 
105,458 
Cash deposits (4)
11,998 
        
           
 
118,631 
        
 
Notes:
 
(1)
Assets that have been pledged to the SPEs which itself is a subset of the total portfolio of eligible assets within a collateral pool.
(2)
Debt securities that have been sold to third party investors and represents a source of external wholesale funding.
(3)
Debt securities issued pursuant to own-asset securitisations where the debt securities are retained by the Group as a source of contingent liquidity where those securities can be used in repurchase agreements with central banks.
(4)
Cash deposits comprise £4.4 billion (31 March 2012 - £10.4 billion; 31 December 2011 - £11.2 billion) from mortgage repayments and £0.8 billion (31 March 2012 and 31 December 2011 - £0.8 billion) from other loan repayments held in the SPEs, to repay debt securities issued by the own-asset securitisation vehicles.
 
Key point
 
·
The Group unwound a number of own-asset securitisations as part of its strategy on assets used for the Bank of England discount window facility. At 30 June 2012 the Group had £37.1 billion of pre-positioned whole loans in relation to this facility in addition to the balances above.
 


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Securitisations and asset transfers (continued)
 
Securities repurchase agreements
The Group enters into securities repurchase agreements and securities lending transactions (repos) under which it transfers securities in accordance with normal market practice. Generally, the agreements require additional collateral to be provided if the value of the securities falls below a predetermined level. Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction.
 
Securities sold under repurchase transactions are not derecognised if the Group retains substantially all the risks and rewards of ownership. The fair value (which is equivalent to the carrying value) of securities transferred under such repurchase transactions included within securities on the balance sheet is set out below. All of these securities could be sold or repledged by the holder.
 
 
Assets pledged against repos
30 June 
2012 
£m 
31 March 
2012 
£m 
31 December 
2011 
£m 
       
Debt securities
81,871 
80,010 
79,480 
Equity shares
5,069 
3,390 
6,534 
 


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Conduits
The Group sponsors and administers a number of asset-backed commercial paper conduits. The liquidity commitments from the Group to each conduit exceeds the nominal amount of assets funded by a conduit as liquidity commitments are sized to cover the cost of the related assets. Refer to pages 125 to 127 of the Group's 2011 Annual Report and Accounts for more information.
 
The total assets and other aspects relating to the Group's consolidated conduits are set out below.
 
 
 
30 June 2012
  
31 December 2011
 
Core 
£m 
Non-Core 
£m 
Total 
£m 
  
Core 
£m 
Non-Core 
£m 
Total 
£m 
               
Total assets held by the conduits
6,672 
1,575 
8,247 
  
11,208 
1,893 
13,101 
Commercial paper issued (1)
5,361 
96 
5,457 
  
10,590 
859 
11,449 
               
Liquidity and credit enhancements
              
Deal specific liquidity
              
  - drawn
752 
1,493 
2,245 
  
321 
1,051 
1,372 
  - undrawn
9,104 
366 
9,470 
  
15,324 
1,144 
16,468 
PWCE (2)
417 
155 
572 
  
795 
193 
988 
               
 
10,273 
2,014 
12,287 
  
16,440 
2,388 
18,828 
               
Maximum exposure to loss (3)
9,856 
1,859 
11,715 
  
15,646 
2,194 
17,840 
 
Notes:
 
(1)
Includes £1.3 billion of asset backed commercial paper issued to RBS plc (31 December 2011 - £0.3 billion).
(2)
Programme-wide credit enhancement (PWCE) is an additional programme-wide credit support which would absorb the first loss on transactions where liquidity support is provided by a third party.
(3)
Maximum exposure to loss quantifies the Group's exposure to its sponsored conduits. It is determined as the Group's liquidity commitment to its sponsored conduits and additional PWCE which would absorb the first loss on transactions where liquidity support is provided by third parties. Historically, PWCE has been greater than third party liquidity. Therefore the maximum exposure to loss is total deal specific liquidity.
(4)
Liquidity commitments from the Group to the conduit exceed the nominal amount of assets funded by the conduit given that liquidity commitments are sized to cover the accrued funding cost of the related assets.
 
Key points
 
·
During the half year, conduit assets decreased by £4.9 billion reflecting the accelerated run-off of the portfolio in line with Group strategy
   
·
The Group drawn liquidity increased by £0.9 billion to £2.2 billion as the rating downgrade resulted in a number of conduits being unable to issue commercial paper.
 


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Liquidity portfolio
The table below shows the composition of the Group's liquidity portfolio (at estimated liquidity value). All assets within the liquidity portfolio are unencumbered.
 
 
 
30 June 2012
  
31 March 2012
  
31 December 2011
 
Quarterly 
average 
Period 
 end 
  
Quarterly 
average 
Period 
end 
  
Quarterly 
average 
Period 
 end 
 
£m 
£m 
  
£m 
£m 
  
£m 
£m 
                 
Cash and balances at central banks
87,114 
71,890 
  
91,287 
69,489 
  
89,377 
69,932 
Central and local government bonds (1)
                
 AAA rated governments and US agencies
20,163 
26,315 
  
19,085 
29,639 
  
30,421 
29,632 
 AA- to AA+ rated governments (2)
10,739 
14,449 
  
8,924 
14,903 
  
5,056 
14,102 
 governments rated below AA
609 
519 
  
797 
544 
  
1,011 
955 
 local government
2,546 
1,872 
  
3,980 
2,933 
  
4,517 
4,302 
 
34,057 
43,155 
  
32,786 
48,019 
  
41,005 
48,991 
Treasury bills
- 
- 
  
- 
- 
  
444 
- 
                 
 
121,171 
115,045 
  
124,073 
117,508 
  
130,826 
118,923 
                 
Other assets (3)
                
 AAA rated
22,505 
10,712 
  
26,435 
24,243 
  
25,083 
25,202 
 below AAA rated and other high quality assets
13,789 
30,244 
  
9,194 
10,972 
  
11,400 
11,205 
                 
 
36,294 
40,956 
  
35,629 
35,215 
  
36,483 
36,407 
                 
Total liquidity portfolio
157,465 
156,001 
  
159,702 
152,723 
  
167,309 
155,330 
 
Notes:
 
(1)
Includes FSA eligible government bonds of £29.7 billion (31 March 2012 - £30.5 billion; 31 December 2011 - £36.7 billion).
(2)
Includes US government guaranteed and US government sponsored agencies.
(3)
Other assets are a diversified pool of unencumbered assets that would be accepted as collateral by central banks as part of open market operations.
 
Key points
 
·
The liquidity portfolio was maintained at £156 billion representing 17% of the funded balance sheet and covers short-term wholesale funding 2.5 times.
   
·
AAA rated government and US agencies bonds held decreased by £3.3 billion in the first half of 2012, mainly in the second quarter, tracking the reducing short-term wholesale funding balances.


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Net stable funding ratio*
The table below shows the composition of the Group's net stable funding ratio (NSFR), estimated by applying the Basel III guidance issued in December 2010. The Group's NSFR will also continue to be refined over time in line with regulatory developments and related interpretations. It may also be calculated on a basis that may differ from other financial institutions.
 
 
 
30 June 2012
  
31 March 2012
  
31 December 2011
    
   
ASF (1)
    
ASF (1)
    
ASF (1)
  
Weighting 
 
£bn 
£bn 
  
£bn 
£bn 
  
£bn 
£bn 
  
% 
                     
Equity
75 
75 
  
75 
75 
  
76 
76 
  
100 
Wholesale funding  > 1 year
119 
119 
  
125 
125 
  
124 
124 
  
100 
Wholesale funding < 1 year
94 
- 
  
109 
- 
  
134 
- 
  
- 
Derivatives
481 
- 
  
447 
- 
  
524 
- 
  
- 
Repurchase agreements
128 
- 
  
129 
- 
  
129 
- 
  
- 
Deposits
                    
  - Retail and SME - more stable
235 
212 
  
230 
207 
  
227 
204 
  
90 
  - Retail and SME - less stable
29 
23 
  
30 
24 
  
31 
25 
  
80 
  - Other
171 
86 
  
173 
87 
  
179 
89 
  
50 
Other (2)
83 
- 
  
85 
- 
  
83 
- 
  
- 
                     
Total liabilities and equity
1,415 
515 
  
1,403 
518 
  
1,507 
518 
    
                     
Cash
79 
- 
  
82 
- 
  
79 
- 
  
- 
Inter-bank lending
39 
- 
  
36 
- 
  
44 
- 
  
- 
Debt securities > 1 year
                    
  - governments AAA to AA-
70 
4 
  
70 
3 
  
77 
4 
  
5 
  - other eligible bonds
60 
12 
  
64 
13 
  
73 
15 
  
20 
  - other bonds
20 
20 
  
20 
20 
  
14 
14 
  
100 
Debt securities < 1 year
38 
- 
  
42 
- 
  
45 
- 
  
- 
Derivatives
486 
- 
  
453 
- 
  
530 
- 
  
- 
Reverse repurchase agreements
98 
- 
  
91 
- 
  
101 
- 
  
- 
Customer loans and advances > 1 year
                    
  - residential mortgages
146 
95 
  
145 
94 
  
145 
94 
  
65 
  - other
151 
151 
  
167 
167 
  
173 
173 
  
100 
Customer loans and advances < 1 year
                    
  - retail loans
18 
15 
  
19 
16 
  
19 
16 
  
85 
  - other
140 
70 
  
129 
65 
  
137 
69 
  
50 
Other (3)
70 
70 
  
85 
85 
  
70 
70 
  
100 
                     
Total assets
1,415 
437 
  
1,403 
463 
  
1,507 
455 
    
Undrawn commitments
228 
11 
  
237 
12 
  
240 
12 
  
5 
                     
Total assets and undrawn commitments
1,643 
448 
  
1,640 
475 
  
1,747 
467 
    
                     
Net stable funding ratio
  
115% 
    
109% 
    
111% 
    
 
Notes:
 
(1)
Available stable funding.
(2)
Deferred tax, insurance liabilities and other liabilities.
(3)
Prepayments, accrued income, deferred tax, settlement balances and other assets.
 
 
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Liquidity and funding risk (continued)
 
Net stable funding ratio* (continued)
 
Key points*
 
·
The NSFR improved by 400 basis points in H1 2012 (Q2 2012 - 600 basis points) to 115%. Long-term funding decreased by £3 billion all in Q2 2012 with £5 billion (Q2 2012 - £6 billion) in term wholesale funding. This was partly offset by a £3 billion net increase in customer deposits in ASF terms all in Q1 2012 and predominately in more stable deposits (Retail & Commercial increased by £8 billion).
   
·
The funding requirement in relation to lending decreased £19 billion in H1 2012 (Q2 2012 - £27 billion) reflects derisking, sales and repayments in Non-Core and capital management led loan portfolio reductions in International Banking.
 
 
Non-traded interest rate risk
Non-traded interest rate risk impacts earnings arising from the Group's banking activities. This excludes positions in financial instruments or commodities which are deemed to be held-for-trading or hedging items that are held-for-trading.
 
The Group provides a range of financial products to meet a variety of customer requirements. These products differ with regard to repricing frequency, tenor, indexation, prepayments, optionality and other features. When aggregated, they form portfolios of assets and liabilities with varying degrees of sensitivity to changes in market rates.
 
Mismatches in these sensitivities give rise to net interest income volatility as interest rates rise and fall. For example, a bank with a floating rate loan portfolio and largely fixed rate deposits will see its net interest income rise as interest rates rise and fall as rates decline.
 
The Group policy is to manage interest rate sensitivity in banking book portfolios within defined risk limits. Interest rate risk is transferred from the banking divisions to Group Treasury. Aggregate positions are then hedged externally using cash and derivative instruments, primarily interest rate swaps, to manage exposures within Group Asset and Liability Management Committee (GALCO) approved limits.
 
The Group assesses interest rate risk in the banking book (IRRBB) using a set of standards to define, measure and report the risk. These standards incorporate the expected divergence between contractual terms and the actual behaviour of fixed rate loan portfolios due to refinancing incentives and the risks associated with structural hedges of interest rate insensitive balances.
 
Key measures used to evaluate IRRBB are subject to approval by divisional Asset and Liability Management Committees (ALCOs) and GALCO. Limits on IRRBB are proposed by the Group Treasurer for approval by the Executive Risk Forum annually. Residual risk positions are reported on a regular basis to divisional ALCOs and monthly to the Group Balance Sheet Management Committee, GALCO, the Group Board and the Executive Risk Forum.
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Non-traded interest rate risk (continued)
The Group uses a variety of approaches to quantify its interest rate risk encompassing both earnings and value metrics. IRRBB is measured using a version of the same VaR methodology that is used for the Group's trading portfolios. Net interest income exposures are measured in terms of earnings sensitivity over time against movements in interest rates.
 
VaR metrics are based on interest rate repricing gap reports as at the reporting date. These incorporate customer products and associated funding and hedging transactions as well as non-financial assets and liabilities such as property, equipment, capital and reserves. Behavioural assumptions are applied as appropriate.
 
The VaR does not provide a dynamic measurement of interest rate risk since static underlying repricing gap positions are assumed. Changes in customer behaviour under varying interest rate scenarios are captured by way of earnings risk measures.
 
Interest rate risk
 
Value-at-risk
IRRBB VaR for the Group's retail and commercial banking activities at 99% confidence level and currency analysis of period end VaR were as follows:
 
 
 
Average 
Period end 
  
Maximum 
Minimum 
 
£m 
£m 
  
£m 
£m 
           
30 June 2012
56 
55 
  
65 
51 
31 December 2011
63 
51 
  
80 
44 
 
 
 
 
30 June 
2012 
£m 
31 December 
2011 
£m 
     
Euro
21 
26 
Sterling
43 
57 
US dollar
62 
61 
Other
4 
5 
 
Sensitivity of net interest income*
Earnings sensitivity to rate movements is derived from a central forecast over a twelve month period. Market implied forward rates and new business volume, mix and pricing consistent with business assumptions are used to generate a base case earnings forecast. The rates used to calculate this forecast are then shifted up and down by 100 basis points and the earnings recalculated. New business assumptions and the behavioural maturity profile of existing business may vary under the different rate scenarios.
 
 
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Interest rate risk (continued)
The following table shows the sensitivity of net interest income, over the next twelve months, to an immediate upward or downward change of 100 basis points to all interest rates. In addition, the table includes the impact of a gradual 400 basis point steepening and a gradual 300 basis point flattening of the yield curve at tenors greater than a year.
 
 
Euro 
Sterling 
US dollar 
Other 
Total 
30 June 2012
£m 
£m 
£m 
£m 
£m 
           
+ 100 basis points shift in yield curves
14 
214 
90 
26 
344 
- 100 basis points shift in yield curves
20 
(273)
(25)
(36)
(314)
Bear steepener
        
237 
Bull flattener
        
(161)
           
31 December 2011
          
           
+ 100 basis points shift in yield curves
(19)
190 
59 
14 
244 
- 100 basis points shift in yield curves
25 
(188)
(4)
(16)
(183)
Bear steepener
        
443 
Bull flattener
        
(146)
 
Key points*
 
·
The Group remains slightly asset sensitive, largely as a consequence of the current low interest rate environment. An increase in rates would be positive for both deposit margins and the reinvestment of structural hedges. Conversely, falling rates would result in a further deposit margin compression and the reinvestment of structural hedges at lower levels than forecast.
   
·
Steepening and flattening scenarios which impact the long end of the yield curve serve to emphasise the impact of reinvesting structural hedges and the extent of any customer optionality.
 
Structural hedges
Banks generally have the benefit of a significant pool of stable, non and low interest bearing liabilities, principally comprising equity and money transmission accounts. These balances are usually invested in longer-term fixed rate assets, either directly or by the use of interest rate swaps, in order to minimise earnings volatility and to provide a consistent and predictable revenue stream.
 
The Group targets a weighted average life for these economic hedges. This is accomplished using a continuous rolling maturity programme to achieve the desired profile and is primarily managed by Group Treasury.
 
It is estimated that this programme, encompassing both equity and product structural hedges, contributed an additional £750 million to the Group's net interest income over the half year 2012 relative to base rate. The maturity profile of the hedge aims to reduce the potential sensitivity of income to rate movements and residual sensitivity is estimated at £50 to £75 million for a 100 basis point adverse movement in rates over a twelve month horizon.
 
Fixed rate returns on liability structural hedges are expected to decline over the next twelve months as projected market rates continue to trend below historic averages. However, the portfolio maturity profile continues to moderate this impact and the Group expects the net contribution from these hedges to remain broadly stable.
 
* not within the scope of Deloitte LLP's review report


 
Risk and balance sheet management (continued)
 
 
Balance sheet management: Structural foreign currency exposures
The Group does not maintain material non-trading open currency positions, other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding.
 
The table below shows the Group's structural foreign currency exposures.
 
 
30 June 2012
Net 
assets of 
overseas 
operations 
RFS 
MI 
Net 
investments 
in foreign 
operations 
Net 
investment 
hedges 
Structural 
foreign 
currency 
exposures 
pre-economic 
hedges 
Economic 
hedges (1)
Residual 
structural 
foreign 
currency 
exposures 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
               
US dollar
17,518 
1 
17,517 
(2,394)
15,123 
(4,014)
11,109 
Euro
8,975 
(1)
8,976 
(831)
8,145 
(2,159)
5,986 
Other non-sterling
4,751 
268 
4,483 
(3,631)
852 
- 
852 
               
 
31,244 
268 
30,976 
(6,856)
24,120 
(6,173)
17,947 
               
31 December 2011
              
               
US dollar
17,570 
1 
17,569 
(2,049)
15,520 
(4,071)
11,449 
Euro
8,428 
(3)
8,431 
(621)
7,810 
(2,236)
5,574 
Other non-sterling
5,224 
272 
4,952 
(4,100)
852 
- 
852 
               
 
31,222 
270 
30,952 
(6,770)
24,182 
(6,307)
17,875 
 
Note:
 
(1)
The economic hedges represents US and EU preference shares in issue that are treated as equity under IFRS and do not qualify as hedges for accounting purposes.
 
Key points
 
·
The Group's structural foreign currency exposure at 30 June 2012 was £24.1 billion and £17.9 billion before and after economic hedges respectively, broadly unchanged from the end of 2011 position.
   
·
Changes in foreign currency exchange rates will affect equity in proportion to structural foreign currency exposure. A 5% strengthening in foreign currencies against sterling would result in a gain of £1.2 billion (2011 - £1.2 billion) in equity, while a 5% weakening would result in a loss of £1.1 billion (2011 - £1.2 billion) in equity.
 
 

 
 
 

 
 

 
 
Signatures


 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.







 
 
Date: 3 August 2012
 
 
THE ROYAL BANK OF SCOTLAND GROUP plc (Registrant)
 
 
 
By:
/s/ Jan Cargill
 
 
Name:
Title:
Jan Cargill
Deputy Secretary