UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________


FORM 20-F
(Mark One)
 
 
o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
OR
 
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the fiscal year ended December 31, 2011
OR
 
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
OR
 
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

 
Commission file number: 001-10306
 
THE ROYAL BANK OF SCOTLAND GROUP plc
 (Exact name of Registrant as specified in its charter)
 
United Kingdom
(Jurisdiction of incorporation)
 
RBS Gogarburn, PO Box 1000, Edinburgh EH12 1HQ, United Kingdom
(Address of principal executive offices)
 
Aileen Taylor, Group Secretary, Tel: +44 (0) 131 626 4099, Fax: +44 (0) 131 626 3081
 
PO Box 1000, Gogarburn, Edinburgh EH12 1HQ
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
 
Name of each exchange on which registered
American Depositary Shares, each representing 20 ordinary shares, nominal value £0.25 per share
Ordinary shares, nominal value £0.25 per share
American Depositary Shares Series F, H, L, M, N, P, Q, R, S, T and U each representing one Non-Cumulative Dollar Preference Share, Series F, H, L, M, N, P, Q, R, S, T and U respectively
Dollar Perpetual Regulatory tier one securities, Series 1
Senior Floating Rate Notes due 2013
3.400% Senior Notes due 2013
3.250% Senior Notes due 2014
3.950% Senior Notes due 2015
4.875% Senior Notes due 2015
4.375% Senior Notes due 2016
5.625% Senior Notes due 2020
6.125% Senior Notes due 2021
 
New York Stock Exchange
 
New York Stock Exchange*
New York Stock Exchange
 
 
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
______________________________________
* Not for trading, but only in connection with the registration of American Depositary Shares representing such ordinary shares pursuant to the requirements of the Securities and Exchange Commission.
 
 
 

 

 
Securities registered or to be registered pursuant to Section 12(g) of the Act:
 
None
 
_______________
 
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
 
None
 
_______________
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2011, the close of the period covered by the annual report:
 
 
(Title of each class)
 
 
(Number of outstanding shares)
Ordinary shares of 25 pence each
B Shares
Dividend Access Share
11% cumulative preference shares
5½% cumulative preference shares
Non-cumulative dollar preference shares, Series F, H and L to U
Non-cumulative convertible dollar preference shares, Series 1
Non-cumulative euro preference shares, Series 1 to 3
Non-cumulative convertible sterling preference shares, Series 1
Non-cumulative sterling preference shares, Series 1
 
 
59,228,412,207
51,000,000,000
1
500,000
400,000
209,609,154
64,772
2,044,418
14,866
54,442
 

 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
x  Yes      o  No
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
o  Yes      x  No
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
 

 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
x  Yes      o  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
o  Yes      o  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large accelerated filer  x  Accelerated filer  o  Non-Accelerated filer o
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
o    U.S. GAAP
x  International Financial Reporting Standards as issued by the International Accounting Standards Board
o    Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
 
o   Item 17        o   Item 18

 
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
o  Yes        x  No
 
 
 

 
SEC Form 20-F cross reference guide
 
 
Item    Item Caption    Pages
         
PART I        
1   Identity of Directors, Senior Management and Advisers   Not applicable
         
2   Offer Statistics and Expected Timetable   Not applicable
         
3  
Key Information
Selected financial data
Capitalisation and indebtedness
Reasons for the offer and use of proceeds
Risk factors
 
8-9, 350-352, 386-387, 394, 424-425
Not applicable
Not applicable
7, 405-418
         
4   Information on the Company    12-16, 57, 74-165, 323-324, 327-328, 332-333, 386-394
    History and development of the Company
Business overview
Organisational structure
Property, plant and equipment
  4-6, 257-259, 334-335, 430, 451
4-6, 257-259, 370-375, 395-398
4-5
332-333, 398
         
4A   Unresolved Staff Comments   Not applicable
         
5  
Operating and Financial Review and Prospects
Operating results
Liquidity and capital resources
 
 
6, 8-57, 325-326, 395-397
56-57, 68-91, 299-323, 325-328, 332-333,
351-352, 360, 368-369, 393-394
         
    Research and development, patents, licences etc
Trend information
Off balance sheet arrangements
Contractual obligations
  Not applicable
4-7, 405-418
82-85, 359-360
74-81, 353-356
         
6   Directors, Senior Management and Employees
Directors and senior management
Compensation 
Board practices
Employees
Share ownership
  211-214
232-253, 288-296, 376
216-225, 230-231, 247-253, 261
25, 258, 288-290
250-251, 262
         
7  
Major Shareholders and Related Party Transactions
Major shareholders
Related party transactions
Interests of experts and counsel
  261, 398
377-378
Not applicable
         
8   Financial Information
Consolidated statements and other financial information
Significant changes
  257, 264-384, 425
5, 378
 
 
 

 
 
 
Item    Item Caption    Pages
         
9  
The Offer and Listing
Offer and listing details 
Plan of distribution
Markets
Selling shareholders
Dilution
Expenses of the issue
 
423-424
Not applicable
422
Not applicable
Not applicable
Not applicable
         
10  
Additional Information
Share capital
Memorandum and articles of association
Material contracts
Exchange controls
Taxation
Dividends and paying agents
Statement of experts 
Documents on display
Subsidiary information 
  Not applicable
430-438
398-403
429
426-429
Not applicable
Not applicable
439
Not applicable
         
11  
Quantitative and Qualitative Disclosure  
about Market Risk
  58-207, 299-320, 325-326
         
12  
Description of Securities other than
Equity Securities
  404
         
PART II        
         
13   Defaults, Dividend Arrearages and Delinquencies   Not applicable
         
14  
Material Modifications to the Rights of Security
Holders and Use of Proceeds
  Not applicable
         
15   Controls and Procedures   223-225, 265
         
16    [Reserved]    
         
    A Audit Committee financial expert
B Code of ethics 
C Principal Accountant Fees and services
D Exemptions from the Listing Standards for Audit Committees    
E Purchases of Equity Securities by the  
F Change in Registrant’s Certifying Accountant
G Corporate Governance
H Mine Safety Disclosure
 
221-225
259
221-225, 296
Not applicable
Not applicable
Not applicable
216-220
Not applicable
         
PART III        
17   Financial Statements   Not applicable
         
18   Financial Statements    264-384
         
19   Exhibits   452-455
         
    Signature    456
 
 
 
 

 
                                               
 
Form 20-F
 
 
2
Presentation of information
3
Forward-looking statements
4
Description of business
5
Recent developments
6
Competition
7
Risk factors
8
Key financials
9
Summary consolidated income statement
9
Results summary
12
Analysis of results
23
Divisional performance
53
Consolidated balance sheet
56
Cash flow
57
Capital resources
58
Risk and balance sheet management
58
  Introduction
68
  Balance sheet management
68
    - Capital management
74
    - Liquidity and funding risk
89
    - Interest rate risk
91
    - Structural foreign currency exposures
91
    - Equity risk
92
  Risk management
92
    - Credit risk
166
    - Country risk
187
    - Market risk
194
    - Insurance risk
194
    - Operational risk
197
    - Compliance risk
202
    - Reputational risk
202
    - Business risk
203
    - Pension risk
205
  Asset Protection Scheme


 
1

 
 
Presentation of information
 
In this document and unless specified otherwise, the term ‘company’ or ‘RBSG’ means The Royal Bank of Scotland Group plc, ‘RBS’, ‘RBS Group’ or the ‘Group’ means the company and its subsidiaries, ‘the Royal Bank’ means The Royal Bank of Scotland plc and ‘NatWest’ means National Westminster Bank Plc.

The company publishes its financial statements in pounds sterling (‘£’ or ‘sterling’). The abbreviations ‘£m’ and ‘£bn’ represent millions and thousands of millions of pounds sterling, respectively, and references to ‘pence’ represent pence in the United Kingdom (‘UK’). Reference to ‘dollars’ or ‘$’ are to United States of America (‘US’) dollars. The abbreviations ‘$m’ and ‘$bn’ represent millions and thousands of millions of dollars, respectively, and references to ‘cents’ represent cents in the US. The abbreviation ‘€’ represents the ‘euro’, the European single currency, and the abbreviations ‘€m’ and ‘€bn’ represent millions and thousands of millions of euros, respectively.

Certain information in this report is presented separately for domestic and foreign activities. Domestic activities primarily consist of the UK domestic transactions of the Group. Foreign activities comprise the Group's transactions conducted through those offices in the UK specifically organised to service international banking transactions and transactions conducted through offices outside the UK.

The geographic analysis in the Business Review, including the average balance sheet and interest rates, changes in net interest income and average interest rates, yields, spreads and margins in this report have been compiled on the basis of location of office - UK and overseas. Management believes that this presentation provides more useful information on the Group's yields, spreads and margins of the Group's activities than would be provided by presentation on the basis of the domestic and foreign activities analysis used elsewhere in this report as it more closely reflects the basis on which the Group is managed. ‘UK’ in this context includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.

The results, assets and liabilities of individual business units are classified as trading or non-trading based on their predominant activity. Although this method may result in some non-trading activity being classified as trading, and vice versa, the Group believes that any resulting misclassification is not material.

International Financial Reporting Standards
As required by the Companies Act 2006 and Article 4 of the European Union IAS Regulation, the consolidated financial statements of the Group are prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (together ‘IFRS’). They also comply with IFRS as issued by the IASB.

RBS Holdings N.V. (formerly ABN AMRO Holding N.V.)
In 2007, RFS Holdings B.V., which was jointly owned by the Group, the Dutch State (successor to Fortis) and Santander (together, the “Consortium Members”) completed the acquisition of ABN AMRO Holding N.V.
 
On 6 February 2010, the businesses of ABN AMRO Holding N.V. acquired by the Dutch State were legally demerged to a newly established company, ABN AMRO Bank N.V., which on 1 April 2010 was transferred to ABN AMRO Group N.V., itself owned by the Dutch State. Following legal separation, RBS Holdings N.V. (formerly ABN AMRO Holding N.V.) has one operating subsidiary, The Royal Bank of Scotland N.V. (“RBS N.V.”), a fully operational bank within the Group. RBS N.V. is independently rated and regulated by the Dutch Central Bank. Certain assets within RBS N.V. continue to be shared by the Consortium Members.

On 19 April 2011, the Group announced the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank. Subject to, among other matters, regulatory and other approvals and procedures, it is expected that the transfers will be implemented on a phased basis over a period ending 31 December 2013. A large part of the transfers is expected to have taken place by the end of 2012.

On 17 October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of the UK Financial Services and Markets Act 2000.

Approximately 98% of the issued share capital of RFS Holdings B.V. is held by the Group.

Non-GAAP financial information
The directors manage the Group’s performance by class of business, before certain reconciling items, as is presented in the segmental analysis on pages 371 to 375 (the “managed basis”). Discussion of the Group’s performance focuses on the managed basis as the Group believes that such measures allow a more meaningful analysis of the Group’s financial condition and the results of its operations. These measures are non-GAAP financial measures. A body of generally accepted accounting principles such as IFRS is commonly referred to as ‘GAAP’. A non-GAAP financial measure is defined as one that measures historical or future financial performance, financial position or cash flows but which excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. Reconciliations of these non-GAAP measures are presented throughout this document or in the segmental analysis on pages 371 to 375. These non-GAAP financial measures are not a substitute for GAAP measures. Furthermore, RBS has divided its operations into “Core” and “Non- Core”. Certain measures disclosed in this document for Core operations and used by RBS management are non-GAAP financial measures as they represent a combination of all reportable segments with the exception of Non-Core. In addition, RBS has further divided parts of the Core business into “Retail & Commercial” consisting of the UK Retail, UK Corporate, Wealth, Global Transaction Services, Ulster Bank and US Retail & Commercial divisions. This is a non GAAP financial measure. Lastly, the Basel III net stable funding ratio (see page 81) represents a non-GAAP financial measure given it is a metric that is not yet required to be disclosed by a government, governmental authority or self-regulatory organisation.

Glossary
A glossary of terms is provided on pages 440 to 447.
 
 
2

 
 
 
Forward-looking statements
 
Certain sections in this document contain ‘forward-looking statements’ as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words ‘expect’, ‘estimate’, ‘project’, ‘anticipate’, ‘believes’, ‘should’, ‘intend’, ‘plan’, ‘could’, ‘probability’, ‘risk’, ‘Value-at-Risk (VaR)’, ‘target’, ‘goal’, ‘objective’, ‘will’, ‘endeavour’, ‘outlook’, ‘optimistic’, ‘prospects’ and similar expressions or variations on such expressions.

In particular, this document includes forward-looking statements relating, but not limited to: the Group’s restructuring plans, divestments, capitalisation, portfolios, net interest margin, capital ratios, liquidity, risk weighted assets (RWAs), return on equity (ROE), profitability, cost:income ratios, leverage and loan:deposit ratios, funding and risk profile; certain ring-fencing proposals; sustainability targets; the Group’s future financial performance; the level and extent of future impairments and write-downs, including sovereign debt impairments; the protection provided by the Asset Protection Scheme (APS); and the Group’s potential exposures to various types of market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. These statements are based on current plans, estimates and projections, and are subject to inherent risks, uncertainties and other factors which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated.

Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: the global economic and financial market conditions and other geopolitical risks, and their impact on the financial industry in general and on the Group in particular; the ability to access sufficient sources of liquidity and funding; the recommendations made by the Independent Commission on Banking (ICB) and their potential implications; the ability to implement strategic plans on a timely basis, or at all, including the disposal of certain Non-Core assets and assets and businesses required as part of the State Aid restructuring plan; organisational restructuring, including any adverse consequences of a failure to transfer, or delay in transferring, certain business assets and liabilities from RBS N.V. to RBS; the full nationalisation of the Group or other resolution procedures under the Banking Act 2009; deteriorations in borrower and counterparty credit quality; costs or exposures borne by the Group arising out of the origination or sale of mortgages or mortgage-backed securities in the United States; the extent of future write-downs and impairment charges caused by depressed asset valuations; the value and effectiveness of any credit protection purchased by the Group; unanticipated turbulence in interest rates, yield curves, foreign currency exchange rates, credit spreads, bond prices, commodity prices, equity prices and basis, volatility and correlation risks; changes in the credit ratings of the Group; ineffective management of capital or changes to capital adequacy or liquidity requirements; litigation and regulatory investigations; changes to the valuation of financial instruments recorded at fair value; competition and consolidation in the banking sector; the ability of the Group to attract or retain senior management or other key employees; regulatory or legal changes (including those requiring any restructuring of the Group’s operations) in the United Kingdom, the United States and other countries in which the Group operates or a change in United Kingdom Government policy; changes to regulatory requirements relating to capital and liquidity; changes to the monetary and interest rate policies of central banks and other governmental and regulatory bodies; changes in UK and foreign laws, regulations, accounting standards and taxes, including changes in regulatory capital regulations and liquidity requirements; impairments of goodwill; pension fund shortfalls; general operational risks; HM Treasury exercising influence over the operations of the Group; insurance claims; reputational risk; the ability to access the contingent capital arrangements with HM Treasury; the participation of the Group in the APS and the effect of the APS on the Group’s financial and capital position; the conversion of the B Shares in accordance with their terms; limitations on, or additional requirements imposed on, the Group’s activities as a result of HM Treasury’s investment in the Group; and the success of the Group in managing the risks involved in the foregoing.

The forward-looking statements contained in this document speak only as of the date of this announcement, and the Group does not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

The information, statements and opinions contained in this document do not constitute a public offer under any applicable legislation or an offer to sell or solicitation of any offer to buy any securities or financial instruments or any advice or recommendation with respect to such securities or other financial instruments.

 
3

 
 

 
Description of business
Introduction
The Royal Bank of Scotland Group plc is the holding company of a large global banking and financial services group. Headquartered in Edinburgh, the Group operates in the United Kingdom, the United States and internationally through its principal subsidiaries, the Royal Bank and NatWest. Both the Royal Bank and NatWest are major UK clearing banks. In the United States, the Group's subsidiary Citizens is a large commercial banking organisation. Globally, the Group has a diversified customer base and provides a wide range of products and services to personal, commercial and large corporate and institutional customers.

Following the placing and open offers in December 2008 and in April 2009, HM Treasury owned approximately 70.3% of the enlarged ordinary share capital of the company. In December 2009, the company issued a further £25.5 billion of new capital to HM Treasury. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as Core Tier 1 capital. Following the issuance of the B shares, HM Treasury's holding of ordinary shares of the company remained at 70.3% although its economic interest rose to 84.4%.

At 31 December 2011, HM Treasury’s holding in the company’s ordinary shares was 66.9% and its economic interest was 82.2%.

The Group had total assets of £1,506.9 billion and owners' equity of
£74.8 billion at 31 December 2011. The Group's risk asset ratios at 31 December 2011, were a Total capital ratio of 13.8%, a Core Tier 1 capital ratio of 10.6% and a Tier 1 capital ratio of 13.0%.

Organisational structure and business overview
The Group’s activities are organised on a divisional basis as follows:
 
UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through a number of channels including: the RBS and NatWest network of branches and ATMs in the United Kingdom, telephony, online and mobile. UK Retail remains committed to delivering ‘Helpful and Sustainable’ banking and to the commitments set out in its Customer Charter - the results of which are externally assessed and published every six months.

UK Corporate is a leading provider of banking, finance and risk management services to the corporate and SME sector in the United Kingdom. It offers a full range of banking products and related financial services through a nationwide network of relationship managers, and also through telephone and internet channels. The product range includes asset finance through the Lombard brand.

Wealth provides private banking and investment services in the UK through Coutts & Co and Adam & Company, offshore banking through RBS International, NatWest Offshore and Isle of Man Bank, and international private banking through Coutts & Co Ltd.

Global Transaction Services (GTS) ranks among the top tier of global transaction banks, offering payments, cash and liquidity management, trade finance and commercial card products and services. Through the network and extensive partner bank agreements, GTS is able to support and connect customers across 128 countries.

Ulster Bank is the leading retail and business bank in Northern Ireland and the third largest banking group on the island of Ireland. It provides a comprehensive range of financial services. The Retail Markets division which has a network of 236 branches, operates in the personal and financial planning sectors. The Corporate Markets division provides services to SME business customers, corporates and institutional markets.

US Retail & Commercial provides financial services primarily through the Citizens and Charter One brands. US Retail & Commercial is engaged in retail and corporate banking activities through its branch network in 12 states in the United States and through non-branch offices in other states.

The divisions discussed above are collectively referred to as Retail & Commercial.

Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is organised along six principal business lines: money markets; rates flow trading; currencies; equities; credit and mortgage markets; and portfolio management & origination.

RBS Insurance provides a wide range of general insurance products to consumers through a number of well known brands including; Direct Line, Churchill and Privilege. It also provides insurance services for third party brands, through its UKI Partnerships business. In the commercial sector, its NIG and Direct Line for Business operations provide insurance products for businesses via brokers or direct respectively. Through its international division, RBS Insurance sells general insurance, mainly motor, in Germany and Italy. In addition to insurance services, RBS Insurance continues to provide support and reassurance to millions of UK motorists through its Green Flag breakdown recovery service and Tracker stolen vehicle recovery and telematics business. On 15 February 2012, a new corporate brand, Direct Line Group, was announced.

To comply with EC State Aid requirements, the Group has agreed to dispose of RBS Insurance.  It continues to be reported as a separate operating segment rather than within the Non-Core division as its business is distinct from the activities of the Non-Core division.

Central Functions comprises Group and corporate functions, such as treasury, funding and finance, risk management, legal, communications and human resources. The Centre manages the Group's capital resources and Group-wide regulatory projects and provides services to the operating divisions.

 
4

 
 
Business review continued
 
Non-Core division manages separately assets that the Group intends to run off or dispose of. The division contains a range of businesses and asset portfolios primarily from the GBM division, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses including regional markets businesses that the Group has concluded are no longer strategic.

Business Services supports the customer-facing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services. Business Services drives efficiencies and supports income growth across multiple brands and channels by using a single, scalable platform and common processes wherever possible. It also leverages the Group's purchasing power and is the Group's centre of excellence for managing large-scale and complex change. For reporting purposes, Business Services costs are allocated to the divisions above. It is not deemed a reportable segment.

Organisational change
In January 2012, the Group announced changes to its wholesale banking operations in light of a changed market and regulatory environment.  The changes will see the reorganisation of the Group’s wholesale businesses into ‘Markets’ and ‘International Banking’ and the exit and downsizing of selected activities.  The changes will ensure the wholesale businesses continue to deliver against the Group’s strategy.

The changes will include an exit from cash equities, corporate brokering, equity capital markets and mergers and acquisitions businesses.  Significant reductions in balance sheet, funding requirements and cost base in the remaining wholesale businesses will be implemented.

Existing GBM and GTS divisions will be reorganised as follows:

·
The ‘Markets’ business will maintain its focus on fixed income, with strong positions in debt capital raising, securitisation, risk management, foreign exchange and rates. It will serve the corporate and institutional clients of all Group businesses.
 
 
·
GBM's corporate banking business will combine with the international businesses of our GTS arm into a new ‘International Banking’ unit and provide clients with a 'one-stop shop' access to the Group’s debt financing, risk management and payments services. This international corporate business will be self-funded through its stable corporate deposit base.

·
The domestic small and mid-size corporates currently served within GTS will be managed within RBS's domestic corporate banking businesses in the UK, Ireland (Ulster Bank) and the US (US Retail & Commercial).

Our wholesale business will be retaining its international footprint to ensure that it can serve our customers' needs globally. We believe, that despite current challenges to the sector, wholesale banking services can play a central role in supporting cross border trade and capital flows, financing requirements and risk management and we remain committed to this business.

Going forward the Group will comprise the following segments:

·
Retail and Commercial
 
  - UK Retail
 
  - UK Corporate
 
  - Wealth
 
  - US Retail & Commercial
 
  - Ulster Bank
 
  - International Banking
·
Markets
·
RBS Insurance
·
Group Centre
·
Core
·
Non-Core

Business divestments
To comply with EC State Aid requirements the Group agreed a series of restructuring measures to be implemented over a four year period from December 2009. This supplements the measures in the Strategic Plan previously announced by the Group. These include divesting RBS Insurance, 80.01% of GMS (completed in 2010) and substantially all of RBS Sempra Commodities JV business (largely completed in 2010), as well as divesting the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.

Recent developments
Liability management: Exchange offer
On 28 February 2012, The Royal Bank of Scotland plc announced an invitation to offer to exchange certain Canadian Dollar, Australian Dollar, US Dollar, Euro and Swiss Franc denominated subordinated notes for new Canadian Dollar, Australian Dollar, US Dollar, Euro and Swiss Franc denominated subordinated notes, due 2022 and callable 2017. The new notes, other than the Australian Dollar denominated new notes, were issued on 16 March 2012, and the Australian Dollar denominated new notes were issued on 19 March 2012, in each case under the £90,000,000,000 Euro Medium Term Note Programme of The Royal Bank of Scotland plc and The Royal Bank of Scotland Group plc.

National Loan Guarantee Scheme
On 20 March 2012, RBS agreed to participate in the National Loan Guarantee Scheme (the Scheme), pursuant to which The Commissioners of Her Majesty’s Treasury (HM Treasury) have agreed to unconditionally and irrevocably guarantee the due payment of all sums due and payable by RBS under any senior unsecured notes issued by RBS in accordance with the terms of the Scheme in respect of which HM Treasury issues a Guarantee Certificate (as defined in a deed of guarantee dated 20 March 2012 (the “Deed of Guarantee”)). The Guarantor’s obligations in that respect, are contained in the Deed of Guarantee, the form of which is available at www.dmo.gov.uk.
 
2012 Budget
In the Budget statement on 21 March 2012, the Chancellor of the Exchequer announced a further reduction of 1% in the rate of corporation tax such that the rate will fall by 2% from 26% to 24% in April 2012, to 23% in April 2013 and to 22% in April 2014.
 
It was also announced in the Budget statement that the full rate of the bank levy will increase to 0.105 per cent. from 1 January 2013.

 
5

 
 
Business review continued

Competition
The Group faces strong competition in all the markets it serves. Banks’ balance sheets have strengthened whilst loan demand has been subdued as many customers have sought to delever and the UK economy has remained weak. Competition for retail deposits remains intense as institutions continue to target strong and diverse funding platforms for their balance sheets.

Competition for corporate and institutional customers in the UK is from UK banks and from large foreign financial institutions who are also active and offer combined investment and commercial banking capabilities. In asset finance, the Group competes with banks and specialist asset finance providers, both captive and non-captive. In European and Asian corporate and institutional banking markets the Group competes with the large domestic banks active in these markets and with the major international banks.

In the small business banking market, the Group competes with other UK clearing banks, specialist finance providers and building societies.

In the personal banking segment, the Group competes with UK clearing banks and building societies, major retailers and life assurance companies. In the mortgage market, the Group competes with UK clearing banks and building societies. The ambitions of non-traditional players in the UK market remain strong, with new entrants active and potentially seeking to build their platforms by acquiring businesses made available through restructuring of incumbents. The Group distributes life assurance products to banking customers in competition with independent advisors and life assurance companies.

In the UK credit card market large retailers and specialist card issuers are active in addition to the UK banks. In addition to physical distribution channels, providers compete through direct marketing activity and the internet.

In Wealth Management, The Royal Bank of Scotland International competes with other UK and international banks to offer offshore banking services. Coutts and Adam & Company compete as private banks with UK clearing and private banks, and with international private banks. Competition in wealth management remains strong as banks maintain their focus on competing for affluent and high net worth customers.

RBS Insurance competes in personal lines insurance and, to a more limited extent, in commercial insurance. There is strong competition from a range of insurance companies which now operate telephone and internet direct sales businesses. Competition in the UK motor market remains intense, and price comparison internet sites now play a major role in the marketplace. These sites are now extending their scope to home insurance and other lines. RBS Insurance also competes with local insurance companies in the direct motor insurance markets in Italy and Germany.

In Ireland, Ulster Bank competes in retail and commercial banking with the major Irish banks and building societies, and with other UK and international banks and building societies active in the market. The challenging conditions in the Irish economy persist and many of the domestic Irish banks have required State support and are engaged in significant restructuring actions.

In the United States, Citizens competes in the New England, Mid-Atlantic and Mid-West retail and mid-corporate banking markets with local and regional banks and other financial institutions. The Group also competes in the US in large corporate lending and specialised finance markets, and in fixed-income trading and sales. Competition is principally with the large US commercial and investment banks and international banks active in the US. The economic recovery in the US is proving weaker than expected and loan demand is weak in Citizens’ markets.

 
6

 
Business review continued
 
 
Risk factors

Set out below is a summary of certain risks which could adversely affect the Group; it should be read in conjunction with the Risk and balance sheet management section of the Business review (pages 58 to 207). This summary should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. A fuller description of these and other risk factors is included on pages 405 to 418.

·
The Group’s businesses, earnings and financial condition have been and will continue to be affected by geopolitical conditions, the global economy, the instability in the global financial markets and increased competition. Together with a perceived increased risk of default on the sovereign debt of certain European countries and unprecedented stresses on the financial system within the eurozone, these factors have resulted in significant changes in market conditions including interest rates, foreign exchange rates, credit spreads, and other market factors and consequent changes in asset valuations.

·
The Group’s ability to meet its obligations’ including its funding commitments, depends on the Group’s ability to access sources of liquidity and funding. The inability to access liquidity and funding due to market conditions or otherwise could adversely affect the Group’s financial condition. Furthermore, the Group’s borrowing costs and its access to the debt capital markets and other sources of liquidity depend significantly on its and the UK Government’s credit ratings.

·
The Independent Commission on Banking has published its final report on competition and possible structural reforms in the UK banking industry. The Government has indicated that it supports and intends to implement the recommendations substantially as proposed which could have a material adverse effect on the Group.

·
The Group’s ability to implement its Strategic Plan depends on the success of its efforts to refocus on its core strengths and its balance sheet reduction programme. As part of the Group’s Strategic Plan and implementation of the State Aid restructuring plan agreed with the European Commission and HM Treasury, the Group is undertaking an extensive restructuring which may adversely affect the Group’s business, results of operations and financial condition and give rise to increased operational risk and may impair the Group’s ability to raise new Tier 1 capital due to restrictions on its ability to make discretionary dividend or coupon payments on certain securities.

·
The occurrence of a delay in the implementation of (or any failure to implement) the approved proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank may have a material adverse effect on the Group.

·
The Group or any of its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures and various actions could be taken by or on behalf of the UK Government, including actions in relation to any securities issued, new or existing contractual arrangements and transfers of part or all of the Group’s businesses.

·
The actual or perceived failure or worsening credit of the Group’s counterparties or borrowers and depressed asset valuations resulting from poor market conditions have adversely affected and could continue to adversely affect the Group.

·
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate.

·
The Group’s insurance businesses are subject to inherent risks involving claims on insured events.

·
The Group’s business performance, financial condition and capital and liquidity ratios could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements, including those arising out of Basel III implementation (globally or by European or UK authorities), or if the Group is unable to issue Contingent B Shares to HM Treasury under certain circumstances.

·
The Group could fail to attract or retain senior management, which may include members of the Group Board, or other key employees, and it may suffer if it does not maintain good employee relations.

·
Any significant developments in regulatory or tax legislation could have an effect on how the Group conducts its business and on its results of operations and financial condition, and the recoverability of certain deferred tax assets recognised by the Group is subject to uncertainty.

·
The Group is subject to substantial regulation and oversight, and any significant regulatory or legal developments could have an adverse effect on how the Group conducts its business and on its results of operations and financial condition.  In addition, the Group is, and may be, subject to litigation and regulatory investigations that may impact its business, results of operations and financial condition.

·
Operational and reputational risks are inherent in the Group’s operations.

·
The Group may be required to make contributions to its pension schemes and government compensation schemes, either of which may have an adverse impact on the Group’s results of operations, cash flow and financial condition.

·
As a result of the UK Government’s majority shareholding in the Group it can, and in the future may decide to, exercise a significant degree of influence over the Group including on dividend policy, modifying or cancelling contracts or limiting the Group’s operations. The offer or sale by the UK Government of all or a portion of its shareholding in the company could affect the market price of the equity shares and other securities and acquisitions of ordinary shares by the UK Government (including through conversions of other securities or further purchases of shares) may result in the delisting of the Group from the Official List.

 
7

 
 
Business review continued

 
Key financials
for the year ended 31 December
2011 
£m 
2010 
£m 
2009 
£m 
Total income
28,937 
31,868 
33,026 
Operating loss before tax
(766)
(399)
(2,647)
Loss attributable to ordinary and B shareholders
(1,997)
(1,125)
(3,607)
Cost:income ratio
62% 
57% 
52% 
Basic loss per ordinary and B share from continuing operations (pence)
(1.8p)
(0.5p)
(6.3p)


at 31 December
2011 
£m 
2010 
£m 
2009 
£m 
Funded balance sheet (1)
977,249 
1,026,499 
1,255,032 
Total assets
1,506,867 
1,453,576 
1,696,486 
Loans and advances to customers
515,606 
555,260 
728,393 
Deposits
611,759 
609,483 
756,346 
Owners' equity
74,819 
75,132 
77,736 
Risk asset ratios
- Core Tier 1
10.6% 
10.7% 
11.0% 
 
- Tier 1
13.0% 
12.9% 
14.1% 
 
- Total
13.8% 
14.0% 
16.1% 
Note:
 (1)
Funded balance sheet represents total assets less derivatives.


Overview of results
The results of RFS Holdings B.V., the entity that acquired ABN AMRO, are fully consolidated in the Group’s financial statements. The interests of the State of the Netherlands and Santander in RFS Holdings are included in non-controlling interests. Legal separation of ABN AMRO Bank N.V. took place on 1 April 2010. As a result, RBS presents the interests of the Consortium Members in ABN AMRO as discontinued operations.
 
 
8

 
 
 
Summary consolidated income statement
for the year ended 31 December 2011
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
12,679 
14,209 
13,388 
Fees and commissions receivable
6,384 
8,193 
8,738 
Fees and commissions payable
(1,460)
(2,211)
(2,790)
Other non-interest income
7,078 
6,549 
8,424 
Insurance net premium income
4,256 
5,128 
5,266 
Non-interest income
16,258 
17,659 
19,638 
Total income
28,937 
31,868 
33,026 
Operating expenses
(18,026)
(18,228)
(17,417)
Profit before insurance net claims and impairment losses
10,911 
13,640 
15,609 
Insurance net claims
(2,968)
(4,783)
(4,357)
Impairment losses
(8,709)
(9,256)
(13,899)
Operating loss before tax
(766)
(399)
(2,647)
Tax (charge)/credit
(1,250)
(634)
429 
Loss from continuing operations
(2,016)
(1,033)
(2,218)
Profit/(loss) from discontinued operations, net of tax
47 
(633)
(105)
Loss for the year
(1,969)
(1,666)
(2,323)
Non-controlling interests
(28)
665 
(349)
Other owners’ dividends
— 
(124)
(935)
Loss attributable to ordinary and B shareholders
(1,997)
(1,125)
(3,607)
       
Basic loss per ordinary and B share from continuing operations
(1.8p)
(0.5p)
(6.3p)
       

Results summary
2011 compared with 2010
Operating profit
Group operating loss before tax for the year was £766 million compared with £399 million in 2010.  Group operating profit on a managed basis was £1,892 million compared with £1,913 million in 2010.  Adjusting for the impact of the disposal of GMS in 2010, which recorded an operating profit of £207 million, Group operating profit on a managed basis was up 11%. The improvement was driven by a strong Retail & Commercial (R&C) operating performance and the return to profit of RBS Insurance. Ulster Bank and GBM faced more difficult conditions, leaving total Core operating profit on a managed basis at £6,095 million. Non-Core operating loss in 2011 was 24% lower compared with 2010, despite the acceleration of disposals in the second half of the year.

Total income
Total income fell by 9% to £28,937 million, primarily reflecting lower net interest income, lower trading income in GBM and Non-Core and a fall in insurance net premium income.

Net interest income
Group net interest income fell 11% to £12,679 million largely driven by the run-off of balances and exit of higher margin and higher risk segments in Non-Core. Group NIM was 14 basis points lower, reflecting the cost of carrying a higher liquidity portfolio and by the impact of non-performing assets in the Non-Core division. However, R&C NIM was up 7 basis points, with strengthening asset margins in the first half of the year offsetting the impact of a competitive deposit market.

Non-interest income
Non-interest income decreased to £16,258 million from £17,659 million in 2010. This included movements in the fair value of the Asset Protection Scheme resulting in a £906 million charge (2010 - £1,550 million), gain on redemption of own debt of £255 million (2010 - £553 million) and a gain on movements in the fair value of own debt of £1,846 million (2010 - £174 million gain). Excluding these items, non-interest income was down 19% primarily reflecting a reduction in income from trading activities and lower net fees and commissions.

 
9

 
 
Business review continued


Operating expenses
Operating expenses decreased to £18,026 million (2010 - £18,228 million). Operating expenses on a managed basis fell to £15,478 million from £16,710 million in 2010.

This decrease was primarily driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits. Staff costs fell 9%, driven by lower GBM variable compensation as a result of its decrease in revenues, and in Non-Core, given the impact of a 32% reduction in headcount and continued business disposals and country exits.

The Group cost:income ratio was 62% in 2011 compared with 57% in 2010.

Net insurance claims
Bancassurance and general insurance claims, after reinsurance, reduced by 38% to £2,968 million.

General insurance claims were £1,730 million lower, mainly due to the non-repeat of bodily injury reserve strengthening in 2010, de-risking of the motor book, more benign weather in 2011 and claims in Non-Core decreasing as legacy policies ran-off.
 
Impairment losses
Impairment losses were £8,709 million compared with £9,256 million in 2010, with Core loan impairments falling by £260 million and Non-Core by £1,557 million, despite continuing challenges in Ulster Bank and corporate real estate portfolios, partially offset by an impairment of £1,099 million and interest rate hedge adjustments on impaired available-for-sale Greek government bonds of £169 million.

Risk elements in lending represented 8.6% of gross loans and advances to customers excluding reverse repos at 31 December 2011
(2010 - 7.3%).

Provision coverage of risk elements in lending was 49% (2010 - 47%).

Tax
The tax charge was £1,250 million in 2011, compared with £634 million in 2010. The high tax charge in the year reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.

Earnings
Basic loss per ordinary and B share from continuing operations increased from a loss of 0.5p to a loss of 1.8p.

 
10

 
 
Business review continued
 
Results summary continued
2010 compared with 2009

Operating loss
Operating loss before tax for the year was £399 million compared with a loss of £2,647 million in 2009. The improvement in performance is primarily driven by stronger Core Retail & Commercial operating profits offsetting more normal results from Global Banking & Markets, coupled with lower impairments in the Non-Core division.

After tax, non-controlling interests and preference share and other dividends, the loss attributable to ordinary and B shareholders was £1,125 million, compared with an attributable loss of £3,607 million in 2009.

Total income
Total income decreased 4% to £31,868 million in 2010 reflecting the return to more normal levels in Global Banking & Markets compared with the favourable market conditions seen in 2009.  This was offset by good growth in Core Retail & Commercial and the improvement in Non-Core.

Net interest income
Net interest income increased by 6% to £14,209 million, reflecting improvements in net interest margin which more than offset lower interest-earning assets and interest-bearing liabilities. Group net interest margin increased from 1.83% to 2.06% largely reflecting expanding asset margins in UK Retail and UK Corporate divisions as well as in US Retail & Commercial. The run-off of low-yielding Non-Core assets also contributed to this increase. The Group net interest margin was also affected by increased funding costs.

Non-interest income
Non-interest income decreased to £17,659 million from £19,638 million in 2009. This included movements in the fair value of the Asset Protection Scheme - credit default swap resulting in a £1,550 million charge and gain on redemption of own debt of £553 million (2009 - £3,790 million). Excluding these items, non-interest income was up 18% primarily reflecting an increase in income from trading activities.
 
Operating expenses
Operating expenses increased to £18,228 million (2009 - £17,417 million). The main driver of this 5% increase was the impact of a £2,148 million gains on pension curtailment in 2009. This was partially offset by gains on the recognition of benefits from the Group-wide efficiency programme. The programme continues to deliver material savings which have been funding investments to strengthen our Core franchises. Annualised savings are now just ahead of the £2.5 billion target for 2011 and are forecast to exceed £3 billion by 2013. Integration and restructuring costs were £1,032 million compared with £1,286 million in 2009. Write-down of goodwill and other intangible assets was £10 million compared with £363 million in 2009. Premises and equipment costs fell by 7% in the year largely driven by efficiency cost savings, significant
one-off property impairments recognised in 2009 and country exits following Non-Core disposals.

Net insurance claims
Bancassurance and general insurance claims, after reinsurance, increased by 10% to £4,783 million.

Impairment losses
Impairment losses were £9,256 million compared with £13,899 million in 2009, with Core impairments falling by £898 million and Non-Core by £3,745 million. The decrease reflects an overall improvement in the economic environment. Impairments fell in all businesses, except Ulster Bank, which has faced an economic environment that remains challenging.

Risk elements in lending and potential problem loans represented 7.4% of gross loans and advances to customers excluding reverse repos at 31 December 2010 (2009 - 5.5%).

Provision coverage of risk elements in lending and potential problem loans was 46% (2009 - 45%).

Tax
The Group recorded a tax charge of £634 million in 2010, compared with a tax credit of £429 million in 2009.

Earnings
Basic loss per ordinary and B share from continuing operations improved from a loss of 6.3p to a loss of 0.5p.
 
11

 
 
Business review continued
 
 
Analysis of results
Net interest income
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Interest receivable
21,410 
22,776 
33,836 
Interest payable
(8,731)
(8,567)
(17,332)
Net interest income
12,679 
14,209 
16,504 
       
 
   
Gross yield on interest-earning assets of the banking business (1)
3.24 
3.30 
3.76 
Cost of interest-bearing liabilities of the banking business
(1.68)
(1.47)
(2.18)
Interest spread of the banking business (2)
1.56 
1.83 
1.58 
Benefit from interest-free funds
0.36 
0.23 
0.25 
Net interest margin of the banking business (3)
1.92 
2.06 
1.83 
       
Yields, spreads and margins of the banking business
% 
% 
Gross yield (1)
     
  - Group
3.24 
3.30 
3.76 
  - UK
3.56 
3.42 
3.35 
  - Overseas
2.77 
3.15 
4.09 
Interest spread (2)
     
  - Group
1.56 
1.83 
1.58 
  - UK
1.81 
2.01 
1.50 
  - Overseas
1.22 
1.59 
1.67 
Net interest margin (3)
     
  - Group
1.92 
2.06 
1.83 
  - UK
2.07 
2.22 
1.81 
  - Overseas
1.70 
1.84 
1.85 
       
The Royal Bank of Scotland plc base rate (average)
0.50 
0.50 
0.64 
London inter-bank three month offered rates (average)
     
  - Sterling
0.87 
0.70 
1.21 
  - Eurodollar
0.33 
0.34 
0.69 
  - Euro
1.36 
0.75 
1.21 

Notes:
(1)
Gross yield is the interest earned on average interest-earning assets of the banking book.
(2)
Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business.
(3)
Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business.
(4)
The analysis into UK and overseas has been compiled on the basis of location of office.
(5)
Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities.
 
 
12

 
Business review continued
 
 
 
Average balance sheet and related interest

   
2011
 
2010
   
Average 
 Balance 
Interest  
Rate 
 
Average 
 balance 
Interest 
Rate 
   
£m 
£m 
% 
 
£m 
£m 
% 
Assets
               
Loans and advances to banks
- UK
31,994 
293 
0.92 
 
22,714 
222 
0.98 
 
- Overseas
41,840 
404 
0.97 
 
30,148 
369 
1.22 
Loans and advances to customers
- UK
294,301 
12,105 
4.11 
 
310,712 
11,989 
3.86 
 
- Overseas
171,979 
5,864 
3.41 
 
195,858 
6,900 
3.52 
Debt securities
- UK
62,231 
1,449 
2.33 
 
66,765 
1,459 
2.19 
 
- Overseas
58,773 
1,295 
2.20 
 
63,334 
1,837 
2.90 
Interest-earning assets
- UK
388,526 
13,847 
3.56 
 
400,191 
13,670 
3.42 
 
- Overseas
272,592 
7,563 
2.77 
 
289,340 
9,106 
3.15 
Total interest-earning assets
- banking business
661,118 
21,410 
3.24 
 
689,531 
22,776 
3.30 
 
- trading business
278,975 
     
276,330 
   
Interest-earning assets
 
940,093 
     
965,861 
   
Non-interest-earning assets (5)
 
595,062 
     
706,343 
   
Total assets
 
1,535,155 
     
1,672,204 
   
                 
Percentage of assets applicable to overseas operations
40.2% 
     
44.0% 
   
                 
Liabilities
               
Deposits by banks
- UK
17,224 
242 
1.41 
 
21,816 
334 
1.53 
 
- Overseas
47,371 
740 
1.56 
 
59,799 
999 
1.67 
Customer accounts: demand deposits
- UK
112,522 
664 
0.59 
 
120,796 
621 
0.51 
 
- Overseas
43,177 
483 
1.12 
 
39,127 
607 
1.55 
Customer accounts: savings deposits
- UK
76,719 
1,177 
1.53 
 
68,142 
935 
1.37 
 
- Overseas
25,257 
130 
0.51 
 
25,587 
213 
0.83 
Customer accounts: other time deposits
- UK
39,672 
481 
1.21 
 
39,934 
431 
1.08 
 
- Overseas
33,971 
594 
1.75 
 
43,996 
914 
2.08 
Debt securities in issue
- UK
108,406 
2,606 
2.40 
 
111,277 
2,212 
1.99 
 
- Overseas
42,769 
765 
1.79 
 
72,175 
1,065 
1.48 
Subordinated liabilities
- UK
16,874 
470 
2.79 
 
19,442 
398 
2.05 
 
- Overseas
5,677 
270 
4.76 
 
8,714 
19 
0.22 
Internal funding of trading business
- UK
(40,242)
149 
(0.37)
 
(41,451)
(140)
0.34 
 
- Overseas
(8,783)
(40)
0.46 
 
(6,864)
(41)
0.60 
Interest-bearing liabilities
- UK
331,175 
5,789 
1.75 
 
339,956 
4,791 
1.41 
 
- Overseas
189,439 
2,942 
1.55 
 
242,534 
3,776 
1.56 
Total interest-bearing liabilities
- banking business
520,614 
8,731 
1.68 
 
582,490 
8,567 
1.47 
 
- trading business (5)
307,564 
     
293,993 
   
Interest-bearing liabilities
 
828,178 
     
876,483 
   
Non-interest-bearing liabilities:
               
Demand deposits
- UK
46,495 
     
46,692 
   
 
- Overseas
19,909 
     
23,994 
   
Other liabilities (5)
 
565,534 
     
648,129 
   
Owners' equity
 
75,039 
     
76,906 
   
Total liabilities and owners' equity
 
1,535,155 
     
1,672,204 
   
                 
Percentage of liabilities applicable to overseas operations
37.1% 
     
41.7% 
   


For notes relating to this table refer to page 12.

 
13

 
 
Business review continued

 
Average balance sheet and related interest continued

   
2009
   
Average 
balance 
Interest 
Rate 
   
£m 
£m 
% 
Assets
       
Loans and advances to banks
- UK
21,616 
310 
1.43 
 
- Overseas
32,367 
613 
1.89 
Loans and advances to customers
- UK
333,230 
11,940 
3.58 
 
- Overseas
376,382 
16,339 
4.34 
Debt securities
- UK
52,470 
1,414 
2.69 
 
- Overseas
84,822 
3,220 
3.80 
Interest-earning assets
- UK
407,316 
13,664 
3.35 
 
- Overseas
493,571 
20,172 
4.09 
Total interest-earning assets
- banking business
900,887 
33,836 
3.76 
 
- trading business (5)
291,092 
   
Interest-earning assets
 
1,191,979 
   
Non-interest-earning assets
 
831,501 
   
Total assets
 
2,023,480 
   
         
Percentage of assets applicable to overseas operations
 
47.4% 
   
         
Liabilities
       
Deposits by banks
- UK
24,837 
679 
2.73 
 
- Overseas
104,396 
2,362 
2.26 
Customer accounts: demand deposits
- UK
110,294 
569 
0.52 
 
- Overseas
82,177 
1,330 
1.62 
Customer accounts: savings deposits
- UK
54,270 
780 
1.44 
 
- Overseas
83,388 
2,114 
2.54 
Customer accounts: other time deposits
- UK
68,625 
932 
1.36 
 
- Overseas
71,315 
2,255 
3.16 
Debt securities in issue
- UK
116,536 
2,830 
2.43 
 
- Overseas
117,428 
2,500 
2.13 
Subordinated liabilities
- UK
26,053 
834 
3.20 
 
- Overseas
12,468 
656 
5.26 
Internal funding of trading business
- UK
(60,284)
(317)
0.53 
 
- Overseas
(14,845)
(192)
1.29 
Interest-bearing liabilities
- UK
340,331 
6,307 
1.85 
 
- Overseas
456,327 
11,025 
2.42 
Total interest-bearing liabilities
- banking business
796,658 
17,332 
2.18 
 
- trading business (5)
331,380 
   
Interest-bearing liabilities
 
1,128,038 
   
Non-interest-bearing liabilities:
       
Demand deposits
- UK
38,220 
   
 
- Overseas
27,149 
   
Other liabilities (5)
 
772,770 
   
Owners' equity
 
57,303 
   
Total liabilities and owners' equity
 
2,023,480 
   
         
Percentage of liabilities applicable to overseas operations
 
45.8% 
   


 
For notes relating to this table refer to page 12.
 
 
14

 
Business review continued

 
Analysis of change in net interest income - volume and rate analysis
Volume and rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and rate are allocated pro rata to volume and rate movements.

 
2011 over 2010
 
Increase/(decrease) due to changes in:
 
Average 
 volume 
Average 
 rate 
Net 
 change 
 
£m 
£m 
£m 
Interest-earning assets
     
Loans and advances to banks
     
  UK
86 
(15)
71 
  Overseas
124 
(89)
35 
Loans and advances to customers
     
  UK
(652)
768 
116 
  Overseas
(820)
(216)
(1,036)
Debt securities
     
  UK
(102)
92 
(10)
  Overseas
(125)
(417)
(542)
Total interest receivable of the banking business
     
  UK
(668)
845 
177 
  Overseas
(821)
(722)
(1,543)
 
(1,489)
123 
(1,366)
Interest-bearing liabilities
     
Deposits by banks
     
  UK
66 
26 
92 
  Overseas
197 
62 
259 
Customer accounts: demand deposits
     
  UK
45 
(88)
(43)
  Overseas
(58)
182 
124 
Customer accounts: savings deposits
     
  UK
(125)
(117)
(242)
  Overseas
80 
83 
Customer accounts: other time deposits
     
  UK
(53)
(50)
  Overseas
189 
131 
320 
Debt securities in issue
     
  UK
58 
(452)
(394)
  Overseas
494 
(194)
300 
Subordinated liabilities
     
  UK
58 
(130)
(72)
  Overseas
(260)
(251)
Internal funding of trading business
     
  UK
(4)
(285)
(289)
  Overseas
10 
(11)
(1)
Total interest payable of the banking business
     
  UK
101 
(1,099)
(998)
  Overseas
844 
(10)
834 
 
945 
(1,109)
(164)
Movement in net interest income
     
  UK
(567)
(254)
(821)
  Overseas
23 
(732)
(709)
 
(544)
(986)
(1,530)

 
15

 
 
Business review continued

Analysis of change in net interest income - volume and rate analysis continued

 
2010 over 2009
 
Increase/(decrease) due to changes in:
 
Average 
 volume 
Average 
 rate 
Net 
 change 
 
£m 
£m 
£m 
Interest-earning assets
     
Loans and advances to banks
     
  UK
15 
(103)
(88)
  Overseas
(40)
(204)
(244)
Loans and advances to customers
     
  UK
(836)
885 
49 
  Overseas
(6,776)
(2,663)
(9,439)
Debt securities
     
  UK
342 
(297)
45 
  Overseas
(716)
(667)
(1,383)
Total interest receivable of the banking business
     
  UK
(479)
485 
  Overseas
(7,532)
(3,534)
(11,066)
 
(8,011)
(3,049)
(11,060)
Interest-bearing liabilities
     
Deposits by banks
     
  UK
75 
270 
345 
  Overseas
845 
518 
1,363 
Customer accounts: demand deposits
     
  UK
(54)
(52)
  Overseas
670 
53 
723 
Customer accounts: savings deposits
     
  UK
(192)
37 
(155)
  Overseas
965 
936 
1,901 
Customer accounts: other time deposits
     
  UK
336 
165 
501 
  Overseas
708 
633 
1,341 
Debt securities in issue
     
  UK
123 
495 
618 
  Overseas
799 
636 
1,435 
Subordinated liabilities
     
  UK
180 
256 
436 
  Overseas
152 
485 
637 
Internal funding of trading business
     
  UK
(83)
(94)
(177)
  Overseas
(75)
(76)
(151)
Total interest payable of the banking business
     
  UK
385 
1,131 
1,516 
  Overseas
4,064 
3,185 
7,249 
 
4,449 
4,316 
8,765 
Movement in net interest income
     
  UK
(94)
1,616 
1,522 
  Overseas
(3,468)
(349)
(3,817)
 
(3,562)
1,267 
(2,295)

 
16

 
Business review continued
 
 
Non-interest income
   
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Fees and commissions receivable
6,384 
8,193 
8,738 
Fees and commissions payable
(1,460)
(2,211)
(2,790)
Income from trading activities
     
  - managed basis
3,382 
6,142 
3,954 
  - Asset Protection Scheme
(906)
(1,550)
— 
  - movements in the fair value of own debt
225 
(75)
(193)
 
2,701
4,517
3,761
Gain on redemption of own debt
255 
553 
3,790 
Other operating income (excluding insurance net premium income)
     
  - managed basis
2,525 
1,059 
690 
  - strategic disposals
(24)
171 
132 
  - movements in the fair value of own debt
1,621 
249 
51 
 
4,122 
1,479 
873 
Insurance net premium income
4,256 
5,128 
5,266 
Total non-interest income
16,258 
17,659 
19,638 

2011 compared with 2010
Non-interest income decreased by £1,401 million in 2011 principally driven by lower trading income in GBM and Non-Core and a fall in insurance net premium income, partially offset by a higher gain on movements in the fair value of own debt.

Volatile market conditions led to a reduction in GBM trading income, driven by the deterioration in global credit markets as sovereign difficulties in the eurozone grew.

Non-Core trading losses increased by £690 million, reflecting costs incurred as part of the division’s focus on reducing capital trading assets, with activity including the restructuring of monoline exposures, which mitigated both significant immediate and future regulatory uplifts in risk-weighted assets.

A gain on movements in the fair value of own debt of £1,846 million was recorded as a result of Group credit spreads widening, partially offset by the 2011 charges. This compares with a smaller gain of £174 million in 2010.

Insurance net premium income fell by 17% largely driven by RBS Insurance’s exit from certain business segments, along with reduced volumes driven by the de-risking of the motor book.  Insurance net premium income in Non-Core also decreased as legacy policies ran-off.

2010 results included £482 million of income recorded for GMS prior to its disposal in November 2010.

2010 compared with 2009
Net fees and commissions increased by £34 million to £5,982 million primarily due to improved performance in GBM (£160 million), driven by higher portfolio management and origination income, and UK Corporate (£94 million), principally reflecting strong refinancing levels and increased operating lease activity. This increase was partially offset by reduced fees in UK Retail (£144 million) and Ulster Bank (£72 million) principally reflecting the restructuring of current account overdraft fees.

Income from trading activities, excluding fair value movements in the Asset Protection Scheme, rose substantially during the year by £2,306 million to £6,067 million. Trading revenues in GBM were lower than 2009, which saw unusually buoyant market conditions as rapidly falling interest rates generated significant revenue opportunities. This was more than offset by the improvement in Non-Core trading losses from £5,161 million for 2009 to £31 million for 2010 as underlying asset prices recovered and monoline spreads tightened. The unwinding of some banking book hedges also helped reduce trading losses.

The Asset Protection Scheme is accounted for as a credit derivative, and movements in the fair value of the contract are recorded as income from trading activities. The charge of £1,550 million in 2010 reflects improving credit spreads on the portfolio of covered assets.

A gain of £553 million was booked associated with the liability management exercise undertaken in May 2010, through which the Group strengthened its Core Tier 1 capital base by repurchasing existing Tier 1 securities and exchanging selected existing Upper Tier 2 securities for new senior debt securities. A similar series of exchange and tender offers concluded in April 2009 resulted in a gain of £3,790 million.

Other operating income increased by £606 million to £1,479 million. This improvement principally reflected a profit on sale of securities of £496 million compared with £162 million in 2009, higher profits from associated entities and an increased credit of £249 million compared with £51 million in 2009 relating to movements in fair value of own debt. These were partially offset by losses in the fair value of securities and investment properties.

Insurance net premium income fell by £138 million to £5,128 million principally reflecting lower general insurance premiums, driven by a managed reduction in the risk of the UK motor book, largely offset by price increases.

 
17

 
 
Business review continued


Operating expenses and insurance claims
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
     
  - excluding gains on pensions curtailment
8,678 
9,671 
9,993 
  - gains on pensions curtailment
— 
— 
(2,148)
 
8,678 
9,671 
7,845 
Premises and equipment
2,451 
2,402 
2,594 
Other administrative expenses
     
  - managed basis
2,722 
2,963 
3,163
  - Payment Protection Insurance costs
850 
— 
— 
  - integration and restructuring costs
1,059 
1,032 
1,286
  - bank levy
300 
— 
— 
 
4,931
3,995 
4,449 
Administrative expenses
16,060 
16,068 
14,888 
Depreciation and amortisation
1,875 
2,150 
2,166 
Write-down of goodwill and other intangible assets
91 
10 
363 
Operating expenses
18,026 
18,228 
17,417 
       
General insurance
2,968 
4,698 
4,223 
Bancassurance
— 
85 
134 
Insurance net claims
2,968 
4,783 
4,357 
       
Staff costs as a percentage of total income
30% 
30% 
30% 



2011 compared with 2010
Group operating expenses fell by 1% in 2011, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits, partially offset by Payment Protection Insurance costs.

Staff costs fell 10%, driven by lower GBM discretionary compensation as a result of its decrease in revenues, and in Non-Core, given the impact of a 32% reduction in headcount and continued business disposals and country exits.

In May 2011, following the decision of the British Bankers’ Association not to appeal the judgement of the judicial review, the Group recorded a provision of £850 million in respect of the costs of Payment Protection Insurance redress.

General insurance claims were £1,730 million lower, mainly due to the non-repeat of bodily injury reserve strengthening in 2010, de-risking of the motor book, more benign weather in 2011 and claims in Non-Core decreasing as legacy policies ran-off.

The Group’s cost reduction programme delivered cost savings with an underlying run rate of over £3 billion by the end of 2011.

 
18

 
 
Business review continued

 
Operating expenses and insurance claims continued
2010 compared with 2009
The main driver of a 7% decrease in operating expenses, excluding gains on pensions curtailment of £2,148 million, is the recognition of benefits from the Group-wide efficiency programme. The programme continues to deliver material savings which have been funding investments to strengthen our Core franchises.  Annualised savings are now just ahead of the £2.5 billion target for 2011 and are forecast to exceed £3 billion by 2013.

Staff costs, excluding pension schemes curtailment gains, fell by £322 million to £9,671 million, driven by savings in Global Banking & Markets, UK Retail and Non-Core partially offset by higher costs in Group Centre.

Premises and equipment costs fell by 7% in the year to £2,402 million largely driven by efficiency cost savings, significant one-off property impairments recognised in 2009 and country exits following Non-Core disposals.

Other administrative expenses fell by £454 million to £3,995 million principally reflecting continued savings from the Group’s efficiency programme.

Insurance net claims increased 10% to £4,783 million.

Integration costs
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
38 
210 
365 
Premises and equipment
78 
Other administrative expenses
51 
143 
398 
Depreciation and amortisation
11 
20 
18 
 
106 
376 
859 

Note:
(1)
Integration costs for 2011 above exclude £2 million charge included within net interest income and a loss of £3 million within other operating income in respect of integration activities.


2011 compared with 2010
Integration costs were £106 million compared with £376 million in 2010. Integration costs decreased primarily due to a reduction of RBS N.V. (formerly ABN AMRO) integration activity during the year.

2010 compared with 2009
Integration costs were £376 million compared with £859 million in 2009. The fall in integration costs primarily relates to RBS N.V., as they migrate onto RBS systems.


Accruals in relation to integration costs are set out below.
 
At  
1 January 
Charge 
to income 
Utilised 
during 
At 
31 December 
 
2011 
statement 
the year 
2011 
 
£m 
£m 
£m 
£m 
Staff costs - redundancy
— 
(8)
— 
Staff costs - other
— 
30 
(30)
— 
Premises and equipment
24 
(19)
11 
Other administrative expenses
— 
51 
(48)
Depreciation and amortisation
— 
11 
(11)
— 
 
24 
106 
(116)
14 

 
19

 
 
Business review continued
 
 
Restructuring costs
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
356 
353 
328 
Premises and equipment
156 
117 
48 
Other administrative expenses
276 
104 
51 
 
788 
574 
427 

2011 compared with 2010
Restructuring costs were £788 million compared with £574 million in 2010. The increase is due to the number of Group restructuring projects increasing during the year.

2010 compared with 2009
Restructuring costs were £574 million compared with £427 million in 2009. The increase is a result of the number of restructuring projects being undertaken.
 
Accruals in relation to restructuring costs are set out below.
 
At 
Currency 
Charge 
Utilised 
At 
 
1 January 
translation 
to income 
during 
  31 December 
 
2011 
adjustments 
statement 
the year 
2011 
 
£m 
£m 
£m 
£m 
£m 
Staff costs - redundancy
201 
— 
274 
(349)
126 
Staff costs - other
17 
(1)
82 
(58)
40 
Premises and equipment
117 
— 
156 
(107)
166 
Other administrative expenses
46 
(2)
276 
(210)
110 
 
381 
(3)
788 
(724)
442 

Divestment costs
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
95 
51 
— 
Premises and equipment
11 
— 
Other administrative expenses
59 
25 
— 
 
165 
82 
— 

2011 compared with 2010
Divestment costs of £165 million compared to £82 million in 2010 related to the European Commission mandated divestments.

2010 compared with 2009
Divestment costs of £82 million in the year relate to the European Commission mandated divestments.
 
Accruals in relation to divestment costs are set out below.
 
At 
Charge 
Utilised 
At 
 
1 January 
to income 
during 
31 December 
 
2011 
statement 
the year 
2011 
 
£m 
£m 
£m 
£m 
Staff costs - redundancy
22 
36 
(13)
45 
Staff costs - other
59 
(66)
Premises and equipment
— 
11 
(11)
— 
Other administrative expenses
59 
(40)
21 
 
32 
165 
(130)
67 

 
20

 
 
Business review continued
 
 
Impairment losses
   
 
2011 
2010 
2009 
 
£m 
£m 
£m 
New impairment losses
9,236 
9,667 
14,224 
Less: recoveries of amounts previously written-off
(527)
(411)
(325)
Charge to income statement
8,709 
9,256 
13,899 
       
Comprising:
     
Loan impairment losses
7,241 
9,144 
13,090 
Securities
 
 
 
  - managed bases
200 
112 
809 
  - sovereign debt impairment
1,099 
— 
— 
  - interest rate hedge adjustments on impaired available-for-sale Greek government bonds
169 
— 
 
1,468 
112 
809 
Charge to income statement
8,709 
9,256 
13,899 

2011 compared with 2010
Impairment losses decreased by 6% compared with 2010, driven largely by a £1,569 million reduction in Non-Core loan impairments, despite continuing challenges in Ulster Bank and corporate real estate portfolios. This was partially offset by impairments taken on the Group’s available-for-sale bond portfolio, as a result of the decline in the value of Greek sovereign bonds.

Retail & Commercial impairment losses fell by £153 million, driven by improving credit metrics in UK Retail and US Retail & Commercial partially offset by increases in Ulster Bank, largely reflecting a deterioration in credit metrics on the mortgage portfolio, and a single name provision in GTS.

Total Core and Non-Core Ulster Bank impairment losses decreased by 4%, as the £223 million increase in Core Ulster Bank losses was more than offset by a decrease in losses recognised in Non-Core.

The Group holds Greek government bonds with a notional amount of £1.45 billion. As a result of Greece’s continuing fiscal difficulties, the Group recorded impairment charges on these bonds totalling £1,099 million during the year. These charges were recorded to write the bonds down to their market price as at 31 December 2011 (c.21% of notional).
 
2010 compared with 2009
Impairment losses were £9,256 million, compared with £13,899 million in 2009. The 33% decrease reflects an overall improvement in the economic environments in which the Group operates.

Impairments fell in all Core businesses, except Ulster Bank Group, which faced an economic environment that remains challenging, with rising default levels across both personal and corporate portfolios.

Impairments for Ulster Bank Group (Core and Non-Core) increased to £3,843 million compared with £1,927 million in 2009.

A significant proportion of the reduction in Core impairments relates to lower specific and latent provisions in UK Corporate, US Retail & Commercial and GBM.

Non-Core impairments fell by 41% in 2010 reflecting the gradual improvement in the economic environment through 2010 and lower specific provisions, alongside a non-repeat of the large single name losses seen in 2009.

 
21

 
 
Business review continued


Tax
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Tax (charge)/credit
(1,250)
(634)
429 
       
 
% 
% 
UK corporation tax rate
26.5 
28.0 
28.0 
Effective tax rate
nm 
nm 
16.2 

nm = not meaningful

The actual tax (charge)/credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax as follows:

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Expected tax credit
203 
112 
741 
Sovereign debt impairment where no deferred tax asset recognised
(275)
— 
— 
Other losses in year where no deferred tax asset recognised
(530)
(450)
(780)
Foreign profits taxed at other rates
(417)
(517)
(276)
UK tax rate change - deferred tax impact
(110)
(82)
— 
Unrecognised timing differences
(20)
11 
274 
Non-deductible goodwill impairment
(24)
(3)
(102)
Items not allowed for tax
     
  - losses on strategic disposals and write-downs
(72)
(311)
(152)
  - UK Bank levy
(80)
— 
— 
  - employee share schemes
(113)
(32)
(29)
  - other disallowable items
(271)
(296)
(327)
Non-taxable items
     
  - gain on sale of Global Merchant Services
12 
221 
— 
  - gain on redemption of own debt
— 
11 
693 
  - other non-taxable items
245 
341 
410 
Taxable foreign exchange movements
1 
Losses brought forward and utilised
94 
Adjustments in respect of prior years
196 
355 
(118)
Actual tax (charge)/credit
(1,250)
(634)
429 

2011 compared with 2010
The high tax charge in 2011 reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.

2010 compared with 2009
The high tax charge in 2010 reflects profits in high tax regimes and losses in low tax regimes, together with £450 million relating to losses in overseas subsidiaries for which a deferred tax asset has not been recognised, and £311 million mainly in respect of losses on disposal of businesses for which no tax relief if available. This was offset in part by the non-taxable gain arising on the disposal of 80.01% of the GMS business.
 

 
 
22

 
Business review continued

Divisional performance

Operating profit/(loss) by division
2011  
£m  
2010 
£m 
2009 
£m 
UK Retail
1,991 
1,372 
229 
UK Corporate
1,414 
1,463 
1,125 
Wealth
321 
304 
420 
Global Transaction Services
743 
1,088 
973 
Ulster Bank
(1,024)
(761)
(368)
US Retail & Commercial
479 
306 
(113)
Retail & Commercial
3,924 
3,772 
2,266 
Global Banking & Markets
1,561 
3,364 
5,758 
RBS Insurance
454 
(295)
58 
Central items
156 
577 
385 
Core
6,095 
7,418 
8,467 
Non-Core
(4,203)
(5,505)
(14,557)
Managed basis
1,892 
1,913 
(6,090)
       
Reconciling items
     
Fair value of own debt
1,846 
174 
(142)
Asset Protection Scheme
(906)
(1,550)
 
Payment Protection Insurance costs
(850)
— 
— 
Sovereign debt impairment
(1,099)
— 
— 
Amortisation of purchased intangible assets
(222)
(369)
(272)
Integration and restructuring costs
(1,064)
(1,032)
(1,286)
Gain on redemption of own debt
255 
553 
3,790 
Strategic disposals
(104)
171 
132 
Bank levy
(300)
— 
— 
Other
(214)
(259)
1,221 
Group operating loss before tax
(766)
(399)
(2,647)
 

 
 
23

 
Business review continued
 
Impairment losses/(recoveries) by division
2011 
£m 
2010 
£m 
2009 
£m 
UK Retail
788 
1,160 
1,679 
UK Corporate
785 
761 
927 
Wealth
25 
18 
33 
Global Transaction Services
166 
39 
Ulster Bank
1,384 
1,161 
649 
US Retail & Commercial
325 
517 
702 
Retail & Commercial
3,473 
3,626 
4,029 
Global Banking & Markets
49 
151 
640 
RBS Insurance
— 
— 
Central items
(2)
Core
3,520 
3,780 
4,678 
Non-Core
3,919 
5,476 
9,221 
Managed basis
7,439 
9,256 
13,899 
Reconciling items
     
Sovereign debt impairment
1,099 
— 
— 
Interest rate hedge adjustments on impaired available-for-sale Greek government bonds
169 
— 
— 
RFS Holdings minority interest
— 
— 
Group impairment losses
8,709 
9,256 
13,899 


Net interest margin by division
2011 
% 
2010 
2009 
UK Retail
3.92 
3.91 
3.59 
UK Corporate
2.58 
2.51 
2.22 
Wealth
3.59 
3.37 
4.38 
Global Transaction Services
5.52 
6.73 
9.22 
Ulster Bank
1.77 
1.84 
1.87 
US Retail & Commercial
3.06 
2.85 
2.37 
Retail & Commercial
3.21 
3.14 
2.89 
Global Banking & Markets
0.73 
1.05 
1.38 
Non-Core
0.64 
1.16 
0.69 
       
Group net interest margin
1.92 
2.06 
1.76 


Risk-weighted assets by division
2011 
£bn 
2010 
£bn 
2009 
£bn 
UK Retail
48.4 
48.8 
51.3 
UK Corporate
76.1 
81.4 
90.2 
Wealth
12.9 
12.5 
11.2 
Global Transaction Services
17.3 
18.3 
19.1 
Ulster Bank
36.3 
31.6 
29.9 
US Retail & Commercial
58.8 
57.0 
59.7 
Retail & Commercial
249.8 
249.6 
261.4 
Global Banking & Markets
151.1 
146.9 
123.7 
Other
10.8 
18.0 
9.4 
Core
411.7 
414.5 
394.5 
Non-Core
93.3 
153.7 
171.3 
Group before benefit of Asset Protection Scheme
505.0 
568.2 
565.8 
Benefit of Asset Protection Scheme
(69.1)
(105.6)
(127.6)
Group before RFS Holdings minority interest
435.9 
462.6 
438.2 
RFS Holdings minority interest
3.1 
2.9 
102.8 
Group
439.0 
465.5 
541.0 
 
 
 
24

 
Business review continued


 
Divisional performance continued
Employee numbers at 31 December
(full time equivalents in continuing operations rounded to the nearest hundred)

 
2011 
2010 
2009 
UK Retail
27,700 
28,200 
30,000 
UK Corporate
13,500 
13,100 
12,300 
Wealth
5,700 
5,200 
4,600 
Global Transaction Services
2,600 
2,600 
3,500 
Ulster Bank
4,200 
4,200 
4,500 
US Retail & Commercial
15,200 
15,700 
15,500 
Retail & Commercial
68,900 
69,000 
70,400 
Global Banking & Markets
17,000 
18,700 
17,900 
RBS Insurance
14,900 
14,500 
13,900 
Central items
6,200 
4,700 
4,200 
Core
107,000 
106,900 
106,400 
Non-Core
4,700 
6,900 
15,100 
 
111,700 
113,800 
121,500 
Business Services
34,000 
34,400 
38,600 
Integration and restructuring
1,100 
300 
500 
RFS Holdings minority interest
— 
— 
300 
Group
146,800 
148,500 
160,900 

 
25

 
Business review continued


UK Retail
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
4,272 
4,078 
3,452 
Net fees and commissions
1,066 
1,100 
1,244 
Other non-interest income
140 
322 
391 
Non-interest income
1,206 
1,422 
1,635 
Total income
5,478 
5,500 
5,087 
Direct expenses
     
  - staff
(839)
(889)
(968)
  - other
(437)
(480)
(458)
Indirect expenses
(1,423)
(1,514)
(1,619)
 
(2,699)
(2,883)
(3,045)
Insurance net claims
—  
(85)
(134)
Impairment losses
(788)
(1,160)
(1,679)
Operating profit
1,991 
1,372 
229 
       
Analysis of income by product
     
Personal advances
1,089 
993 
1,192 
Personal deposits
961 
1,102 
1,349 
Mortgages
2,277 
1,984 
1,214 
Cards
950 
962 
869 
Other, including bancassurance
201 
459 
463 
Total income
5,478 
5,500 
5,087 
       
Analysis of impairments by sector
     
Mortgages
182 
177 
124 
Personal
437 
682 
1,023 
Cards
169 
301 
532 
Total impairment losses
788 
1,160 
1,679 
       
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector
     
Mortgages
0.2% 
0.2% 
0.1% 
Personal
4.3% 
5.8% 
7.5% 
Cards
3.0% 
4.9% 
8.6% 
Total
0.7% 
1.1% 
1.6% 
       
Performance ratios
     
Return on equity (1)
26.4% 
18.0% 
3.0% 
Net interest margin
3.92% 
3.91% 
3.59% 
Cost:income ratio
49% 
52% 
60% 
Adjusted cost:income ratio (2)
49% 
53% 
61% 
       
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Loans and advances to customers (gross) (3)
     
  - mortgages
95.0 
90.6 
83.2 
  - personal
10.1 
11.7 
13.6 
  - cards
5.7 
6.1 
6.2 
 
110.8 
108.4 
103.0 
Customer deposits (excluding bancassurance) (3)
101.9 
96.1 
87.2 
Assets under management (excluding deposits)
5.5 
5.7 
5.3 
Risk elements in lending(3)
4.6 
4.6 
5.7 
Loan:deposit ratio (excluding repos)
106% 
110% 
115% 
Risk-weighted assets
48.4 
48.8 
51.3 
 
Notes:
(1)
Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital  deductions).
(2)
Adjusted cost:income ratio is based on total income after netting insurance claims, and operating expenses.
(3)
Includes disposal groups: loans and advances to customers - £7.3 billion; customer deposits - £8.8 billion; risk elements in lending - £0.5 billion.
 
 
 
26

 
Business review continued

 
UK Retail continued
In 2010, UK Retail set out an aspiration to become the UK’s most helpful bank and launched the Customer Charter.  In 2011, we made good progress on our Customer Charter commitments and the roll-out of innovation that actually helps customers. In December 2011, UK Retail refined its staff incentive scheme to further strengthen the role of customer service and to help build long lasting customer relationships.

Progress against the Customer Charter commitments is independently assessed and has shown encouraging results. By the end of 2011, we achieved the goal of serving 80% of our customers in less than 5 minutes in our busiest branches. Branch opening hours have also been extended and standardised, which means that our branches are now open for an additional 5,000 hours per week at times our customers have told us suit them.

Innovation has supported the delivery of Helpful Banking by focusing on solutions that make it easier for customers to bank with RBS and NatWest. An important example has been giving customers access to 24 hour emergency cash from NatWest and RBS ATMs when their cards are lost or stolen. We also updated our market-leading iPhone application and by the end of the year 1 million customers had downloaded the application. With successful apps also launched for iPad, Android and Blackberry, RBS is now the leading mobile bank in the UK.

2011 compared with 2010
UK Retail delivered strong full year results, as operating profit increased by £619 million to £1,991 million, despite continued uncertainty in the economic climate and the low interest rate environment. Impairments fell by £372 million, with further improvements in the unsecured book and continued careful mortgage underwriting. Return on equity improved to 26.4%.

The division continued to focus on growing secured lending while at the same time building customer deposits, thereby reducing the Group’s reliance on wholesale funding. Loans and advances to customers grew 2%, with a change in mix from unsecured to secured as the Group actively sought to improve its risk profile. Mortgage balances grew by 5%, while unsecured lending contracted by 11%.
 
-
Mortgage growth reflected continued strong new business levels. Gross mortgage lending market share of 10% continues above our stock position of 8%.

-
Customer deposits grew 6%, outperforming the market total deposit growth of 3%.  Savings balances grew by £6 billion, or 9%, with 1.5 million accounts opened, demonstrating the strength of our customer franchise and our strategy to further develop primary banking relationships.

Net interest income increased by 5% to £4,272 million, driven by strong balance sheet growth. Net interest margin remained broadly flat with recovering asset margins largely offset by more competitive savings rates and lower long term swap rate returns adversely impacting liability margins.

Non-interest income declined 15% to £1,206 million, primarily driven by lower investment and protection income as a result of the dissolution of the bancassurance joint venture.  In addition, a number of changes have been made to support delivery of Helpful Banking, such as ‘Act Now’ text alerts, which have decreased fee income.

Overall expenses decreased by 6%, with the adjusted cost:income ratio improving from 53% to 49%.  Cost reductions were driven by a clear management focus on process re-engineering and operational efficiency together with benefits from the dissolution of the bancassurance joint venture, partly offset by higher inflation rates in utility and mail costs.

Impairment losses decreased 32% to £788 million reflecting the impact of a strengthened risk appetite, and a more stable economic environment.

Risk-weighted assets were broadly stable, with volume growth in lower risk secured mortgages partly offset by a decrease in the unsecured portfolio.


 
27

 
Business review continued

2010 compared with 2009
Operating profit recovered strongly from the low levels recorded in 2008 and 2009 to £1,372 million and impairments fell by £519 million as the economic environment continued to recover.

The division has continued to focus in 2010 on growing secured lending while at the same time building customer deposits, thereby reducing the Group’s reliance on wholesale funding. Loans and advances to customers grew 5%, with a change in mix from unsecured to secured as the Group actively sought to improve its risk profile. Mortgage balances grew by 9% while unsecured lending contracted by 10%.

·  
Mortgage growth was due to good retention of existing customers and new business, the majority of which comes from the existing customer base. Gross mortgage lending market share remained broadly in line with 2009 at 12%, with the Group on track to meet its Government target on net mortgage lending.

·  
Customer deposits grew 10% on 2009, reflecting the strength of the UK Retail customer franchise, which outperformed the market in an increasingly competitive environment. Savings balances grew by £8 billion or 13% with 1.8 million accounts opened, outperforming the market total deposit growth of 3%. Personal current account balances increased by 3% on 2009.

Net interest income increased significantly by 18% to £4,078 million, driven by strong balance sheet growth and repricing. Net interest margin improved by 32 basis points to 3.91%, with widening asset margins partially offset by contracting liability margins in the face of a competitive deposit market.
 
Non-interest income declined 13% to £1,422 million, principally reflecting the restructuring of current account overdraft fees in the final quarter of 2009.

Expenses decreased by 5%, with the cost:income ratio (net of insurance claims) improving from 61% to 53%.

·  
Direct staff costs declined by 8%, largely driven by a clear management focus on process re-engineering enabling a 7% reduction in headcount.

·  
RBS continues to progress towards a more convenient, lower cost operating model, with over 4.8 million active users of online banking and a record share of new sales achieved through direct channels. More than 7.8 million accounts have switched to paperless statements and 276 branches now utilise automated cash deposit machines.

Impairment losses decreased 31% to £1,160 million primarily reflecting the recovery in the economic environment.

·  
The mortgage impairment charge was £177 million (2009 - £124 million) on a total book of £91 billion. Mortgage arrears rates marginally increased in 2010 but remain below the industry average, as reported by the Council of Mortgage Lenders. Repossessions showed only a small increase on 2009, as the Group continues to support customers facing financial difficulties.

·  
The unsecured lending impairment charge was £983 million (2009 - £1,555 million) on a total book of £18 billion.

Risk-weighted assets decreased by 5% to £48.8 billion, with lower unsecured lending, improving portfolio credit metrics and small procyclicality benefits more than offsetting growth in mortgages.

 
28

 
Business review continued


UK Corporate

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
2,585 
2,572 
2,292 
Net fees and commissions
948 
952 
858 
Other non-interest income
327 
371 
432 
Non-interest income
1,275 
1,323 
1,290 
Total income
3,860 
3,895 
3,582 
Direct expenses
     
  - staff
(780)
(778)
(753)
  - other
(335)
(359)
(260)
Indirect expenses
(546)
(534)
(517)
 
(1,661)
(1,671)
(1,530)
Impairment losses
(785)
(761)
(927)
Operating profit
1,414 
1,463 
1,125 
       
Analysis of income by business
     
Corporate and commercial lending
2,676 
2,598 
2,131 
Asset and invoice finance
660 
617 
501 
Corporate deposits
683 
728 
986 
Other
(159)
(48)
(36)
Total income
3,860 
3,895 
3,582 
       
Analysis of impairments by sector
     
Banks and financial institutions
20 
20 
15 
Hotels and restaurants
59 
52 
98 
Housebuilding and construction
103 
131 
106 
Manufacturing
34 
51 
Other
163 
127 
150 
Private sector education, health, social work, recreational and community services
113 
30 
59 
Property
170 
245 
259 
Wholesale and retail trade, repairs
85 
91 
76 
Asset and invoice finance
38 
64 
113 
Total impairment losses
785 
761 
927 
       
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector
     
Banks and financial institutions
0.4% 
0.3% 
0.2% 
Hotels and restaurants
1.0% 
0.8% 
1.5% 
Housebuilding and construction
2.6% 
2.9% 
2.5% 
Manufacturing
0.7% 
— 
0.9% 
Other
0.5% 
0.4% 
0.5% 
Private sector education, health, social work, recreational and community services
1.3% 
0.3% 
0.9% 
Property
0.6% 
0.8% 
0.8% 
Wholesale and retail trade, repairs
1.0% 
0.9% 
0.7% 
Asset and invoice finance
0.4% 
0.6% 
1.3% 
Total
0.7% 
0.7% 
0.8% 
       
Performance ratios
     
Return on equity (1)
12.4% 
12.1% 
9.4% 
Net interest margin
2.58% 
2.51% 
2.22% 
Cost:income ratio
43% 
43% 
43% 

Note:
(1)
Divisional return on equity is based on divisional operating profit after tax, divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital deductions).


 
29

 
Business review continued


 
2011 
2010 
2009 
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Total third party assets
111.8 
114.6 
114.9 
Loans and advances to customers (gross) (1)
     
  - banks and financial institutions
5.7 
6.1 
6.3 
  - hotels and restaurants
6.1 
6.8 
6.7 
  - housebuilding and construction
3.9 
4.5 
4.3 
  - manufacturing
4.6 
5.3 
5.9 
  - other
32.6 
31.0 
29.9 
  - private sector education, health, social work, recreational and community services
8.7 
9.0 
6.5 
  - property
28.2 
29.5 
33.0 
  - wholesale and retail trade, repairs
8.5 
9.6 
10.2 
  - asset and invoice finance
10.4 
9.9 
8.8 
 
108.7 
111.7 
111.6 
       
Customer deposits (1)
100.9 
100.0 
87.8 
Risk elements in lending (1)
5.0 
4.0 
2.3 
Loan:deposit ratio (excluding repos)
106% 
110% 
126% 
Risk-weighted assets
76.1 
81.4 
90.2 

Note:
(1)
Includes disposal groups: loans and advances to customers - £12.2 billion; customer deposits - £21.8 billion; risk elements in lending - £1.0 billion.

In 2011, UK Corporate focused on supporting its customers through challenging economic times. As a result of over 5,000 hours of customer research, UK Corporate launched the ‘Ahead for Business’ promise to its small and medium-sized enterprise (SME) customers.

To deliver on this, the division launched a number of initiatives to improve the service it offers to customers. For example, the ‘Working with You’ initiative, has seen over 4,600 visits to customer businesses since its launch in Q2 2011.  Additionally, following the launch of the relationship manager accreditation programme, also in Q2 2011, almost all relationship managers have gained full accreditation in the initial phase.

UK Corporate continued to support new and existing businesses during 2011:
·  
launching its best ever fixed rate loan product for SMEs;
·  
reacting quickly after the August riots to give affected businesses access to special interest rate and fee free lending products;
·  
answering over 4,000 calls on the Start-up Hotline, offering free advice and a complementary business plan review service; and
·  
supporting more debt capital and loan market deals for larger corporates than any other bank.

The division also took measures to reduce the risk retained in the business allowing for quicker and more consistent decisions by simplifying the credit underwriting process and improving automated decision making.

2011 compared with 2010
Operating profit decreased 3% to £1,414 million, as lower income and higher impairments were only partially offset by a decrease in expenses. Net interest income remained broadly flat.  Net interest margin improved 7 basis points with benefits from re-pricing the lending portfolio and the revision to income deferral assumptions in Q1 2011 partially offset by increased funding costs together with continued pressure on deposit margins.  A 1% increase in deposit balances supported an improvement in the loan:deposit ratio to 106%.

Non-interest income decreased by 4% as a result of lower GBM cross-sales and fee income, partially offset by increased Invoice Finance and Lombard income.

Excluding the £29 million OFT penalty in 2010, total costs increased by 1%, largely reflecting increased investment in the business and higher costs of managing the non-performing book.

Impairments of £785 million were 3% higher due to increased specific impairments and collectively assessed provisions, partially offset by lower latent loss provisions.

2010 compared with 2009
Operating profit grew by £338 million, 30%, compared with 2009, driven by strong income growth and significantly lower impairments, partially offset by higher costs.

UK Corporate performed strongly in the deposit market, with customer deposit balance growth of £12 billion contributing to a 16 percentage point improvement in the loan:deposit ratio in 2010. While customer lending increased only marginally (with gross lending largely offset by customer deleveraging) net interest income rose by £280 million, 12%, and net interest margin rose by 29 basis points driven primarily by the good progress made on loan repricing.

Non-interest income increased 3% reflecting strong refinancing levels and increased operating lease activity, partially offset by lower sales of financial market products.

Total costs increased 9% (£141 million) or 5% excluding the OFT penalty in 2010, legal recovery in 2009 and the normalisation of staff compensation phasing.

Impairments were 18% lower, primarily as a result of higher charges taken during the first half of 2009 to reflect potential losses in the portfolio not yet specifically identified.

Return on equity increased from 9.4% to 12.1%, reflecting higher operating profit and lower RWAs as a result of improved risk metrics.
 
30

 
Business review continued


Wealth

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
718 
609 
663 
Net fees and commissions
375 
376 
363 
Other non-interest income
84 
71 
83 
Non-interest income
459 
447 
446 
Total income
1,177 
1,056 
1,109 
Direct expenses
     
  - staff
(413)
(382)
(357)
  - other
(195)
(142)
(144)
Indirect expenses
(223)
(210)
(155)
 
(831)
(734)
(656)
Impairment losses
(25)
(18)
(33)
Operating profit
321 
304 
420 
       
Analysis of income
     
Private banking
975 
857 
916 
Investments
202 
199 
193 
Total income
1,177 
1,056 
1,109 
       
Performance ratios
     
Return on equity (1)
18.7% 
18.9% 
30.3% 
Net interest margin
3.59% 
3.37% 
4.38% 
Cost:income ratio
71% 
70% 
59% 
       
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Loans and advances to customers (gross)
     
  - mortgages
8.3 
7.8 
6.5 
  - personal
6.9 
6.7 
4.9 
  - other
1.7 
1.6 
2.3 
 
16.9 
16.1 
13.7 
Customer deposits (2)
38.2 
37.1 
35.7 
Assets under management (excluding deposits) (2)
30.9 
33.9 
32.5 
Risk elements in lending
0.2 
0.2 
0.2 
Loan:deposit ratio (excluding repos) (2)
44% 
43% 
38% 
Risk-weighted assets
12.9 
12.5 
11.2 

Notes:
(1)
Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital deductions).
(2)
2010 and 2009 comparatives have been revised to reflect the current reporting methodology.
 
 
 
31

 
Business review continued

 
2011 has been a significant year for the Coutts businesses from a strategic perspective. In Q1 2011, a new divisional strategy was defined with the execution of early changes already making an impact.

Key strategic changes in 2011 included:

·  
A refreshed Coutts brand bringing Coutts UK and RBS Coutts under one single contemporary brand.

·  
A refocus on territories where the businesses have the opportunity for greatest scale or growth such as UK, Asia, Middle East, and Eastern Europe.

·  
Further development of client propositions as well as the portfolio of products and services for key international markets.

·  
Strategic investment in technology leading to the development of a single global technology platform for the Wealth division. The platform was successfully deployed in Adam & Company in 2011 with Coutts UK to follow in 2012.

·  
Strengthening the connectivity between Wealth and other Group divisions including referrals in international jurisdictions and improved connectivity with UK Corporate.

·  
Continued activity to ensure the division responds to new or expected regulatory changes with proactive solution design and preparation.

·  
Injection of new management into key roles from both internal and external sources including key segment heads, marketing, products & services, and international executive leadership.

Following the establishment of a single global brand in Q4 2011, focus turned to the reorganisation of key global functions such as marketing and product & services, as well as some local management structures. These reorganisations have realigned the division to maximise execution of the divisional strategy.

The execution plan for the strategy will continue into 2012 and position Wealth strongly against its peers.

2011 compared with 2010
Operating profit increased by 6% on 2010 to £321 million, driven by an 11% growth in income partially offset by increases in expenses and impairments.

Income increased by £121 million with a 24 basis points improvement in lending margins, strong treasury income and increases in lending and deposit volumes. Non-interest income rose 3%, with investment income growing 2% despite turbulent market conditions.

Expenses increased by £97 million, largely driven by adverse foreign exchange movements and headcount growth to service the increased revenue base.  Additional strategic investment in technology enhancement, rebranding and programmes to support regulatory change also contributed to the increase.

Client assets and liabilities managed by the division decreased by 1%. Customer deposits grew 3% in a competitive environment and lending volumes grew 5%. Assets under management declined 9%, with fund outflows contributing 3% of the decrease and market conditions making up the balance.

2010 compared with 2009
2010 operating profit fell by 28% driven by lower net interest income and higher expenses, partly offset by a 45% decline in impairments in the year.

Income declined by 5% primarily due to lower net interest income. Strong lending and investment income was offset by the impact of a competitive deposit market.

Expenses grew by 12% to £734 million. Direct expenses were up 5%, £23 million reflecting additional strategic investment. Indirect expenses increased by £55 million reflecting a change in allocation of Business Services costs.

Assets under management grew by 4% largely through improving market conditions..
 
32

 
Business review continued


Global Transaction Services

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
1,076 
974 
912 
Non-interest income
1,175 
1,587 
1,575 
Total income
2,251 
2,561 
2,487 
Direct expenses
     
  - staff
(375)
(411)
(371)
  - other
(113)
(159)
(161)
Indirect expenses
(854)
(894)
(943)
 
(1,342)
(1,464)
(1,475)
Impairment losses
(166)
(9)
(39)
Operating profit
743 
1,088 
973 
       
Analysis of income by product
     
Domestic cash management
866 
818 
805 
International cash management
868 
801 
734 
Trade finance
318 
309 
290 
Merchant acquiring
16 
451 
505 
Commercial cards
183 
182 
153 
Total income
2,251 
2,561 
2,487 
       
Performance ratios
     
Return on equity (1)
30.4% 
42.8% 
42.2% 
Net interest margin
5.52% 
6.73% 
9.22% 
Cost:income ratio
60% 
57% 
59% 
       
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Total third party assets
25.9 
25.2 
18.4 
Loans and advances
15.8 
14.4 
12.7 
Customer deposits
71.7 
69.9 
61.8 
Risk elements in lending
0.2 
0.1 
0.2 
Loan:deposit ratio (excluding repos)
22% 
21% 
21% 
Risk-weighted assets
17.3 
18.3 
19.1 

Note:
(1)
Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital deductions).
 
 

 
 
33

 
Business review continued

Global Transaction Services (GTS) recognises the important role international trade plays in a strong global economy and throughout 2011 the division supported UK companies, both in the UK and overseas, to do more business internationally.  This support included delivering a series of UK Government-backed ‘Doing Business in Asia’ events.

During the year, GTS invested in improving existing products and services and also in developing new ones.  To help corporate treasurers manage their global positions, the division launched a global Liquidity Solutions Portal, giving its customers a view of their operational and investment balances and rates all in one place, improving transparency, and enabling them to execute and redeem investments effectively.

2011 compared with 2010
Operating profit was down 32%, partly reflecting the sale of Global Merchant Services (GMS) which completed on 30 November 2010. Adjusting for the disposal, operating profit decreased 16%, driven by an impairment provision on a single name in 2011.

Excluding GMS income of £451 million, income was 7% higher driven by the success of deposit-gathering initiatives, as deposits increased £2 billion in a competitive environment.

Excluding GMS expenses of £244 million, expenses increased by 10%, reflecting business improvement initiatives and investment in technology and support infrastructure.

Impairment losses increased to £166 million compared with £9 million in 2010 reflecting a single name impairment.

For the eleven months in 2010 before completion of the disposal, GMS generated income of £451 million, total expenses of £244 million and an operating profit of £207 million.

2010 compared with 2009
Operating profit increased 12%,  driven by a robust income performance (which has more than compensated for the loss of Global Merchant Services (GMS) income), good cost control and lower impairments. Adjusting for the disposal operating profit increased 21%.

For the eleven months before disposal, GTS booked income of £451 million and total expenses of £244 million for GMS, generating an operating profit of £207 million.

Income was up 3%, or 6% excluding GMS, reflecting higher deposit volumes in the International Cash Management business, growth in the Trade Finance business and improved Commercial Card transaction volumes.

Expenses were broadly in line with 2009, at £1,464 million, as increased investment in front office and support infrastructure was mitigated by tight management of business costs.

Third party assets increased by £6.8 billion, or £7.6 billion excluding GMS, as Yen clearing activities were brought in-house and loans and advances increased.

 
34

 
Business review continued


Ulster Bank

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
696 
761 
780 
Net fees and commissions
142 
156 
228 
Other non-interest income
69 
58 
26 
Non-interest income
211 
214 
254 
Total income
907 
975 
1,034 
Direct expenses
     
  - staff
(221)
(237)
(325)
  - other
(67)
(74)
(86)
Indirect expenses
(259)
(264)
(342)
 
(547)
(575)
(753)
Impairment losses
(1,384)
(1,161)
(649)
Operating loss
(1,024)
(761)
(368)
       
Analysis of income by business
     
Corporate
435 
521 
580 
Retail
428 
465 
412 
Other
44 
(11)
42 
Total income
907 
975 
1,034 
       
Analysis of impairments by sector
     
Mortgages
570 
294 
74 
Corporate
     
  - property
324 
375 
306 
  - other corporate
434 
444 
203 
Other lending
56 
48 
66 
Total impairment losses
1,384 
1,161 
649 
       
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector
     
Mortgages
2.8% 
1.4% 
0.5% 
Corporate
     
  - property
6.8% 
6.9% 
3.0% 
  - other corporate
5.6% 
4.9% 
1.8% 
Other lending
3.5% 
3.7% 
2.7% 
Total
4.1% 
3.1% 
1.6% 
Performance ratios
     
Return on equity (1)
(26.1%)
(21.0%)
(11.7%)
Net interest margin
1.77% 
1.84% 
1.87% 
Cost:income ratio
60% 
59% 
73% 


Note:
(1)
Divisional return on equity is based on divisional operating loss after tax divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital deductions).
 
 
 
35

 
Business review continued


 
2011 
2010 
2009 
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Loans and advances to customers (gross)
     
  - mortgages
20.0 
21.2 
16.2 
  - corporate
     
      - property
4.8 
5.4 
10.1 
      - other corporate
7.7 
9.0 
11.0 
  - other lending
1.6 
1.3 
2.4 
 
34.1 
36.9 
39.7 
       
Customer deposits
21.8 
23.1 
21.9 
Risk elements in lending
     
  - mortgages
2.2 
1.5 
0.6 
  - corporate
     
      - property
1.3 
0.7 
0.7 
      - other corporate
1.8 
1.2 
0.8 
  - other lending
0.2 
0.2 
0.2 
 
5.5 
3.6 
2.3 
Total risk elements in lending
     
Loan:deposit ratio (excluding repos)
143% 
152% 
177% 
Risk-weighted assets
36.3 
31.6 
29.9 
       
Spot exchange rate - €/£
1.196 
1.160 
1.126 


2011 was another difficult year for the business due to the continued challenging economic environment. This was reflected in the financial performance, with ongoing pressure on income and a further increase in impairment losses.

Ulster Bank continues to make progress on its customer commitments and deposit gathering strategy, while cost management and targeting growth in areas that leverage competitive advantage, remain priorities.  In 2011, customer numbers increased by 2%, representing a strong performance in current and savings accounts, driven by the enhanced customer service highlighted by our 'Help for what matters' programme.

Following a review of the cost base and operating model, 950 proposed job losses were announced in January 2012, the majority of which are expected by the end of 2012. This decision is a necessary part of the changes required to build a stronger sustainable business for the future.
 
2011 compared with 2010
Operating profit before impairment losses decreased by £40 million in 2011 with lower income partially mitigated by cost savings. Impairment losses of £1,384 million increased by 19% from 2010 resulting in an operating loss of £1,024 million, 35% higher than 2010.

Income fell by 7% driven by a contracting performing loan book coupled with higher funding costs. Loans and advances to customers decreased by 8% during 2011.

Expenses fell by 5% reflecting tight management of the cost base across the business.

Impairment losses increased by 19% largely reflecting the deterioration in credit metrics on the mortgage portfolio driven by a combination of higher debt flow and further fall in asset prices.

Despite intense competition, retail and small business deposit balances have grown strongly throughout 2011, driven by the benefits of a focused deposit gathering strategy.  However, total customer deposit balances fell by 6% terms largely driven by the outflow of wholesale customer balances due to rating downgrades.

Risk-weighted assets increased by 15% in 2011 reflecting the deterioration in credit risk metrics.

 
36

 
Business review continued


Ulster Bank continued
2010 compared with 2009
Overall performance deteriorated in 2010, largely as a result of an increase in impairment losses of £512 million. Operating profit before impairment increased to £400 million, up 42%, driven by the culmination of a bank-wide cost saving programme during 2010

Net interest income decreased by 2%, as actions to increase asset margins were eroded by tightening deposit margins due to intensive market competition and movements in foreign exchange rates.

Non-interest income was 16% lower, basis reflecting a non-recurring gain in 2009.

Loans to customers fell by 7%. On 1 July 2010 the division transferred a portfolio of development property assets to the Non-Core division, partially offset by a simultaneous transfer of a portfolio of retail mortgage assets to the core business.

Despite intense competition, customer deposit balances increased by 5% over the year with strong growth across all deposit categories, driven by a focus on improving the bank’s funding profile.

Expenses were 24% lower. The strong year-on-year performance in expenses was primarily driven by an increased focus on active management of the cost base, and the benefits derived from the business restructuring and cost-saving programme which commenced in 2009.

Impairment losses increased by £512 million to £1,161 million reflecting the deteriorating economic environment in Ireland and rising default levels across both personal and corporate portfolios. Lower asset values, particularly in property-related lending together with pressure on borrowers with a dependence on consumer spending have resulted in higher corporate loan losses, while higher unemployment, lower incomes and increased taxation have driven mortgage impairment increases.

Risk-weighted assets have increased due to deteriorating credit risk metrics.

Customer numbers increased by 3% during 2010, with a strong performance in current and savings accounts switchers.
 
37

 
Business review continued


US Retail & Commercial

 
2011 
2010 
2009 
 
2011 
2010 
2009 
 
US$m 
US$m 
US$m 
 
£m 
£m 
£m 
Net interest income
3,042 
2,962 
2,777 
 
1,896 
1,917 
1,775 
Net fees and commissions
1,138 
1,126 
1,119 
 
709 
729 
714 
Other non-interest income
473 
465 
368 
 
295 
300 
235 
Non-interest income
1,611 
1,591 
1,487 
 
1,004 
1,029 
949 
Total income
4,653 
4,553 
4,264 
 
2,900 
2,946 
2,724 
Direct expenses
             
  - staff
(1,313)
(1,212)
(1,214)
 
(819)
(784)
(776)
  - other
(874)
(880)
(929)
 
(544)
(569)
(593)
Indirect expenses
(1,176)
(1,189)
(1,196)
 
(733)
(770)
(766)
 
(3,363)
(3,281)
(3,339)
 
(2,096)
(2,123)
(2,135)
Impairment losses
(521)
(799)
(1,099)
 
(325)
(517)
(702)
Operating profit/(loss)
769 
473 
(174)
 
479 
306 
(113)
               
Average exchange rate - US$/£
       
1.604 
1.546 
1.566 
               
Analysis of income by product
             
Mortgages and home equity
744 
786 
781 
 
464 
509 
499 
Personal lending and cards
673 
735 
706 
 
420 
476 
451 
Retail deposits
1,474 
1,397 
1,296 
 
918 
903 
828 
Commercial lending
931 
896 
848 
 
580 
580 
542 
Commercial deposits
469 
495 
624 
 
292 
320 
398 
Other
362 
244 
 
226 
158 
Total income
4,653 
4,553 
4,264 
 
2,900 
2,946 
2,724 
               
Analysis of impairments by sector
             
Residential mortgages
56 
90 
113 
 
35 
58 
72 
Home equity
160 
194 
261 
 
99 
126 
167 
Corporate and commercial
87 
312 
510 
 
54 
202 
326 
Other consumer
92 
150 
215 
 
57 
97 
137 
Securities
126 
53 
— 
 
80 
34 
— 
Total impairment losses
521 
799 
1,099 
 
325 
517 
702 
               
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) by sector
             
Residential mortgages
0.6% 
1.0% 
1.1% 
 
0.6% 
1.0% 
1.1% 
Home equity
0.7% 
0.8% 
1.0% 
 
0.7% 
0.8% 
1.1% 
Corporate and commercial
0.2% 
1.0% 
1.6% 
 
0.2% 
1.0% 
1.7% 
Other consumer
0.8% 
1.4% 
1.8% 
 
0.8% 
1.4% 
1.8% 
Total
0.5% 
1.0% 
1.4% 
 
0.5% 
1.0% 
1.4% 
               
Performance ratios
             
Return on equity (1)
6.3% 
3.6% 
(1.3%)
 
6.3% 
3.6% 
(1.3%)
Net interest margin
3.06% 
2.85% 
2.37% 
 
3.06% 
2.85% 
2.37% 
Cost:income ratio
72% 
72% 
78% 
 
72% 
72% 
78% 


Note:
(1)
Divisional return on equity is based on divisional operating profit/(loss) after tax divided by average notional equity (based on 9% of the monthly average of divisional RWAs, adjusted for capital deductions).
 
 
 
38

 
Business review continued


 
US Retail & Commercial continued
 
2011 
2010 
2009 
 
2011 
2010 
2009 
 
US$bn 
US$bn 
US$bn 
 
£bn 
£bn 
£bn 
Capital and balance sheet
             
Total third party assets
115.3 
110.5 
122.3 
 
74.5 
71.2 
75.4 
Loans and advances to customers (gross)
             
  - residential mortgages
9.4 
9.4 
10.6 
 
6.1 
6.1 
6.5 
  - home equity
23.1 
23.6 
25.0 
 
14.9 
15.2 
15.4 
  - corporate and commercial
35.3 
31.7 
31.6 
 
22.8 
20.4 
19.5 
  - other consumer
11.8 
10.6 
12.1 
 
7.6 
6.9 
7.5 
 
79.6 
75.3 
79.3 
 
51.4 
48.6 
48.9 
Customer deposits (excluding repos)
92.1 
91.2 
97.4 
 
59.5 
58.7 
60.1 
Risk elements in lending
             
  - retail
1.0 
0.7 
0.6 
 
0.6 
0.4 
0.4 
  - commercial
0.6 
0.7 
0.4 
 
0.4 
0.5 
0.2 
Total risk elements in lending
1.6 
1.4 
1.0 
 
1.0 
0.9 
0.6 
Loan:deposit ratio (excluding repos)
85% 
81% 
80% 
 
85% 
81% 
80% 
Risk-weighted assets
91.1 
88.4 
96.9 
 
58.8 
57.0 
59.7 
               
Spot exchange rate - US$/£
       
1.548 
1.552 
1.622 


Sterling weakened relative to the US dollar during the fourth quarter, with the average exchange rate decreasing by 2% compared with Q3 2011.

US R&C continued to focus on its back-to-basics strategy, with good progress made in developing the division’s customer franchise during 2011. The bank continued to re-energise the franchise through new branding, product development and competitive pricing.

To strengthen retail alignment and improve efficiencies, US R&C formed a consolidated Consumer Banking division by combining management of the retail banking franchise with the consumer lending division during H2 2011. This continued focus on alignment is expected to further contribute to the improved penetration of loan products to deposit households, which has already increased in ten consecutive quarters. The penetration of on-line banking customers, a key indicator of customer retention, also continued to improve during 2011.
 
To enhance the customer experience, in Q4 2011, Consumer Banking introduced four core Customer Commitments, built around feedback received from customers in Massachusetts. In Q1 2012, the Commitments will be rolled out to Citizens Financial Group’s (CFG’s) entire branch footprint.

Significant organisational changes and investment in Commercial Banking, including unification under the RBS Citizens brand, has been important in positioning the business for growth. The enhanced sales training programme for managers and sales colleagues in this business has begun to deliver results with both higher credit balances and increased client satisfaction.  External researchers TNS awarded Citizens the second highest score in relationship manager satisfaction among its competitors for 2011.

Risk management was also an important focus for 2011 and in Q4 2011, CFG’s Board of directors approved a new formal risk appetite statement aimed at ensuring sustained predictable earnings and further strengthening the control environment.


 
39

 
Business review continued


2011 compared with 2010
Operating profit increased to £479 million ($769 million) from £306 million ($473 million), an increase of £173 million ($296 million), or 56%.  Excluding a credit of £73 million ($113 million) related to changes to the defined benefit plan in Q2 2010, operating profit increased by £246 million ($409 million), or 106%, substantially driven by lower impairments and improved income.

The macroeconomic operating environment remained challenging, with low rates, high unemployment, a soft housing market, sluggish consumer activity and the continuing impact of legislative changes including the Durbin Amendment in the Dodd-Frank Act which became effective on 1 October 2011.

The Durbin Amendment lowers the allowable interchange on debit transactions to $0.23-$0.24 per transaction. The current annualised impact of the Durbin Amendment is estimated at £94 million ($150 million).

Net interest income was down £21 million, 2%. In US dollar terms, net interest income increased by $80 million, 3%. Net interest margin improved by 21 basis points to 3.06% reflecting changes in deposit mix, continued discipline around deposit pricing and the positive impact from the balance sheet restructuring programme carried out during Q3 2010 combined with strong commercial loan growth, partially offset by run-off of consumer loans.

Non-interest income was down £25 million, 1%. In US dollar terms, non-interest income increased by $20 million, 1%. The increase is primarily driven by higher account and transaction fees, partially offset by the impact of legislative changes on debit card and deposit fees.

Excluding the defined benefit plan credit of £73 million ($113 million) in Q2 2010, total expenses were down £100 million, 5% ($31 million in US dollar terms) due to a number of factors including lower Federal Deposit Insurance Corporation (FDIC) deposit insurance levies, and lower litigation and marketing costs, partially offset by higher regulatory costs.

Impairment losses declined by £192 million ($278 million), or 37%, largely reflecting an improved credit environment slightly offset by higher impairments related to securities.  Loan impairments as a percent of loans and advances improved to 0.5% from 1.0%.

Customer deposits were up 1% with particularly strong growth achieved in checking balances.  Consumer checking balances grew by 6%, while small business checking balances grew by 5% over the year.
 
2010 compared with 2009
Operating profit of £306 million ($473 million) represented a marked improvement from an operating loss of £113 million ($174 million) with income up 7%, expenses down 2% and impairment losses down 27%.

Net interest income was up 7%, despite a smaller balance sheet, with net interest margin improving by 48 basis points to 2.85%.

Non-interest income was up 7% reflecting higher mortgage banking and debit card income, commercial banking fees and higher gains on securities realisations. This was partially offset by lower deposit fees which were impacted by Regulation E legislative changes in 2010. In addition, gains of £213 million ($330 million) were recognised on the sale of available-for-sale securities as part of the balance sheet restructuring exercise, but these were almost wholly offset by losses crystallised on the termination of swaps hedging fixed-rate funding.

Total expenses were down 2%, reflecting a £73 million ($113 million) credit related to changes to the defined benefit pension plan, and lower Federal Deposit Insurance Corporation (FDIC) deposit insurance levies, partially offset by the impact of changing rates on the valuation of mortgage servicing rights and litigation costs.

Impairment losses declined 27%, following significant loan reserve building in 2009 and a gradual improvement in the underlying credit environment, offset by higher impairments related to securities. Loan impairments as a percentage of loans and advances decreased from 1.4% to 1.0%.
 
40

 
Business review continued


Global Banking & Markets

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income from banking activities
707 
1,252 
2,424 
Funding costs of rental assets
(42)
(37)
(49)
Net interest income
665 
1,215 
2,375 
Net fees and commissions receivable
1,049 
1,283 
1,335 
Income from trading activities
4,735 
5,218 
7,812 
Other operating income
(508)
196 
(464)
Non-interest income
5,276 
6,697 
8,683 
Total income
5,941 
7,912 
11,058 
Direct expenses
     
  - staff
(2,454)
(2,693)
(2,904)
  - other
(928)
(842)
(777)
Indirect expenses
(949)
(862)
(979)
 
(4,331)
(4,397)
(4,660)
Impairment losses
(49)
(151)
(640)
Operating profit
1,561 
3,364 
5,758 
       
Analysis of income by product
     
Rates - money markets
(212)
65 
1,714 
Rates - flow
1,668 
1,985 
3,142 
Currencies
868 
870 
1,277 
Credit and asset-backed markets
1,424 
2,215 
2,255 
Fixed income & currencies
3,748 
5,135 
8,388 
Portfolio management and origination
1,343 
1,777 
1,185 
Equities
781 
933 
1,474 
Total excluding fair value derivative liabilities
5,872 
7,845 
11,047 
Fair value derivative liabilities
69 
67 
11 
Total income
5,941 
7,912 
11,058 
       
Analysis of impairments by sector
     
Manufacturing and infrastructure
(139)
51
(91)
Property and construction
(42)
(74)
(49)
Banks and financial institutions
54 
(177)
(348)
Other
78 
49
(152)
Total impairment losses
(49)
(151)
(640)
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements)
0.1% 
0.2% 
0.6% 
       
Performance ratios
     
Return on equity (1)
7.7% 
16.6% 
29.8% 
Net interest margin
0.73% 
1.05% 
1.38% 
Cost:income ratio
73% 
56% 
42% 
Compensation ratio (2)
41% 
34% 
26% 
Compensation ratio - continuing business
39% 
32% 
 


Notes:
(1)
Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions).
(2)
Compensation ratio is based on staff costs as a percentage of total income.
 

 
 
41

 
Business review continued


 
2011 
2010 
2009 
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Loans and advances to customers
74.7 
75.1 
90.9 
Loans and advances to banks
29.9 
44.5 
36.9 
Reverse repos
100.5 
94.8 
73.3 
Securities
111.0 
119.2 
106.0 
Cash and eligible bills
28.1 
38.8 
74.0 
Other
17.5 
24.3 
31.1 
Total third party assets (excluding derivatives mark-to-market)
361.7 
396.7 
412.2 
Net derivative assets (after netting)
37.0 
37.4 
68.0 
Customer deposits (excluding repos)
37.4 
38.9 
46.9 
Risk elements in lending
1.8 
1.7 
1.8 
Risk-weighted assets
151.1 
146.9 
123.7 

During Q4 2011, the market environment continued to weaken.  Market volatility remained elevated and liquidity depressed as markets reacted to developments in the European sovereign debt crisis.  Deal flow was weak reflecting investor pessimism about the outlook for the world economy.  Throughout the year, GBM continued to deliver core products and innovative solutions to clients, while also focusing on management of its cost base and on tight control of its risk positions.

On 12 January 2012 the Group announced changes to its wholesale banking operations in light of a changed market and regulatory environment. The changes will see the reorganisation of RBS’s wholesale businesses into ‘Markets’ and ‘International Banking’ and the exit and downsizing of selected activities.  The changes will ensure the wholesale businesses continue to deliver against the Group’s strategy.

2011 compared with 2010
Operating profit fell by 54%, from £3,364 million for 2010 to £1,561 million for 2011, driven by a 25% decrease in revenue. The year was characterised by volatile and deteriorating credit markets, especially during the second half of the year when the European sovereign debt crisis drove a sharp widening in credit spreads.

Due to this deterioration in the markets both the Rates and Credit businesses suffered significantly, and income from trading activities, which is after funding costs both internal and external, fell from £5,218 million in 2010, to £4,735  million in 2011. The heightened volatility increased risk aversion amongst clients and limited opportunities for revenue generation in the secondary markets.

Portfolio Management and Origination revenue also fell sharply as clients curtailed new activity and continued to repay existing debt.

Equities revenue fell 16% as wider market conditions reduced investor confidence, resulting in lower client issuance and reduced activity in the secondary markets.

Total costs fell by 2% despite increased investment costs in 2011, which included a programme to meet new regulatory requirements. The compensation ratio in GBM excluding discontinued businesses was 39%, driven by fixed salary costs and prior year deferred awards. Variable compensation accrued in the first half of the year were reduced in the second half of the year, leaving the 2011 variable compensation awards 58% lower than 2010, compared with a 54% fall in operating profit, as detailed on page 289.

Third party assets fell from £396.7 billion in 2010 to £361.7 billion in 2011 as a result of lower levels of activity and careful management of balance sheet exposures.

A 3% increase in risk-weighted assets reflected the impact of significant regulatory changes, with a £21 billion uplift as a result of CRD III, largely offset by the impact of the division’s focus on risk management.

2010 compared with 2009
A fall in operating profit, of 42% year on year reflects sharply reduced revenue partially offset by lower costs and a significant improvement in impairments.

Total income was £3,146 million lower in 2010 driven by increased risk aversion in the market during Q3 and Q4 2010, combined with the non-repeat of favourable market conditions seen in the first half of 2009.

·  
Higher revenue across the Rates and Currencies businesses during 2009 was driven by rapidly falling interest rates and wide bid-offer spreads generating exceptional revenue opportunities, which have not been repeated in 2010.
·  
The Credit Markets business remained broadly flat, supported by strong Mortgage Trading income where customer demand remained buoyant during 2010.
·  
Increased revenue from Portfolio Management was driven by disciplined lending alongside a reduction in balance sheet management activities and associated costs.

Expenses fell by 6% to £4,397 million. This was largely driven by a decrease in staff costs, including on-going benefits from cost synergies.

The low level of impairments in 2010 reflected a small number of specific cases partially offset by an improved picture on latent loss provisions. This contrasted with 2009, which witnessed a significantly higher level of specific impairments.

At 16.6%, return on equity remained consistent with the 15% targeted over the business cycle in GBM’s strategic plan. The compensation ratio of 34% was below that of peers.
 
42

 
Business review continued


RBS Insurance

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Earned premiums
4,221 
4,459 
4,519 
Reinsurers' share
(252)
(148)
(165)
Net premium income
3,969 
4,311 
4,354 
Fees and commissions
(400)
(410)
(367)
Instalment income
138 
159 
171 
Investment income
265 
277 
214 
Other income
100 
179 
242 
Total income
4,072 
4,516 
4,614 
Direct expenses
     
 - staff expenses
(288)
(287)
(304)
 - other expenses
(333)
(325)
(368)
Indirect expenses
(225)
(267)
(270)
 
(846)
(879)
(942)
Impairment losses
— 
— 
(8)
Net claims
(2,772)
(3,932)
(3,606)
Operating profit/(loss)
454 
(295)
58 
       
Analysis of income by product
     
Personal lines motor excluding broker
     
  - own brands
1,874 
1,962 
1,814 
  - partnerships
228 
373 
360 
Personal lines home excluding broker
     
  - own brands
490 
488 
442 
  - partnerships
378 
408 
389 
Personal lines rescue and other excluding broker
     
  - own brands
185 
197 
191 
  - partnerships
132 
168 
220 
Commercial
365 
341 
305 
International
346 
333 
288 
Other (1)
74 
246 
605 
Total income
4,072 
4,516 
4,614 
       
In-force policies (000s)
     
Personal lines motor excluding broker
     
  - own brands
3,787 
4,162 
4,762 
  - partnerships
320 
645 
844 
Personal lines home excluding broker
     
  - own brands
1,811 
1,797 
1,774 
  - partnerships
2,497 
2,530 
2,566 
Personal lines rescue and other excluding broker
     
  - own brands
1,844 
1,966 
2,262 
  - partnerships
7,307 
7,497 
6,688 
Commercial
422 
352 
346 
International
1,387 
1,082 
944 
Other (1)
644 
1,049 
Total in-force policies (2)
19,376 
20,675 
21,235 


For notes relating to this table refer to page 44.

 
43

 
Business review continued


 
2011 
£m 
2010 
£m 
2009 
£m 
Gross written premium
     
Personal lines motor excluding broker
     
  - own brand
1,584 
1,647 
1,738 
  - partnerships
137 
257 
311 
Personal lines home excluding broker
     
  - own brand
474 
478 
462 
  - partnerships
549 
556 
560 
Personal lines rescue and other excluding broker
     
  - own brand
174 
178 
176 
  - partnerships
174 
159 
141 
Commercial
435 
397 
395 
International
570 
425 
354 
Other (1)
201 
343 
Total gross written premium
4,098 
4,298 
4,480 
       
Performance ratios
     
Return on regulatory capital (3)
11.3% 
(7.9%)
1.7% 
Return on tangible equity (4)
10.3% 
(6.8%)
1.4% 
Loss ratio (5)
70% 
91% 
83% 
Commission ratio (6)
10% 
10% 
8% 
Expense ratio (7)
20% 
20% 
21% 
Combined operating ratio (8)
100% 
121% 
112% 
Balance sheet
     
Total insurance reserves (£m) (9)
7,284 
7,643 
7,139 

Notes:
(1)
‘Other’ predominately consists of the personal lines broker business.
(2)
Total in-force policies include travel and creditor policies sold through RBS Group. These comprise travel policies included in bank accounts e.g. Royalties Gold Account, and creditor policies sold with bank products including mortgage, loan and card payment protection.
(3)
Return on regulatory capital required is based on annualised operating profit/(loss) after tax divided by average notional regulatory equity.
(4)
Return on tangible equity is based on annualised operating profit/(loss) after tax divided by average tangible equity.
(5)
Loss ratio is based on net claims divided by net premium income.
(6)
Commission ratio is based on fees and commissions divided by gross written premium income.
(7)
Expense ratio is based on expenses divided by gross written premium.
(8)
Combined operating ratio is the sum of the loss, commission and expense ratios.
(9)
Consists of general and life insurance liabilities, unearned premium reserves and liability adequacy reserve.

 
44

 
Business review continued


RBS Insurance continued
RBS Insurance continues to make good progress ahead of its divestment from the Group. Operating profit of £454 million for 2011 shows a return to full year profitability and represents close to a £750 million turnaround from 2010. These results demonstrate the success of the first phase of management’s transformation plan - to return to profit in 2011. The full year combined operating ratio improved to 100% (2010 - 121%) with a full year return on equity of 10.3% compared with a negative return of 6.8% in 2010.

The second phase of the RBS Insurance transformation plan, to build competitive advantage, is underway and tangible benefits are already being delivered. All new Churchill, Direct Line and Privilege motor claims, as well as all new Churchill home claims, are now being processed through a new claims management system.  Within motor, the rollout of a new rating engine and new pricing tools ensured more accurate and tailored pricing with the aim of generating greater value from RBS Insurance's multi-brand, multi-distribution strategy.

As part of the plan to build competitive advantage, the rationalisation of occupied sites continues, with 15 site exits by the end of 2011. The consolidation of the four UK general insurance underwriting entities within the RBS Insurance Group was successfully completed in December 2011. All UK general insurance business is now written through one underwriter with the aim of improving operational and capital efficiency.

Marking a significant new partnership, RBS Insurance signed a five-year contract with Sainsbury’s Finance in 2011 to provide underwriting, sales, service and claims management for its car insurance customers. Following the successful launch and development of the car insurance partnership, a further contract was signed early in 2012 to provide home insurance for Sainsbury’s customers.  Building on RBS Insurance’s established successful relationship with Nationwide Building Society, a deal was concluded to extend its provision of home insurance until the end of 2015.  RBS Insurance is also concluding terms with RBS Group’s UK Retail bank on the details of a five-year agreement for the continued provision of general insurance products post separation.  The term would commence from the point of initial divestment.

While overall gross written premium fell by 5% in 2011, it increased by 10% in Commercial, which includes NIG, the commercial broker business, and Direct Line for Business, the direct SME insurer.  A new brand identity was unveiled for NIG and work continued to improve its product offering and service to brokers. Direct Line for Business continued to develop well.

RBS Insurance’s international division showed strong growth in gross written premiums primarily in Italy, assisted by the first full year of its sales agreements with FGA Capital, a joint venture between Fiat and Credit Agricole.  The German business also showed good growth following improvements in the second half of 2011 to its direct and partnership business, including strengthening its relationship with Renault.

Ahead of the planned divestment in the second half of 2012, RBS Insurance has begun separating its activities and operations from RBS Group. Its corporate functions have been strengthened, arm’s length agreements are under discussion with the Group where appropriate, a new corporate brand, Direct Line Group was announced on 15 February 2012 and a new risk and control framework has been implemented, in readiness for standalone status.

Overall, RBS Insurance has powerful brands, improved earnings, a robust balance sheet and is executing the second phase of its transformation plan to rebuild competitive advantage.



 
45

 
Business review continued


2011 compared with 2010
Operating profit rose by £749 million in 2011, principally due to the non repeat of the bodily injury reserve strengthening in 2010, de-risking of the motor book, exit of certain business segments and more benign weather in 2011.

Gross written premium fell £200 million, 5%, as the business continued to drive improved profitability through reduced volumes in unattractive segments.  This was partially offset by growth in Commercial and International.

Total income fell £444 million, 10%, following the exit of personal lines broker, a decline in premiums reflecting reduced motor volumes and higher reinsurance costs to reduce the risk profile of the book. Investment income fell £12 million, 4%, reflecting decreased yields on the portfolio in 2011, partially offset by higher realised gains.
 
Total direct expenses rose by £9 million principally driven by project activity to support the transformation plan.

Net claims fell £1,160 million, 30%, due to the non recurrence of bodily injury reserve strengthening in 2010, actions taken to de-risk the book, the exit of certain business segments and more benign weather in 2011.

At the end of 2011, RBS Insurance's investment portfolios comprised primarily cash, gilts and investment grade bonds.  Within the UK portfolio, £8.9 billion, and the International portfolio, £827 million, there was no exposure to sovereign debt issued by Portugal, Ireland, Italy, Greece or Spain.

Total in-force policies fell 6% in the year due to planned de-risking of the motor book and the exiting of certain other segments and partnerships, including personal lines broker.

2010 compared with 2009
RBS Insurance has embarked on a significant programme of investment designed to achieve a substantial lift in operational and financial performance, ahead of the planned divestment of the business, with a current target date of 2012. This programme encompasses the enhancement of pricing capability, transformation of claims operations and expense reduction, together with a range of other improvements across the business, including a greater focus on capital management.

2010 as a whole was a disappointing profit year, impacted by significant reserve strengthening for bodily injury claims and severe weather, resulting in a loss of £295 million.

Income was down 2% (£98 million) against 2009, driven by a managed reduction in the risk of the UK motor book, largely offset by significant price increases:

·  
This de-risking was achieved by a combination of rating action to reduce the mix of higher-risk drivers, and the partial or total exit of higher risk business lines (significantly scaling back the fleet and taxi business and the exit of personal lines business sold through insurance brokers). As a result in-force motor policies fell 14% compared with 2009.
 
·  
Even with the significant reduction in the risk mix of the book, average motor premiums were up 7% in the year, due to significant price increases. The prices of like-for-like policies have increased by 35-40% over the last year. These increases were in addition to the significant increases achieved in 2009.

Initiatives to grow ancillary income were also implemented during the year resulting in revenues of £46 million in 2010 (£25 million in 2009). Away from UK motor, overall home gross written premiums grew by 2%. This included the exit from less profitable business in line with overall strategy. Our underlying own brands business continues to grow successfully, with gross written premiums increasing 4%.

The International business continued to invest in growth in 2010 with gross written premiums of £425 million up 20% on 2009. The Italian business successfully grew to a market share approaching 30% of the direct insurer market. The German business grew 7% and is well positioned to take advantage of the emerging shift to direct/internet distribution in that market.

Several programmes to further improve the overall efficiency of the business took effect during the year, including a reduction of six sites and operational process improvements, which will continue to improve efficiency.

Total in-force policies declined by 3%, driven by a fall of 14% in motor policies. This was partly offset by higher travel policies, up 64% with new business from a partnership with Nationwide Building Society commencing in Q4 2010. The personal lines broker segment overall declined by 43%, in line with business strategy.

Underwriting income declined by £63 million, with lower motor premium income, driven by rating action. Increased fees and commissions reflected profit sharing arrangements with UK Retail in relation to insurance distribution to bank customers. Investment income was £28 million lower, reflecting the impact of low interest rates on returns on the investment portfolio as well as lower gains realised on the sale of investments.

Net claims were £326 million higher than in 2009, driven by increases to bodily injury reserves relating to prior years, including allowance for higher claims costs in respect of Periodic Payment Orders due to an increased settlement rate of such claims. Although bodily injury frequency has stabilised, severity has continued to deteriorate.  Claims were also impacted by the adverse weather experienced in the first and fourth quarters.

Expenses were down 7%, driven by lower industry levies and marketing costs.

 
46

 
Business review continued


Central items

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Central items not allocated
156 
577 
385 


Funding and operating costs have been allocated to operating divisions, based on direct service usage, requirement for market funding and other appropriate drivers where services span more than one division.

Residual unallocated items relate to volatile corporate items that do not naturally reside within a division.
 
2011 compared with 2010
Central items not allocated represented a credit of £156 million in 2011, a decline of £421 million compared with 2010.

2010 benefited from c.£300 million of accounting gains on hybrid securities, c.£150 million of which was amortised during 2011.

A VAT recovery of £176 million in 2010 compared with £85 million recovered in 2011.

2010 compared with 2009
Central items not allocated including available-for-sale (AFS) gains of £237 million and one-off VAT recovery in 2010 of £170 million, amounted to a net credit of £577 million, an increase of £192 million on 2009.

The Group’s credit spreads have fluctuated over the course of the year, but ended the year slightly wider, resulting in an overall annual decrease in the carrying value of own debt.


 
47

 
Business review continued


Non-Core

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net interest income
876 
1,959 
1,506 
Funding costs of rental assets
(210)
(276)
(256)
Net interest income
666 
1,683 
1,250 
Net fees and commissions
(38)
471 
510 
Loss from trading activities
(721)
(31)
(5,161)
Insurance net premium income
286 
695 
784 
Other operating income
     
  - rental income
953 
1,035 
690 
  - other (1)
60 
(889)
(443)
Non-interest income
540 
1,281 
(3,620)
Total income/(loss)
1,206 
2,964 
(2,370)
Direct expenses
     
  - staff
(375)
(731)
(851)
  - operating lease depreciation
(347)
(452)
(402)
  - other
(256)
(573)
(573)
Indirect expenses
(317)
(500)
(552)
 
(1,295)
(2,256)
(2,378)
Insurance net claims
(195)
(737)
(588)
Impairment losses
(3,919)
(5,476)
(9,221)
Operating loss
(4,203)
(5,505)
(14,557)
       
Analysis of income/(loss) by business
     
Banking & portfolios
1,474 
1,673 
(155)
International businesses
419 
778 
1,204 
Markets
(687)
513 
(3,419)
Total income/(loss)
1,206 
2,964 
(2,370)
       
Loss from trading activities
     
Monoline exposures
(670)
(5)
(2,387)
Credit derivative product companies
(85)
(139)
(947)
Asset-backed products (2)
29 
235 
(288)
Other credit exotics
(175)
77 
(558)
Equities
(11)
(17)
(47)
Banking book hedges
(1)
(82)
(1,613)
Other (3)
192 
(100)
679 
 
(721)
(31)
(5,161)
       
Impairment losses
     
Banking & portfolios
3,833 
5,328 
8,350 
International businesses
82 
200 
499 
Markets
(52)
372 
Total impairment losses
3,919 
5,476 
9,221 
       
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase agreements) (4)
     
Banking & portfolios
4.9% 
5.0% 
5.8% 
International businesses
3.7% 
4.4% 
4.1% 
Markets
(3.0%)
0.2% 
7.5% 
Total
4.8% 
4.9% 
5.7% 
       

Notes:
(1)
Includes losses on disposals of £127 million for  2011 (2010 - £504 million).
(2)
Asset-backed products include super asset backed structures and other asset-backed products.
(3)
Includes profits in RBS Sempra Commodities JV of £4 million for 2011 (2010 - £372 million).
(4)
Includes disposal groups.
 
 
 
48

 
Business review continued

 
Non-Core continued

 
2011 
2010 
2009 
Performance ratios
     
Net interest margin
0.64% 
1.16% 
0.69% 
Cost:income ratio
107% 
76% 
(100%)
Adjusted cost:income ratio
128% 
101% 
(80%)
       
 
£bn 
£bn 
£bn 
Capital and balance sheet
     
Total third party assets (excluding derivatives) (1)
93.7 
137.9 
201.0 
Total third party assets (including derivatives) (1)
104.7 
153.9 
220.9 
Loans and advances to customers (gross) (2)
79.4 
108.4 
149.5 
Customer deposits (2)
3.5 
6.7 
12.6 
Risk elements in lending (2)
24.0 
23.4 
22.9 
Risk-weighted assets (1)
93.3 
153.7 
171.3 
       
Gross customer loans and advances
     
Banking & portfolios
77.3 
104.9 
138.3 
International businesses
2.0 
3.5 
9.4 
Markets
0.1 
— 
1.8 
 
79.4 
108.4 
149.5 
       
Risk-weighted assets
     
Banking & portfolios
64.8 
83.5 
92.5 
International businesses
4.1 
5.6 
11.5 
Markets
24.4 
64.6 
67.3 
 
93.3 
153.7 
171.3 
       
Third party assets (excluding derivatives)
     
Banking & portfolios
81.3 
113.9 
58.2 
International businesses
2.9 
4.4 
43.8 
Markets
9.5 
19.6 
69.3 
 
93.7 
137.9 
171.3 


 
31 December 
2010 
£bn 
Run-off 
£bn 
Disposals/ 
restructuring 
£bn 
Drawings/ 
roll overs 
£bn 
Impairments 
£bn 
FX 
£bn 
31 December 
2011 
£bn 
Third party assets (excluding derivatives)
Commercial real estate
42.6 
(5.6)
(2.4)
0.7 
(3.4)
(0.4)
31.5 
Corporate
59.8 
(8.5)
(11.3)
2.5 
(0.1)
(0.2)
42.2 
SME
3.7 
(1.6)
— 
0.1 
(0.1)
— 
2.1 
Retail
9.0 
(1.1)
(1.4)
— 
(0.3)
(0.1)
6.1 
Other
2.5 
(0.6)
— 
— 
— 
— 
1.9 
Markets
13.6 
(2.9)
(1.8)
1.0 
 
(0.1)
9.8 
Total (excluding derivatives)
131.2 
(20.3)
(16.9)
4.3 
(3.9)
(0.8)
93.6 
Markets - RBS Sempra Commodities JV
6.7 
(1.3)
(5.0)
— 
— 
(0.3)
0.1 
Total (3)
137.9 
(21.6)
(21.9)
4.3 
(3.9)
(1.1)
93.7 

Notes:
(1)
Includes RBS Sempra Commodities JV (2011 third party assets, excluding derivatives (TPAs) £0.1 billion, RWAs  £1.6 billion; 2010 TPAs £6.7 billion, RWAs £4.3 billion).
(2)
Excluding disposal groups.
(3)
Disposals of £0.2 billion have been signed as at  31 December 2011 (2010 - £12 billion).
 

 
 
49

 
Business review continued


Impairment losses by donating division and sector
2011 
£m 
2010 
£m 
2009 
£m 
UK Retail
     
Mortgages
Personal
(27)
47 
Total UK Retail
(22)
13 
53 
       
UK Corporate
     
Manufacturing and infrastructure
76 
26 
87 
Property and construction
224 
437 
651 
Transport
52 
10 
Banking and financial institutions
69 
102 
Lombard
75 
129 
95 
Other
96 
166 
732 
Total UK Corporate
528 
830 
1,677 
       
Ulster Bank
     
Mortgages
 
42 
42 
Commercial real estate
     
  - investment
609 
630 
286 
  - development
1,552 
1,759 
733 
Other corporate
173 
251 
217 
Other EMEA
15 
52 
106 
Total Ulster Bank
2,349 
2,734 
1,384 
       
US Retail & Commercial
     
Auto and consumer
58 
82 
136 
Cards
(9)
23 
130 
SBO/home equity
201 
277 
452 
Residential mortgages
16 
54 
Commercial real estate
40 
185 
224 
Commercial and other
(3)
17 
83 
Total US Retail & Commercial
303 
588 
1,079 
       
Global Banking & Markets
     
Manufacturing and infrastructure
57 
(290)
1,404 
Property and construction
752 
1,296 
1,413 
Transport
(3)
33 
178 
Telecoms, media and technology
68 
545 
Banking and financial institutions
(98)
196 
620 
Other
(20)
14 
567 
Total Global Banking & Markets
756 
1,258 
4,727 
       
Other
     
Wealth
51 
251 
Global Transaction Services
— 
49 
Central items
Total Other
53 
301 
       
Total impairment losses
3,919 
5,476 
9,221 


 
50

 
Business review continued

Non-Core continued

Gross loans and advances to customers (excluding reverse repurchase agreements) by donating division and sector
2011 
£bn 
2010 
£bn 
2009 
£bn 
UK Retail
     
Mortgages
1.4 
1.6 
1.9 
Personal
0.1 
0.4 
0.7 
Total UK Retail
1.5 
2.0 
2.6 
       
UK Corporate
     
Manufacturing and infrastructure
0.1 
0.3 
0.3 
Property and construction
5.9 
11.4 
14.1 
Transport
4.5 
5.4 
— 
Banking and financial institutions
0.6 
0.8 
— 
Lombard
1.0 
1.7 
2.9 
Other
7.5 
7.4 
17.6 
Total UK Corporate
19.6 
27.0 
34.9 
       
Ulster Bank
     
Mortgages
— 
— 
6.0 
Commercial real estate
     
  - investment
3.9 
4.0 
2.1 
  - development
8.5 
8.4 
6.3 
Other corporate
1.6 
2.2 
1.3 
Other EMEA
0.4 
0.4 
1.0 
Total Ulster Bank
14.4 
15.0 
16.7 
       
US Retail & Commercial
     
Auto and consumer
0.8 
2.6 
3.2 
Cards
0.1 
0.1 
0.5 
SBO/home equity
2.5 
3.2 
3.7 
Residential mortgages
0.6 
0.7 
0.8 
Commercial real estate
1.0 
1.5 
1.9 
Commercial and other
0.4 
0.5 
0.9 
Total US Retail & Commercial
5.4 
8.6 
11.0 
       
Global Banking & Markets
     
Manufacturing and infrastructure
6.6 
8.7 
17.5 
Property and construction
15.3 
19.6 
25.7 
Transport
3.2 
5.5 
5.8 
Telecoms, media and technology
0.7 
0.9 
3.2 
Banking and financial institutions
5.6 
12.0 
16.0 
Other
6.8 
9.0 
13.5 
Total Global Banking & Markets
38.2 
55.7 
81.7 
       
Other
     
Wealth
0.2 
0.4 
2.6 
Global Transaction Services
0.2 
0.3 
0.8 
RBS Insurance
— 
0.2 
0.2 
Central items
(0.2)
(1.0)
(3.2)
Total Other
0.2 
(0.1)
0.4 
       
Gross loans and advances to customers (excluding reverse repurchase agreements)
79.3 
108.2 
147.3 


 
51

 
Business review continued

Non-Core third party assets fell to £94 billion, below the revised year end target of £96 billion and significantly ahead of the original guidance of £118 billion.  Further reductions will include the sale of RBS Aviation Capital for £4.7 billion, which was signed in January 2012.  Since the division was formed in 2009, the reduction totals £164 billion, or 64%. By the end of 2011, the Non-Core funded balance sheet equated to less than 10% of the Group funded balance sheet compared with 21% when the division was created.

The division focused on reducing capital intensive trading assets, with activity including the restructuring of monoline exposures, which, at a cost of c.£600 million in 2011, achieved a reduction of £32 billion in risk-weighted assets.

An operating loss of £4,203 million for 2011 was £1,302 million lower than 2010.  Income declined by £1,758 million reflecting continued divestment, including business and country exits.  The decrease was partially offset by a reduction in expenses of £961 million, largely driven by the fall in headcount. Impairment losses fell by £1,557 million despite ongoing challenges in the real estate and Ulster Bank portfolios.

2011 compared with 2010
Operating loss of £4,203 million in 2011 was £1,302 million lower than the loss recorded in 2010. The continued divestment of Non-Core businesses and portfolios has reduced revenue streams as well as the cost base.

Losses from trading activities increased by £690 million compared with 2010, principally as a result of the disposal of RBS Sempra Commodities in 2010 and costs incurred as part of the division’s focus on reducing capital intensive trading assets and mitigating future regulatory uplifts in risk-weighted assets.

Impairment losses fell by £1,557 million despite ongoing challenges in the real estate and Ulster Bank portfolios, reflecting improvements in other asset classes.

Third party assets declined by £44 billion (32%) reflecting disposals of £22 billion and run-off of £22 billion.

Risk-weighted assets were £60 billion lower than 2010, principally driven by significant disposal activity on trading book assets combined with run-off.

Headcount declined by 2,189 (32%) to 4,669 in 2011, largely reflecting the divestment activity in relation to Asia, Non-Core Insurance and RBS Sempra Commodities.

2010 compared with 2009
By the end of 2010 third party assets (excluding derivatives) had decreased to £138 billion, £5 billion lower than the end of year target, as a result of a successful disposal strategy, managed portfolio run-off and impairments.

2010 operating losses in Non-Core were 62% lower than those recorded in 2009. The improvement in performance was driven by significantly lower trading losses, reduced expenses and a marked decline in impairments.

Losses from trading activities declined from £5,161 million for 2009 to £31 million for 2010 as underlying asset prices recovered, offset by continuing weakness in credit spreads. The division has recorded profits on the disposal of many asset-backed securities positions. In addition, a significantly smaller loss of £161 million was recorded on banking book hedges as spreads tightened, compared with £1,728 million in 2009.

Staff expenses fell by 14% over the year, largely driven by the impact of business divestments, including a number of country exits and the disposal of substantially all of the Group’s interest in the RBS Sempra Commodities JV.

Impairments were £3,745 million lower than 2009. The decline reflects the overall improvement in the economic environment, although still high loss rates reflect the difficult conditions experienced in specific sectors, including both UK and Irish commercial property sectors.

Wholesale country exits completed during 2010 were Chile, Colombia, Pakistan and Taiwan.

Risk-weighted assets decreased by £18 billion (10%), reflecting active management to reduce trading book risk and disposals, partially offset by the impact of regulatory changes (£30 billion) and more conservative weightings applied to large corporate exposures.

 
52

 
Business review continued


Consolidated balance sheet at 31 December 2011

 
2011
2010
2009
 
£m
£m
£m
Assets
     
Cash and balances at central banks
79,269
57,014
52,261
Net loans and advances to banks
43,870
57,911
56,656
Reverse repurchase agreements and stock borrowing
39,440
42,607
35,097
Loans and advances to banks
83,310
100,518
91,753
Net loans and advances to customers
454,112
502,748
687,353
Reverse repurchase agreements and stock borrowing
61,494
52,512
41,040
Loans and advances to customers
515,606
555,260
728,393
Debt securities
209,080
217,480
267,254
Equity shares
15,183
22,198
19,528
Settlement balances
7,771
11,605
12,033
Derivatives
529,618
427,077
441,454
Intangible assets
14,858
14,448
17,847
Property, plant and equipment
11,868
16,543
19,397
Deferred tax
3,878
6,373
7,039
Prepayments, accrued income and other assets
10,976
12,576
20,985
Assets of disposal groups
25,450
12,484
18,542
Total assets
1,506,867
1,453,576
1,696,486
       
Liabilities
     
Bank deposits
69,113
66,051
104,138
Repurchase agreements and stock lending
39,691
32,739
38,006
Deposits by banks
108,804
98,790
142,144
Customers deposits
414,143
428,599
545,849
Repurchase agreements and stock lending
88,812
82,094
68,353
Customer accounts
502,955
510,693
614,202
Debt securities in issue
162,621
218,372
267,568
Settlement balances
7,477
10,991
10,413
Short positions
41,039
43,118
40,463
Derivatives
523,983
423,967
424,141
Accruals, deferred income and other liabilities
23,125
23,089
30,327
Retirement benefit liabilities
2,239
2,288
2,963
Deferred tax
1,945
2,142
2,811
Insurance liabilities
6,312
6,794
10,281
Subordinated liabilities
26,319
27,053
37,652
Liabilities of disposal groups
23,995
9,428
18,890
Total liabilities
1,430,814
1,376,725
1,601,855
       
Non-controlling interests
1,234
1,719
16,895
Owners’ equity
74,819
75,132
77,736
Total equity
76,053
76,851
94,631
       
Total liabilities and equity
1,506,867
1,453,576
1,696,486


 
53

 
Business review continued

 
Commentary on consolidated balance sheet
2011 compared with 2010
Total assets of £1,506.9 billion at 31 December 2011 were up £53.3 billion, 4%, compared with 31 December 2010. This principally reflects an increase in cash and balances at central banks and the mark-to-market value of derivatives in Global Banking & Markets, partly offset by decreases in debt securities and equity shares and the continuing disposal and run-off of Non-Core assets.

Cash and balances at central banks were up £22.3 billion, 39%, to £79.3 billion due to improvements in the Group’s structured liquidity position during 2011.

Loans and advances to banks decreased by £17.2 billion, 17%, to £83.3 billion. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were down £3.2 billion, 7%, to £39.4 billion and bank placings declined £14.0 billion, 24%, to £43.9 billion, primarily as a result of the reduction in exposure to eurozone banks and lower cash collateral requirements.

Loans and advances to customers were down £39.7 billion, 7%, to £515.6 billion. Within this, reverse repurchase agreements were up £9.0 billion, 17%, to £61.5 billion. Customer lending decreased by £48.7 billion, 10%, to £454.1 billion or £46.9 billion, 9%, to £473.9 billion before impairment provisions.  This reflected the transfer to disposal groups of £19.5 billion of customer balances relating to the UK branch-based businesses.  There were also planned reductions in Non-Core of £28.1 billion, together with declines in UK Corporate, £2.9 billion and Ulster Bank, £2.0 billion, together with the effect of exchange rate and other movements, £1.9 billion. These were partially offset by growth in Global Banking & Markets, £0.2 billion, Global Transaction Services, £1.5 billion, Wealth, £0.7 billion, UK Retail, £2.3 billion and US Retail & Commercial, £2.8 billion.

Debt securities were down £8.4 billion, 4%, to £209.1 billion driven mainly by a reduction in holdings of government and financial institution bonds in Global Banking & Markets and Group Treasury.

Equity shares decreased £7.0 billion, 32%, to £15.2 billion which largely reflects the closure of positions to reduce the Group’s level of unsecured funding requirements to mitigate the potential impact of unfavourable market conditions.

Settlement balances declined £3.8 billion, 33% to £7.8 billion as a result of decreased customer activity.

Movements in the value of derivative assets up £102.5 billion, 24%, to £529.6 billion, and liabilities, up £100.0 billion, 24%, to £524.0 billion, primarily reflect increases in interest rate contracts as a result of a significant downward shift in interest rates across all major currencies, together with increases in the mark-to-market value of credit derivatives as a result of widening credit spreads and rising credit default swap prices.

Property, plant and equipment declined £4.7 billion, 28%, to £11.9 billion, primarily as a result of the transfer of RBS Aviation Capital’s operating lease assets to disposal groups.

Deferred taxation was down £2.5 billion, 39%, to £3.9 billion, largely as a result of the utilisation of brought forward tax losses in the UK.

The increase in assets and liabilities of disposal groups reflects the reclassification of the UK branch-based businesses and RBS Aviation Capital pending their disposal, partly offset by the completion of disposals, primarily RBS Sempra Commodities JV and certain Non-Core project finance assets.

Deposits by banks increased £10.0 billion, 10%, to £108.8 billion, with higher repurchase agreements and stock lending (‘repos’), up £6.9 billion, 21%, to £39.7 billion and higher inter-bank deposits, up £3.1 billion, 5%, to £69.1 billion.

Customer accounts fell £7.7 billion, 2%, to £503.0 billion. Within this, repos increased £6.7 billion, 8%, to £88.8 billion. Excluding repos, customer deposits were down £14.4 billion, 3%, to £414.1 billion, reflecting the transfer to disposal groups of £21.8 billion of customer accounts relating to the UK branch-based businesses. This was partly offset by the net effect of growth in Global Transaction Services £2.7 billion, UK Corporate, £0.9 billion, UK Retail, £5.8 billion, US Retail & Commercial, £0.6 billion and Wealth, £1.8 billion, together with exchange rate and other movements of £0.3 billion and declines in Global Banking & Markets, £0.8 billion, Ulster Bank, £0.8 billion and Non-Core, £3.1 billion.

Debt securities in issue were down £55.8billion, 26% to £162.6 billion driven by reductions in the level of certificates of deposit and commercial paper in Global Banking & Markets and Group Treasury.

Settlement balances declined £3.5 billion, 32%, to £7.5 billion and short positions were down £2.1 billion, 5%, to £41.0 billion due to decreased customer activity.

Subordinated liabilities were down £0.7 billion, 3%, to £26.3 billion, primarily reflecting the redemption of £0.2 billion US dollar and £0.4 billion Euro denominated dated loan capital.

The Group’s non-controlling interests decreased by £0.5 billion, 28%, to £1.2 billion, primarily due to the disposal of the majority of the RBS Sempra Commodities JV business, £0.4 billion.

Owners’ equity decreased by £0.3 billion to £74.8 billion. This was driven by the attributable loss for the year, £2.0 billion, together with the recognition of actuarial losses in respect of the Group’s defined benefit pension schemes, net of tax, £0.5 billion and exchange rate and other movements of £0.3 billion.  Offsetting these reductions were gains in available-for-sale reserves, £1.1 billion and cashflow hedging reserves, £1.0 billion and the issue of shares under employee share schemes, £0.4 billion.

 
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Commentary on consolidated balance sheet

2010 compared with 2009
Total assets of £1,453.6 billion at 31 December 2010 were down £242.9 billion, 14%, compared with 31 December 2009. This principally reflects the disposal of the RFS minority interest, the continuing planned disposal of Non-Core assets, together with a reduction in the level of debt securities and the mark-to-market value of derivatives.

Cash and balances at central banks were up £4.8 billion, 9%, to £57.0 billion principally due to an improvement in the Group's structural liquidity position during 2010.

Loans and advances to banks increased by £8.8 billion, 10%, to £100.5 billion. Adjusting for the disposal of the RFS minority interest, the increase was £16.6 billion, 20%. Reverse repurchase agreements and stock borrowing (‘reverse repos’) were up £7.5 billion, 21% to £42.6 billion and bank placings rose £9.1 billion, 19%, to £57.9 billion, primarily as a result of the investment of surplus liquidity in short-term assets.

Loans and advances to customers decreased £173.1 billion, 24%, to £555.3 billion. Excluding the disposal of the RFS minority interest, lending to customers was down £40.4 billion, 7%. Within this, reverse repurchase agreements were up £11.5 billion, 28%, to £52.5 billion. Customer lending decreased by £51.9 billion to £502.7 billion or £48.9 billion before impairment provisions. This reflected planned reductions in Non-Core of £39.7 billion along with declines in Global Banking & Markets, £16.7 billion, US Retail & Commercial, £2.6 billion and Ulster Bank, £2.0 billion. These were partially offset by growth in UK Retail, £5.4 billion, Wealth, £2.4 billion and Global Transaction Services, £1.7 billion, together with the effect of exchange rate and other movements, £2.6 billion.

Debt securities were down £49.8 billion, 19%, to £217.5 billion, or £31.6 billion, 13%, adjusting for the disposal of the RFS minority interest, driven mainly by reductions in Global Banking & Markets.

The value of derivative assets were down £14.4 billion, 3%, to £427.1 billion, primarily reflecting a decrease in interest contracts, movements in five to ten year interest yields, and the combined effect of currency movements, with Sterling weakening against the dollar but strengthening against the Euro.

The reduction in assets and liabilities of disposal groups resulted from the completion of disposals of certain of the Group’s Asian and Latin American businesses, and substantially all of the RBS Sempra Commodities JV business.

Deposits by banks declined £43.4 billion, 31%, to £98.8 billion or £66.1 billion, 36% following the disposal of the RFS minority interest, with reduced inter-bank deposits, down £49.7 billion, 43%, to £66.1 billion and lower repurchase agreements and stock lending (‘repos’), down £5.3 billion, 14%, to £32.7 billion.

Customer accounts decreased £103.5 billion, 17%, to £510.7 billion but excluding the disposal of the RFS minority interest were up £28.1 billion, 6%. Within this, repos increased £13.7 billion, 20%, to £82.1 billion. Excluding repos, customer deposits were up £14.3 billion, 3%, to £428.6 billion, reflecting growth in UK Corporate, £12.2 billion, Global Transaction Services, £7.8 billion, UK Retail, £7.0 billion, Ulster Bank, £1.7 billion and Wealth, £0.8 billion, together with exchange rate and other movements of £3.0 billion. This was partially offset by decreases in Global Banking & Markets, £8.3 billion, US Retail & Commercial, £4.0 billion and Non-Core, £5.9 billion.

Debt securities in issue were down £49.2 billion, 18%, to £218.4 billion. Excluding the RFS minority interest disposal, they declined £28.0 billion, 11%, to £218.4 billion. Reductions in the level of certificates of deposit and commercial paper in Global Banking & Markets were partially offset by a programme of new term issuances totalling £38.4 billion.

Subordinated liabilities decreased by £10.6 billion, 28% to £27.1 billion or £4.5 billion, 14% excluding the disposal of the RFS minority interest. This reflected the redemption of £2.6 billion undated loan capital, debt preference shares and trust preferred securities under the liability management exercise completed in May, together with the conversion of £0.8 billion US dollar and Sterling preference shares and the redemption of £1.6 billion of other dated and undated loan capital, which were partially offset by the effect of exchange rate movements and other adjustments of £0.5 billion.

The Group’s non-controlling interests decreased by £15.2 billion, primarily reflecting the disposal of the RFS minority interest, £14.4 billion, the majority of the RBS Sempra Commodities JV business, £0.6 billion, and the life assurance business, £0.2 billion.

Owner’s equity decreased by £2.6 billion, 3%, to £75.1 billion. This was driven by the partial redemption of preference shares and paid-in equity, £3.1 billion less related gains of £0.6 billion, the attributable loss for the period, £1.1 billion, together with an increase in own shares held of £0.7 billion and higher losses in available-for-sale reserves, £0.3 billion. Offsetting these reductions were the issue of £0.8 billion ordinary shares on conversion of US dollar and Sterling non-cumulative preference shares classified as debt and exchange rate and other movements, £1.2 billion.

 
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Cash flow
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net cash flows from operating activities
3,325 
19,291 
(992)
Net cash flows from investing activities
14 
3,351 
54 
Net cash flows from financing activities
(1,741)
(14,380)
18,791 
Effects of exchange rate changes on cash and cash equivalents
(1,473)
82 
(8,592)
Net increase in cash and cash equivalents
125 
8,344 
9,261 


2011
The major factors contributing to the net cash inflow from operating activities of £3,325 million were the elimination of foreign exchange differences of £2,702 million, depreciation and amortisation of £1,875 million and inflow from other items of £2,900 million, partially offset by the net operating loss before tax of £708 million from continuing and discontinued operations and the decrease of £3,444 million in operating assets and liabilities.

Net cash inflows from investing activities of £14 million related to the net inflows from sales of securities of £3,074 million, and sale of property, plant and equipment of £1,840 million offset by net cash outflows from investments in business interests and intangible assets of £1,428 million and from the purchase of property, plant and equipment of £3,472 million.

Net cash outflows from financing activities of £1,741 million relate primarily to interest on subordinated liabilities of £714 million, repayment of subordinated liabilities of £627 million and redemption of non-controlling interests of £382 million.

2010
The major factors contributing to the net cash inflow from operating activities of £19,291 million were the increase of £17,095 million in operating assets less operating liabilities, depreciation and amortisation of £2,220 million and income taxes received of £565 million, partly offset by the net operating loss before tax of £940 million from continuing and discontinued operations.

Net cash flows from investing activities of £3,351 million relate to the net inflows from sales of securities of £4,119 million and investments in business interests and intangibles of £3,446 million. This was partially offset by the outflow of £4,112 million from investing activities of discontinued operations.

Net cash outflow from financing activities of £14,380 million primarily arose from the redemption of non-controlling interests of £5,282 million, dividends paid of £4,240 million, repayment of subordinated liabilities of £1,588 million and the redemption of preference shares of £2,359 million.

2009
The major factors contributing to the net cash outflow from operating activities of £992 million were the net operating loss before tax of £2,696 million from continuing and discontinued operations, the decrease of £15,964 million in operating liabilities less operating assets, partly offset by the elimination of foreign exchange differences of £12,217 million and other items of £5,451 million.

Net cash flows from investing activities of £54 million relate to the net sales and maturities of securities of £2,899 million and a net cash inflow of £105 million in respect of other acquisitions and disposals less the net cash outflow on disposals of property, plant and equipment of £2,950 million.

Net cash flows from financing activities of £18,791 million primarily arose from the capital raised from the issue of B shares of £25,101 million, the placing and open offer of £5,274 million and the issue of subordinated liabilities of £2,309 million. This was offset in part by the cash outflow on repayment of subordinated liabilities of £5,145 million, redemption of preference shares of £5,000 million, interest paid on subordinated liabilities of £1,746 million and dividends paid of £1,248 million.

 
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Capital resources
The following table analyses the Group's regulatory capital resources on a fully consolidated basis at 31 December as monitored by the FSA for regulatory purposes.

 
2011 
2010 
2009 
2008 
2007 
 
£m 
£m 
£m 
£m 
£m 
Capital base
         
Tier 1 capital
56,990 
60,124 
76,421 
69,847 
44,364 
Tier 2 capital
8,546 
9,897 
15,389 
32,223 
33,693 
Tier 3 capital
— 
— 
— 
260 
200 
 
65,536 
70,021 
91,810 
102,330 
78,257 
Less: Supervisory deductions
(4,828)
(4,732)
(4,565)
(4,155)
(10,283)
Total regulatory capital
60,708 
65,289 
87,245 
98,175 
67,974 
           
Risk-weighted assets (1)
         
Credit risk
344,300 
385,900 
513,200 
551,300 
 
Counterparty risk
61,900 
68,100 
56,500 
61,100 
 
Market risk
64,000 
80,000 
65,000 
46,500 
 
Operational risk
37,900 
37,100 
33,900 
36,900 
 
 
508,100 
571,100 
668,600 
695,800 
 
Asset Protection Scheme relief
(69,100)
(105,600)
(127,600)
n/a 
 
 
439,000 
465,500 
541,000 
695,800 
 

Banking book:
     
  On-balance sheet
   
480,200 
  Off-balance sheet
   
84,600 
Trading book
   
44,200 
     
609,000 

Risk asset ratios
% 
Core Tier 1
10.6 
10.7 
11.0 
6.6 
4.5 
Tier 1
13.0 
12.9 
14.1 
10.0 
7.3 
Total
13.8 
14.0 
16.1 
14.1 
11.2 

Note:
(1)
The data for 2008 onwards are on a Basel II basis; 2007 is on a Basel I basis.

It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the Financial Services Authority (FSA). The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are 'weighted' to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. At 31 December 2011, the Group's total RAR was 13.8% (2010 - 14.0%) and the Tier 1 RAR was 13.0% (2010 -12.9%). For further information refer to Balance sheet management: Capital management on pages 68 to 73.

 
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Business review Risk and balance sheet management
 
 
Risk and balance sheet management
In this section (pages 58 to 207) of the Business review, certain information has been audited and is part of the Group’s financial statements as permitted by IFRS 7. Other disclosures are unaudited and are labelled with an asterisk (*). In this section, the 2009 data relate to the Group before RFS Holdings minority interest (RFS MI).

Introduction*
All the disclosures in this section (pages 58 to 67) are unaudited as indicated by an asterisk (*).

Risk management plays an integral role in the delivery of the Group’s strategic goal to be a safe and secure banking group. The implementation of a stronger and more effective culture of risk management and control provides the platform necessary to address historical vulnerabilities, rebuild upon the Group’s core strengths and position it on a sustainable and profitable path for future growth.

Financial strength and resilience are at the heart of the Group’s Strategic Plan. The Group has defined this level of robustness as that which is capable of achieving and sustaining a standalone credit rating (i.e. without government support) that is in line with those of its strongest international peers.

Given this central aim, in 2009 the Group Board set out four key strategic risk objectives, aligned to the Group’s Strategic Plan. These are to:

·
maintain capital adequacy: to ensure that the Group has sufficient (and easily accessible) capital resources to meet regulatory requirements and to cover the potential for unexpected losses in its asset portfolio;

·
deliver stable earnings growth: to ensure that strategic growth is based around a longer-term risk versus reward consideration, with significantly lower volatility in underlying profitability than was seen over the previous five years;

·
ensure stable and efficient access to funding and liquidity: such that the Group has sufficient funding to meet its obligations, taking account of the constraint that some forms of funding may not be available when they are most needed; and

·
maintain stakeholder confidence: to ensure that stakeholders have confidence in the Group’s recovery plan, its ability to deliver its strategic objectives and the effectiveness of its business culture and operational controls.

Each objective is essential in its own right, but also mutually supportive of the others.

These strategic risk objectives are the bridge between the Group-level business strategy and the frameworks, limits and tolerances that are used to set risk appetite and manage risk in the business divisions on a day-to-day basis.
 
 
In 2011, the Group made significant progress in strengthening its approach to risk management in an external environment that remained challenging.

The task of setting a comprehensive risk appetite and aligning it with the Group’s business strategy demands a clear understanding of the types of risk the Group faces and their potential size. With this goal in mind, over the past year the Group has developed a catalogue of the risks it faces (a risk taxonomy) and undertaken a Group-wide material risk assessment to analyse the scale of each risk and the potential interactions between them (for a detailed discussion of risk appetite, see page 59).

The delivery of proactive and effective risk management relies on high quality data inputs on which to make assessments. It also requires robust forward-looking measurement and stress testing capabilities (see stress testing on page 60). Both of these areas continue to be enhanced and improvements embedded across the Group.

Risk control frameworks are used to identify and address concentrations of risk. These systems are reinforced by a Group Policy Framework (see page 60), which was enhanced during 2011, with assurance activity ongoing to ensure the policy standards it comprises remain appropriate.

Effective risk management also requires a robust governance framework. During 2011, the roles and responsibilities of the Executive Risk Forum and its supporting committees were reviewed and more clearly defined (see pages 62 to 64).

The Group has launched a common set of values for the risk community that impact directly on behaviours and help to engender a risk management function that is widely respected and valued across the Group. A Group-wide policy that explicitly aligns remuneration with effective risk management has also been put in place.

The focus is now on fully embedding the Group’s strategy for risk management into the day-to-day management of its businesses, as well as preparing the Group to face future challenges in a rapidly evolving external environment. More detailed discussions on how the Group strengthened its approach to risk management in 2011 and the areas of focus going forward is contained within the relevant sub-sections on the following pages.
 
* unaudited
 
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Business review Risk and balance sheet management continued
 

Risk appetite*
The Group’s focus on setting a clear risk appetite and embedding a strong culture of risk management and control is designed to ensure it is able to proactively identify and reduce risk exposures and has the resilience to respond effectively to any unforeseen shocks.

The Group’s risk appetite identifies and establishes the level and type of risks that it is able and willing to take in order to:

·
meet its strategic objectives - this includes the Group’s stated objective of achieving and sustaining a standalone credit rating in line with those of its strongest international peers; and

·
meet its wider obligations to stakeholders - the Group’s Strategic Plan is built on the core foundations of serving its customers well, acting responsibly and creating sustainable value for its shareholders.

A clear risk appetite provides a greater understanding across the Group of the acceptable levels of risk for each business. It provides a solid platform from which the Group can focus on its key business strengths and competitive advantages over the long-term.

Approach and key principles
The Strategic Plan set key performance indicators for capital, leverage, liquidity and funding, aligned with the Group’s strategic objectives. It also established a Non-Core division to manage, dispose of and run-off assets that the Group was seeking to exit from, which by definition were outside its appetite.

Building on these core foundations, the Group has developed a framework that sets and implements an appropriate risk appetite for the Group (and its main businesses), supported by a regular monitoring and review process.

Under this framework, risk appetite targets - based on both the quantitative and qualitative aspects of risk - have been set by the Group Board, aligned with Group and divisional strategic objectives. These targets support and augment the strategic, financial and risk controls that are already in place and help to shape the way the Group operates at all levels. Clear roles and responsibilities are established to measure, cascade and report performance against risk appetite and to provide assurances that business is being conducted within approved risk limits and tolerances.

The development of this framework has been based on the following best practice principles:

·
strong leadership from the Group Board in establishing and setting risk appetite and in ensuring its purpose is understood and its use promoted as good business practice;

·
a strong risk management culture, in which risk is clearly and meaningfully aligned with business behaviours and outcomes;

·
a close collaborative partnership between the risk, strategy, treasury and finance functions that facilitates a broader internal debate on key issues; and

·
clear accountability by each division (and business unit) for the level of risk it is prepared to take to achieve its business objectives.

Group-wide stress testing is used to assess whether strategic plans are consistent with risk appetite and to measure the key drivers of risk (down to business unit level), with mitigating actions identified whenever the risk profile is considered to be outside (or close to) acceptable levels (see page 60).

Design to delivery
The Group’s risk appetite has been set by the Group Board and is now operational. Significant progress has been made in establishing the underlying framework and rolling it out across the Group and its divisions.

The key channels through which risk appetite is cascaded throughout and embedded in each division are:

·
divisional risk appetite statements - each division has developed its own risk appetite statement, which is based on the four strategic risk objectives and is appropriate for its business plans but also aligned with the Group’s risk appetite targets;

·
risk control frameworks and limits - risk control frameworks set clear guidance on acceptable limits and tolerances for all material risk types (e.g. credit, market and country risk), aligned with the Group’s risk appetite targets;

·
Group operational and conduct risk appetite - the Group has developed a robust control environment to ensure it conducts its activities in accordance with its regulatory and other obligations; and

·
culture, values and remuneration - a programme of communication, engagement and training is being rolled out across the Group to engender a wide understanding of the purpose of risk appetite.

The Group regards the implementation of its risk appetite framework as an essential step in driving the cultural change required to achieve its strategic objectives and a dynamic, ongoing process. The Board Risk Committee (see the Report of the Board Risk Committee on pages 226 to 229) reviews both the targets and the framework on a regular basis, to ensure they remain aligned to strategic objectives, business performance, emerging risks and changes in the external environment.
 
* unaudited
 
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Business review Risk and balance sheet management continued

Introduction*: Stress testing
Stress testing describes the evaluation of a bank’s financial position under severe but plausible stress scenarios. Stress testing refers to the application of individual stress tests and the broader framework under which these tests are developed, evaluated and used within the Group’s decision-making process in the context of the wider economic environment.

Internal stress tests
The Group’s stress testing framework is designed to embed stress testing as a key risk management technique into mainstream risk reporting, capital planning and business processes at both Group and divisional levels.

The Executive Risk Forum (see Risk governance on page 61) is the main body overseeing the Group’s stress testing approach, processes and results. The forum is primarily responsible for reviewing and challenging the results of any Group-wide stress test and ensuring that, where necessary, appropriate management actions are undertaken. The Board Risk Committee will provide oversight and challenge as appropriate.

Stress testing forms part of the Group’s risk and capital management framework and is a major component of the Basel III requirements. It highlights to senior management potential adverse unexpected outcomes related to a mixture of risks and provides an indication of how much capital might be required to absorb losses should adverse scenarios materialise.

Stress testing is used at both divisional and Group levels to assess risk concentrations and estimate the impact of stressed earnings, impairments and write-downs on capital as well as the liquidity and funding position of the Group. It determines overall capital adequacy under a variety of adverse scenarios.

A series of stress events are monitored on a regular basis to assess the potential impact of a severe yet plausible event on the Group. There are four core types of scenario stress testing:

·
macroeconomic stress testing, which considers the impact on both earnings and capital for a range of scenarios;

·
enterprise-wide stress testing, which considers scenarios that are not macroeconomic in nature but are sufficiently broad to entail multiple risks or affect multiple divisions and are likely to affect earnings, capital and funding;

·
cross-divisional stress testing, which includes scenarios that affect multiple divisions due to their sensitivity to a common risk factor; and

·
divisional and risk-specific stress testing, which is undertaken to support risk identification and management.
 
Portfolio analysis, using historical performance and forward-looking indicators of change, uses stress testing to assess potential exposure to events and seeks to quantify the impact of an adverse change in factors that drive the performance and profitability of a portfolio.

Industry-wide stress tests
The Group takes part in a number of industry-wide stress tests, in particular, the European Banking Authority Stress Test and IMF UK Financial Sector Assessment Program, results of which were published in July 2011. These confirmed that the Group remains well capitalised with a strong Core Tier 1 capital ratio and a strong Total capital ratio under both baseline and adverse scenarios. During 2011, the Group also undertook the FSA anchor scenario test.

In December 2011, the European Banking Authority published the results of its recapitalisation exercise - a review of banks’ actual capital positions on sovereign exposures - showing the Group had no overall capital shortfall after including the sovereign capital buffer.

Group Policy Framework*
Achieving and sustaining a robust control framework in line with those of the Group’s strongest international peers is critical to achieving the successful delivery of the Group’s risk objectives.

With this goal in mind, the Group Policy Framework (GPF) has been revised and broadened. The GPF consolidates a large number of individual policies under a consistent and structured overarching framework for conduct, control and governance. It provides clear guidance and controls on how the Group does business, linked to its risk appetite, its business conduct and compliance responsibilities and its focus on delivering a control environment consistent with best practice against relevant external benchmarks.

The GPF and related initiatives aim to ensure that:

·
the Group has clear control standards and ethical principles to cover the risks that it faces to support effective risk management and meet regulatory and legal requirements;

·
policies are followed across the Group and compliance can be clearly evidenced, assessed and reported by line management; and

·
the control environment is monitored and overseen through good governance.

Communication and training programmes are provided to all relevant staff as the policies are embedded, ensuring that staff are aware of their responsibilities. The GPF is structured to ensure that policy standard owners and sponsors review their policies on a regular basis, with any identified shortfalls against industry best practice documented and addressed within an agreed time frame.
 
* unaudited
 
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Business review Risk and balance sheet management continued

The GPF was introduced in 2009. Enhancements applied in 2011 included the following:

·
the Group’s policy standards, which comprise the GPF, were rewritten to ensure they clearly express the mandatory controls required to mitigate the key risks the Group faces;

·
all of the Group’s policy standards were benchmarked against relevant external reference points such as peer organisations to challenge and verify the content of the policy standards. Where identified, further improvements to the policy standards are now being implemented;

·
for each policy standard, appropriate risk based assurance activity was introduced to ensure each division is appropriately controlled and compliance with policy can be demonstrated; and

·
risk appetite has its own policy standard within the GPF that clearly sets out roles and responsibilities in relation to the implementation of the risk appetite framework and provides assurance that risks are being actively managed within approved levels and tolerances.

The GPF will continue to be improved and embedded. The results of assurance activity, monitoring and analysis of the internal and external environment will be used to reassess the policy standards on a regular basis.

Risk governance*
The Group is committed to the highest standards of corporate governance in every aspect of the business, including risk management.
A key aspect of the Group Board’s responsibility as the main decision making body at Group level is the setting of Group risk appetite to ensure that the levels of risk that the Group is willing to accept in the attainment of its strategic business and financial objectives are clearly understood.

To enable the Group Board to carry out its objectives, it has delegated authority to senior Board and executive committees, as required and appropriate. A number of key committees specifically consider risk across the Group, as set out in the diagram below.



 
Notes:
(1)
The Capital and Stress Testing Committee is a sub-committee of the Group Asset and Liability Management Committee.
(2)
The following specialist sub-committees report directly to the Group Risk Committee: Global Markets Risk Committee, Group Country Risk Committee, Group Models Committee, Group Credit Risk Committee and Operational Risk Executive Committee. In addition, Divisional Risk Committees report to the Group Risk Committee.
 
* unaudited
 
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Business review Risk and balance sheet management continued
 
Introduction*: Risk governance continued
The key risk responsibilities of each of these committees as well as their membership are set out in the table below. Further information on the Group Board and Board Committees is available on page 210.

These committees are supported at a divisional level by a risk governance structure embedded in the business. These committees play a key role in ensuring that the Group’s risk appetite is supported by effective risk management frameworks, limits and policies, together with clear accountabilities for approval, monitoring, oversight, reporting and escalation.

During 2011, the roles and responsibilities of the Executive Risk Forum and its supporting committees were reviewed and more clearly defined, to meet the future needs of the Group.

In particular, the Executive Risk Forum was repositioned as a strategic committee focusing on strategic level risks and issues, and retaining the approval authority for the most material risk limits and decisions. The Group Risk Committee was refocused to operate primarily as an oversight committee across risk types, concentrating particularly on thematic and emerging risks and issues.


The committees that sit below the Group Risk Committee were streamlined significantly, aligned more closely to key risk types and given clearer empowerment and accountability where required.

A Capital and Stress Testing Committee was created as a sub-committee of the Group Asset and Liability Management Committee to cover risk and capital matters.

The improvements made in 2011 provide further clarity of roles and responsibilities, as well as clear reporting lines and accountabilities. They promote clearer and timelier decision making and more effective risk management and oversight.

The role and remit of the Group committees is set out below. These committees are supported at a divisional level by a risk governance structure embedded in the business.

Board/Committee
Risk focus
Membership
Group Board
 
The Group Board ensures that the Group manages risk effectively through approving and monitoring the Group’s risk appetite, considering Group stress scenarios and agreed mitigants and identifying longer-term strategic threats to the Group’s business operations.
The Board of directors
Executive Committee
 
 
The Executive Committee considers recommendations on risk management matters referred by the Executive Risk Forum and/or Group Risk Committee, including recommendations on risk appetite, risk policies and risk management strategies.
Group Chief Executive
Group Finance Director
Chief Administrative Officer
Chief Executive Officers of divisions
Head of Restructuring and Risk
Board Risk Committee
 
The Board Risk Committee provides oversight and advice to the Group Board on current and potential future risk exposures of the Group and future risk strategy, including determination of risk appetite and tolerance. It also provides a risk review of remuneration arrangements and provides advice to the Remuneration Committee. It operates under delegated authority from the Group Board.
At least three independent non-executive directors, one of whom is the Chairman of the Group Audit Committee.
 
* unaudited
 
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Business review Risk and balance sheet management continued

 


Introduction*: Risk governance continued
 
Board/Committee
Risk focus
Membership
Group Audit Committee
The Group Audit Committee reviews accounting policies and practices, controls and procedures established by management for compliance with regulatory and financial reporting requirements and requirements of external regulations. It has responsibility for monitoring relationships with regulatory authorities. It operates under delegated authority from the Group Board.
At least three independent non-executive directors, at least one of whom is a financial expert as defined in the SEC rules under the US Exchange Act and one of whom is Chairman of the Board Risk Committee.
Group Remuneration Committee
 
The Group Remuneration Committee is responsible for the overview of the Group’s policy on remuneration and receives advice from Risk Management and the Board Risk Committee to ensure that there is thorough risk input into incentive plan design and target setting as well as risk review of performance bonus pools and clawback. It operates under delegated authority from the Group Board.
At least three independent non-executive directors
Executive Risk Forum
 
The Executive Risk Forum operates as a committee of the Executive Committee with full authority to act on all risk and control matters across the Group.
 
The Executive Risk Forum approves the most material limits and decisions above defined thresholds and delegates decisions below these thresholds to sub-committees and appropriate individuals.
Group Chief Executive
Group Finance Director
Chief Administrative Officer
Chief Executive Officers of divisions
Head of Restructuring and Risk
Deputy Chief Risk Officer
Group Asset and Liability Management Committee
 
The Group Asset and Liability Management Committee (GALCO) is a sub-committee of the Executive Risk Forum and is responsible for identifying, managing and controlling Group balance sheet risks in executing its chosen business strategy.
Group Finance Director
Group Treasurer
Chief Executive Officers of divisions
Head of Restructuring and Risk
Key Group Finance function heads
Global Head of Markets
Group Risk Committee
 
The Group Risk Committee is a sub-committee of the Executive Risk Forum. It is an oversight committee which reviews and challenges risks and limits across the functional areas and plays a key role exercising and demonstrating effective risk oversight across the Group. It reviews risks and issues on a thematic as well as a specific basis and focuses on forward-looking, emerging risks. It considers the overall risk profile across the Group and identifies any key issues for escalation to the Executive Risk Forum.
Deputy Chief Risk Officer
Divisional Chief Risk Officers
Key Group Risk function heads
 
 
* unaudited
 
 
63

 
Business review Risk and balance sheet management continued
 

Introduction*: Risk governance continued

Board/Committee
Risk focus
Membership
Capital and Stress Testing Committee
The Capital and Stress Testing Committee is a sub-committee of the Group Asset and Liability Management Committee and focuses on the broad risk capital agenda, including risk appetite, capital usage, stress testing, Internal Capital Adequacy Assessment Process, capital planning, allocation and management, economic capital and prudential developments, including Basel oversight.
Group Finance Director
Key Group Finance function heads
Key Group Risk function heads
Executive Credit Group
 
The Executive Credit Group decides on requests for the extension of existing or new credit limits on behalf of the Group Board where the proposed aggregate facility limits are in excess of the credit approval authorities granted to individuals in divisions or in Group Risk Management, or where an appeal against a decline decision of the Group Chief Credit Officer (or delegates) or Group Chief Risk Officer is referred for final decision.
 
Group A members (1)
Head of Restructuring and Risk
Deputy Chief Risk Officer
Group Chief Credit Officer/Chief Credit Officer N.V.
Head of Global Restructuring Group
Chief Risk Officer, Non-Core division/APS (alternate)
 
Group B members (1)
Group Chief Executive
Group Finance Director
Chief Executive officers of divisions
 
(1)   Decisions require input from at least one member from each of Group A and Group B.
Divisional Risk and Audit Committees
Divisional Risk and Audit Committees report to the Board Risk Committee and the Group Audit Committee on a quarterly basis. Their main responsibilities are to:
 
·  monitor the performance of the divisions relative to divisional and Group risk appetite;
 
·      review matters relative to accounting policies, internal control, financial reporting, internal audit, external audit and regulatory compliance as set out in their terms of reference; and
 
·  assist on such other matters as may be referred to them by the relevant divisional Executive Committee, the Group Audit Committee or the Board Risk Committee.
Members: at least three non-executive members who are executives of the Group who do not have executive responsibility in the relevant division.
 
Attendees: at least two executives of the division, as appropriate. Representatives from finance, risk, internal audit and external audit.
 
Members of the Board Risk Committee and Group Audit Committee also have the right to attend.

* unaudited
 
 
64

 
Business review Risk and balance sheet management continued
 

Introduction*: Risk coverage
The main risk types faced by the Group are presented below, together with a summary of the key areas of focus and how the Group managed these risks in 2011.

Risk type
Definition
Features
How the Group managed risk and the focus in 2011
Capital, liquidity and funding risk
The risk that the Group has insufficient capital or is unable to meet its financial liabilities as they fall due.
Potential to disrupt the business model and stop normal functions of the Group.
 
Potential to cause the Group to fail to meet the supervisory requirements of regulators.
 
Significantly driven by credit risk losses.
The Group plans for and maintains an adequate amount and mix of capital consistent with its risk profile. This ensures that in any foreseeable scenario the Group holds minimum capital to meet the standards and requirements of investors, regulators and depositors. The amount of capital required is determined through risk assessments and stress testing.
 
Active run-off of capital intensive assets in Non-Core and other risk mitigation left the Core Tier 1 ratio strong at 10.6%, despite a £21 billion uplift in RWAs from the implementation of CRD III in December 2011. Refer to pages 68 to 73.
 
Maintaining the structural integrity of the Group’s balance sheet requires active management of both asset and liability portfolios as necessary. Strong term debt issuance and planned reductions in the funded balance sheet enabled the Group to strengthen its liquidity and funding position as market conditions worsened. Refer to pages 74 to 88.
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.
Loss characteristics vary materially across portfolios.
 
Significant link between losses and the macroeconomic environment.
 
Can include concentration risk - the risk of loss due to the concentration of credit risk to a specific product, asset class, sector or counterparty.
The Group manages credit risk based on a suite of credit approval and risk concentration frameworks and associated risk management systems and tools. It also continues to reduce the risk associated with legacy exposures through further reductions in Non-Core assets.
 
During 2011, asset quality continued to improve, resulting in loan impairment charges 21% lower than in 2010 despite continuing challenges in Ulster Bank Group (Core and Non-Core) and corporate real estate portfolios. The Group continued to make progress in reducing key credit concentration risks, with credit exposures in excess of single name concentration limits declining 15% during the year and exposure to commercial real estate declining 14%. Refer to pages 92 to 165.
Country risk
The risk of material losses arising from significant country-specific events.
Can arise from sovereign events, economic events, political events, natural disasters or conflicts.
 
Potential to affect parts of the Group’s credit portfolio that are directly or indirectly linked to the country in question.
All country exposures are covered by the Group’s country risk management framework. This includes active management of portfolios either when these have been identified as exhibiting signs of stress through the Group’s country Watchlist process or when it is otherwise considered appropriate. Portfolio reviews are undertaken to align country risk profiles to the Group’s country risk appetite in light of economic and political developments.
 
Sovereign risk increased in 2011, resulting in rating downgrades for a number of countries, including several eurozone members. This resulted in an impairment charge recognised by the Group in 2011 in respect of available-for-sale Greek government bonds. In response, the Group further strengthened its country risk appetite setting and risk management systems during the year and brought a number of advanced countries under limit control. This contributed to a reduction in exposure to a range of countries. Refer to pages 166 to 186.

* unaudited
 
 
65

 
 
Business review Risk and balance sheet management continued

Introduction*: Risk coverage continued

Risk type
Definition
Features
How the Group managed risk and the focus in 2011
Market risk
The risk arising from changes in interest rates, foreign currency, credit spreads, equity prices and risk related factors such as market volatilities.
Frequent small losses which are material in aggregate.
 
Infrequent large material losses due to stress events.
A comprehensive structure is in place aimed at ensuring the Group does not exceed its qualitative and quantitative tolerance for market risk.
 
The Group’s market risk policy statements set out its qualitative tolerance for market risk. They define the governance, responsibilities and requirements for the identification, measurement, analysis, management and communication of the market risk arising from the Group’s trading and non-trading investment activities.
 
The Group Market Risk limit framework expresses the Group’s quantitative tolerance for market risk. The Group limit metrics capture, in broad terms, the full range of market risk exposures, ensuring the risk is appropriately defined and communicated.
 
During 2011, the Group continued to manage down its market risk exposure in Non-Core and reduce the asset-backed securities trading inventory such that the trading portfolio became less exposed to credit risk. Refer to pages 187 to 193.
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.
Frequent small losses which are material in aggregate.
 
Infrequent large material losses.
The Group’s framework for managing insurance risk, with associated risk appetite and policy frameworks, is designed to ensure insurance risks are appropriately identified, controlled, managed, monitored, reported and mitigated.
 
Procedures are in place to address any issues, such as breaches of risk appetite that are identified through monitoring and reporting activities. If a breach occurs, an action plan to address the issue is developed, implemented and monitored to ensure the risk is adequately mitigated or a decision is taken to accept it.
 
During 2011, focus on insurance risk appetite resulted in the de-risking and significant re-pricing of certain classes of business and exiting some altogether. Refer to page 194.
Operational risk
The risk of loss resulting from inadequate or failed processes, people, systems or from external events.
Frequent small losses.
 
Infrequent material losses.
The objective of operational risk management is to manage it to an acceptable level. Processes to achieve this objective take into account the cost of minimising the risk against the resultant reduction in exposure.
 
During 2011, the Group took steps to enhance its management of operational risks. This was particularly evident in respect of risk appetite, the Group Policy Framework, risk assessment, scenario analysis and statistical modelling for capital requirements.
 
The level of operational risk remains high due to the scale of structural change occurring across the Group, the pace of regulatory change, the economic downturn and other external threats, such as e-crime. Refer to pages 194 to 197.

* unaudited
 
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Business review Risk and balance sheet management continued

 
Introduction*: Risk coverage continued
 
Risk type
Definition
Features
How the Group managed risk and the focus in 2011
Compliance risk
The risk arising from non-compliance with national and international laws, rules and regulations.
Adverse impacts on strategy, capital structure, business models and operational effectiveness.
 
Financial cost of adapting to changes in laws, rules or regulations or of penalties for non-compliance.
Management of compliance risk entails early identification and effective management of changes in legislative, regulatory and other requirements that may affect the Group.
 
It also requires active engagement with regulators, close analysis of emerging regulatory themes, and interaction with rule-makers and legislators.
 
Within the GPF, compliance risk policies define minimum standards to which all businesses must adhere. GPF policies are supplemented, where appropriate, by divisional policies to meet local product or market requirements.
 
During 2011, the Group managed the increased levels of scrutiny and legislation by enlarging the capacity of its compliance, anti-money laundering and regulatory affairs teams and taking steps to improve its operating models, tools, systems and processes. Refer to pages 197 to 202.
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.
Potential to put the entire business at risk. Otherwise, could lead to negative publicity, loss of revenue, costly litigation or a decline in customer base.
 
Can arise from actions taken by the Group or a failure to take action.
The Group Sustainability Committee and risk committees continue to assess reputational risk issues. In 2011, an Environmental, Social and Ethical (ESE) Risk Policy was developed with sector ESE risk appetite positions drawn up to assess the Group’s appetite to support customers in sensitive sectors including defence, oil and gas. This also included the establishment of divisional reputational risk committees.
 
Stakeholder engagement was broadened with the implementation of formal sessions between the Group Sustainability Committee and relevant advocacy groups and non-governmental organisations. Refer to page 202.
Business risk
The risk of lower-than-expected revenues and/or higher-than-expected operating costs.
Influenced by many factors such as pricing, sales volume, input costs, regulations and market and economic conditions.
Forecasts of revenues and costs are tested against a range of stress scenarios to identify key risk drivers and the appropriate actions to address and manage them.
 
Business risk is incorporated within the Group's risk appetite target for earnings volatility that was set in 2011. Refer to page 202.
Pension risk
The risk that the Group will have to make additional contributions to its defined benefit pension schemes.
Funding position can be volatile due to the uncertainty of future investment returns and the projected value of schemes’ liabilities.
The Group manages pension risk from a sponsor perspective using a framework that encompasses risk reporting and monitoring, stress testing, modelling and an associated governance structure that helps ensure the Group is able to fulfil its obligation to support the defined benefit pension schemes to which it has exposure.
 
In 2011, the Group focused on improved stress testing and risk governance mechanisms. This included the establishment of the Pension Risk Committee and the articulation of its view of risk appetite for the various Group pension schemes. Refer to pages 203 and 204.

Each risk type maps into the Group’s risk appetite framework and contributes to the overall achievement of its strategic objectives with underlying frameworks and limits. The key frameworks and developments over the past year are described in the relevant sections of the following pages.

* unaudited

 
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Business review Risk and balance sheet management continued
 
 
 
Balance sheet management
All disclosures in this section (pages 68 to 91) are audited unless otherwise indicated by an asterisk (*).

Two of the Group’s four key strategic risk objectives relate to the maintenance of capital adequacy and ensuring stable and efficient access to liquidity and funding. This section on balance sheet management explains how the Group is performing on achieving these objectives.

Capital management
Introduction*
The Group aims to maintain an appropriate level of capital to meet its business needs and regulatory requirements as capital adequacy and risk management are closely aligned. The Group operates within an agreed risk appetite whilst optimising the use of shareholders’ funds to deliver sustainable returns.

The appropriate level of capital is determined based on the dual aims of: (i) meeting minimum regulatory capital requirements; and (ii) ensuring the Group maintains sufficient capital to uphold investor and rating agency confidence in the organisation, thereby supporting the business franchise and funding capacity.

Governance*
The Group Asset and Liability Management Committee (GALCO) is responsible for ensuring the Group maintains adequate capital at all times. The newly established Capital and Stress Testing Committee (CAST) is a cross-functional body driving and directing integrated risk capital activities including stress testing economic capital and capital allocation. These activities have linkages to capital planning, risk appetite and regulatory change. CAST reports through GALCO and comprises senior representatives from Risk Management, Group Finance and Group Treasury.

Determining appropriate capital*
The minimum regulatory capital requirements are identified by the Group through the Internal Capital Adequacy Assessment Process and then agreed between the Group Board and the appropriate supervisory authority.

The Group’s own determination of how much capital is sufficient is derived from the desired credit rating level and the application of both internally and externally defined stress tests that identify potential changes in capital ratios over time.

Monitoring and maintenance*
Based on these determinations, which are continually reassessed, the Group aims to maintain capital adequacy both at Group level and in each regulated entity.

The Group operates a rigorous capital planning process aimed at ensuring the capital position is controlled within the agreed parameters. This incorporates regular re-forecasts of the capital positions of the regulated entities and the overall Group. In the event that the projected position deteriorates beyond acceptable levels, the Group would issue further capital and/or revise business plans accordingly.

Stress testing approaches are used to determine the level of capital required to ensure the Group remains adequately capitalised.

Capital allocation*
Capital resources are allocated to the Group’s businesses based on key performance parameters agreed by the Group Board in the annual strategic planning process. Principal among these is a profitability metric which assesses the effective use of the capital allocated to the business. Projected and actual return on equity is assessed against target returns set by the Group Board. The allocations also reflect strategic priorities and balance sheet and funding metrics.

Economic profit is also planned and measured for each division during the annual planning process. It is calculated by deducting the cost of equity utilised in the particular business from its operating profit and measures the value added over and above the cost of equity.

The Group aims to deliver sustainable returns across the portfolio of businesses with projected business returns stressed to test key vulnerabilities.

The divisions use return on capital metrics when making pricing decisions on products and transactions with a view to ensuring customer activity is appropriately aligned with Group and divisional targets and allocations.

The FSA uses the risk asset ratio as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its RWAs (the assets and off-balance sheet exposures are weighted to reflect the inherent credit and other risks); by international agreement the risk asset ratios should not be less than 8% with a Tier 1 component of not less than 4%.
 

 
* unaudited

 
68

 
Business review Risk and balance sheet management continued
 
 
Capital adequacy*
The Group’s RWAs and risk asset ratios, calculated in accordance with FSA definitions, are set out below.

 
Statutory
 
Proportional 
Risk-weighted assets by risk
2011 
£bn 
2010 
£bn 
2009 
£bn 
 
2009 
£bn 
Credit risk
344.3 
385.9 
513.2 
 
410.4 
Counterparty risk
61.9 
68.1 
56.5 
 
56.5 
Market risk
64.0 
80.0 
65.0 
 
65.0 
Operational risk
37.9 
37.1 
33.9 
 
33.9 
 
508.1 
571.1 
668.6 
 
565.8 
Asset Protection Scheme relief
(69.1)
(105.6)
(127.6)
 
(127.6)
 
439.0 
465.5 
541.0 
 
438.2 

Risk asset ratios
%
%
%
 
%
Core Tier 1
10.6
10.7 
11.0 
 
11.0 
Tier 1
13.0
12.9 
14.1 
 
14.4 
Total
13.8
14.0 
16.1 
 
16.3 



Key points*
·  
Market risk RWAs were impacted by the new CRD III rules but decreased overall by £16 billion in 2011 reflecting de-risking of Non-Core and a reduction in trading VaR.

·  
APS relief decreased by £36.5 million, reflecting pool movements, assets moving into default and changes in risk parameters.



Pillar 3*
The Group publishes its Pillar 3 Disclosures on its website, providing a range of additional information relating to Basel II and risk and capital management across the Group. The disclosures focus on capital resources and adequacy and discuss a range of credit risk measures and  management methods (such as credit risk mitigation, counterparty credit risk and provisions) and their associated RWAs under the various Basel II approaches. Detailed disclosures are also made on equity exposures, securitisations, operational risk, market risk and interest rate risk in the banking book.

* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Balance sheet management: Capital management continued
Capital resources
The Group’s regulatory capital resources in accordance with FSA definitions were as follows:

 
Statutory
 
Proportional*
Shareholders’ equity (excluding non-controlling interests)
2011 
£m 
2010 
£m 
2009 
£m 
 
2009 
£m 
Shareholders’ equity per balance sheet
74,819 
75,132 
77,736 
 
77,736 
Preference shares - equity
(4,313)
(4,313)
(7,281)
 
(7,281)
Other equity instruments
(431)
(431)
(565)
 
(565)
 
70,075 
70,388 
69,890 
 
69,890 
           
Non-controlling interests
         
Non-controlling interests per balance sheet
1,234 
1,719 
16,895 
 
2,227 
Non-controlling preference shares
(548)
(548)
(656)
 
(656)
Other adjustments to non-controlling interests for regulatory purposes
(259)
(259)
(497)
 
(497)
 
427 
912 
15,742 
 
1,074 
           
Regulatory adjustments and deductions
         
Own credit
(2,634)
(1,182)
(1,057)
 
(1,057)
Unrealised losses on AFS debt securities
1,065 
2,061 
1,888 
 
1,888 
Unrealised gains on AFS equity shares
(108)
(25)
(134)
 
(134)
Cash flow hedging reserve
(879)
140 
252 
 
252 
Other adjustments for regulatory purposes
571 
204 
(193)
 
41 
Goodwill and other intangible assets
(14,858)
(14,448)
(17,847)
 
(14,786)
50% excess of expected losses over impairment provisions (net of tax)
(2,536)
(1,900)
(2,558)
 
(2,558)
50% of securitisation positions
(2,019)
(2,321)
(1,353)
 
(1,353)
50% of APS first loss
(2,763)
(4,225)
(5,106)
 
(5,106)
 
(24,161)
(21,696)
(26,108)
 
(22,813)
           
Core Tier 1 capital
46,341 
49,604 
59,524 
 
48,151 
           
Other Tier 1 capital
         
Preference shares - equity
4,313 
4,313 
7,281 
 
7,281 
Preference shares - debt
1,094 
1,097 
3,984 
 
3,984 
Innovative/hybrid Tier 1 securities
4,667 
4,662 
5,213 
 
2,772 
 
10,074 
10,072 
16,478 
 
14,037 
           
Tier 1 deductions
         
50% of material holdings
(340)
(310)
(601)
 
(310)
Tax on excess of expected losses over impairment provisions
915 
758 
1,020 
 
1,020 
 
575 
448 
419 
 
710 
           
Total Tier 1 capital
56,990 
60,124 
76,421 
 
62,898 



* unaudited

 
70

 
Business review Risk and balance sheet management continued
 
Capital resources continued

 
Statutory
 
Proportional*
Qualifying Tier 2 capital
2011 
£m 
2010 
£m 
2009 
£m 
 
2009 
£m 
Undated subordinated debt
1,838 
1,852 
4,950 
 
4,200 
Dated subordinated debt - net of amortisation
14,527 
16,745 
20,063 
 
18,120 
Reserves arising on revaluation of property
— 
— 
73 
 
73 
Unrealised gains on AFS equity shares
108 
25 
134 
 
134 
Collectively assessed impairment provisions
635 
778 
796 
 
796 
Non-controlling Tier 2 capital
11 
11 
11 
 
11 
 
17,119 
19,411 
26,027 
 
23,334 
           
Tier 2 deductions
         
50% of securitisation positions
(2,019)
(2,321)
(1,353)
 
(1,353)
50% excess of expected losses over impairment provisions
(3,451)
(2,658)
(3,578)
 
(3,578)
50% of material holdings
(340)
(310)
(601)
 
(310)
50% of APS first loss
(2,763)
(4,225)
(5,106)
 
(5,106)
 
(8,573)
(9,514)
(10,638)
 
(10,347)
           
Total Tier 2 capital
8,546 
9,897 
15,389 
 
12,987
           
Supervisory deductions
         
Unconsolidated investments
         
  - RBS Insurance
(4,354)
(3,962)
(4,068)
 
(4,068)
  - Other investments
(239)
(318)
(404)
 
(404)
Other deductions
(235)
(452)
(93)
 
(93)
 
(4,828)
(4,732)
(4,565)
 
(4,565)
           
Total regulatory capital (1)
60,708 
65,289 
87,245 
 
71,320 


Movement in Core Tier 1 capital
2011 
£m 
At beginning of the year
49,604 
Attributable loss net of movements in fair value of own debt
(3,449)
Foreign currency reserves
(363)
Decrease in non-controlling interests
(485)
Decrease in capital deductions including APS first loss
1,128 
Other movements
(94)
At end of the year
46,341 

Note:
(1)
Total capital includes certain instruments issued by RBS N.V. Group that are treated consistent with the local implementation of the Capital Requirements Directive (including the transitional provisions of that Directive). The FSA formally confirmed this treatment in 2012.


* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Balance sheet management: Capital management continued
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 
APS 
 relief 
Net 
RWAs 
2011
£bn 
£bn 
£bn 
£bn 
£bn 
£bn 
£bn 
UK Retail
41.1 
7.3 
48.4 
(9.4)
39.0 
UK Corporate
69.4 
6.7 
76.1 
(15.5)
60.6 
Wealth
10.9 
0.1 
1.9 
12.9 
12.9 
Global Transaction Services
12.4 
4.9 
17.3 
17.3 
Ulster Bank
33.6 
0.6 
0.3 
1.8 
36.3 
(6.8)
29.5 
US Retail & Commercial
53.4 
1.0 
4.4 
58.8 
58.8 
Retail & Commercial
220.8 
1.6 
0.4 
27.0 
249.8 
(31.7)
218.1 
Global Banking & Markets
45.1 
39.9 
50.6 
15.5 
151.1 
(8.5)
142.6 
Other
9.9 
0.2 
0.7 
10.8 
10.8 
Core
275.8 
41.7 
51.0 
43.2 
411.7 
(40.2)
371.5 
Non-Core
65.6 
20.2 
13.0 
(5.5)
93.3 
(28.9)
64.4 
Group before RFS MI
341.4 
61.9 
64.0 
37.7 
505.0 
(69.1)
435.9 
RFS MI
2.9 
0.2 
3.1 
3.1 
Group
344.3 
61.9 
64.0 
37.9 
508.1 
(69.1)
439.0 

2010
             
UK Retail
41.7 
— 
— 
7.1 
48.8 
(12.4)
36.4 
UK Corporate
74.8 
— 
— 
6.6 
81.4 
(22.9)
58.5 
Wealth
10.4 
— 
0.1 
2.0 
12.5 
— 
12.5 
Global Transaction Services
13.7 
— 
— 
4.6 
18.3 
— 
18.3 
Ulster Bank
29.2 
0.5 
0.1 
1.8 
31.6 
(7.9)
23.7 
US Retail & Commercial
52.0 
0.9 
— 
4.1 
57.0 
— 
57.0 
Retail & Commercial
221.8 
1.4 
0.2 
26.2 
249.6 
(43.2)
206.4 
Global Banking & Markets
53.5 
34.5 
44.7 
14.2 
146.9 
(11.5)
135.4 
Other
16.4 
0.4 
0.2 
1.0 
18.0 
— 
18.0 
Core
291.7 
36.3 
45.1 
41.4 
414.5 
(54.7)
359.8 
Non-Core
91.3 
31.8 
34.9 
(4.3)
153.7 
(50.9)
102.8 
Group before RFS MI
383.0 
68.1 
80.0 
37.1 
568.2 
(105.6)
462.6 
RFS MI
2.9 
— 
— 
— 
2.9 
— 
2.9 
Group
385.9 
68.1 
80.0 
37.1 
571.1 
(105.6)
465.5 


Asset Protection Scheme*
The Group acceded to the Asset Protection Scheme (APS or ‘the Scheme’) in December 2009.

Following the accession to the APS, HM Treasury provides loss protection against potential losses arising in a pool of assets. HM Treasury also subscribed to £25.5 billion of capital in the form of B shares and a Dividend Access Share, with a further £8 billion of capital in the form of B shares potentially available as contingent capital. The Group pays fees in respect of the protection and contingent capital. The Group has the option, subject to HM Treasury consent, to pay the premium, contingent capital and the exit fee payable in connection with any termination of the Group’s participation in the APS in whole or in part, by waiving the entitlements of members of the Group to certain UK tax reliefs.

Following accession to the APS, arrangements were put in place within the Group that extended effective APS protection to all other regulated entities holding assets covered by the APS.






* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Regulatory capital impact of the APS*
Methodology
The regulatory capital requirements for assets covered by the Scheme are calculated using the securitisation framework under the FSA prudential rules. The calculation is as follows (the output is known as ‘the uncapped amount’):

·  
First loss - the residual first loss, after impairments and write-downs, to date, is deducted from available capital split equally between Core Tier 1 and Tier 2 capital;
·  
HM Treasury share of covered losses - after the first loss has been deducted, 90% of assets covered by HM Treasury are risk-weighted at nil; and
·  
RBS share of covered losses - the remaining 10% share of loss is borne by RBS and is risk-weighted in the normal way.

Should the uncapped amount be higher than the capital requirements for the underlying assets calculated as normal, ignoring the Scheme, the capital requirements for the Scheme are capped at the level of the requirements for the underlying assets (‘capped amount’). Where capped, the Group apportions the capped amount up to the level of the first loss as calculated above; any unused capped amount after the first loss capital deduction will be taken as RWAs for the Group’s share of covered losses.

Adjustments to the regulatory capital calculation can be made for either currency or maturity mismatches. These occur where there is a difference between the currency or maturity of the protection and that of the underlying asset. These mismatches will have an impact upon the timing of the removal of the cap and level of regulatory capital benefit on the uncapped amount, but this effect is not material.

Impact
The Group calculates its capital requirements in accordance with the capped basis. Accordingly, the APS has no impact on the Pillar 1 regulatory capital requirement in respect of the assets covered by the APS. It does, however, improve the Core Tier 1 capital ratio of the Group. The protection afforded by the APS assists the Group in satisfying the forward-looking stress testing framework applied by the FSA.

Future regulatory capital effects
As impairments or write-downs on the pool of assets are recognised, they reduce Core Tier 1 capital in the normal way. This will reduce the first loss deduction for the Scheme, potentially leading to a position where the capital requirement on the uncapped basis would no longer, for the assets covered by the APS, exceed the non-APS requirement and as a result, the Group would expect to start reporting the regulatory capital treatment on the uncapped basis.

For further information on the assets covered by APS see pages 205 to 207.

Basel III*
The rules issued by the Basel Committee on Banking Supervision (BCBS), commonly referred to as Basel III, are a comprehensive set of reforms designed to strengthen the regulation, supervision, risk and liquidity management of the banking sector. In the EU they will be enacted through a revised Capital Requirements Directive referred to as CRD IV.

In December 2010, the BCBS issued the final text of the Basel III rules, providing details of the global standards agreed by the Group of Governors and Heads of Supervision, the oversight body of the BCBS and endorsed by the G20 leaders at their November 2010 Seoul summit. There are transition arrangements proposed for implementing these new standards as follows:

·  
National implementation of increased capital requirements will begin on 1 January 2013;
·  
There will be a phased five year implementation of new deductions and regulatory adjustments to Core Tier 1 capital commencing on 1 January 2014;
·  
The de-recognition of non-qualifying non-common Tier 1 and Tier 2 capital instruments will be phased in over 10 years from 1 January 2013; and
·  
Requirements for changes to minimum capital ratios, including conservation and countercyclical buffers, as well as additional requirements for Global Systemically Important Banks, will be phased in from 2013 to 2019.

The Group, in conjunction with the FSA, regularly evaluates 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.

Other regulatory capital changes*
The Group is 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.

The Group is managing the changes to capital requirements from new regulation and model changes and the resulting impact on the common equity Tier 1 ratio, focusing on risk reduction and deleveraging. This is principally being achieved through the continued run-off and disposal of Non-Core assets and deleveraging in GBM as the business focuses on the most productive returns on capital.

The major categories of new deductions and regulatory adjustments which are being phased in over a five year period from 1 January 2014 include:

·  
Expected loss net of provisions;
·  
Deferred tax assets not relating to timing differences;
·  
Unrealised losses on available-for-sale securities; and
·  
Significant investments in non-consolidated financial institutions.

The net impact of these changes is expected to be manageable as the aggregation of these drivers is projected to be lower by 2014 and declining during the phase-in period.

* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Balance sheet management: Liquidity and funding risk
All disclosures in this section (pages 74 to 91) are audited unless otherwise indicated with an asterisk (*).

Liquidity 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. 

Liquidity risk is dynamic, being influenced by movements in markets and perceptions that are driven by firm specific or external factors. Managing liquidity risk effectively is a key component of the Group’s risk reduction strategy. The Group's 2011 performance demonstrates continued improvements in managing liquidity risk and reflects actions taken in light of an uncertain economic outlook, which resulted in improvements in key measures:

·  
Deposit growth - Core Retail & Commercial deposits rose by 9%, and together with Non-Core deleveraging, took the Group loan:deposit ratio to 108%, compared with 118% at the end of 2010.

·  
Wholesale funding - £21 billion of net term wholesale debt was issued in 2011 from secured and unsecured funding programmes, across a variety of maturities and currencies.

·  
Short-term wholesale funding (STWF) - the overall level of STWF fell by £27 billion to £102 billion, below the 2013 target of circa £125 billion.

·  
Liquidity portfolio - the liquidity portfolio of £155 billion was maintained above the 2013 target level of £150 billion against a backdrop of heightened market uncertainty in the second half of the year and was higher than STWF. This represents a £53 billion cushion over STWF.
 
Funding issuance
The Group has access to a variety of funding sources across the globe, including short-term money markets, repurchase agreement markets and term debt investors through its secured and unsecured funding programmes. Diversity in funding is provided by its active role in the money markets, along with access to global capital flows through GBM’s international client base. The Group’s wholesale funding franchise is well diversified by currency, geography, maturity and type.

The Group has been a regular issuer in the debt capital markets in both secured and unsecured arrangements. 2011 net new term debt issuance was £21 billion, with 49% secured and 51% unsecured, of which 71% were public transactions and 29% were private.

Balance sheet composition
The Group’s balance sheet composition is a function of the broad array of product offerings and diverse markets served by its Core divisions. The structural composition of the balance sheet is augmented as needed through active management of both asset and liability portfolios. The objective of these activities is to optimise liquidity transformation in normal business environments, while ensuring adequate coverage of all cash requirements under extreme stress conditions.

Diversification of the Group’s funding base is central to its balance sheet management strategy. The Group’s businesses have developed large customer franchises based on strong relationship management and high quality service. These customer franchises are strongest in the UK, the US and Ireland, but extend into Europe and Asia. Customer deposits provide large pools of stable funding to support the majority of the Group’s lending. Improvement of the Group’s loan:deposit ratio to 100% or better, by 2013, is a strategic objective.

The Group also accesses professional markets funding by way of public and private debt issuances on an unsecured and secured basis. These debt issuance programmes are spread across multiple currencies and maturities, to appeal to a broad range of investor types and preferences around the world. This market-based funding supplements the Group’s structural liquidity needs and, in some cases, achieves certain capital objectives.



 
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Business review Risk and balance sheet management continued
 
 
Stress testing
The strength of a bank’s liquidity risk management can only be evaluated based on its ability to survive under stress. The Group evaluates the survivability of the major legal entities and legal entity groups when subjected to simulated stress conditions.

Simulated liquidity stress testing is periodically performed for each business as well as the major operating subsidiaries. A variety of firm-specific and market-related scenarios are used at the consolidated level and in individual countries. These scenarios include assumptions about significant changes in key funding sources, credit ratings, contingent uses of funding, and political and economic conditions in certain countries.

The Group’s actual experiences from the 2008 and 2009 period factor heavily into the liquidity analysis. This systemic and name-specific crisis provides important data points in estimating stress severity.

Stress scenarios are applied to both on-balance sheet and off-balance sheet commitments, to provide a comprehensive view of potential cash flows.

Contingency planning
The Group has a Contingency Funding Plan (CFP), which is updated as the balance sheet evolves. The CFP is linked to stress test results and forms the foundation for liquidity risk limits. Limits in the business-as-usual environment are bounded by capacity to satisfy the Group’s liquidity needs in the stress environments. The CFP provides a detailed description of the availability, size and timing of all sources of contingent liquidity available to the Group in a stress event. These are ranked in order of economic impact and effectiveness to meet the anticipated stress requirement. The CFP includes documented procedures and sign-offs for actions that may require businesses to provide access to customer assets for collateralised borrowing, securitisation or sale. Roles and responsibilities for the effective implementation of the CFP are also documented.

Liquidity reserves
The Group maintains liquidity reserves sufficient to satisfy cash requirements, in the event of a severe disruption in its access to funding sources. The reserves consist of cash held on deposit at central banks, high quality unencumbered government securities and other unencumbered collateral. Government securities vary by type and jurisdiction based on local regulatory considerations. The currency mix of the reserves reflects the underlying balance sheet composition.
 
Regulatory oversight
The Group operates in multiple jurisdictions and is subject to a number of regulatory regimes.

The Group’s lead regulator is the UK Financial Services Authority (FSA). The FSA implemented a new liquidity regime on 1 June 2010. The new rules provide a standardised approach applied to all UK banks. At RBS Group, the rules focus on the UK Defined Liquidity Group (a subset comprising the Group’s five UK banks, The Royal Bank of Scotland plc, National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co and Adam & Co) and cover adequacy of liquidity resources, controls, stress testing and the Individual Liquidity Adequacy Assessment (ILAA). The ILAA informs the Group Board and the FSA of the assessment and quantification of the Group’s liquidity risks and their mitigation, and how much current and future liquidity is required.

In the US, the Group’s operations must meet liquidity requirements set out by the US Federal Reserve Bank, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Financial Industry Regulatory Authority. In the Netherlands, the Group is subject to the De Nederlandsche Bank liquidity oversight regime.

Regulatory developments*
There have been a number of significant developments in the regulation of liquidity risk.

In December 2010, the Basel Committee on Banking Supervision issued the ‘International framework for liquidity risk measurement, standards and monitoring’ which confirmed the introduction of two liquidity ratios: the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).

The introduction of both of these ratios will be subject to an observation period, which includes review clauses to identify and address any unintended consequences.

After an observation period beginning in 2011, the LCR, including any revisions, will be introduced on 1 January 2015. The NSFR, including any revisions, will move to a minimum standard by 1 January 2018.


* unaudited

 
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Business review 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.

 
2011
 
2010
 
2009
 
£m
%
 
£m
%
 
£m
%
Deposits by banks
               
  - central banks
3,680
0.5
 
6,655
0.9
 
8,535
1.0
  - derivative cash collateral
31,807
4.6
 
28,074
3.8
 
32,552
4.0
  - other
33,627
4.8
 
31,588
4.3
 
75,173
9.2
 
69,114
9.9
 
66,317
9.0
 
116,260
14.2
Debt securities in issue
               
  - conduit asset backed commercial paper (ABCP)
11,164
1.6
 
17,320
2.3
 
25,583
3.1
  - other commercial paper (CP)
5,310
0.8
 
8,915
1.2
 
18,724
2.3
  - certificates of deposit (CDs)
16,367
2.4
 
37,855
5.1
 
58,195
7.1
  - medium-term notes (MTNs)
105,709
15.2
 
131,026
17.6
 
125,800
15.4
  - covered bonds
9,107
1.3
 
4,100
0.6
 
  - securitisations
14,964
2.1
 
19,156
2.6
 
18,027
2.2
 
162,621
23.4
 
218,372
29.4
 
246,329
30.1
Subordinated liabilities
26,319
3.8
 
27,053
3.6
 
31,538
3.9
Notes issued
188,940
27.2
 
245,425
33.0
 
277,867
34.0
Wholesale funding
258,054
37.1
 
311,742
42.0
 
394,127
48.2
Customer deposits
               
  - cash collateral
9,242
1.4
 
10,433
1.4
 
9,934
1.2
  - other
427,511
61.5
 
420,433
56.6
 
413,224
50.6
Total customer deposits
436,753
62.9
 
430,866
58.0
 
423,158
51.8
                 
Total funding
694,807
100.0
 
742,608
100.0
 
817,285
100.0
                 
Disposal group deposits included above
               
  - banks
   
266 
   
618 
 
  - customers
22,610 
   
2,267 
   
8,907 
 
 
22,611 
   
2,533 
   
9,525 
 

Short-term wholesale funding
2011 
£bn 
2010 
£bn 
2009 
£bn 
Deposits
32.9 
34.7 
77.3 
Notes issued
69.5 
95.0 
139.0 
STWF excluding derivative collateral
102.4 
129.7 
216.3 
Derivative collateral
31.8 
28.1 
32.6 
STWF including derivative collateral
134.2 
157.8 
248.9 
       
Interbank funding excluding derivative collateral
     
  - bank deposits
37.3 
38.2 
83.7 
  - bank loans
(24.3)
(31.3)
(31.3)
Net interbank funding
13.0 
6.9 
52.4 


Key points
·  
Short-term wholesale funding excluding derivative collateral declined £27.3 billion in 2011, from £129.7 billion to £102.4 billion. This is £52.9 billion lower than the Group’s liquidity portfolio. Deleveraging in Non-Core and GBM has led to the reduced need for funding.
 
·  
The Group’s customer deposits excluding cash collateral grew by approximately £7.1 billion in 2011.
 
 
 
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Business review Risk and balance sheet management continued

 
The table below shows the Group’s debt securities in issue and subordinated liabilities by remaining maturity.

 
Debt securities in issue
     
2011
Conduit 
ABCP 
Other 
CP and 
CDs 
MTNs 
Covered 
bonds 
Securitisations 
Total 
Subordinated 
liabilities 
Total 
notes 
issued 
Total 
notes 
issued 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
% 
Less than 1 year
11,164 
21,396 
36,302 
— 
27 
68,889 
624 
69,513 
36.8 
1-3 years
— 
278 
26,595 
2,760 
479 
30,112 
3,338 
33,450 
17.7 
3-5 years
— 
16,627 
3,673 
— 
20,302 
7,232 
27,534 
14.6 
More than 5 years
— 
26,185 
2,674 
14,458 
43,318 
15,125 
58,443 
30.9 
 
11,164 
21,677 
105,709 
9,107 
14,964 
162,621 
26,319 
188,940 
100.0 
                   
2010
                 
Less than 1 year
17,320 
46,051 
30,589 
— 
88 
94,048 
964 
95,012 
38.7 
1-3 years
— 
702 
47,357 
1,078 
12 
49,149 
754 
49,903 
20.3 
3-5 years
— 
12 
21,466 
1,294 
34 
22,806 
8,476 
31,282 
12.8 
More than 5 years
— 
31,614 
1,728 
19,022 
52,369 
16,859 
69,228 
28.2 
 
17,320 
46,770 
131,026 
4,100 
19,156 
218,372 
27,053 
245,425 
100.0 
                   
2009
                 
Less than 1 year
25,583 
76,008 
33,696 
— 
1,614 
136,901 
2,144 
139,045 
50.0 
1-5 years
— 
895 
69,400 
— 
142 
70,437 
4,235 
74,672 
26.9 
More than 5 years
— 
16 
22,704 
— 
16,271 
38,991 
25,159 
64,150 
23.1 
 
25,583 
76,919 
125,800 
— 
18,027 
246,329 
31,538 
277,867 
100.0 

Key point
·  
Debt securities in issue with a maturity of less than one year declined £25.1 billion from £94.0 billion at 31 December 2010 to £68.9 billion at 31 December 2011, largely due to the maturity of £20.1 billion of notes issued under the UK Government’s Credit Guarantee Scheme (CGS). The remaining notes issued under the CGS are due to mature in 2012, £15.6 billion in the first quarter of the year and £5.7 billion in the second quarter.

Short-term borrowings*
Short-term borrowings comprise repurchase agreements, borrowings from financial institutions, commercial paper and certificates of deposit. Derivative collateral received from financial institutions is excluded from the table below, as are certain long-term borrowings.

The table below shows details of the Group’s short-term borrowings.

 
Repurchase 
agreements 
Financial 
 institutions 
(1,2) 
CP 
CDs 
2011 
Total 
Repurchase 
agreements 
Financial 
 institutions 
(1,2) 
CP 
CDs 
2010 
Total 
2009 
Total 
At year end
                     
  - balance (£bn)
129 
93 
16 
16 
254 
115 
92 
26 
38 
271 
242 
  - weighted average interest rate
0.6% 
0.9% 
0.9% 
1.4% 
0.8% 
0.5% 
0.6% 
0.7% 
0.6% 
0.6% 
0.8% 
                       
During the year
                     
  - maximum balance (£bn)
175 
111 
32 
39 
357 
157 
127 
37 
57 
378 
357 
  - average balance (£bn)
142 
93 
22 
31 
288 
137 
109 
34 
50 
330 
292 
  - weighted average interest rate
0.9% 
1.1% 
0.7% 
1.2% 
1.0% 
0.6% 
0.8% 
0.9% 
1.0% 
0.7% 
1.9% 

Notes:
(1)
Excludes derivative cash collateral of £41 billion at 31 December 2011 (2010 - £38 billion; 2009 - £33 billion), 2011 average of £35 billion (2010 - £34 billion; 2009 - £40 billion).
(2)
Excludes Federal Home Loan Bank’s long-term borrowings of £1 billion at 31 December 2011 (2010 - £1 billion), 2011 average of £1 billion (2010 - £1 billion).

Balances are generally based on monthly data. Average interest rates during the year are computed by dividing total interest expense by the average amount borrowed. Average interest rates at year end are average rates for a single day and as such may reflect one-day market distortions, which may not be indicative of generally prevailing rates.


* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Balance sheet management: Liquidity and funding risk continued
Long-term debt issuances
The table below shows debt securities issued by the Group 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.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Public
     
  - unsecured
5,085 
12,887 
8,386 
  - unsecured: guaranteed
— 
— 
19,663 
  - secured
9,807 
8,041 
— 
       
Private
     
  - unsecured
12,414 
17,450 
14,895 
  - unsecured: guaranteed
— 
— 
15,459 
  - secured
500 
— 
— 
Gross issuance
27,806 
38,378 
58,403 
Buybacks
(6,892)
(6,298)
(7,264)
Net issuance
20,914 
32,080 
51,139

Key points
·  
In line with the Group’s Strategic Plan, it has been an active issuer in recent years as it improved its liquidity and funding profile. Secured funding has increased as a proportion of total wholesale funding more recently as market dislocation and uncertainty over future regulatory developments have made unsecured markets less liquid.

·  
As the Group delevers, with Non-Core and GBM third party assets decreasing and Retail & Commercial deposits increasing, net term debt issuance decreased from £32 billion in 2010 to £21 billion in 2011. The net requirement in 2012 is not expected to exceed £10 billion as further deleveraging should cover the differences.*

·  
The Group undertakes voluntary buybacks of its privately issued debt in order to maintain client relationships and as part of its normal market making activities. These transactions are conducted at prevailing market rates.


The table below shows the original maturity of public long-term debt securities issued.
 
 
1-3 years 
3-5 years 
5-10 years 
>10 years 
Total 
2011
£m 
£m 
£m 
£m 
£m 
MTNs
904 
1,407 
1,839 
935 
5,085 
Covered bonds
— 
1,721 
3,280 
— 
5,001 
Securitisations
— 
— 
— 
4,806 
4,806 
 
904 
3,128 
5,119 
5,741 
14,892 
           
% of total
21 
34 
39 
100 

2010
         
MTNs
1,445 
2,150 
6,559 
2,733 
12,887 
Covered bonds
— 
1,030 
1,244 
1,725 
3,999 
Securitisations
— 
— 
— 
4,042 
4,042 
 
1,445 
3,180 
7,803 
8,500 
20,928 
           
% of total
15 
37 
41 
100 
           
2009
         
MTNs
13,450 
7,457 
3,477 
3,665 
28,049 
           
% of total
48 
27 
12 
13 
100 


* unaudited

 
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Business review Risk and balance sheet management continued
 
 
The table below shows the currency breakdown of public and private long-term debt securities issued.

 
GBP 
EUR 
USD 
AUD 
Other 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
Public
           
  - MTNs
— 
1,808 
2,181 
1,096 
— 
5,085 
  - covered bonds
— 
5,001 
— 
— 
— 
5,001 
  - securitisations
478 
1,478 
2,850 
— 
— 
4,806 
Private
2,872 
3,856 
3,183 
302 
2,701 
12,914 
 
3,350 
12,143 
8,214 
1,398 
2,701 
27,806 
             
% of total
12 
44 
29 
10 
100 
             
2010
           
Public
           
  - MTNs
1,260 
3,969 
5,131 
1,236 
1,291 
12,887 
  - covered bonds
— 
3,999 
— 
— 
— 
3,999 
  - securitisations
663 
1,629 
1,750 
— 
— 
4,042 
Private
2,184 
10,041 
2,879 
174 
2,172 
17,450 
 
4,107 
19,638 
9,760 
1,410 
3,463 
38,378 
             
% of total
11 
51 
25 
100 
             
2009
           
Public
           
  - MTNs
7,267 
4,795 
10,940 
3,173 
1,874 
28,049 
Private
4,932 
9,773 
9,668 
2,738 
3,243 
30,354 
 
12,199 
14,568 
20,608 
5,911 
5,117 
58,403 
             
% of total
21 
25 
35 
10 
100 


Key points
·  
In line with the Group’s plan to diversify its funding mix, issuances were spread across G10 currencies and maturity bands, including £5.7 billion of public issuance with an original maturity of greater than 10 years.
 
·  
The Group has issued approximately £2.8 billion since year end, including a £1 billion public covered bond issuance and a US$1.2 billion securitisation.



Secured funding
The Group has access to secured funding markets through own-asset securitisation and covered bond funding programmes to complement existing wholesale funding programmes and access to the repo markets. The Group monitors and manages encumbrance levels related to these secured funding programmes. This includes 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.

For information on the Group’s own-asset securitisations, covered bond programme and securities repurchase agreements, refer to Note 30 on the consolidated accounts on pages 355 and 356.

Liquidity management
Liquidity risk management requires ongoing assessment and calibration of: how the various sources of the Group’s liquidity risk interact with each other; market dynamics; and regulatory developments to determine the overall size of the Group’s liquid asset buffer. In addition to the size determination, the composition of the buffer is also important. The composition is reviewed on a continuous basis in order to ensure that the Group holds an appropriate portfolio of high quality assets that can provide a cushion against market disruption and dislocation, even in the most extreme stress circumstances.

 
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Business review 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.

 
2011
2010 
2009 
 
Average 
£m 
Period end 
£m 
Period end 
£m 
Period end 
£m 
Cash and balances at central banks
74,711 
69,932 
53,661 
51,500 
Treasury bills
5,937 
— 
14,529 
30,010 
Central and local government bonds (1)
       
- AAA rated governments and US agencies
37,947 
29,632 
41,435 
30,140 
- AA- to AA+ rated governments (2)
3,074 
14,102 
3,744 
2,011 
- governments rated below AA
925 
955 
1,029 
1,630 
- local government
4,779 
4,302 
5,672 
5,706 
 
46,725 
48,991 
51,880 
39,487 
Other assets (3)
       
- AAA rated
21,973 
25,202 
17,836 
20,246 
- below AAA rated and other high quality assets
12,102 
11,205 
16,693 
29,418 
 
34,075 
36,407 
34,529 
49,664 
Total liquidity portfolio
161,448 
155,330 
154,599 
170,661 

Notes:
(1)
Includes FSA eligible government bonds of £36.7 billion at 31 December 2011 (2010 - £34.7 billion; 2009 - £19.9 billion).
(2)
Includes AAA rated US government guaranteed and US government sponsored agencies. The US government was downgraded from AAA to AA+ by S&P on 5 August 2011, although not by Moody’s or Fitch. These securities are reflected here.
(3)
Includes assets eligible for discounting at central banks.



Key point
·  
In view of the continuing uncertain market conditions, the liquidity portfolio was maintained above the Group’s target level of £150 billion at £155.3 billion, with an average balance in 2011 of £161.4 billion. In anticipation of challenging market conditions, the composition was altered to become more liquid and conservative, as cash and balances at central banks rose to 45% of the total portfolio at 31 December 2011, from 35% at 31 December 2010.

Liquidity and funding metrics
The Group continues to improve and augment liquidity and funding risk management practices, in light of market experience and emerging regulatory and industry standards. The Group monitors a range of liquidity and funding indicators. These metrics encompass short and long-term liquidity requirements under stress and normal operating conditions. Two key structural ratios are described below.

Loan to deposit ratio and funding gap
The table below shows the Group’s loan:deposit ratio and customer funding gap, including disposal groups.

 
Loan:deposit ratio
 
Customer 
 funding gap 
Group 
£bn 
 
Group 
Core 
 
2011
108 
94 
 
37 
2010
118 
96 
 
77 
2009
132 
103 
 
137 


Note:
(1)
Loans are net of provisions, excluding repos. For Group before RFS MI only for 2009.


Key points
·  
The Group’s loan:deposit ratio improved 1,000 basis points to 108% during 2011, as loans declined and deposits grew.
 
·  
The customer funding gap almost halved with Non-Core contributing £27 billion of the £40 billion reduction.


 
80

 
Business review Risk and balance sheet management continued
 
 
Net stable funding ratio*
The table below shows the Group’s net stable funding ratio (NSFR), estimated by applying the Basel III guidance issued in December 2010, which represents a non-GAAP measure as described on page 2. The Group is aiming to meet the minimum required NSFR of 100% over the longer term. This measure seeks to show the proportion of structural term assets which are funded by stable funding, including customer deposits, long-term wholesale funding and equity. One of the main components of the ratio entails categorising retail and SME deposits as either ‘more stable’ or ‘less stable’. The Group’s NSFR will also continue to be refined over time in line with regulatory developments. It may be calculated on a basis that is not consistent with that used by other financial institutions.

 
2011
 
2010
 
2009
   
   
ASF(1) 
   
ASF(1) 
   
ASF(1) 
 
Weighting 
 
£bn 
£bn 
 
£bn 
£bn 
 
£bn 
£bn 
 
Equity
76 
76 
 
77 
77 
 
80 
80 
 
100 
Wholesale funding > 1 year
124 
124 
 
154 
154 
 
144 
144 
 
100 
Wholesale funding < 1 year
134 
— 
 
157 
— 
 
250 
— 
 
— 
Derivatives
524 
— 
 
424 
— 
 
422 
— 
 
— 
Repurchase agreements
129 
— 
 
115 
— 
 
106 
— 
 
— 
Deposits
                   
  - Retail and SME - more stable
227 
204 
 
172 
155 
 
166 
149 
 
9
  - Retail and SME - less stable
31 
25 
 
51 
41 
 
50 
40 
 
8
  - Other
179 
89 
 
206 
103 
 
199 
99 
 
50 
Other (2)
83 
— 
 
98 
— 
 
105 
— 
 
— 
Total liabilities and equity
1,507 
518 
 
1,454 
530 
 
1,522 
512 
   
                     
Cash
79 
— 
 
57 
— 
 
52 
— 
 
— 
Inter-bank lending
44 
— 
 
58 
— 
 
49 
— 
 
— 
Debt securities > 1 year
                   
  - central and local governments AAA to AA-
77 
 
89 
 
84 
 
  - other eligible bonds
73 
15 
 
75 
15 
 
87 
17 
 
20 
  - other bonds
14 
14 
 
10 
10 
 
 
100 
Debt securities < 1 year
45 
— 
 
43 
— 
 
69 
— 
 
— 
Derivatives
530 
— 
 
427 
— 
 
438 
— 
 
— 
Reverse repurchase agreements
101 
— 
 
95 
— 
 
76 
— 
 
— 
Customer loans and advances > 1 year
                   
  - residential mortgages
145 
94 
 
145 
94 
 
137 
89 
 
65 
  - other
173 
173 
 
211 
211 
 
241 
241 
 
100 
Customer loans and advances < 1 year
                   
  - retail loans
19 
16 
 
22 
19 
 
24 
20 
 
85 
  - other
137 
69 
 
125 
63 
 
153 
77 
 
50 
Other (3)
70 
70 
 
97 
97 
 
103 
103 
 
100 
Total assets
1,507 
455 
 
1,454 
513 
 
1,522 
560 
   
Undrawn commitments
240 
12 
 
267 
13 
 
289 
14 
 
Total assets and undrawn commitments
1,747 
467 
 
1,721 
526 
 
1,811 
574 
   
                     
Net stable funding ratio
 
111% 
   
101% 
   
89% 
   

Notes:
(1)
Available stable funding.
(2)
Deferred tax, insurance liabilities and other liabilities.
(3)
Prepayments, accrued income, deferred tax and other assets.

Key points*
·  
The NSFR increased by 10% in the year to 111%, with the funding cushion over term assets and undrawn commitments increasing from £4 billion to £51 billion.

·  
Available stable funding decreased by £12 billion in the year as a result of a £30 billion reduction in long-term wholesale funding, including the move into short-term of approximately £20 billion of balances under the CGS. This was offset by a £19 billion increase in qualifying deposit balances, including classification of certain deposits as more stable, as some assumptions and methodologies were refined.

·  
Term assets decreased in the year by £38 billion primarily reflecting Non-Core disposals and run-offs. The decrease in other assets is primarily due to the closure of certain equities businesses in Global Banking & Markets and other asset movements.

* unaudited

 
81

 
Business review Risk and balance sheet management continued
 
 
Balance sheet management: Liquidity and funding risk continued
Special purpose entities
The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.

The Group applies the guidance in IAS 27 ‘Consolidated and Separate Financial Statements’ and SIC 12 ‘Consolidation - Special Purpose Entities’ in determining whether or not to consolidate an SPE. SPEs are consolidated where the substance of the relationship between the Group and the SPE is such that the SPE is controlled by the Group. In determining whether the SPE is controlled by the Group, the Group considers whether the activities of the SPE are being conducted on its behalf so that it obtains benefits from its operation; whether the Group has the decision-making powers to obtain the majority of the benefits of the SPE’s activities; whether the Group has rights to obtain the majority of the benefits of the SPE; and whether the Group retains the majority of the residual or ownership risks related to the SPE or its assets so as to obtain benefits from its activities. As a result of applying these principles, the Group does not consolidate those SPEs where its interests in the SPE do not provide the Group with a majority of the benefits and/or residual or ownership risks and therefore the SPE is not controlled by the Group. SPEs that are in substance controlled by the Group are consolidated. The Group accounts for its interests, for example, holdings of securities issued and liquidity commitments, in SPEs it does not consolidate in accordance with its accounting policy for these items.

The Group sponsors and arranges own-asset securitisations, whereby the sale of assets or interests in a pool of assets into an SPE is financed by the issuance of securities to investors. The pool of assets held by the SPE may be originated by the Group, or (in the case of whole loan programmes) purchased from third parties, and may be of varying credit quality. Investors in the debt securities issued by the SPE are rewarded through credit-linked returns, according to the credit rating of their securities. The majority of securitisations are supported through liquidity facilities, other credit enhancements and derivative hedges extended by financial institutions, some of which offer protection against initial defaults in the pool of assets. Thereafter, losses are absorbed by investors in the lowest ranking notes in the priority of payments. Investors in the most senior ranking debt securities are typically shielded from loss, since any subsequent losses may trigger repayment of their initial principal.

The Group also employs synthetic structures, where assets are not sold to the SPE, but credit derivatives are used to transfer the credit risk of the assets to an SPE. Securities may then be issued by the SPE to investors, on the back of the credit protection sold to the Group by the SPE.

Residential and commercial mortgages and credit card receivables form the types of assets generally included in cash securitisations, while corporate loans and commercial mortgages typically serve as reference obligations in synthetic securitisations.

The Group sponsors own-asset securitisations primarily as a way of diversifying funding sources. The Group purchases the securities issued in own-asset securitisations and may pledge as collateral for repurchase agreements with major central banks.

Refer to Note 30 on the consolidated accounts on page 355 for the asset categories, together with the carrying value of the assets and associated liabilities for those securitisations and other asset transfers, other than conduits (refer to page 83), where the assets continue to be recorded on the Group's balance sheet.



 
82

 
Business review Risk and balance sheet management continued
 
 
Conduits
The Group sponsors and administers a number of asset-backed commercial paper (ABCP) conduits. A conduit is a SPE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is typically short-dated, usually up to three months.

Group-sponsored conduits can be divided into multi-seller conduits and own-asset conduits. In determining whether or not to consolidate a conduit the Group applies the same criteria as to SPEs. Liquidity commitments from the Group to the conduit exceed the nominal amount of assets funded by the conduit as liquidity commitments are sized to cover the funding cost of the related assets.

The ways the Group may be involved with conduits and other special purpose entities are described on page 82.

The Group’s involvement in conduits takes a number of forms. It may:

·  
Sponsor an ABCP programme i.e. establish the programme and approve the sellers permitted to participate in the programme and the asset pools to be purchased by the programme;

·  
Administer an ABCP programme;

·  
Provide the ABCP conduit with liquidity facilities;

·  
Provide the ABCP conduit with a programme-wide credit enhancement facility; or

·  
Purchase commercial paper from an ABCP conduit.

Total assets and other aspects relating to the Group’s conduits are set out below.


 
2011
 
2010
 
2009
 
Core 
£m 
Non-Core 
£m 
Total 
£m 
 
Core 
£m 
Non-Core 
£m 
Total 
£m 
 
Core 
£m 
Non-Core 
£m 
Total 
£m 
Total assets held by the conduits
11,208 
1,893 
13,101 
 
16,390 
3,624 
20,014 
 
23,409 
3,957 
27,366 
Commercial paper issued (1)
10,590 
859 
11,449 
 
15,522 
2,540 
18,062 
 
22,644 
2,939 
25,583 
                       
Liquidity and credit enhancements
                     
Deal specific liquidity
                     
  - drawn
321 
1,051 
1,372 
 
868 
1,109 
1,977 
 
738 
1,059 
1,797 
  - undrawn
15,324 
1,144 
16,468 
 
21,935 
2,980 
24,915 
 
28,628 
3,852 
32,480 
PWCE (2)
795 
193 
988 
 
1,025 
257 
1,282 
 
1,167 
341 
1,508 
 
16,440 
2,388 
18,828 
 
23,828 
4,346 
28,174 
 
30,533 
5,252 
35,785 
                       
Maximum exposure to loss (3)
15,646 
2,194 
17,840 
 
22,803 
4,089 
26,892 
 
29,365 
4,911 
34,276 

Notes:
(1)
Includes £0.3 billion of ABCP issued to RBS plc at 31 December 2011 (2010 - £0.7 billion).
(2)
Programme-wide credit enhancement (PWCE) is an additional programme-wide credit support which would absorb 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 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 2011, both multi-seller and own-asset conduit assets decreased, as deals terminated and Non-Core assets were sold. The total assets held by Group-sponsored conduits were £13.1 billion at 31 December 2011 (2010 - £20.0 billion; 2009 - £27.4 billion).

·  
The average maturity of ABCP issued by the Group’s conduits at 31 December 2011 was 42.6 days (2010 - 69.4 days; 2009 - 58.4 days).

·  
The maturity of the commercial paper issued by the Group’s conduits is managed to mitigate the short-term contingent liquidity risk of providing back-up facilities. The Group’s limits sanctioned for such liquidity facilities in 2011 totalled approximately £16.8 billion for multi-seller conduits (2010 - £22.6 billion; 2009 - £25.0 billion).

·  
The weighted average life of the funded assets was 1.9 years at 31 December 2011 (2010 - 2.3 years; 2009 - 1.9 years).
 
·  
The Group’s maximum exposure to loss on its multi-seller conduits is £16.7 billion (2010 - £22.8 billion; 2009 - £25.2 billion), being the total amount of the Group’s liquidity commitments plus the extent of the programme-wide credit enhancement of conduit assets for which facilities were not provided by third parties.

·  
The Group holds a single own-asset conduit, which has assets funded by the Group. The Group’s maximum exposure to loss on own-asset conduits was £1.1 billion in 2011 (2010 - £4.1 billion; 2009 - £9.1 billion), with no ABCP outstanding at that date (2010 - £2.2 billion; 2009 - £7.7 billion).

·  
Multi-seller conduits accounted for 93% of the total liquidity and credit enhancements committed by the Group at 31 December 2011 (2010 - 84%; 2009 - 73%). The Group’s multi-seller conduits have continued to fund the vast majority of their assets solely through ABCP issuance.

 
83

 
Business review Risk and balance sheet management continued
 

Balance sheet management: Liquidity and funding risk continued
Conduits continued
The Group has not utilised its own-asset conduit with a committed liquidity of £26 billion (2010 - £26 billion) to access the Bank of England’s open market operations for contingent funding purposes. This conduit is not included above, or in the tables on pages 84 and 85.

Collateral analysis, profile, credit ratings and weighted average lives relating to the Group’s consolidated conduits are detailed below.

 
Funded assets
Undrawn 
commitments 
to fund assets 
Liquidity 
from third 
parties 
Total 
exposure 
 
Loans 
Securities 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
Auto loans
3,663 
390 
4,053 
2,241 
— 
6,294 
Corporate loans
146 
72 
218 
16 
— 
234 
Credit card receivables
865 
— 
865 
699 
— 
1,564 
Trade receivables
1,136 
126 
1,262 
649 
— 
1,911 
Student loans
488 
— 
488 
352 
— 
840 
Consumer loans
1,362 
— 
1,362 
101 
— 
1,463 
Mortgages
           
  - prime
2,239 
— 
2,239 
308 
— 
2,547 
  - non-conforming
727 
— 
727 
34 
— 
761 
  - commercial
21 
489 
510 
— 
518 
Other
760 
617 
1,377 
331 
— 
1,708 
 
11,407 
1,694 
13,101 
4,739 
— 
17,840 
             
2010
           
Auto loans
4,943 
346 
5,289 
2,964 
— 
8,253 
Corporate loans
115 
2,340 
2,455 
106 
— 
2,561 
Credit card receivables
2,088 
— 
2,088 
1,209 
— 
3,297 
Trade receivables
761 
— 
761 
1,090 
— 
1,851 
Student loans
757 
— 
757 
532 
(132)
1,157 
Consumer loans
1,889 
— 
1,889 
111 
— 
2,000 
Mortgages
           
  - prime
2,569 
2,572 
752 
— 
3,324 
  - non-conforming
1,371 
— 
1,371 
20 
— 
1,391 
  - sub-prime
103 
— 
103 
19 
— 
122 
  - commercial
210 
450 
660 
76 
(21)
715 
Other
1,072 
997 
2,069 
(1)
(10)
2,058 
 
15,878 
4,136 
20,014 
6,878 
(163)
26,729 

2009
           
Auto loans
4,293 
356 
4,649 
2,526 
— 
7,175 
Corporate loans
106 
7,695 
7,801 
161 
— 
7,962 
Credit card receivables
4,083 
— 
4,083 
1,058 
— 
5,141 
Trade receivables
806 
— 
806 
1,351 
— 
2,157 
Student loans
915 
— 
915 
263 
(132)
1,046 
Consumer loans
1,686 
— 
1,686 
222 
— 
1,908 
Mortgages
           
  - prime
2,739 
2,742 
750 
— 
3,492 
  - non-conforming
1,548 
— 
1,548 
193 
— 
1,741 
  - commercial
413 
458 
871 
155 
(22)
1,004 
Other
872 
1,393 
2,265 
232 
(12)
2,485 
 
17,461 
9,905 
27,366 
6,911 
(166)
34,111 


 
84

 
Business review Risk and balance sheet management continued
 
 
Conduits continued
 
CP funded assets
     
Credit ratings (S&P equivalent)
 
UK
 
Europe
US
RoW
Total
 
AAA
AA
A
BBB
Below
BBB
2011
£m
£m
£m
£m
£m
 
£m
£m
£m
£m
£m
Auto loans
518
1,145
2,141
249
4,053
 
3,323
683
40
7
Corporate loans
160
58
218
 
9
94
27
88
Credit card receivables
865
865
 
774
91
Trade receivables
567
695
1,262
 
449
343
426
44
Student loans
488
488
 
488
Consumer loans
716
646
1,362
 
1,362
Mortgages
                     
  - prime
182
2,057
2,239
 
1,446
737
39
17
  - non-conforming
667
60
727
 
157
265
287
18
  - commercial
489
21
510
 
2
5
498
5
Other
124
201
531
521
1,377
 
363
42
402
180
390
 
2,696
2,133
5,424
2,848
13,101
 
7,011
2,169
3,172
359
390
                       
2010
                     
Auto loans
429
962
3,434
464
5,289
 
4,827
354
101
7
Corporate loans
22
1,513
709
211
2,455
 
2,166
161
128
Credit card receivables
144
1,944
2,088
 
1,912
125
51
Trade receivables
261
500
761
 
265
353
95
48
Student loans
116
641
757
 
641
116
Consumer loans
766
462
661
1,889
 
16
1,873
Mortgages
                   
  - prime
161
2,411
2,572
 
1,043
1,476
32
21
  - non-conforming
712
659
1,371
 
782
273
316
  - sub-prime
103
103
 
68
35
  - commercial
627
33
660
 
16
5
635
4
Other
447
455
353
814
2,069
 
95
52
1,242
680
 
3,527
4,312
8,242
3,933
20,014
 
11,763
2,983
4,422
846
                       

2009
                     
Auto loans
476
982
2,621
570
4,649
 
2,965
1,547
137
Corporate loans
312
5,213
1,411
865
7,801
 
7,584
111
106
Credit card receivables
177
3,823
83
4,083
 
2,781
759
420
123
Trade receivables
334
438
34
806
 
446
266
60
34
Student loans
117
798
915
 
798
117
Consumer loans
733
800
153
1,686
 
68
50
1,553
15
Mortgages
                     
  - prime
138
2,604
2,742
 
949
1,746
28
3
16
  - non-conforming
599
949
1,548
 
1,070
379
99
  - commercial
641
194
36
871
 
25
3
840
3
Other
121
670
298
1,176
2,265
 
170
249
950
896
 
3,314
9,142
9,542
5,368
27,366
 
16,856
5,227
4,193
1,071
19


 
85

 
Business review Risk and balance sheet management continued
 

Balance sheet management: Liquidity and funding risk continued
Assets and liabilities by contractual cash flow maturity
The tables below show the contractual undiscounted cash flows receivable and payable, up to a period of twenty years, including future receipts and payments of interest of on-balance sheet assets by contractual maturity. The balances in the table below do not agree directly with the consolidated balance sheet, as the table includes all cash flows relating to principal and future coupon payments, presented on an undiscounted basis. The tables have been prepared on the following basis:

The contractual maturity of on-balance sheet assets and liabilities highlights the maturity transformation which underpins the role of banks to lend long-term, but to fund themselves predominantly by short-term liabilities such as customer deposits. This is achieved through the diversified funding franchise of the Group across an extensive retail, wealth and SME customer base, and across a wide geographic network. In practice, the behavioural profiles of many assets and liabilities exhibit greater stability and longer maturity than the contractual maturity.

Financial assets have been reflected in the time band of the latest date on which they could be repaid, unless earlier repayment can be demanded by the Group. Financial liabilities are included at the earliest date on which the counterparty can require repayment, regardless of whether or not such early repayment results in a penalty. If the repayment of a financial instrument is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the time band that contains the latest date on which it can be repaid, regardless of early repayment. The liability is included in the time band that contains the earliest possible date on which the conditions could be fulfilled, without considering the probability of the conditions being met.

For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period, whatever the level of the index at the year end. The settlement date of debt securities in issue, issued by certain securitisation vehicles consolidated by the Group, depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date. As the repayments of assets and liabilities are linked, the repayment of assets in securitisations is shown on the earliest date that the asset can be prepaid, as this is the basis used for liabilities.

The principal amounts of financial assets and liabilities that are repayable after twenty years or where the counterparty has no right to repayment of the principal are excluded from the table, as are interest payments after twenty years.

 
0-3 months 
3-12 months 
1-3 years 
3-5 years 
5-10 years 
10-20 years 
2011
£m 
£m 
£m 
£m 
£m 
£m 
Assets by contractual maturity
           
Cash and balances at central banks
79,269 
— 
— 
— 
— 
—  
Loans and advances to banks
26,326 
1,294 
544 
121 
114 
—  
Debt securities
7,237 
9,569 
23,137 
21,003 
39,148 
15,869 
Settlement balances
7,759 
8 
— 
1 
— 
—  
Other financial assets
397 
158 
— 
16 
738 
—  
Total maturing assets
120,988 
11,029 
23,681 
21,141 
40,000 
15,869 
Loans and advances to customers
97,318 
90,894 
108,331 
55,785 
62,085 
56,259 
Derivatives held for hedging
519 
1,556 
3,438 
1,695 
596 
138 
 
218,825 
103,479 
135,450 
78,621 
102,681 
72,266 
             
Liabilities by contractual maturity
           
Deposits by banks
39,139 
5,104 
5,513 
461 
1,121 
364 
Debt securities in issue
66,253 
15,756 
25,099 
17,627 
18,833 
4,190 
Subordinated liabilities
133 
1,116 
4,392 
7,872 
8,654 
3,488 
Settlement balances and other liabilities
9,015 
37 
36 
62 
16 
15 
Total maturing liabilities
114,540 
22,013 
35,040 
26,022 
28,624 
8,057 
Customer accounts
379,692 
23,068 
12,643 
5,389 
1,483 
779 
Derivatives held for hedging
525 
788 
1,981 
1,186 
1,101 
821 
 
494,757 
45,869 
49,664 
32,597 
31,208 
9,657 
             
Maturity gap
6,448 
(10,984)
(11,359)
(4,881)
11,376 
7,812 
Cumulative maturity gap
6,448 
(4,536)
(15,895)
(20,776)
(9,400)
(1,588)
             
Guarantees and commitments notional amount
           
Guarantees (1)
24,886 
— 
— 
— 
— 
— 
Commitments (2)
239,963 
— 
— 
— 
— 
— 

For notes relating to this table refer to page 88.

 
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Business review Risk and balance sheet management continued
 
 
Assets and liabilities by contractual cash flow maturity continued 
 
0-3 months 
3-12 months 
1-3 years 
3-5 years 
5-10 years 
10-20 years 
2010
£m 
£m 
£m 
£m 
£m 
£m 
Assets by contractual maturity
           
Cash and balances at central banks
56,988 
— 
— 
— 
25 
Loans and advances to banks
33,809 
1,377 
711 
120 
193 
79 
Debt securities
11,247 
9,816 
25,059 
22,400 
40,600 
22,128 
Settlement balances
11,334 
231 
— 
— 
41 
— 
Other financial assets
458 
221 
207 
15 
405 
— 
Total maturing assets
113,836 
11,645 
25,977 
22,536 
41,239 
22,232 
Loans and advances to customers
112,465 
86,592 
120,139 
69,304 
78,131 
63,015 
Derivatives held for hedging
530 
1,588 
2,612 
638 
210 
101 
 
226,831 
99,825 
148,728 
92,478 
119,580 
85,348 
             
Liabilities by contractual maturity
           
Deposits by banks
43,396 
4,417 
1,243 
304 
651 
374 
Debt securities in issue
89,583 
43,032 
31,862 
22,569 
24,209 
6,697 
Subordinated liabilities
2,485 
2,611 
6,570 
8,691 
8,672 
4,607 
Settlement balances and other liabilities
12,423 
59 
136 
177 
385 
25 
Total maturing liabilities
147,887 
50,119 
39,811 
31,741 
33,917 
11,703 
Customer accounts
402,457 
18,580 
8,360 
4,651 
4,393 
2,384 
Derivatives held for hedging
608 
936 
2,103 
969 
681 
253 
 
550,952 
69,635 
50,274 
37,361 
38,991 
14,340 
             
Maturity gap
(34,051)
(38,474)
(13,834)
(9,205)
7,322 
10,529 
Cumulative maturity gap
(34,051)
(72,525)
(86,359)
(95,564)
(88,242)
(77,713)
             
Guarantees and commitments notional amount
           
Guarantees (1)
31,026 
— 
— 
— 
— 
— 
Commitments (2)
266,822 
— 
— 
— 
— 
— 

For notes relating to this table refer to page 88.

 
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Business review Risk and balance sheet management continued
 

Balance sheet management: Liquidity and funding risk continued
Assets and liabilities by contractual cash flow maturity continued

 
0-3 months 
3-12 months 
1-3 years 
3-5 years 
5-10 years 
10-20 years 
2009
£m 
£m 
£m 
£m 
£m 
£m 
Assets by contractual maturity
           
Cash and balances at central banks
52,239 
— 
— 
25 
— 
Loans and advances to banks
42,615 
1,757 
966 
282 
868 
71 
Debt securities
17,581 
14,484 
29,675 
26,788 
52,104 
30,335 
Settlement balances
12,020 
— 
Other financial assets
265 
215 
402 
127 
421 
— 
Total maturing assets
124,720 
16,462 
31,044 
27,198 
53,426 
30,407 
Loans and advances to customers
126,238 
65,946 
130,323 
101,984 
180,595 
202,809 
Derivatives held for hedging
488 
1,547 
3,049 
1,076 
751 
10 
 
251,446 
83,955 
164,416 
130,258 
234,772 
233,226 
             
Liabilities by contractual maturity
           
Deposits by banks
65,966 
15,541 
3,934 
2,301 
632 
12 
Debt securities in issue
100,220 
49,300 
56,869 
25,915 
27,326 
3,819 
Subordinated liabilities
1,929 
1,892 
3,654 
4,963 
20,157 
6,105 
Settlement balances and other liabilities
12,048 
100 
139 
104 
239 
83 
Total maturing liabilities
180,163 
66,833 
64,596 
33,283 
48,354 
10,019 
Customer accounts
521,400 
15,619 
5,944 
4,221 
8,490 
4,392 
Derivatives held for hedging
660 
1,566 
3,232 
1,264 
1,674 
1,508 
 
702,223 
84,018 
73,772 
38,768 
58,518 
15,919 
             
Maturity gap
(55,443)
(50,371)
(33,552)
(6,085)
5,072 
20,388 
Cumulative maturity gap
(55,443)
(105,814)
(139,366)
(145,451)
(140,379)
(119,991)
             
Guarantees and commitments notional amount
           
Guarantees (1)
39,952 
— 
— 
— 
— 
— 
Commitments (2)
291,634 
— 
— 
— 
— 
— 

Notes:
(1)
The Group is only called upon to satisfy a guarantee when the guaranteed party fails to meet its obligations. The Group expects most guarantees it provides to expire unused.
(2)
The Group has given commitments to provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.


Held-for-trading assets of £763 billion and liabilities of £708 billion (2010 - £665 billion assets, £586 billion liabilities; 2009 - £651 billion assets, £568 billion liabilities) have been excluded from the table in view of their short-term nature.



 
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Business review Risk and balance sheet management continued
 

Interest rate risk
The banking book consists of interest bearing assets, liabilities and derivative instruments used to mitigate risks which are accounted for on an accrual basis, as well as non-interest bearing balance sheet items, which are not subjected to fair value accounting.

The Group provides financial products to satisfy a variety of customer requirements. Loans and deposits are designed to meet customer objectives with regard to repricing frequency, tenor, index, prepayment, optionality and other features. When aggregated, they form portfolios of assets and liabilities with varying degrees of sensitivity to changes in market rates.

However, mismatches in these sensitivities give rise to net interest income (NII) 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 NII rise as interest rates rise and fall as rates decline. Due to the long-term nature of many banking book portfolios, varied interest rate repricing characteristics and maturities, it is likely the NII will vary from period to period, even if interest rates remain the same. New business volumes originated in any period will alter the interest rate sensitivity of a bank if the resulting portfolio differs from portfolios originated in prior periods.

The Group assesses interest rate risk in the banking book (IRRBB) using a set of standards to define, measure and report the market risk. It is the Group’s policy to minimise interest rate sensitivity in banking book portfolios and where interest rate risk is retained, to ensure that appropriate measures and limits are applied. Key measures used to evaluate IRRBB are subjected to approval of divisional Asset and Liability Management Committees (ALCOs) and the Group Asset and Liability Management Committee (GALCO).

Limits on IRRBB are proposed by the Group Treasurer for approval by the Executive Risk Forum annually.

The Group uses a variety of approaches to quantify its interest rate risk. IRRBB is measured using a version of the same value-at-risk (VaR) methodology that is used for the Group’s trading portfolios. Net interest income exposures are measured in terms of sensitivity over time to movements in interest rates. Additionally, Citizens measures the sensitivity of the market value of equity to changes in forward interest rates.

With the exception of Citizens and GBM, divisions are required to manage IRRBB through internal transactions with Group Treasury, to the greatest extent possible. Residual risks in divisions must be measured and reported as described below.

Group Treasury aggregates exposures arising from its own external activities and positions transferred to it from divisions. Where appropriate, Group Treasury nets off-setting risk exposures to determine a residual exposure to interest rate movements. Hedging transactions using cash and derivative instruments are executed to manage IRRBB exposures, within the GALCO approved VaR limits.

Citizens and GBM manage their own IRRBB exposures within approved limits to satisfy their business objectives.

IRRBB VaR for the Group’s retail and commercial banking activities at a 99% a confidence level was as follows:


 
Average 
Period end 
Maximum 
Minimum 
 
£m 
£m 
£m 
£m 
2011
63 
51 
80 
44 
2010
58 
96 
96 
30 
2009
86 
101 
123 
53 

A breakdown of the Group’s IRRBB VaR by currency is shown below.

Currency
2011 
£m 
2010 
£m 
2009 
£m 
Euro
26 
33 
32 
Sterling
57 
79 
111 
US dollar
61 
121 
42 
Other
10 


Key points
·  
Interest rate exposure at 31 December 2011 was considerably lower than at 31 December 2010 but average exposure was 9% higher in 2011 than in 2010.
 
·  
The reduction in US dollar VaR reflects, in part, changes in holding period assumptions following changes in Non-Core assets.*





* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Balance sheet management: Interest rate risk continued
Sensitivity of net interest income*
The Group seeks to mitigate the effect of prospective interest rate movements, which could reduce future net interest income (NII) in the Group’s businesses, whilst balancing the cost of such activities on the current net revenue stream. Hedging activities also consider the impact on market value sensitivity under stress.



The following table shows the sensitivity of NII, 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. This scenario differs from that applied in the previous year in both the severity of the rate shift and the tenors to which this is applied.


Potential favourable/(adverse) impact on NII
2011 
£m 
2010 
£m 
2009 
£m 
+ 100 basis points shift in yield curves
244 
232 
510 
– 100 basis points shift in yield curves
(183)
(352)
(687)
Bear steepener
443 
   
Bull flattener
(146)
   


Key points*
·  
The Group’s interest rate exposure remains slightly asset sensitive, driven in part by changes to underlying business assumptions as rates rise. The impact of the steepening and flattening scenarios is largely driven by the investment of net free reserves.
 
·  
The reported sensitivity will vary over time due to a number of factors such as market conditions and strategic changes to the balance sheet mix and should not therefore be considered predictive of future performance.




* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Structural foreign currency exposures
Structural foreign exchange exposures represent net investment in subsidiaries, associates and branches, the functional currencies of which are currencies other than sterling. The Group hedges structural foreign currency exposures only in limited circumstances. The Group’s objective is to ensure, where practical, that its consolidated capital ratios are largely protected from the effect of changes in exchange rates. The Group seeks to limit the sensitivity to its Core Tier 1 ratio to 20 basis points in a 10% rate shock scenario. The Group’s structural foreign currency position is reviewed by GALCO regularly.

The table below shows the Group’s structural foreign currency exposures.
 
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 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
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 
               
2010
             
US dollar
17,137 
17,135 
(1,820)
15,315 
(4,058)
11,257 
Euro
8,443 
33 
8,410 
(578)
7,832 
(2,305)
5,527 
Other non-sterling
5,320 
244 
5,076 
(4,135)
941 
— 
941 
 
30,900 
279 
30,621 
(6,533)
24,088 
(6,363)
17,725 
               
2009
             
US dollar
15,589 
(2)
15,591 
(3,846)
11,745 
(5,696)
6,049 
Euro
21,900 
13,938 
7,962 
(2,351)
5,611 
(3,522)
2,089 
Other non-sterling
5,706 
511 
5,195 
(4,001)
1,194 
— 
1,194 
 
43,195 
14,447 
28,748 
(10,198)
18,550 
(9,218)
9,332 

Note:
(1)
The economic hedges represent US dollar and euro 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 31 December 2011 was £24.2 billion and £17.9 billion before and after economic hedges respectively, broadly unchanged from the end of 2010 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 £1.27 billion (2010 - £1.27 billion; 2009 - £0.98 billion) in equity, while a 5% weakening would result in a loss of £1.15 billion (2010 - £1.15 billion; 2009 - £0.88 billion) in equity.

Equity risk
The Group holds equity positions in the banking book in order to achieve strategic objectives, such as membership of an exchange or clearing house, or to support venture capital transactions or customer restructuring arrangements. The Group is exposed to market risk on these banking book equity positions because they are measured at fair value. Fair values are based on available market prices where possible. In the event that market prices are not available, fair value is based on appropriate valuation techniques or management estimates.

The table below sets out the Group’s banking book equity positions.
 
Listed
Unlisted
Total
2011
£m
£m
£m
Group
576
1,768
2,344
       
2010
     
Group
535
2,080
2,615
       
2009
     
Group before RFS Holdings minority interest
401
2,388
2,789
RFS Holdings minority interest
60
211
271
Group
461
2,599
3,060

Note:
(1)
The table above excludes equity exposures held-for-trading and those held by insurance/assurance entities.
 
 
 
 
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Business review Risk and balance sheet management continued
 
Risk management
Introduction
This section focuses on each of the key types of risk that RBS Group faces - explaining how the Group manages these risks and highlighting the enhancements made as a result of progress under the Group’s ongoing initiatives to strengthen its approach to risk management.

Credit risk
All the disclosures in this section (pages 92 to 118) are audited unless otherwise indicated by an asterisk (*).

Credit risk is the risk of financial loss owing to the failure of a customer to meet its obligation to settle outstanding amounts. The quantum and nature of credit risk assumed across the Group’s different businesses vary considerably, while the overall credit risk outcome usually exhibits a high degree of correlation with the macroeconomic environment.

Organisation
The existence of a strong credit risk management function is vital to support the ongoing profitability of the Group. The potential for loss through economic cycles is mitigated through the embedding of a robust credit risk culture within the business units and through a focus on the importance of sustainable lending practices. The role of the credit risk management function is to own the credit approval, concentration and credit risk control frameworks and to act as the ultimate authority for the approval of credit. This, together with strong independent oversight and challenge, enables the business to maintain a sound lending environment within risk appetite.

Responsibility for development of Group-wide policies, credit risk frameworks, Group-wide portfolio management and assessment of provision adequacy, sits within the Group Credit Risk (GCR) function under the management of the Group Chief Credit Officer. Execution of these policies and frameworks is the responsibility of the risk management functions, located within the Group’s business divisions. These divisional credit risk functions work together with GCR to ensure that the Group Board’s expressed risk appetite is met, within a clearly defined and managed control environment. The credit risk function within each division is managed by a Chief Credit Officer, who reports jointly to a divisional Chief Risk Officer and to the Group Chief Credit Officer. Divisional activities within credit risk include credit approval, transaction and portfolio analysis, early problem recognition and ongoing credit risk stewardship.

GCR is additionally responsible for verifying compliance by the divisions with all Group credit policies.

In the final quarter of 2011, the Executive Risk Forum (ERF) approved a change to the management of the credit portfolio, delegating greater authority to the Group Chief Credit Officer as chair of the functional credit committees that analyse and recommend the limits to the ERF. With effect from October 2011, the Group Chief Credit Officer chairs a single Credit Risk Committee, with the authority to approve limits for the majority of portfolios across the Group. The ERF retains its strategic role as the most senior risk committee outside the Group Board and will continue to approve material portfolio concentrations and higher risk portfolios such as commercial real estate. This change strengthens individual accountability across the risk organisation and encourages the engagement of business leaders in first line of defence risk activity.

Risk appetite
Credit concentration risk is managed and controlled through a series of frameworks designed to limit concentration by product/asset class, sector, single name and country. These are supported by a suite of Group-wide and divisional policies, setting out the risk parameters within which business units may operate. Information on the Group’s credit portfolios is reported to the Group Board by way of the divisional and Group-level risk committees.

Throughout 2011, GCR’s emphasis was on embedding the new risk management frameworks introduced in 2009 and 2010 and on ensuring alignment with the strategic risk objectives being pursued across the Group. Risk appetite has been expressed by the Group Board by reference to earnings volatility and stable capital and these principles underpin the frameworks that GCR has established, and is continuing to refine, to manage the Group’s concentration risks in the Core balance sheet, by product/asset class, sector, single name and country.

In the two years since the new concentration framework was rolled out across the Group, the ERF has reviewed all material industry and product portfolios and agreed a risk appetite commensurate with the franchises represented in these reviews. In particular, limits have been reviewed and re-sized, to refine the Group’s risk appetite in areas where it faces significant balance sheet concentrations or franchise challenges. The product/asset class, sector, single name and country limits are now firmly embedded in the risk management processes of the Group and form a pivotal part of the Risk function’s engagement with the businesses on the appropriateness of risk appetite choices.

The new sector and asset class limits have been informed by the work undertaken to stress the portfolios and historical loss experience. In addition, they factor in the future consequences for risk and return in asset classes likely to be affected by the introduction of new regulatory capital rules under Basel III.

 
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Business review Risk and balance sheet management continued
 
Product/asset class concentration framework
·
Retail - a formal framework establishes Group-level statements and thresholds that are cascaded through all retail franchises in the Group and to granular business lines. These include measures that relate both to aggregate portfolios and to asset quality at origination, which are tracked frequently to ensure consistency with Group standards and appetite. This appetite setting and tracking then informs the processes and parameters employed in origination activities, which require a large volume of small-scale credit decisions, particularly those involving an application for a new product or a change in facilities on an existing product. The majority of these decisions are based upon automated strategies utilising credit and behaviour scoring techniques. Scores and strategies are typically segmented by product, brand and other significant drivers of credit risk. These data driven strategies utilise a wide range of credit information relating to a customer including, where appropriate, information across customer holdings. A small number of credit decisions are subject to additional manual underwriting by authorised approvers in specialist units. These include higher-value, more complex, small business and personal unsecured transactions and some residential mortgage applications.

·
Wholesale - formal policies, specialised tools and expertise, tailored monitoring and reporting and, in certain cases, specific limits and thresholds are deployed to address certain lines of business across the Group, where the nature of credit risk incurred could represent a concentration or a specific/heightened risk in some other form. For example, in response to volatile conditions in the syndicated loan, fixed income and equities markets during 2011, the Group engaged in only selective underwriting activity in these markets. In addition to the limit structures the Group has in place to manage its overall exposure to underwriting activity, market-linked controls were introduced in the loan underwriting book in 2011, to align the risk profile more closely to asset price movements. Those portfolios identified as potentially representing a concentration or heightened risk are subject to formal governance, including periodic review, at either Group or divisional level, depending on materiality.

Sector concentration framework
Across wholesale portfolios, exposures are assigned to, and reviewed in the context of, a defined set of industry sectors. Through this sector framework, appetite and portfolio strategies are agreed and set at aggregate and more granular levels where exposures have the potential to represent excessive concentration or where trends in both external factors and internal portfolio performance give cause for concern. Formal periodic reviews are undertaken at Group or divisional level depending on materiality. These may include an assessment of the Group’s franchise in a particular sector, an analysis of the outlook (including downside outcomes), identification of key vulnerabilities and stress/scenario tests. Specific reporting on trends in sector risk and on status versus agreed appetite and portfolio strategies is provided to senior management and to the Group Board.

As a result of the reviews carried out in 2011, the Group has reduced its risk appetite in the higher-risk sectors of leisure, media, commercial real estate, construction, automotive, and airlines and aerospace.
 
In response to the severe budgetary cuts mandated by the UK Government in 2010, the UK and Northern Ireland teams conducted a full review of the likely impact of the austerity measures on their corporate and retail lending portfolios. Areas of specific focus, such as local authority lending, where budgetary pressures will be hard felt, and portfolios exposed to discretionary consumer spend, such as the retail and leisure industries, were stressed using downside assumptions on further house price deterioration and higher unemployment. The output of these activities was reviewed by the Executive Risk Forum and actions agreed in the event that these scenarios threaten to materialise.

The impact of the eurozone crisis has been felt most significantly in the financial institutions sector, where widening credit spreads and regulatory demand for increases in Tier 1 capital have exacerbated the risk management challenges already posed by the sector’s continued weakness, as provisions and write-downs remain elevated. A material percentage of global banking activity in risk mitigation now passes through the balance sheets of the top global players, increasing the systemic risks to the sector. The Group’s exposures to these banks continue to be closely managed. The increased use of central clearing houses to reduce counterparty credit risk, including settlement risk, among the larger banks is a welcome move but one that will bring its own challenges. The weaker banks in the eurozone have also been the subject of heightened scrutiny and the Group’s risk appetite for these banks was adjusted continuously throughout 2011.

Single name concentration framework*
Within wholesale portfolios, much of the activity undertaken by the credit risk function is organised around the assessment, approval and management of the credit risk associated with a borrower or group of related borrowers.

A formal single name concentration framework addresses the risk of outsized exposure to a borrower or borrower group. The framework includes specific and elevated approval requirements, additional reporting and monitoring, and the requirement to develop plans to address and reduce excess exposures over an appropriate timeframe.

Credit approval authority is discharged by way of a framework of individual delegated authorities, which requires at least two individuals to approve each credit decision, one from the business and one from the credit risk management function. Both parties must hold sufficient delegated authority under the Group-wide authority grid. Whilst both parties are accountable for the quality of each decision taken, the credit risk management approver holds ultimate sanctioning authority. The level of authority granted to individuals is dependent on their experience and expertise, with only a small number of senior executives holding the highest authority provided under the framework. Daily monitoring of individual counterparty limits is undertaken.

At a minimum, credit relationships are reviewed and re-approved annually. The renewal process addresses: borrower performance, including reconfirmation or adjustment of risk parameter estimates; the adequacy of security; and compliance with terms and conditions. For certain counterparties, early warning indicators are also in place to detect deteriorating trends in limit utilisation or account performance, and to prompt additional oversight.
 
* unaudited
 
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Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Risk appetite continued
Since 2009, the Group has been managing its corporate exposures to reduce concentrations and align its appetite for future business to the Group’s broader strategies for its large corporate franchises. In the last quarter of 2011, the Group announced further refinements to the single name exposure management controls already in place, which brings them more closely in line with market best practice and which allows the Group to differentiate more consistently between the different risk types. These changes are expected to be implemented during the first quarter of 2012. The Group is continually reviewing its single name concentration framework to ensure that it remains appropriate for current economic conditions and in line with improvements in the Group’s risk measurement models.

Reducing the risk arising from concentrations to single names remains a key focus of management attention. Continued progress was made in 2011 and credit exposures in excess of single name concentration limits were reduced by over 15% during the year. The challenges posed by continued market illiquidity and the impact of negative credit migration caused by the current economic environment are expected to continue throughout 2012.

Country
For information on how the Group manages credit risk by country, refer to the Country risk section on page 166.

Controls and assurance*
A strong independent assurance function is an important element of a sound control environment. During 2011, the Group took the decision to strengthen its credit quality assurance (CQA) activities and moved all divisional CQA resources under the centralised management of Group Credit Risk. The benefits of this action are already apparent in greater consistency of standards and cross utilisation of resources. Reviews planned for 2012 will benefit from the availability of subject matter experts across all material products and classes and an improved ability to track control breaches and strengthen processes.

Work began in the second half of 2011 on a major revision of the Group’s key credit policies. This will ensure that the Group’s control environment is appropriately aligned to the risk appetite that the Group Board has approved and provide a sound basis for the Group’s independent audit and assurance activities across the credit risk function. The work is expected to be concluded by the end of the second quarter of 2012.

The Group Credit Risk function launched an assurance process to provide the Group Chief Credit Officer with additional evidence of the effectiveness of the controls in place across the Group to manage risk. The results of these reviews will be provided to the Executive Risk Forum and to the Board Risk Committee on a regular basis in support of the self-certification that Group Credit Risk is obliged to complete under the Group Policy Framework (refer to Operational risk on page 194 to 197).

Problem debt management
The Group’s procedures for managing problem debts differ between wholesale and retail customers, as discussed below.

Wholesale customers
The controls and processes for managing wholesale problem debts are embedded within the divisions’ credit approval frameworks and form an essential part of the ongoing credit assessment of customers. Any necessary approvals will be required in accordance with the delegated authority grid governing the extension of credit.

Early problem recognition
Each division has established Early Warning Indicators (EWIs) designed to identify those performing exposures that require close attention due to financial stress or heightened operational issues. Such identification may also take place as part of the annual review cycle. EWIs vary from division to division and comprise both internal parameters (e.g. account level information) and external parameters (e.g. the share price of publicly listed customers).

Customers identified through either the EWIs or annual review are reviewed by portfolio management and/or credit officers within the division, who determine whether or not the customer’s circumstances warrant placing the exposure on the Watchlist process (detailed below).

Watchlist process*
There are three Watchlist ratings - amber, red and black - reflecting progressively deteriorating conditions. Watchlist Amber loans are performing loans where the counterparty or sector shows early signs of potential stress or has other characteristics such that they warrant closer monitoring. Watchlist Red loans are performing loans where indications of the borrower’s declining creditworthiness are such that the exposure requires active management, usually by the Global Restructuring Group (GRG). Watchlist Black loans comprise risk elements in lending and potential problem loans.

Once on the Watchlist process, customers come under heightened scrutiny. The relationship strategy is reassessed by a forum of experienced credit, portfolio management and remedial management professionals within the division. In accordance with Group-wide policies, a number of mandatory actions will be taken, including a review of the customer’s credit grade and facility security documentation. Other appropriate corrective action is taken when circumstances emerge that may affect the customer’s ability to service its debt. Such circumstances include deteriorating trading performance, an imminent breach of covenant, challenging macroeconomic conditions, a late payment or the expectation of a missed payment.

For all Watchlist Red cases, the division is required to consult with the GRG on whether the relationship should be transferred to the GRG (see more on the GRG below). Relationships managed by the divisions tend to be with companies operating in niche sectors such as airlines or products such as securitisation special purpose vehicles. The divisions may also manage those exposures when subject matter expertise is available in the divisions rather than within the GRG.
 
* unaudited

 
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Business review Risk and balance sheet management continued
 
 
Watchlist process* continued

At 31 December 2011, exposure to customers reported as Watchlist Red and managed within the divisions totalled £4.9 billion.
 
Strategies that are available within divisions include granting the customer various types of concessions. Any decision to approve a concession will be a function of the division’s specific country and sector appetite, the key credit metrics of the customer, the market environment and the loan structure/security. Only those concessions deemed to be outside current market norms are reported as restructurings in the discussions below.

Other potential outcomes of the review of the relationship are to: take the customer off Watchlist and return it to the mainstream loan book; offer further lending and maintain ongoing review; transfer the relationship to the GRG for those customers requiring such stewardship; or exit the relationship altogether.
 
Global Restructuring Group
In cases where the Group’s exposure to the customer exceeds £1 million, the relationship may be transferred to the GRG following consultation with the originating division. The GRG’s primary function is active management of the exposures to minimise loss for the Group and where feasible return the exposure to the Group’s mainstream loan book following an assessment by the GRG that no further losses are expected.

At 31 December 2011, credit risk assets relating to exposures under GRG management (excluding those placed under GRG stewardship for operational reasons rather than concerns over credit quality and those in the AQ10 internal asset quality (AQ) band) totalled £22 billion. Credit risk assets are defined on page 102. The internal asset quality bands are defined on page 103.


The following table shows a sector breakdown of these exposures:

Watchlist Red credit risk assets under GRG management
Core
£m
Non-Core
£m
Total
£m
2011
     
Property
6,561
6,011
12,572
Transport
1,159
2,252
3,411
Retail and leisure
1,528
669
2,197
Services
808
141
949
Other
1,952
916
2,868
Total
12,008
9,989
21,997

Types of wholesale restructurings
A number of options are available to the Group when corrective action is deemed necessary. The Group may offer a temporary covenant waiver, a recalibration of covenants and/or an amendment of restrictive covenants to mitigate a potential or actual covenant breach. Such relief is usually granted in exchange for fees, increased margin, additional security, or a reduction in maturity profile of the original loan. Such covenant-related concessions are not included in the quantitative loan restructuring disclosures below.

The reported restructurings comprise the following types of concessions:

·
Variation in margin - the contractual margin may be amended to bolster the customer’s day-to-day liquidity, with the aim of helping to sustain the customer’s business as a going concern. This would normally be seen as a short-term solution and is typically accompanied by the Group receiving an exit payment, a payment in kind or a deferred fee.

·
Payment holidays and loan rescheduling - payment holidays or changes to the contracted amortisation profile including extensions in contracted maturity or roll-overs may be granted to improve the customer’s liquidity. Such concessions often depend on the expectation that the customer’s liquidity will recover when market conditions improve or will benefit from access to alternative sources of liquidity, e.g. an issue of equity capital. Recently, these types of concessions have become more common in commercial real estate transactions, particularly where a shortage of market liquidity rules out immediate refinancing and makes short-term forced collateral sales unattractive.

·
Forgiveness of all or part of the outstanding debt - debt may be forgiven or exchanged for equity in cases where a fundamental shift in the customer’s business or economic environment means that the customer is incapable of servicing current debt obligations and other forms of restructuring are unlikely to succeed in isolation. Debt forgiveness is often an element in leveraged finance transactions, which are typically structured on the basis of projected cash flows from operational activities, rather than underlying tangible asset values. Provided that the underlying business model and strategy are considered viable, maintaining the business as a going concern with a sustainable level of debt is the preferred option, rather than realising the value of the underlying assets.

The vast majority of the restructurings reported by the Group take place within the GRG. Forgiveness of debt and exchange for equity is only available to customers in the GRG.
 
* unaudited
 
 
95

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Problem debt management continued
The wholesale restructured loan data presented in the tables below include only those arrangements that achieved legal completion during 2011 and that individually exceed respective thresholds set at divisional level, which range from nil to £10 million. This population captures approximately 71% of that proportion of the wholesale portfolio that is either on Watchlist or under GRG stewardship. Within this population, restructurings amounting to £8.6 billion achieved legal completion during 2011. A further £14.7 billion was in the process of being completed at year end (these loans are not included in the tables below). Of the loans that were subject to restructuring during 2011 by the divisions, 82% remained in the performing book at 31 December 2011. Of those restructured within the GRG during the year, 17% had been returned to satisfactory by year end.

The asset quality of the restructured loans, the sectors affected and provision coverage are as follows:

Wholesale restructurings by sector
AQ1-AQ9 (1)
£m 
 
AQ10 (2)
£m 
AQ10 (2)
provision 
coverage 
 % 
2011
       
Property
1,980 
 
2,600 
18 
Transport
686 
 
694 
11 
Non-bank financial institutions
228 
 
420 
65 
Retail and leisure
503 
 
148 
24 
Other
1,078 
 
251 
28 
Total
4,475 
 
4,113 
22 
 
Notes:
(1)
Probability of default less than 100%.
(2)
Probability of default is 100%.

The incidence of the main types of restructuring is analysed below:

Wholesale restructurings by type of arrangement
Loans by value 
2011
 
Variation in margin
12 
Payment holidays and loan rescheduling
87 
Forgiveness of all or part of the outstanding debt
31 
Other

Note:
(1)
The total above exceeds 100% as an individual case can involve more than one type of arrangement.

Provisioning for impaired loans
Any one of the above types of restructuring may result in the value of the outstanding debt exceeding the present value of the estimated future cash flows from the restructured loan resulting in the recognition of an impairment loss. Restructurings that include forgiveness of all or part of the outstanding debt account for the majority of such cases.

The customer’s financial position, anticipated prospects and the likely effect of the restructuring, including any concessions granted, are considered in order to establish whether an impairment provision is required.

Provisions on exposures greater than £1 million are individually assessed by the GRG. Exposures smaller than £1 million are deemed not to be individually significant and are assessed collectively by the originating division.

In the case of non-performing loans that are restructured, the loan impairment provision assessment (based on management’s best estimate of the incurred loss) almost invariably takes place prior to the restructuring. The quantum of the loan impairment provision may change once the terms of the restructuring are known, resulting in an additional provision charge or a release of the provision in the period the restructuring takes place.

Refer to Impairment loss provision methodology on pages 160 and 161.
 
 
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Business review Risk and balance sheet management continued
 
 
Recoveries and active insolvency management
The ultimate outcome of a restructuring strategy is unknown at the time of execution. It is highly dependent on the cooperation of the borrower and the continued existence of a viable business. The following are generally considered to be options of last resort:

·
Enforcement of security or otherwise taking control of assets - where the Group holds collateral or other security interest and is entitled to enforce its rights, it may take ownership or control of the assets. The Group’s preferred strategy is to consider other possible options prior to exercising these rights.

·
Insolvency - where there is no suitable restructuring option or the business is no longer regarded as sustainable, insolvency will be considered. Insolvency may be the only option that ensures that the assets of the business are properly and efficiently distributed to relevant creditors.

Retail customers
Early problem recognition and collections
There are collections functions in each of the retail businesses. Their role is to provide support and assistance to customers who are experiencing difficulties in meeting their financial obligations to the Group. Evidence of such difficulties includes, for example, a missed payment on their loan, or a balance that is in excess of the agreed credit limit. Additionally, in UK Retail and Ulster Bank, a dedicated support team aims to identify and help customers who may be facing financial difficulty but who are current with their payments.

Within collections, a range of tools is deployed to initiate contact with the customer, establish the cause of their financial difficulty and, where possible, return the customer to a satisfactory position using, where appropriate, forbearance strategies. If these strategies are unsuccessful, the customer is transferred to the recoveries team.

Recoveries
The goal of the recoveries function is to collect the total amount outstanding and reduce the loss to the Group by maximising the level of cash recovery whilst treating customers fairly. A range of treatment options are available within recoveries, including litigation procedures for secured assets. In UK Retail and Ulster Bank, no repossession procedures are initiated until at least six months following the emergence of arrears. Additionally, certain forbearance options are made available to customers within recoveries.

Forbearance
Within the Group’s retail businesses, forbearance generally occurs when the business, for reasons relating to the actual or potential financial stress of a borrower, grants a permanent or temporary concession to that borrower. Forbearance is granted following an assessment of the customer’s ability to pay. It is granted principally to customers with mortgages. Granting of forbearance to unsecured customers is less extensive.

Identification of forbearance
Mortgages are identified for forbearance treatment following initial contact from the customer, in the event of payment arrears or when the customer is transferred to collections or recoveries.

Types of retail forbearance
A number of forbearance options are utilised by the Group’s retail businesses. These include, but are not limited to, reduced repayments, payment holidays, capitalisations of arrears, term extensions and conversions to interest only. Within UK Retail, interest only conversions are generally made available only to those customers who are current on payments and have a defined repayment source.

The principal types of forbearance granted in RBS Citizens’ mortgage portfolio are the US government mandated HAMP (Home Affordable Modification Program) and Citizens’ proprietary modification programme. Both programmes typically feature a combination of term extensions, capitalisations of arrears, temporary interest rate reductions and conversions from interest only to amortising. These tend to be permanent changes to contractual terms. Borrowers seeking a modification must meet government specified qualifications for HAMP and internal qualifications for Citizens’ modification programme. Both are designed to evidence that the borrower is in financial difficulty as well as demonstrating willingness to pay.

For those loans classified as non-performing, the Group’s objective in granting forbearance is to minimise the loss on these accounts and wherever possible, return the customer to the performing book. For those loans that are performing, the aim is to enable the customers to continue to service the loan.

The mortgage forbearance population is reviewed regularly to ensure that customers are meeting the agreed terms of the arrangement. Key metrics have been developed to record the proportion of customers who fail to meet the agreed terms over time as well as the proportion of customers who return to a performing state with no arrears.

 
97

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Problem debt management continued
The mortgage arrears information for retail accounts in forbearance and related provision arrangements are shown in the table below:
 
 
No missed payments
 
1-3 months in arrears
 
>3 months in arrears
 
Total
Arrears status and provisions
Balance 
£m 
Provision 
£m 
 
Balance 
£m 
Provision 
£m 
 
Balance 
£m 
Provision 
£m 
 
Balance 
£m 
Provision 
£m 
Accounts 
forborne 
£m 
2011
                       
UK Retail (1,2)
3,677 
16 
 
351 
13 
 
407 
59 
 
4,435 
88 
4.7 
                         
                         
Ulster Bank (1,2)
893 
78 
 
516 
45 
 
421 
124 
 
1,830 
247 
9.1 
Citizens
— 
— 
 
91 
10 
 
89 
10 
 
180 
20 
0.8 
Wealth
121 
— 
 
— 
— 
 
— 
 
123 
— 
1.3 
Total
4,691 
94 
 
958 
68 
 
919 
193 
 
6,568 
355 
4.4 

Notes:
(1)
Includes all forbearance arrangements regardless of whether or not the customer is experiencing financial difficulty.
(2)
Comprises the current stock position of forbearance deals agreed since January 2008 for UK Retail and since July 2008 for Ulster Bank.
(3)
Refer to page 113 for details of the proportion of UK Retail and Citizens mortgage loans that have missed three or more payments, compared to the forbearance population above.

The incidence of the main types of retail forbearance on the balance sheet as at 31 December 2011 is analysed below. For a small proportion of mortgages, more than one forbearance type applies.
 
Forbearance arrangements
UK Retail (1)
£m 
Ulster Bank (1)
£m 
Citizens 
£m 
Wealth 
£m 
Total (2)
£m 
2011
         
Interest only conversions
1,269 
795 
— 
2,067 
Term extensions - capital repayment and interest only
1,805 
58 
— 
97 
1,960 
Payment concessions/holidays
198 
876 
180 
— 
1,254 
Capitalisation of arrears
864 
101 
— 
— 
965 
Other
517 
— 
— 
23 
540 
Total
4,653 
1,830 
180 
123 
6,786 

Notes:
(1)
Comprises the current stock position of forbearance deals agreed since January 2008 for UK Retail and since July 2008 for Ulster Bank.
(2)
As an individual case can include more than one type of arrangement, the analysis in the table above can exceed the total forbearance.

For unsecured portfolios in UK Retail, 1.1% of the total unsecured population was subject to forbearance at 31 December 2011 and comprises either debt consolidation loans provided to customers subject to collections activity who do not meet the Group’s standard underwriting criteria or repayment arrangements where the customer's overdraft limit is increased to accommodate account excesses and/or loan arrears. Additionally, support is provided to customers experiencing financial difficulties through ‛breathing space initiatives’ on all unsecured products, including credit cards, whereby a 30-day period is given to allow customers to establish a debt repayment plan. During this time, the Group suspends collection activity and a further extension of 30 days can be granted if progress is made and discussions are continuing. Arrears continue to accrue for customer loans benefiting from breathing space.

Within Citizens, granting of forbearance is significantly less extensive for non real estate portfolios, as it is predominantly restricted to the granting of short-term (1-3 months) loan extensions to customers to alleviate the financial burden caused by temporary hardship. Such extensions are offered only if a customer has demonstrated a capacity and willingness to pay following the extension term. The number and frequency of extensions are limited per customer. Additionally, in the case of loans secured by vehicles and credit cards, Citizens may offer temporary interest rate modifications but no principal reduction. For loans secured by vehicles, this is now restricted to three-month interest rate modifications. For credit cards, customers may be offered short-term (6-12 months) or longer-term (up to 60 months) interest rate modifications. Citizens may also provide forbearance to student loan borrowers consistent with the policy guidelines of the US Office of the Comptroller of the Currency.
 
98

 
Business review Risk and balance sheet management continued
 

Provisioning for retail customers
Within UK Retail and Ulster Bank, provisions are assessed in accordance with the Group’s provisioning policies (refer to Impairment loss provision methodology on pages 160 and 161). For the non-performing population, a collective assessment is made. Within the performing book, latent loss provisions are held for those losses that are incurred but not yet identified.

The majority of mortgage accounts subject to forbearance in these divisions remain in the performing book but are identified and monitored separately from other performing accounts. They are subject to higher provisioning rates than the remainder of the performing book (currently approximately five times higher in UK Retail and approximately eight times higher in Ulster Bank). These rates are reviewed quarterly in UK Retail and monthly in Ulster Bank. Once forbearance is granted, the account continues to be assessed separately for latent provisioning for 24 months (UK Retail only) or until the forbearance period expires. After that point, the account is no longer separately identified for latent provisioning.

Non-performing mortgage accounts that have been granted forbearance carry the same provision rate as non-forborne accounts.

In Citizens, the amount of recorded impairment depends upon whether the loan is collateral dependent. If the loan is considered collateral dependent, the excess of the loan’s carrying amount over the fair value of the collateral is the impairment amount. If the loan is not deemed collateral dependent, the excess of the loan’s carrying amount over the present value of expected future cash flows is the impairment amount.

Credit risk mitigation
Introduction*
The Group employs a number of structures and techniques to mitigate credit risk. Netting of debtor and creditor balances is undertaken in accordance with relevant regulatory and internal policies. Exposure on over-the-counter derivative and secured financing transactions is further mitigated by the exchange of financial collateral and the use of market standard documentation. Further mitigation may be undertaken in a range of transactions, from retail mortgage lending to large wholesale financing. This can include: structuring a security interest in a physical or financial asset; use of credit derivatives, including credit default swaps, credit-linked debt instruments and securitisation structures; and use of guarantees and similar instruments (for example, credit insurance) from related and third parties. Such techniques are used in the management of credit portfolios, typically to mitigate credit concentrations in relation to an individual obligor, a borrower group or a collection of related borrowers.

The use and approach to credit risk mitigation varies by product type, customer and business strategy. Minimum standards applied across the Group cover:

·
The suitability of qualifying credit risk mitigation types and any conditions or restrictions applicable to those mitigants;

·
The means by which legal certainty is to be established, including required documentation and all necessary steps required to establish legal rights;

·
Acceptable methodologies for initial and any subsequent valuations of collateral and the frequency with which collateral is to be revalued and the use of collateral haircuts;

·
Actions to be taken in the event that the value of mitigation falls below required levels;

·
Management of the risk of correlation between changes in the credit risk of the customer and the value of credit risk mitigation;

·
Management of concentration risks, for example, by setting thresholds and controls on the acceptability of credit risk mitigants and on lines of business that are characterised by a specific collateral type or structure; and

·
Collateral management to ensure that credit risk mitigation remains legally effective and enforceable.

Collateral and other credit enhancements received
Within its secured portfolios, the Group has recourse to various types of collateral and other credit enhancements to mitigate credit risk and reduce the loss to the Group arising from the failure of a customer to meet its obligations. These include: cash deposits; charges over residential and commercial property, debt securities and equity shares; and third-party guarantees. The existence of collateral may affect the pricing of a facility and its regulatory capital requirement. When a collateralised financial asset becomes impaired, the impairment charge directly reflects the realisable value of collateral and any other credit enhancements.
 
* unaudited

 
99

 
 
Business review Risk and balance sheet management continued
 


Risk management: Credit risk continued
Credit risk mitigation continued
Corporate exposures
The type of collateral taken by the Group’s commercial and corporate businesses and the manner in which it is taken will vary according to the activity and assets of the customer.

·
Physical assets - these include business assets such as stock, plant and machinery, vehicles, ships and aircraft. In general, physical assets qualify as collateral only if they can be unambiguously identified, located or traced, and segregated from uncharged assets. Assets are valued on a number of bases according to the type of security that is granted.

·
Real estate - the Group takes collateral in the form of real estate, which includes residential and commercial properties. The loan amount will typically exceed the market value of the collateral at origination date. The market value is defined as the estimated amount for which the asset could be sold in an arms length transaction by a willing seller to a willing buyer.

·
Receivables - when taking a charge over receivables, the Group assesses their nature and quality and the borrower’s management and collection processes. The value of the receivables offered as collateral will typically be adjusted to exclude receivables that are past their due dates.
 
The security charges may be floating or fixed, with the type of security likely to impact (i) the credit decision; and (ii) the potential loss upon default. In the case of a general charge such as a mortgage debenture, balance sheet information may be used as a proxy for market value if the information is deemed reliable.

The Group does not recognise certain asset classes as collateral: for example, short leasehold property and equity shares of the borrowing company. Collateral whose value is correlated to that of the obligor is assessed on a case-by-case basis and, where necessary, over-collateralisation may be required.

The Group uses industry-standard loan and security documentation wherever possible. Non standard documentation is typically prepared by external lawyers on a case-by-case basis. The Group’s business and credit teams are supported by in-house specialist documentation teams.

The existence of collateral has an impact on provisioning. Where the Group no longer expects to recover the principal and interest due on a loan in full or in accordance with the original terms and conditions, it is assessed for impairment. If exposures are secured, the current net realisable value of the collateral will be taken into account when assessing the need for a provision. No impairment provision is recognised in cases where all amounts due are expected to be settled in full on realisation of the security.
 
 
2011
 
2010
Corporate risk elements in lending and potential problem loans
  (excluding commercial real estate)
Loans 
£m 
Provisions 
£m 
 
Loans 
£m 
Provisions 
£m 
Secured
7,782 
3,369 
 
6,526 
2,564 
Unsecured
2,712 
1,836 
 
2,769 
1,762 

Commercial real estate
The table below analyses commercial real estate lending by loan-to-value (LTV). Due to market conditions in Ireland and to a lesser extent in the UK, there is a shortage of market based data. In the absence of external valuations, the Group deploys a range of alternative approaches including internal expert judgement and indexation.

 
Ulster Bank
 
Rest of the Group
 
Group
LTVs
AQ1-AQ9
£m
AQ10
£m
 
AQ1-AQ9
£m
AQ10
£m
 
AQ1-AQ9
£m
AQ10
£m
2011
               
<= 50%
81
28
 
7,091
332
 
7,172
360
> 50% and <= 70%
642
121
 
14,105
984
 
14,747
1,105
> 70% and <= 90%
788
293
 
10,042
1,191
 
10,830
1,484
> 90% and <= 100%
541
483
 
2,616
1,679
 
3,157
2,162
> 100% and <= 110%
261
322
 
1,524
1,928
 
1,785
2,250
> 110% and <= 130%
893
1,143
 
698
1,039
 
1,591
2,182
> 130%
1,468
10,004
 
672
2,994
 
2,140
12,998
Total with LTVs
4,674
12,394
 
36,748
10,147
 
41,422
22,541
Other (1)
7
38
 
8,994
1,844
 
9,001
1,882
Total
4,681
12,432
 
45,742
11,991
 
50,423
24,423
                 
Total portfolio average LTV (2)
140%
259%
 
69%
129%
 
77%
201%

Notes:
(1)
Other performing loans of £9.0 billion include unsecured lending to commercial real estate clients, such as major UK homebuilders. The credit quality of these exposures is consistent with that of the performing portfolio overall. Other non-performing loans of £1.9 billion are subject to the Group’s standard provisioning policies.
(2)
Weighted average by exposure.

 
100

 
Business review Risk and balance sheet management continued
 

Wholesale market exposures
As set out in the table below, the Group receives collateral for reverse repurchase transactions and for derivatives, typically in the form of cash, quoted debt securities or equities. The risks inherent in both types of transaction are further mitigated through master bilateral netting arrangements. Industry standard documentation such as master repurchase agreements and credit support annexes accompanied by legal opinion, is used for financial collateral taken as part of trading activities.
 
 
2011 
£bn 
2010 
£bn 
2009 
£bn 
Reverse repurchase agreements
100.9 
95.1 
76.1 
Securities received as collateral (1)
(98.9)
(94.3)
(74.0)
       
Derivative assets gross exposure
529.6 
427.1 
441.5 
Counterparty netting
(441.6)
(330.4)
(358.9)
Cash collateral held
(37.2)
(31.1)
(33.7)
Securities received as collateral
(5.3)
(2.9)
(3.6)

Note:
(1)
In accordance with normal market practice, at 31 December 2011 £95.4 billion (2010 - £93.5 billion; 2009 - £73.0 billion) had been resold or re-pledged as collateral for the Group’s own transactions.

Retail exposures
Within the Group’s retail book, mortgage and home equity lending portfolios are secured by residential property. The Group’s portfolio of US automobile loans is secured by motor cars or other vehicles. Student loans and credit card lending are all unsecured. The vast majority of personal loans are also unsecured.

All borrowing applications, whether secured or not, are subject to appropriate credit risk underwriting processes including affordability assessment. Pricing is typically higher on unsecured than secured loans. For secured loans, pricing will typically vary by LTV. Higher LTV products are typically subject to higher interest rates commensurate with the associated risk.

The value of a property intended to secure a mortgage is assessed during the loan underwriting process using industry-standard methodologies. Property values supporting home equity lending reflect either an individual appraisal or valuations generated by statistically valid automated valuation models. Property values are updated each quarter using the relevant house price index (the Halifax Quarterly Regional House Price Index in the UK, the Case-Shiller Home Value Index in the US, and the Central Statistics Office Residential Property Price Index and the Nationwide House Price Index in Ireland).

For automobile lending in the US, new vehicles are valued at cost and used vehicles at the average trade-in value. At 31 December 2011 this portfolio amounted to £4.8 billion (2010 - £5.1 billion; 2009 - £5.7 billion), all of which was fully secured and predominantly (over 99%) in the performing book.

The existence of collateral has an impact on provisioning levels. Once a secured loan is classified as non-performing, the realisable value of the underlying collateral and the costs associated with repossession are used to estimate the provision required.

Residential mortgages
The table below shows period end LTVs for the Group’s residential mortgage portfolio split between performing and non-performing and calculated on a value basis. Loan balances are as at the end of the year whereas property values are calculated using the appropriate index at 30 September 2011.
 
 
2011
 
2010
 
2009
Residential mortgages by average LTV
Performing
£m
Non-performing
£m
 
Performing
£m
Non-performing
£m
 
Performing
£m
Non-performing
£m
<= 70%
60,799
1,137
 
59,598
1,036
 
55,920
791
> 70% and <= 90%
42,923
1,022
 
41,964
906
 
38,807
697
> 90% and <= 110%
17,856
990
 
20,104
951
 
23,853
754
> 110% and <= 130%
5,809
573
 
7,211
622
 
8,604
507
> 130% (1)
6,684
1,188
 
3,793
507
 
3,059
269
Total
134,071
4,910
 
132,670
4,022
 
130,243
3,018
                 
Total portfolio average LTV (by value)
73.2%
101.4%
 
72.4%
91.7%
 
73.5%
90.1%
 
Note:
(1)
83% of residential mortgages with LTV > 130% are within Ulster Bank due to the continued challenging economic environment in Ireland.


 
101

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Credit risk measurement*
Credit risk models are used throughout the Group to support the quantitative risk assessment element within the credit approval process, ongoing credit risk management, monitoring and reporting and portfolio analytics. Credit risk models used by the Group may be divided into three categories, as follows.

Probability of default/customer credit grade
These models assess the probability that a customer will fail to make full and timely repayment of its obligations. The probability of a customer failing to do so is measured over a one year period through the economic cycle, although certain retail scorecards use longer periods for business management purposes.

Wholesale businesses - as part of the credit assessment process, each counterparty is assigned an internal credit grade derived from a default probability. There are a number of different credit grading models in use across the Group, each of which considers risk characteristics particular to that type of customer. The credit grading models score a combination of quantitative inputs (for example, recent financial performance) and qualitative inputs (for example, management performance or sector outlook).

Retail businesses - each customer account is separately scored using models based on the most material drivers of default. In general, scorecards are statistically derived using customer data. Customers are assigned a score, which in turn is mapped to a probability of default. The probabilities of default are used to support automated credit decision making and to group customers into risk pools for regulatory capital calculations.

Exposure at default
Facility usage models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. For revolving and variable draw down type products which are not fully drawn, the exposure at default (EAD) will typically be higher than the current utilisation. The methodologies used in EAD modelling provide an estimate of potential exposure and recognise that customers may make more use of their existing credit facilities as they approach default.

Counterparty credit risk exposure measurement models are used for derivatives and other traded instruments, where the amount of credit risk exposure may be dependent upon one or more underlying market variables, such as interest or foreign exchange rates. These models drive internal credit risk management activities such as limit and excess management.

Loss given default
These models estimate the economic loss that may be experienced (the amount that cannot be recovered) by the Group on a credit facility in the event of default. The Group’s loss given default models take into account both borrower and facility characteristics for unsecured or partially unsecured facilities, as well as the quality of any risk mitigation that may be in place for secured facilities, the cost of collections and a time discount factor for the delay in cash recovery.

Credit risk assets
In the tables and commentary below, exposure refers to credit risk assets, which consist of:

·
Lending - cash and balances at central banks and loans and advances to banks and customers (including overdraft facilities, instalment credit and finance leases);

·
Rate risk management; and

·
Contingent obligations, primarily letters of credit and guarantees.

Reverse repurchase agreements and issuer risk (primarily debt securities - refer to pages 133 to 135) are excluded. Where relevant and unless otherwise stated, the data reflect the effect of credit mitigation techniques.

Divisional analysis of credit risk assets
2011
£m
2010
£m
2009
£m
UK Retail
111,070
108,302
103,029
UK Corporate
102,468
105,886
110,009
Wealth
20,079
18,875
16,553
Global Transaction Services
34,719
35,462
32,428
Ulster Bank
37,781
40,750
42,042
US Retail & Commercial
56,412
51,699
52,104
Retail & Commercial
362,529
360,974
356,165
Global Banking & Markets
165,616
171,891
205,588
Other
64,518
36,659
3,305
Core
592,663
569,524
565,058
Non-Core
92,710
125,383
158,499
 
685,373
694,907
723,557
* unaudited
 
 
102

 
Business review Risk and balance sheet management continued
 
Credit risk measurement* continued
Key points
·
Exposure to retail portfolios within the UK Retail, Ulster Bank and US Retail & Commercial divisions remained broadly constant during the year. A reduction in wholesale portfolios was seen across all divisions, with the exception of Wealth, for which product demand and risk appetite typically have more in common with retail portfolios. Another exception was ‘Other’, which is driven by Treasury where growth in credit risk assets relates to exposure to central banks in the USA, the UK and Germany and is a function of the Group’s liquidity requirements and cash positions.
 
·
Non-Core exposure declined during 2011 as a result of the continued disposal and run-off of assets. Substantial de-risking was achieved though an exposure reduction of £33 billion over the year, in line with balance sheet reduction targets. Significantly, the division was able to take action to reduce exposure within the Middle East & North Africa region, which saw material volatility early in 2011 (exposure down 66%). The division also reduced single name concentration excesses, in part due to disposals in the leveraged finance book. In addition, the division’s project finance business achieved a material reduction through asset sales, unwinding of trades within the markets business and legal defeasance of structured finance transactions.

Asset quality
Using the probability of default models described previously, customers are assigned credit grades and scores, which are used for internal management reporting across portfolios, including a Group level asset quality scale, as shown below.

Internal reporting and oversight of risk assets is principally differentiated by credit grades. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures, used for internal management reporting across portfolios. Accordingly, measures of risk exposure may be readily aggregated and reported at increasing levels of granularity depending on stakeholder or business need.

The table below shows credit risk assets by asset quality (AQ) band:
 
Asset
quality
Probability of default range
2011
 
2010
 
2009
Core
£m
Non-Core
£m
Total
£m
Total
%
 
Core
£m
Non-Core
£m
Total
£m
Total
%
 
Core
£m
Non-Core
£m
Total
£m
Total
%
AQ1
0% - 0.034%
 206,163
 13,732
 219,895
32.1
 
175,793
17,728
193,521
27.8
 
149,132
23,226
172,358
23.8
AQ2
0.034% - 0.048%
 18,403
 2,915
 21,318
3.1
 
18,274
2,526
20,800
3.0
 
18,029
3,187
21,216
2.9
AQ3
0.048% - 0.095%
 27,082
 2,883
 29,965
4.4
 
26,244
4,259
30,503
4.4
 
26,703
7,613
34,316
4.7
AQ4
0.095% - 0.381%
 65,492
 9,636
 75,128
11.0
 
64,277
15,052
79,329
11.4
 
78,144
18,154
96,298
13.3
AQ5
0.381% - 1.076%
 92,506
 10,873
 103,379
15.1
 
90,639
18,767
109,406
15.7
 
92,908
24,977
117,885
16.3
AQ6
1.076% - 2.153%
 67,260
 6,636
 73,896
10.8
 
73,367
12,913
86,280
12.4
 
76,206
18,072
94,278
13.0
AQ7
2.153% - 6.089%
 36,595
 8,134
 44,729
6.5
 
41,399
10,451
51,850
7.5
 
44,643
15,732
60,375
8.3
AQ8
6.089% - 17.222%
 11,933
 3,320
 15,253
2.2
 
15,300
4,308
19,608
2.8
 
18,923
4,834
23,757
3.4
AQ9
17.222% - 100%
 12,710
 5,024
 17,734
2.6
 
11,398
8,621
20,019
2.9
 
11,589
8,074
19,663
2.7
AQ10
100%
 20,118
 25,020
 45,138
6.6
 
18,003
25,005
43,008
6.2
 
16,756
22,666
39,422
5.5
Other (1)
 
 34,401
 4,537
 38,938
5.6
 
34,830
5,753
40,583
5.9
 
32,025
11,964
43,989
6.1
   
 592,663
 92,710
 685,373
100.0
 
569,524
125,383
694,907
100.0
 
565,058
158,499
723,557
100.0
 
Note:
(1)
‘Other’ largely comprises assets covered by the standardised approach, for which a probability of default equivalent to those assigned to assets covered by the internal ratings based approach is not available.
 
* unaudited
 
103

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Credit risk measurement*: Asset quality continued

 
2011
 
2010
 
2009
AQ10 credit risk assets by division
AQ10
£m
% of divisional credit risk assets
 
AQ10
£m
% of divisional credit risk assets
 
AQ10
£m
% of divisional credit risk assets
UK Retail
         5,097
4.6
 
5,017
4.6
 
4,846
4.7
UK Corporate
         5,469
5.3
 
5,130
4.8
 
5,604
5.1
Wealth
              12
0.1
 
9
 
11
0.1
Global Transaction Services
            275
0.8
 
349
1.0
 
242
0.7
Ulster Bank
         6,305
16.7
 
4,348
10.7
 
2,741
6.5
US Retail & Commercial
            646
1.1
 
599
1.2
 
506
1.0
Retail & Commercial
        17,804
4.9
 
15,452
4.3
 
13,950
3.9
Global Banking & Markets
         2,314
1.4
 
2,551
1.5
 
2,806
1.4
Core
        20,118
3.4
 
18,003
3.2
 
16,756
3.0
Non-Core
        25,020
27.0
 
25,005
19.9
 
22,666
14.3
 
        45,138
6.6
 
43,008
6.2
 
39,422
5.5
 
AQ10 credit risk assets by sector
2011
£m
2010
£m
2009
£m
Personal
    8,398
7,620
6,955
Property
  25,558
23,672
20,145
Banks and financial institutions
    1,934
1,981
1,928
Transport and storage
    1,720
1,689
1,026
Other
    7,528
8,046
9,368
 
45,138
43,008
39,422

Key points
·
Trends in the asset quality of the Group’s credit risk exposures in 2011 reflected changes in the composition of the Core portfolio in line with the re-balancing achieved through the Group’s sector concentration framework, the run-off of Non-Core assets and changes in the external environment. Significant deposits were placed with central banks and this resulted in a large increase in the Group’s exposures within the AQ1 band.

·
Overall, the asset quality of the Group’s corporate exposure was broadly maintained despite the difficult external conditions in the UK, with moderate weakening of credit quality in the Core divisions.

·
A notable exception is Ulster Bank, where weakness in the Irish property sector continued to impact portfolio trends and the stock of defaulted assets in the Core book (AQ10) continued to grow. Refer to the section on Ulster Bank on page 117 for more details.

·
In line with expectations, the percentage of defaulted assets in the Non-Core division increased following the run-off and disposal of performing assets. Weaknesses in the commercial real estate market continued to be the main driver of defaulted assets within Non-Core.
 
* unaudited
 
104

 
Business review Risk and balance sheet management continued
 
Credit risk measurement* continued
 
Portfolio by sector and geographical region
Sector analysis plays an important part in assessing the potential for concentration risk in the loan portfolio. Particular attention is given to sectors where the Group believes there is a high degree of risk or potential for volatility in the future.

The table below details credit risk assets by sector and geographical region. Sectors are based on mappings aligned to the Group’s sector concentration framework. Geographical region is based on country of incorporation.

Credit risk assets by sector and geographical region

2011 
UK
£m
Western
 Europe
(excl. UK)
£m
North
America
£m
Asia
Pacific
£m
Latin
America
£m
Other (1)
£m
Total
£m
Core
£m
Non-Core
£m
Personal
126,945
20,253
33,087
1,604
158
1,114
183,161
176,201
6,960
Banks
4,720
39,290
3,952
11,149
1,740
7,324
68,175
67,614
561
Other financial institutions
17,939
17,503
13,595
3,108
5,841
1,159
59,145
48,765
10,380
Sovereign (2)
21,072
34,258
31,444
3,463
78
1,581
91,896
90,638
1,258
Property
60,099
27,282
8,052
1,370
3,471
1,480
101,754
58,324
43,430
Natural resources
6,553
7,218
8,159
3,805
1,078
2,508
29,321
25,191
4,130
Manufacturing
9,583
7,480
7,098
2,126
1,011
1,381
28,679
26,614
2,065
Transport (3)
13,790
7,705
4,951
5,433
2,500
5,363
39,742
27,531
12,211
Retail and leisure
22,775
6,110
5,762
1,488
1,041
675
37,851
32,775
5,076
Telecommunications, media and technology
5,295
4,941
3,202
1,944
139
609
16,130
12,180
3,950
Business services
17,851
3,718
6,205
910
629
206
29,519
26,830
2,689
 
306,622
175,758
125,507
36,400
17,686
23,400
685,373
592,663
92,710
                   

2010 (4)
                 
Personal
124,594
21,973
34,970
1,864
126
1,531
185,058
174,287
10,771
Banks
6,819
35,619
5,097
11,072
1,394
6,713
66,714
65,494
1,220
Other financial institutions
17,550
14,782
14,773
4,200
8,732
1,762
61,799
47,227
14,572
Sovereign (2)
20,209
24,826
18,088
3,243
125
1,789
68,280
66,556
1,724
Property
65,622
30,925
9,573
1,980
3,090
1,750
112,940
60,590
52,350
Natural resources
6,696
7,863
9,771
3,655
1,396
4,143
33,524
24,427
9,097
Manufacturing
10,599
8,532
6,744
2,673
917
2,059
31,524
28,088
3,436
Transport (3)
13,842
8,726
5,389
6,161
2,658
6,347
43,123
27,899
15,224
Retail and leisure
24,716
6,690
5,316
1,438
1,174
918
40,252
34,100
6,152
Telecommunications, media and technology
5,495
5,764
3,283
2,187
328
786
17,843
12,076
5,767
Business services
19,757
5,116
6,521
985
1,086
385
33,850
28,780
5,070
 
315,899
170,816
119,525
39,458
21,026
28,183
694,907
569,524
125,383
                   

For notes relating to this table refer to page 106.



* unaudited
 
 
105

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Credit risk measurement*: Credit risk assets by sector and geographical region continued

2009
UK
£m
Western
 Europe
(excl. UK)
£m
North
America
£m
Asia
Pacific
£m
Latin
America
£m
Other (1)
£m
Total
£m
Core
£m
Non-Core
£m
Personal
 120,193
23,597
37,680
 1,374
 63
 897
183,804
 165,143
18,661
Banks
7,850
36,705
 4,975
 9,121
 1,378
2,137
62,166
 58,246
3,920
Other financial institutions
14,800
14,125
17,697
 4,820
 8,441
1,473
 61,356
 43,762
17,594
Sovereign (2)
18,172
27,421
 4,038
 3,950
414
2,217
56,212
 53,595
2,617
Property
72,768
35,558
11,221
 3,507
 3,127
1,440
127,621
 74,892
52,729
Natural resources
7,876
 9,460
 9,817
 3,029
 3,523
4,972
38,677
 26,058
12,619
Manufacturing
11,197
14,875
 8,718
 3,695
 1,306
2,633
42,424
 33,400
9,024
Transport (3)
14,097
 7,033
 7,287
 5,294
 2,604
7,140
43,455
 28,362
15,093
Retail and leisure
25,811
 8,236
 6,148
 3,602
 1,205
1,691
46,693
 35,580
11,113
Telecommunications, media and technology
6,128
 8,340
 4,854
 2,040
680
1,409
23,451
 13,645
9,806
Business services
20,497
 6,772
 6,950
 1,137
 1,439
 903
37,698
 32,375
5,323
 
 319,389
192,122
119,385
 41,569
 24,180
26,912
723,557
 565,058
158,499

Notes:
(1)
Comprises Central and Eastern Europe, Middle East, Central Asia and Africa, and supranationals such as the World Bank.
(2)
Includes central bank exposures.
(3)
Excludes net investment in operating leases in shipping and aviation portfolios as they are accounted for as property, plant and equipment. However, operating leases are included in the monitoring and management of these portfolios.
(4)
2010 data were restated due to supranational counterparties being re-mapped from Western Europe to Other.

Key points
·
Conditions in the financial markets and the Group’s focus on risk appetite and sector concentration had a direct impact on the composition of its Core portfolio during the year. The following key trends were observed:

(i)
A 35% increase in exposure to sovereigns, driven by the significant deposits placed with central banks;
(ii)
A 10% reduction in exposure to the property sector, driven by tightened controls in Core as well as by a reduction in Non-Core;
(iii)
A modest reduction in exposure to other corporate and financial institution sectors, driven by subdued borrowing activity by larger corporates; and
(iv)
A broadly flat exposure to the personal sector.

·
The Group’s sovereign portfolio comprises central governments, central banks and sub-sovereigns such as local authorities, primarily in the Group’s key markets in the UK, Western Europe and the US. Exposure predominantly comprises cash balances placed with central banks such as the Bank of England, the Federal Reserve and the Eurosystem (including the European Central Bank and central banks in the eurozone) and consequently, the asset quality of this portfolio is high. Exposure to sovereigns fluctuates according to the Group’s liquidity requirements and cash positions, which determine the level of cash placed with central banks. However, during 2011, there was a marked increase in these balances as the Group boosted its regulatory liquidity position. Information on the Group’s exposure to sovereigns, including eurozone peripheral sovereigns, can be found in the Country risk section on page 166.

·
The bank sector is one of the largest in the Group’s portfolio but the sector is well diversified geographically, largely collateralised and tightly controlled through a combination of the single name concentration framework and a suite of credit policies specifically tailored to the sector and country limits. The largest segment of exposure to the sector remains to globally systemically important financial institutions. The environment remains challenging as a result of low economic growth in advanced economies, higher costs due to increased regulatory requirements and the growing difficulty of returning to historical levels of profitability. Over 2011, there was modest increase in exposure to banks due to mark-to-market movements in derivatives. However, the Group’s portfolio was in general characterised by declining limits, a rising number of counterparties subject to heightened credit monitoring due to the problems faced by the peripheral eurozone countries and a corresponding deterioration in asset quality, balanced to some extent by the improved stability of banks outside the eurozone.

* unaudited
 
106

 
Business review Risk and balance sheet management continued
 
Credit risk measurement* continued

 
·
The other financial institutions sector comprises traded and non-traded products and is spread across a wide range of financial companies including insurance companies, securitisation vehicles, financial intermediaries including central counterparties (CCPs), financial guarantors - monolines and credit derivative product companies (CDPCs) - and unleveraged, hedge and leveraged funds. The size and asset quality of this portfolio are stable and have not changed materially since 2010. However, entities in this sector remain vulnerable to market shocks or contagion from the banking sector crisis. Credit risk for these sectors is managed through both the sector concentration and asset and product class frameworks, with specific sector and product caps introduced where there is a perception of heightened credit risk, such as with leveraged funds and insurance holding companies. Additionally, policies were tightened for riskier products to entities in this portfolio, such as committed lending, to reduce risks from a customer default. During the year, a comprehensive securitisation framework was established to cap the securitisation portfolio and to control concentrations to the underlying asset classes and originators. The Group is currently reassessing its risk appetite framework for CCPs to reflect increases in activity with these entities, as a result of regulatory requirements for derivatives to be cleared through CCPs. In 2011, the Group continued to manage down its exposures to monolines and CDPCs and was successful in commuting trades with entities in this portfolio.

·
The Group’s exposure to the property sector totals £102 billion (a reduction of 10% during the year), the majority of which is commercial real estate (refer to page 108 for further detail). The remainder comprises lending to construction companies, housing associations and building material companies. The majority of property exposure (with the exception of Non-Core) is within UK Corporate (63%). Asset quality in other property sub-sectors remained stable during the year and whilst there are some material single name concentrations in the construction sector due to industry consolidation, overall appetite remains controlled through the sector concentration limits framework.

·
The exposure to the retail sector attracts heightened scrutiny due to its cyclical nature. Stress testing has confirmed that the retail sector has an above average vulnerability to a high UK inflation and interest rate scenario. Certain sub-sectors have proven less vulnerable to macroeconomic volatilities (e.g. food and beverage) as have larger retailers with well established brands and multiple channel offerings. Total exposure declined 6% during 2011. Despite recent high profile failures of UK high street retailers, loss experience on the RBS retail portfolio over 2011 was low, following the earlier exit from some parts of the portfolio. The portfolio is generally well diversified by geography and by counterparty.

·
The leisure sector displays weaker credit metrics than the wider corporate portfolio, in line with the industry trend. Default experience in hotels and restaurants is particularly high. The Group’s risk appetite towards the sector is driven by the importance of the leisure sector to the UK franchise, especially for the UK Corporate division, but is mitigated through tighter origination policies and guidelines and a reduction in exposure to high risk sub-sectors. The gaming sub-sector is subject to specific controls due to its inherent high credit and reputational risk profile.

·
The Group’s transport sector includes £11.7 billion of asset-backed exposure to ocean-going vessels. The downturn observed in the shipping sector since 2008 continued during 2011, with further pressure on second-hand values and deliveries of new build vessels into poor markets. A key protection for the Group is the minimum security covenant. This covenant is tested each quarter on an individual vessel basis to ensure that prompt remedial action is taken if values fall significantly below agreed loan coverage ratios. At 31 December 2011, 1% of the Group’s exposure to this sector was in Watchlist Red.

·
Exposure to the healthcare and education sectors is included in the business services sector and totalled £13.4 billion at year-end. It is mostly UK focused and is heavily biased towards the health sector, which represents 74% of the exposure. The sector has performed well despite the difficult economic conditions but there are continuing uncertainties over the impact of Government spending reductions. Key concerns remain over the nursing home sub-sector, where the lower end of the elderly care home book saw an increased rate of customers being placed on Watchlist and higher defaults over 2011. Actions were taken to rebalance the portfolio towards the stronger operators.
 
* unaudited
 
107

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios*

Commercial real estate
The commercial real estate lending portfolio totalled £74.8 billion at 31 December 2011, a 14% year-on-year decrease (2010 - £87.4 billion). The commercial real estate sector comprises exposure to entities involved in the development of or investment in commercial and residential properties (including homebuilders). The analysis below excludes rate risk management and contingent obligations.

 
2011
 
2010
 
2009
By division
Investment
£m
Development
£m
Total
£m
 
Investment
£m
Development
£m
Total
£m
 
Investment
£m
Development
£m
Total
£m
Core
                     
UK Corporate
25,101
5,023
30,124
 
24,879
5,819
30,698
 
27,143
7,331
34,474
Ulster Bank
3,882
881
4,763
 
4,284
1,090
5,374
 
6,131
3,838
9,969
US Retail & Commercial
4,235
70
4,305
 
4,322
93
4,415
 
2,812
1,084
3,896
Global Banking & Markets
1,013
360
1,373
 
1,131
644
1,775
 
1,997
818
2,815
 
34,231
6,334
40,565
 
34,616
7,646
42,262
 
38,083
13,071
51,154
                       
Non-Core
                     
UK Corporate
3,957
2,020
5,977
 
7,591
3,263
10,854
 
7,390
3,959
11,349
Ulster Bank
3,860
8,490
12,350
 
3,854
8,760
12,614
 
2,061
6,271
8,332
US Retail & Commercial
901
28
929
 
1,325
70
1,395
 
1,409
431
1,840
Global Banking & Markets
14,689
336
15,025
 
19,906
379
20,285
 
24,638
873
25,511
 
23,407
10,874
34,281
 
32,676
12,472
45,148
 
35,498
11,534
47,032
                       
Total
57,638
17,208
74,846
 
67,292
20,118
87,410
 
73,581
24,605
98,186

 
Investment
 
Development
   
Investment
 
Development
 
By geography
Commercial
£m
Residential
£m
 
Commercial
£m
Residential
£m
Total
£m
 
Core
£m
Non-Core
£m
 
Core
£m
Non-Core
£m
Total
£m
2011
                         
UK (excluding NI) (1)
28,653
6,359
 
1,198
6,511
42,721
 
25,904
9,108
 
5,118
2,591
42,721
Ireland (ROI & NI) (1)
5,146
1,132
 
2,591
6,317
15,186
 
3,157
3,121
 
793
8,115
15,186
Western Europe
7,649
1,048
 
9
52
8,758
 
422
8,275
 
20
41
8,758
US
5,552
1,279
 
59
46
6,936
 
4,521
2,310
 
71
34
6,936
RoW
785
35
 
141
284
1,245
 
227
593
 
332
93
1,245
 
47,785
9,853
 
3,998
13,210
74,846
 
34,231
23,407
 
6,334
10,874
74,846

2010 (1)
                         
UK (excluding NI) (1)
32,334
7,255
 
1,520
8,288
49,397
 
26,168
13,421
 
5,997
3,811
49,397
Ireland (ROI & NI) (1)
5,056
1,148
 
2,785
6,578
15,567
 
3,159
3,044
 
963
8,401
15,567
Western Europe
10,568
643
 
25
42
11,278
 
409
10,802
 
25
42
11,278
US
7,345
1,296
 
69
175
8,885
 
4,636
4,005
 
173
71
8,885
RoW
1,622
25
 
138
498
2,283
 
244
1,404
 
488
147
2,283
 
56,925
10,367
 
4,537
15,581
87,410
 
34,616
32,676
 
7,646
12,472
87,410

2009 (1)
                         
UK (excluding NI) (1)
36,801
7,042
 
1,875
10,499
56,217
 
29,230
14,613
 
7,654
4,720
56,217
Ireland (ROI & NI) (1)
5,314
1,047
 
3,484
5,961
15,806
 
4,664
1,697
 
3,530
5,915
15,806
Western Europe
12,565
840
 
184
225
13,814
 
905
12,500
 
215
194
13,814
US
6,522
1,355
 
881
778
9,536
 
3,193
4,684
 
1,289
370
9,536
RoW
2,068
27
 
239
479
2,813
 
91
2,004
 
383
335
2,813
 
63,270
10,311
 
6,663
17,942
98,186
 
38,083
35,498
 
13,071
11,534
98,186
 
Note:
(1)
ROI: Republic of Ireland; NI: Northern Ireland.




*unaudited
 
108

 
Business review Risk and balance sheet management continued
 
Key credit portfolios* continued

By sub-sector
UK 
(excl NI)
£m 
Ireland 
(ROI & NI)
£m 
Western 
 Europe 
£m 
US 
£m 
RoW 
£m 
Total 
£m 
2011
           
Residential
12,871 
7,449 
1,096 
1,325 
319 
23,060 
Office
7,155 
1,354 
2,248 
404 
352 
11,513 
Retail
8,709 
1,641 
1,893 
285 
275 
12,803 
Industrial
4,317 
507 
520 
24 
105 
5,473 
Mixed/other
9,669 
4,235 
3,001 
4,898 
194 
21,997 
 
42,721 
15,186 
8,758 
6,936 
1,245 
74,846 

2010
           
Residential
15,543
7,726
685
1,471
523
25,948
Office
8,539
1,178
2,878
663
891
14,149
Retail
10,607
1,668
1,888
1,025
479
15,667
Industrial
4,912
515
711
80
106
6,324
Mixed/other
9,796
4,480
5,116
5,646
284
25,322
 
49,397
15,567
11,278
8,885
2,283
87,410

2009
           
Residential
17,197
7,352
1,065
2,134
505
28,253
Office
9,381
1,536
5,034
1,614
975
18,540
Retail
5,760
686
998
492
700
8,636
Industrial
11,378
2,599
3,592
2,053
402
20,024
Mixed/other
12,501
3,633
3,125
3,243
231
22,733
 
56,217
15,806
13,814
9,536
2,813
98,186

Note:
(1)
Excludes commercial real estate lending in Wealth as these loans are generally supported by personal guarantees in addition to collateral. This portfolio, which totalled £1.3 billion at 31 December 2011 continues to perform in line with expectations and requires minimal provision.

Key points
·
In line with the Group’s strategy, exposure to commercial real estate was reduced during 2011, affecting mainly the UK and Western Europe given that these regions account for the majority of the portfolio. Overall this portfolio decreased circa 25% from the end of 2009 to the end of 2011.

·
Most of the decrease is in Non-Core due to run-off and asset sales. The Non-Core portfolio totalled £34.3 billion (46% of the portfolio) at 31 December 2011 (2010 - £45.1 billion, or 52% of the portfolio) and includes exposures in Ulster Bank as discussed on page 118.

·
With the exception of exposure in Spain and in Ireland, the Group has minimal commercial real estate exposure to other eurozone periphery countries. Exposure in Spain is predominantly in the Non-Core portfolio and totals £2.3 billion, of which 36% is in AQ1-AQ9. The remainder of the Spanish portfolio has already been subject to material write-off and provision levels have been assessed based on re-appraised values. There are significant differences in values based on geographic location and asset type.

·
The UK portfolio is focused on London and the South East (44%), with the remainder well spread across the UK regions.

·
Short-term lending to property developers without sufficient pre-let revenue at origination to support investment financing after practical completion is classified as speculative. Speculative lending at origination represents approximately 1% of the portfolio. The Group’s appetite for originating speculative commercial real estate lending is very limited and any such business requires senior management approval.

·
  
The commercial real estate market is expected to remain challenging in key markets and new business will be accommodated from run-off of existing Core exposure. As liquidity in the market remains tight, the Group is focusing on re-financings and supporting its existing client base.


* unaudited
 
 
109

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios*: Commercial real estate continued
 
Maturity profile of portfolio
UK Corporate
Ulster Bank
US Retail
& Commercial
Global Banking
 & Markets
Total
£m
£m
£m
£m
£m
2011
         
Core
         
< 1 year (1)
8,268
3,030
1,056
142
12,496
1-2 years
5,187
391
638
278
6,494
2-3 years
3,587
117
765
363
4,832
> 3 years
10,871
1,225
1,846
590
14,532
Not classified (2)
2,211
2,211
Total
30,124
4,763
4,305
1,373
40,565
           
Non-Core
         
< 1 year (1)
3,224
11,089
293
7,093
21,699
1-2 years
508
692
163
3,064
4,427
2-3 years
312
177
152
1,738
2,379
> 3 years
1,636
392
321
3,126
5,475
Not classified (2)
297
4
301
Total
5,977
12,350
929
15,025
34,281
           
2010
         
Core
         
< 1 year (1)
7,563
2,719
1,303
890
12,475
1-2 years
5,154
829
766
247
6,996
2-3 years
4,698
541
751
221
6,211
> 3 years
10,361
1,285
1,595
417
13,658
Not classified (2)
2,922
2,922
Total
30,698
5,374
4,415
1,775
42,262
           
Non-Core
         
< 1 year (1)
4,829
10,809
501
3,887
20,026
1-2 years
1,727
983
109
6,178
8,997
2-3 years
831
128
218
3,967
5,144
> 3 years
2,904
694
567
6,253
10,418
Not classified (2)
563
563
Total
10,854
12,614
1,395
20,285
45,148
 
Notes:
(1)
Includes on demand and past due assets.
(2)
Predominantly comprises multi-option facilities for which there is no single maturity date.

Key point
·
The majority of Ulster Bank Group’s commercial real estate portfolio is categorised as < 1 year, including on demand assets, owing to the high level of non-performing assets in the portfolio. Ulster Bank places most restructured facilities on demand rather than extending the maturity date.

* unaudited
 
110

 
Business review Risk and balance sheet management continued
 
Key credit portfolios* continued
 
Breakdown of portfolio by asset quality (AQ) band
 
AQ1-AQ2 
AQ3-AQ4 
AQ5-AQ6 
AQ7-AQ8 
AQ9 
AQ10 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Core
1,094 
6,714 
19,054 
6,254 
3,111 
4,338 
40,565 
Non-Core
680 
1,287 
5,951 
3,893 
2,385 
20,085 
34,281 
Total
1,774 
8,001 
25,005 
10,147 
5,496 
24,423 
74,846 
               
2010
             
Core
1,055 
7,087 
20,588 
7,829 
2,171 
3,532 
42,262 
Non-Core
1,003 
2,694 
11,249 
7,608 
4,105 
18,489 
45,148 
Total
2,058 
9,781 
31,837 
15,437 
6,276 
22,021 
87,410 

Key points
·
Approximately 13% of the commercial real estate exposure is within the AQ1-AQ4 bands. This includes unsecured lending to property companies and real estate investment trusts. The high proportion of the exposure in the AQ10 band is driven by Ulster Bank Group (Core and Non-Core) and GBM (Non-Core).

·
Of the total portfolio of £74.8 billion at 31 December 2011, £34.7 billion (2010 - £45.1 billion) is managed within the Group’s standard credit processes and £5.9 billion (2010 - £9.2 billion) is receiving varying degrees of heightened credit management under the Group Watchlist process (this includes all Watchlist Amber cases and Watchlist Red cases managed outside the Global Restructuring Group (GRG)). A further £34.3 billion (2010 - £33.1 billion) is managed within the GRG and includes both Watchlist and non-performing exposures. The increase in the portfolio managed by the GRG is driven by Ulster Bank Group (Core and Non-Core).

The table below analyses commercial real estate lending by loan-to-value (LTV). Due to market conditions in Ireland and to a lesser extent in the UK, there is a shortage of market based data. In the absence of external valuations, the Group deploys a range of alternative approaches including internal expert judgement and indexation.

 
Ulster Bank
 
Rest of the Group
 
Group
LTVs
AQ1-AQ9
£m
AQ10
£m
 
AQ1-AQ9
£m
AQ10
£m
 
AQ1-AQ9
£m
AQ10
£m
2011
               
<= 50%
81
28
 
7,091
332
 
7,172
360
> 50% and <= 70%
642
121
 
14,105
984
 
14,747
1,105
> 70% and <= 90%
788
293
 
10,042
1,191
 
10,830
1,484
> 90% and <= 100%
541
483
 
2,616
1,679
 
3,157
2,162
> 100% and <= 110%
261
322
 
1,524
1,928
 
1,785
2,250
> 110% and <= 130%
893
1,143
 
698
1,039
 
1,591
2,182
> 130%
1,468
10,004
 
672
2,994
 
2,140
12,998
Total with LTVs
4,674
12,394
 
36,748
10,147
 
41,422
22,541
Other (1)
7
38
 
8,994
1,844
 
9,001
1,882
Total
4,681
12,432
 
45,742
11,991
 
50,423
24,423
                 
Total portfolio average LTV (2)
140%
259%
 
69%
129%
 
77%
201%

Notes:
(1)
Other performing loans of £9.0 billion include unsecured lending to commercial real estate clients, such as major UK homebuilders. The credit quality of these exposures is consistent with that of the performing portfolio overall. Other non-performing loans of £1.9 billion are subject to the Group’s standard provisioning policies.
(2)
Weighted average by exposure.

Key points
·
Nearly 85% of the commercial real estate portfolio with LTV > 100% is within Ulster Bank Group (Core and Non-Core) and GBM (Non-Core). A majority of portfolios are managed within the GRG and are subject to monthly reviews. Significant levels of provisions have been taken against these portfolios; provisions as a percentage of risk elements in lending for the Ulster Bank Group commercial real estate portfolio were 53% at 31 December 2011 (2010 - 44%). The reported LTV levels are based on gross loan values. The weighted average LTV for AQ10 excluding Ulster Bank is 129%.
 
·
The average interest coverage ratios (ICR) for UK Corporate (Core and Non-Core) and GBM (Non-Core) investment properties are 2.37x and 1.25x respectively. The US Retail & Commercial portfolio is managed on the basis of debt service coverage, which includes scheduled principal amortisation. The average debt service interest coverage for this portfolio on this basis was 1.24x at 31 December 2011. There are a number of different approaches used within the Group and across the industry to calculate ICR. Ratios for different portfolio types, and organisations may not therefore be comparable.

* unaudited
 
 
111

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios* continued
Retail assets
The Group’s retail lending portfolio includes mortgages, credit cards, unsecured loans, auto finance and overdrafts. The majority of personal lending exposures are in the UK, Ireland and the US. The analysis below includes both Core and Non-Core balances.
Personal credit loans and receivables
2011 
£m 
2010 
 £m 
2009
£m
UK Retail
     
  - mortgages
96,388 
92,592 
85,529
  - cards, loans and overdrafts
16,004 
18,072 
20,316
Ulster Bank
     
  - mortgages
20,020 
21,162 
22,304
  - other personal
1,533 
1,017 
1,172
Citizens
     
  - mortgages
23,829 
24,575 
26,534
  - auto and cards
5,731 
6,062 
6,917
  - other (1)
2,111 
3,455 
4,205
Other (2)
17,545 
18,123 
16,827
 
183,161 
185,058 
183,804

Notes:
(1)
Mainly student loans and loans secured by recreational vehicles or marine vessels.
(2)
Personal exposures in other divisions.

Residential mortgages
The tables below detail the distribution of residential mortgages by indexed LTV. LTV averages are calculated by transaction volume and transaction value. Refer to the section on Ulster Bank Group on page 117 for analysis of residential mortgages.
 

 
UK Retail
 
Citizens
LTV distribution calculated on a volume basis
2011
%
2010
%
2009
%
 
2011
%
2010 
% 
2009
%
<= 70%
62.1
61.6
60.2
 
43.5
43.4
43.6
> 70% and <= 90%
27.1
26.2
24.5
 
26.9
27.6
26.8
> 90% and <= 110%
9.4
10.4
12.5
 
16.7
17.2
18.0
> 110% and <= 130%
1.4
1.7
2.7
 
6.9
6.0
5.4
> 130%
0.1
0.1
 
6.0
5.8
6.2
               
Total portfolio average LTV at 31 December
57.8
58.2
59.1
 
73.8
75.3
74.5
               
Average LTV on new originations during the year
58.4
64.2
67.2
 
63.8
64.8
62.6

LTV distribution calculated on a value basis
2011
£m
2010
£m
2009
£m
 
2011
£m
2010
£m
2009
£m
<= 70%
47,811
44,522
37,666
 
9,669
10,375
11,675
> 70% and <= 90%
34,410
32,299
28,280
 
7,011
7,196
7,440
> 90% and <= 110%
11,800
12,660
15,112
 
3,947
4,080
4,569
> 110% and <= 130%
1,713
1,924
3,104
 
1,580
1,488
1,486
> 130%
74
73
86
 
1,263
1,252
1,540
               
Total portfolio average LTV at 31 December
67.2%
68.1%
70.4%
 
75.9%
75.4%
74.7%
               
Average LTV on new originations during the year
63.0%
68.0%
70.3%
 
65.8%
65.3%
64.4%
 
* unaudited

 
112

 
Business review Risk and balance sheet management continued
 
Key credit portfolios* continued

Residential mortgages which are three months or more in arrears (by volume)
2011 
%
2010
%
2009
%
UK Retail (1)
1.6 
1.7
1.6
Citizens
2.0 
1.4
1.5
 
 
Note:
(1)
The ‘One Account’ current account mortgage is excluded (£5.4 billion - 5.6% of assets) at 31 December 2011, 0.9% of these accounts were 90 days continually in excess of the limit (2010 - 0.8%). Consistent with the way the Council of Mortgage Lenders publishes member arrears information, the 3+ months arrears rate now excludes accounts in repossession and cases with shortfalls post property sale.
 
 
Key points
UK Retail
·
The UK Retail mortgage portfolio totalled £96.4 billion (98.6% in Core) at 31 December 2011, an increase of 4.1% from 2010, due to continued strong sales growth and lower redemption rates from before the financial crisis.

·
Of the total portfolio, 98.6% is designated as Core business, primarily comprising mortgages branded the Royal Bank of Scotland, NatWest, the One Account and First Active. Non-Core comprises Direct Line Mortgages.

·
The assets are prime mortgages and include 7.2% (£6.9 billion) of exposure to residential buy-to-let. There is a small legacy self-certification book (0.3% of total assets). Self-certified mortgages were withdrawn from sale in 2004.

·
Gross new mortgage lending in 2011 remained strong at £14.7 billion. The average LTV for new business during 2011 declined in comparison to 2010 and the maximum LTV available to new customers remained at 90%. Based on the Halifax House Price index at September 2011, the book average indexed LTV improved marginally when compared to December 2010, with the proportion of balances with an LTV over 100% also lower. Refer to the table on page 117, which details LTV information on a volume and value basis.

·
The arrears rate (more than three payments in arrears, excluding repossessions and shortfalls post property sale) has remained broadly stable since late 2009 at 1.6%.

·
The number of properties repossessed in 2011 was 1,671, up from 1,392 in 2010.

·
The mortgage impairment charge was £187 million for 2011, an increase of 2% from 2010. A significant part of the mortgage impairment charge related to reduced expectations of cash recovery on already defaulted debt. It also included an additional provision charge for mortgage customers who received forbearance.

·
Default and arrears rates remain sensitive to economic developments and are currently supported by the low interest rate environment and strong book growth, with recent business yet to fully mature.

Citizens
·
Citizens’ residential mortgage portfolio totalled £23.8 billion at 31 December 2011, a reduction of 3% from 2010 (£24.6 billion).

·
The mortgage portfolio comprises £6.4 billion of residential mortgages (99% in first lien position: Core - £5.8 billion; Non-Core - £0.6 billion) and £17.4 billion of home equity loans and lines (41% in first lien position: Core - £14.9 billion; Non-Core - £2.5 billion). Home equity Core consists of 47% in first lien position.

·
Citizens continues to focus on the ‘footprint’ states of New England, Mid Atlantic and Mid West, targeting low risk products and maintaining conservative risk policies. At 31 December 2011, the portfolio consisted of £19.5 billion (82% of the total portfolio) within footprint.

·
Loan acceptance criteria were tightened during 2009 to address deteriorating economic and market conditions.

·
Non-Core comprises 13% of the residential mortgage portfolio. Its largest component (74%) is the serviced by others (SBO) home equity portfolio. The SBO portfolio consists of purchased pools of home equity loans and lines, which resulted in an annualised charge-off rate of 8.7% in 2011. It is characterised by out-of-footprint geographies, high second lien concentration (95%) and high average LTV (113% at 31 December 2011). The SBO book has been closed to new purchases since the third quarter of 2007 and is in run-off, with exposure down from £2.8 billion in 2010, to £2.3 billion at 31 December 2011. The arrears rate of the SBO portfolio decreased from 3.0% in 2010, to 2.3% at 31 December 2011, as the legacy of poorer assets receded, and account servicing and collections became more effective following a servicer conversion in 2009.
* unaudited
 
 
113

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios* continued
Retail credit assets: Personal lending
The Group’s personal lending portfolio includes credit cards, unsecured loans, auto finance and overdrafts. The majority of personal lending exposures exist in the UK and the US. Impairment charges as a proportion of average loans and receivables are shown in the following table.
 
 
2011
 
2010
 
2009
 
Personal lending
Average
 loans and
 receivables
£m
Impairment
charge as a %
of average
 loans and
 receivables
%
 
Average
 loans and receivables
£m
Impairment
charge as a %
of average
 loans and
 receivables
%
 
Average
 loans and receivables
£m
Impairment
charge as a %
of average
 loans and
 receivables
%
UK Retail cards (1)
5,675
3.0
 
6,025
5.0
 
6,101
8.7
UK Retail loans (1)
7,755
2.8
 
9,863
4.8
 
12,062
5.9
                 
                 
Citizens cards (2)
936
5.1
 
1,005
9.9
 
1,145
9.7
Citizens auto loans (2)
4,856
0.2
 
5,256
0.6
 
6,306
1.2
 
Notes:
(1)
The ratio for UK Retail assets refers to the impairment charges for the year. This is the Core UK loans book and excludes the Non-Core direct loans book that was sold in late 2011.
(2)
The ratio for Citizens refers to the impairment charges in the year, net of recoveries realised in the year.

Key points
UK Retail
·
The UK personal lending portfolio, of which 99.4% is in Core businesses, comprises credit cards, unsecured loans and overdrafts, and totalled £16.0 billion at 31 December 2011 (2010 - £18.1 billion).

·
The decrease in portfolio size of 11.6% was driven by continued subdued loan recruitment activity and a continuing general market trend of customers repaying unsecured debt.

·
The Non-Core portfolio consists of the direct finance loan portfolios (Direct Line, Lombard, Mint and Churchill) and totalled £0.1 billion at 31 December 2011 (2010 - £0.4 billion). In the last quarter of 2011, a portfolio of £170 million of balances was disposed of.

·
Risk appetite continues to be actively managed across all products with investment in collection and recovery processes continuing, addressing both continued support for the Group’s customers and the management of impairments.

·
Support continues for customers experiencing financial difficulties through ‘breathing space initiatives’. Refer to the disclosures on forbearance on page 98 for more information.

·
The impairment charge on unsecured lending was £579 million for the year, down 42% on 2010, reflecting the effect of risk appetite tightening. The sale of the direct finance loan book gave rise to a one-off benefit of approximately £30 million.

·
Impairments remain sensitive to the external environment, including unemployment levels and interest rates.

·
Industry benchmarks for cards arrears remain stable, with the Group continuing to perform favourably.

Citizens
·
Citizens’ average credit card portfolio totalled £936 million during 2011, with Core assets comprising 90.2% of the portfolio. Citizens’ cards business has traditionally adopted conservative risk strategies compared with the US market and given the economic climate, has introduced tighter lending criteria and lower credit limits. These actions have led to improving new business quality and a business performing better than industry benchmarks (provided by VISA). The latest available metrics show the 60+ days delinquency as a percentage of total outstandings at 2.15% at November 2011 (compared to an industry figure of 2.45%) and net contractual charge-offs as a percentage of total outstandings at 2.89% at November 2011 (compared to an industry figure of 3.69%).

·
Citizens’ average auto loan portfolio totalled £4.9 billion during 2011, of which 98% is considered Core. £101 million (2%) is Non-Core and anticipated to run off by 2013. Citizens’ vehicle financing business lends to US consumers through a network of 4,200 auto dealers in 25 US states. Citizens’ credit policy is considered conservative, targeting prime customers and has historically experienced credit losses below those of industry peers.

·
The net write-off rate on the total auto portfolio fell to 0.18% at 31 December 2011, from 0.34% in 2010. The 30+ days past due delinquency rate fell to 1.04% at 31 December 2011, from 1.57% in 2010.

*unaudited
 
114

 
Business review Risk and balance sheet management continued
 
Key credit portfolios* continued
 
Ulster Bank Group (Core and Non-Core)
At 31 December 2011, Ulster Bank Group accounted for 10% of the Group’s total customer loans (2010 - 10%; 2009 - 10%) and 9% of the Group’s Core customer loans (2010 - 9%; 2009 - 9%). Ulster Bank’s financial performance continues to be overshadowed by the challenging economic climate in Ireland, with impairments remaining elevated as high unemployment, coupled with higher taxation and limited liquidity in the economy, continues to depress the property market and domestic spending.

The impairment charge of £3,717 million for 2011 (2010 - £3,843 million; 2009 - £1,926 million) was driven by a combination of new defaulting customers and deteriorating security values. Provisions as a percentage of risk elements in lending increased from 44% in 2010, to 53% at 31 December 2011, predominantly as a result of the deterioration in the value of the Non-Core commercial real estate development portfolio.

Core
The impairment charge for the year of £1,384 million (2010 - £1,161 million; 2009 - £649 million) reflects the difficult economic climate in Ireland, with elevated default levels across both mortgage and other corporate portfolios. The mortgage sector accounted for £570 million (41%) of the total 2011 impairment charge.

Non-Core
The impairment charge for the year was £2,333 million (2010 - £2,682 million; 2009 - £1,277 million), with the commercial real estate sector accounting for £2,160 million (93%) of the total 2011 charge.

Loans, risk elements in lending (REIL) and impairments by sector
 
Gross 
 loans 
REIL
Provisions
REIL
as a % of
 gross loans
Provisions
 as a % of
 REIL
Provisions
 as a % of
 gross loans
Impairment
charge
Amounts
 written-off
2011
£m 
£m
£m
%
%
%
£m
£m
Core
               
Mortgages
20,020 
2,184
945
10.9
43
4.7
570
11
Personal unsecured
1,533 
201
184
13.1
92
12.0
56
25
Commercial real estate
               
  - investment
3,882 
1,014
413
26.1
41
10.6
225
  - development
881 
290
145
32.9
50
16.5
99
16
Other corporate
7,736 
1,834
1,062
23.7
58
13.7
434
72
 
34,052 
5,523
2,749
16.2
50
8.1
1,384
124
Non-Core
               
Commercial real estate
               
  - investment
3,860 
2,916
1,364
75.5
47
35.3
609
1
  - development
8,49
7,536
4,295
88.8
57
50.6
1,551
32
Other corporate
1,630 
1,159
642
71.1
55
39.4
173
16
 
13,980 
11,611
6,301
83.1
54
45.1
2,333
49
Ulster Bank Group
               
Mortgages
20,020 
2,184
945
10.9
43
4.7
570
11
Personal unsecured
1,533 
201
184
13.1
92
12.0
56
25
Commercial real estate
               
  - investment
7,742 
3,930
1,777
50.8
45
23.0
834
1
  - development
9,371 
7,826
4,440
83.5
57
47.4
1,650
48
Other corporate
9,366 
2,993
1,704
32.0
57
18.2
607
88
 
48,032 
17,134
9,050
35.7
53
18.8
3,717
173
 
* unaudited
 
115

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios*: Ulster Bank Group (Core and Non-Core) continued

 
Gross 
 loans 
REIL 
Provisions 
REIL 
as a % of 
 gross loans 
Provisions 
 as a % of 
 REIL 
Provisions 
 as a % of 
 gross loans 
Impairment 
charge 
Amounts 
 written-off 
2010
£m 
£m 
£m 
%
%
%
£m 
£m 
Core
               
Mortgages
21,162 
1,566 
439 
7.4 
28 
2.1 
294 
7
Personal unsecured
1,282 
185 
158 
14.4 
85 
12.3 
48 
3
Commercial real estate
               
  - investment
4,284 
598 
332 
14.0 
56 
7.7 
259 
— 
  - development
1,090 
65 
37 
6.0 
57 
3.4 
116 
— 
Other corporate
9,039 
1,205 
667 
13.3 
55 
7.4 
444 
11 
 
36,857 
3,619 
 1,633 
9.8 
45 
4.4 
1,161 
48 
Non-Core
               
Mortgages
— 
— 
— 
— 
— 
— 
42 
— 
Commercial real estate
               
  - investment
3,854 
2,391 
1,000 
62.0 
42 
25.9 
630 
— 
  - development
8,760 
6,341 
2,783 
72.4 
44 
31.8 
1,759 
— 
Other corporate
1,970 
 1,310 
561 
66.5 
43 
28.5 
251 
— 
 
14,584 
 10,042 
 4,344 
68.9 
43 
29.8 
2,682 
— 
Ulster Bank Group
               
Mortgages
21,162 
1,566 
439 
7.4 
28 
2.1 
336 
7
Personal unsecured
1,282 
185 
158 
14.4 
85 
12.3 
48 
3
Commercial real estate
               
  - investment
8,138 
2,989 
1,332 
36.7 
45 
16.4 
889 
— 
  - development
9,850 
6,406 
2,820 
65.0 
44 
28.6 
1,875 
— 
Other corporate
11,009 
2,515 
1,228 
22.8 
49 
11.2 
695 
11 
 
51,441 
13,661 
5,977 
26.6 
44 
11.6 
3,843 
48 

2009
               
Core
               
Mortgages
16,199 
558 
102 
3.4 
18 
0.6 
74 
3
Personal unsecured
2,433 
174 
145 
7.2 
83 
6.0 
66 
27 
Commercial real estate
               
  - investment
6,131 
250 
105 
4.1 
42 
1.7 
84 
— 
  - development
3,838 
428 
284 
11.2 
66 
7.4 
221 
Other corporate
11,106 
850 
326 
7.7 
38 
2.9 
204 
— 
 
39,707 
2,260 
 962 
5.7 
43 
2.4 
649 
34 
Non-Core
               
Mortgages
6,002 
324 
51 
5.4 
16 
0.8 
42 
— 
Commercial real estate
               
  - investment
2,061 
1,498 
308 
72.7 
21 
14.9 
286 
— 
  - development
6,271 
3,840 
822 
61.2 
21 
13.1 
732 
— 
Other corporate
1,373 
1,126 
322 
82.0 
29 
23.5 
217 
— 
 
15,707 
6,788 
 1,503 
43.2 
22 
9.6 
1,277 
— 
Ulster Bank Group
               
Mortgages
22,201 
882 
153 
4.0 
17 
0.7 
116 
Personal unsecured
2,433 
174 
145 
7.2 
83 
6.0 
66 
27 
Commercial real estate
               
  - investment
8,192 
1,748 
413 
21.3 
24 
5.0 
370 
— 
  - development
10,109 
4,268 
1,106 
42.2 
26 
10.9 
953 
Other corporate
12,479 
1,976 
648 
15.8 
33 
5.2 
421 
— 
 
55,414 
9,048 
2,465 
16.3 
27 
4.4 
1,926 
34 

* unaudited
 
116

 
Business review Risk and balance sheet management continued
 
Key credit portfolios* continued
 
Key points
 
·
REIL increased by £3.5 billion during the year, which reflects continuing difficult conditions in both the commercial and residential sectors in Ireland. Growth moderated in the last two quarters of 2011 as default trends for corporate portfolios declined.
 
·
At 31 December 2011, 68% of REIL was in Non-Core (2010 - 74%; 2009 - 75%). The majority of the Non-Core commercial real estate development portfolio (89%) is REIL with a 57% provision coverage.

Residential mortgages
The tables below show how the continued decrease in property values has affected the distribution of residential mortgages by indexed LTV. LTV is based upon gross loan amounts and whilst including defaulted loans, does not take account of provisions made.

LTV distribution calculated on a volume basis*
2011
%
2010
%
2009
%
<= 70%
45.0
50.3
59.2
> 70% and <= 90%
11.4
13.0
12.0
> 90% and <= 110%
12.0
14.5
13.4
> 110% and <= 130%
10.9
13.5
11.3
> 130%
20.7
8.7
4.1
       
Total portfolio average LTV at 31 December
81.0
71.2
62.5
       
Average LTV on new originations during the year
67.0
75.9
72.8

LTV distribution calculated on a value basis
2011
£m
2010
£m
2009
£m
<= 70%
4,526
5,928
7,393
> 70% and <= 90%
2,501
3,291
3,830
> 90% and <= 110%
3,086
4,256
4,907
> 110% and <= 130%
3,072
4,391
4,491
> 130%
6,517
2,958
1,681
       
Total portfolio average LTV at 31 December
106.1%
91.7%
86.2%
       
Average LTV on new originations during the year
73.9%
78.9%
78.5%

Key points
·
The residential mortgage portfolio across Ulster Bank Group totalled £20 billion at 31 December 2011, with 89% in the Republic of Ireland and 11% in Northern Ireland.

·
The mortgage REIL continued to increase as a result of the continued challenging economic environment. At 31 December 2011, REIL as a percentage of gross mortgages was 10.9% (by value) compared with 7.4% in 2010. The impairment charge for 2011 was £570 million compared with £336 million for 2010. Repossession levels were higher than in 2010, with a total of 161 properties repossessed during 2011 (compared with 76 during 2010). 76% of repossessions during 2011 were through voluntary surrender or abandonment of the property.

·
Ulster Bank is assisting customers in this difficult environment. Mortgage forbearance policies which are deployed through the ‛Flex’ initiative are aimed at assisting customers in financial difficulty. At 31 December 2011, 9.1% (by value) of the mortgage book (£1.8 billion) was on a forbearance arrangement compared with 5.8% (£1.2 billion) at 31 December 2010. The majority of these forbearance arrangements are in the performing book (77%) and not 90 days past due.

* unaudited
 
117

 
 
Business review Risk and balance sheet management continued
 

Risk management: Credit risk continued
Key credit portfolios*: Ulster Bank Group (Core and Non-Core) continued
Commercial real estate
The commercial real estate lending portfolio for Ulster Bank Group totalled £17.1 billion at 31 December 2011, of which £12.3 billion or 72% is Non-Core. The geographic split of the total Ulster Bank Group commercial real estate portfolio remained similar to 2010, with 26% in Northern Ireland, 63% in the Republic of Ireland and 11% in the UK.
 
 
Development
 
Investment
 
 
Commercial
£m
Residential
£m
 
Commercial
£m
Residential
£m
Total
£m
Exposure by geography
2011
           
Ireland (ROI & NI)
2,591
6,317
 
5,097
1,132
15,137
UK (excluding NI)
95
336
 
1,371
111
1,913
RoW
32
 
27
4
63
 
2,686
6,685
 
6,495
1,247
17,113
             
2010
           
Ireland (ROI & NI)
2,785
6,578
 
5,032
1,098
15,493
UK (excluding NI)
110
359
 
1,869
115
2,453
RoW
18
 
23
1
42
 
2,895
6,955
 
6,924
1,214
17,988

2009
           
Ireland (ROI & NI)
3,075
5,961
 
5,314
1,031
15,381
UK (excluding NI)
217
849
 
1,692
132
2,890
RoW
7
 
20
3
30
 
3,292
6,817
 
7,026
1,166
18,301

Key points
·
Commercial real estate remains the primary driver of the increase in the defaulted loan book for Ulster Bank Group. The outlook remains challenging, with limited liquidity in the marketplace to support sales or refinancing. The decrease in asset valuations has placed pressure on the portfolio.
 
·
Within its early problem management framework, Ulster Bank may agree various remedial measures with customers whose loans are performing but who are experiencing temporary financial difficulties. During 2011, commercial real estate loans amounting to £0.8 billion (exposures greater than £10 million) benefited from such measures.

·
During 2011, impaired commercial real estate loans amounting to £1 billion (exposures greater than £10 million) were restructured and remain in the non-performing book.
 
* unaudited

 
118

 

Business review Risk and balance sheet management continued

Balance sheet analysis
All the disclosures in this section (pages 119 to 186) are audited unless otherwise indicated by an asterisk (*).

The following tables provide an analysis of credit concentration of financial assets by sector, geography and internal credit quality gradings. Credit risk assets analysed on the pages 102 to 107 are reported internally to senior management. However, they exclude certain exposures, primarily securities, and take account of legal netting agreements, that provide a right of legal set-off but do not meet the criteria for offset in IFRS. The analysis below is therefore provided to supplement the credit risk assets analysis and to reconcile to the consolidated balance sheet.

Credit concentration: Sector and geographical region
The tables on pages 119 to 128 analyse total financial assets gross of provisions by sector (for Group before RFS MI) and geographical region (for Group before RFS MI and RFS MI). Geographical regions are based on the location of the lending or issuing office.

The tables below and on pages 120 and 121 analyse total financial assets by sector.
 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting 
 and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2011
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
Central and local government
2,247 
 
8,359 
1,383 
9,742 
 
126,604 
328 
126,932 
5,541 
641 
145,103 
 
1,098 
144,005 
Finance - banks
39,345 
 
43,374 
619 
43,993 
 
16,940 
— 
16,940 
— 
79,269 
179,547 
 
18,693 
160,854 
            - other (3)
58,478 
 
46,452 
3,229 
49,681 
 
60,453 
5,618 
66,071 
497,993 
7,437 
679,660 
 
508,481 
171,179 
Residential mortgages
— 
 
138,509 
5,102 
143,611 
 
— 
— 
— 
48 
— 
143,659 
 
— 
143,659 
Personal lending
— 
 
31,067 
1,556 
32,623 
 
— 
— 
— 
52 
52 
32,727 
 
32,720 
Property
— 
 
38,704 
38,064 
76,768 
 
573 
175 
748 
4,599 
82,116 
 
1,274 
80,842 
Construction
— 
 
6,781 
2,672 
9,453 
 
50 
53 
103 
946 
— 
10,502 
 
1,139 
9,363 
Manufacturing
254 
 
23,201 
4,931 
28,132 
 
664 
1,938 
2,602 
3,786 
306 
35,080 
 
2,214 
32,866 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
21,314 
2,339 
23,653 
 
645 
2,652 
3,297 
1,134 
18 
28,102 
 
1,671 
26,431 
  - transport and storage
436 
 
16,454 
5,477 
21,931 
 
539 
74 
613 
3,759 
— 
26,739 
 
241 
26,498 
  - health, education and recreation
— 
 
13,273 
1,419 
14,692 
 
310 
21 
331 
885 
— 
15,908 
 
973 
14,935 
  - hotels and restaurants
— 
 
7,143 
1,161 
8,304 
 
116 
121 
671 
— 
9,096 
 
184 
8,912 
  - utilities
— 
 
6,543 
1,849 
8,392 
 
1,530 
554 
2,084 
3,708 
30 
14,214 
 
450 
13,764 
  - other
23 
 
24,228 
3,772 
28,000 
 
1,655 
3,893 
5,548 
6,300 
595 
40,466 
 
855 
39,611 
Agriculture, forestry and fishing
— 
 
3,471 
129 
3,600 
 
25 
11 
36 
121 
— 
3,757 
 
148 
3,609 
Finance lease and instalment credit
— 
 
8,440 
6,059 
14,499 
 
145 
147 
75 
— 
14,721 
 
16 
14,705 
Interest accruals
151 
 
675 
116 
791 
 
1,219 
— 
1,219 
— 
— 
2,161 
 
— 
2,161 
Total gross of provisions
100,934 
 
437,988 
79,877 
517,865 
 
211,468 
15,324 
226,792 
529,618 
88,349 
1,463,558 
 
537,444 
926,114 
Provisions
— 
 
(8,414)
(11,469)
(19,883)
 
(2,388)
(141)
(2,529)
— 
— 
(22,412)
 
n/a 
(22,412)
Group
100,934 
 
429,574 
68,408 
497,982 
 
209,080 
15,183 
224,263 
529,618 
88,349 
1,441,146 
 
537,444 
903,702 
                               
Comprising:
                             
Repurchase agreements
                         
15,246 
 
Derivative balances
                         
478,848 
 
Derivative collateral
                         
31,368 
 
Other
                         
11,982 
 
                           
537,444 
 

For notes relating to this table refer to page 128.
 
 
119

 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Credit concentration: Sector and geographical region continued

 
 
Reverse 
 repos 
 
Loans and advances
 
Securities
       
Netting 
 and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net  
2010
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m  
Central and local
  government
645 
 
6,781 
1,671 
8,452 
 
130,123 
767 
130,890 
7,560 
291 
147,838 
 
3,916 
143,922 
Finance - banks
42,571 
 
57,033 
1,003 
58,036 
 
22,474 
— 
22,474 
— 
57,014 
180,095 
 
24,673 
155,422 
              - other (3)
51,297 
 
46,910 
7,651 
54,561 
 
54,726 
19,562 
74,288 
399,318 
12,185 
591,649 
 
378,714 
212,935 
Residential mortgages
— 
 
140,359 
6,142 
146,501 
 
— 
— 
 
— 
146,507 
 
19 
146,488 
Personal lending
— 
 
33,581 
3,891 
37,472 
 
63 
— 
63 
15 
48 
37,598 
 
11 
37,587 
Property
— 
 
42,455 
47,651 
90,106 
 
2,700 
237 
2,937 
3,830 
28 
96,901 
 
1,046 
95,855 
Construction
— 
 
8,680 
3,352 
12,032 
 
56 
31 
87 
780 
— 
12,899 
 
1,406 
11,493 
Manufacturing
389 
 
25,797 
6,520 
32,317 
 
784 
113 
897 
3,229 
— 
36,832 
 
2,156 
34,676 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
21,974 
3,191 
25,165 
 
520 
41 
561 
1,124 
— 
26,850 
 
2,468 
24,382 
  - transport and storage
— 
 
15,946 
8,195 
24,141 
 
879 
54 
933 
2,703 
— 
27,777 
 
224 
27,553 
  - health, education and recreation
— 
 
17,456 
1,865 
19,321 
 
1,495 
42 
1,537 
1,198 
— 
22,056 
 
1,047 
21,009 
  - hotels and restaurants
— 
 
8,189 
1,492 
9,681 
 
276 
123 
399 
525 
— 
10,605 
 
253 
10,352 
  - utilities
— 
 
7,098 
2,110 
9,208 
 
1,714 
229 
1,943 
2,491 
13,644 
 
985 
12,659 
  - other
126 
 
24,464 
5,530 
29,994 
 
1,532 
1,172 
2,704 
4,244 
386 
37,454 
 
1,378 
36,076 
Agriculture, forestry and fishing
— 
 
3,758 
135 
3,893 
 
28 
29 
40 
— 
3,962 
 
115 
3,847 
Finance lease and instalment credit
— 
 
8,321 
8,529 
16,850 
 
13 
15 
14 
— 
16,879 
 
134 
16,745 
Interest accruals
91 
 
831 
278 
1,109 
 
1,398 
— 
1,398 
— 
— 
2,598 
 
— 
2,598 
Total gross of provisions
95,119 
 
469,633 
109,206 
578,839 
 
218,781 
28,374 
241,155 
427,077 
69,954 
1,412,144 
 
418,545 
993,599 
Provisions
— 
 
(7,866)
(10,316)
(18,182)
 
(1,301)
(176)
(1,477)
— 
(29)
(19,688)
 
n/a 
(19,688)
Group before RFS MI
95,119 
 
461,767 
98,890 
560,657 
 
217,480 
22,198 
239,678 
427,077 
69,925 
1,392,456 
 
418,545 
973,911 
RFS MI gross of provisions
— 
 
— 
— 
 
— 
— 
— 
— 
— 
 
— 
2
Group
95,119 
 
461,767 
98,890 
560,659 
 
217,480 
22,198 
239,678 
427,077 
69,925 
1,392,458 
 
418,545 
973,913 
                               
Comprising:
                             
Repurchase agreements
                         
10,712 
 
Derivative balances
                         
361,493 
 
Derivative collateral
                         
31,015 
 
Other
                         
15,325 
 
                           
418,545 
 

For notes relating to this table refer to page 128.

 
120

 
Business review Risk and balance sheet management continued
 
 
Reverse 
 repos
 
Loans and advances
 
Securities
       
Netting 
 and 
offset (2)
 
   
Core
Non-Core 
Total
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2009
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m  
£m 
 
£m 
£m 
Central and local government
260 
 
6,128 
1,532 
7,660 
 
142,032 
780 
142,812 
6,998 
205 
157,935 
 
1,725 
156,210 
Finance - banks
34,698 
 
47,574 
1,360 
48,934 
 
24,550 
— 
24,550 
— 
52,261 
160,443 
 
2,546 
157,897 
              - other (3)
40,188 
 
50,673 
9,713 
60,386 
 
68,824 
6,627 
75,451 
409,452 
12,110 
597,587 
 
369,797 
227,790 
Residential mortgages
— 
 
127,975 
12,932 
140,907 
 
— 
— 
— 
11 
— 
140,918 
 
140,911 
Personal lending
— 
 
35,313 
6,358 
41,671 
 
— 
38 
40 
41,750 
 
21 
41,729 
Property
— 
 
49,054 
50,372 
99,426 
 
4,028 
469 
4,497 
4,184 
108 
108,215 
 
1,114 
107,101 
Construction
— 
 
9,502 
5,258 
14,760 
 
295 
320 
615 
923 
63 
16,361 
 
1,450 
14,911 
Manufacturing
182 
 
30,272 
14,402 
44,674 
 
878 
1,076 
1,954 
5,353 
116 
52,279 
 
3,184 
49,095 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
23,385 
5,082 
28,467 
 
602 
283 
885 
996 
29 
30,377 
 
2,550 
27,827 
  - transport and storage
— 
 
16,693 
8,812 
25,505 
 
607 
198 
805 
1,820 
17 
28,147 
 
201 
27,946 
  - health, education and recreation
22 
 
18,797 
3,743 
22,540 
 
2,055 
188 
2,243 
1,300 
— 
26,105 
 
1,057 
25,048 
  - hotels and restaurants
— 
 
9,699 
1,710 
11,409 
 
418 
595 
1,013 
832 
90 
13,344 
 
284 
13,060 
  - utilities
— 
 
6,772 
3,106 
9,878 
 
1,298 
2,379 
3,677 
2,613 
296 
16,464 
 
445 
16,019 
  - other
293 
 
25,092 
11,185 
36,277 
 
2,814 
3,082 
5,896 
3,619 
362 
46,447 
 
1,274 
45,173 
Agriculture, forestry and fishing
— 
 
3,726 
553 
4,279 
 
44 
210 
254 
44 
4,586 
 
76 
4,510 
Finance lease and instalment credit
— 
 
8,147 
11,956 
20,103 
 
291 
15 
306 
16 
— 
20,425 
 
39 
20,386 
Interest accruals
494 
 
1,179 
549 
1,728 
 
1,571 
— 
1,571 
— 
— 
3,793 
 
— 
3,793 
Total gross of provisions
76,137 
 
469,981 
148,623 
618,604 
 
250,308 
16,222 
266,530 
438,199 
65,706 
1,465,176 
 
385,770 
1,079,406 
Provisions
— 
 
(6,921)
(8,252)
(15,173)
 
(1,198)
(277)
(1,475)
— 
— 
(16,648)
 
n/a 
(16,648)
Group before RFS MI
76,137 
 
463,060 
140,371 
603,431 
 
249,110 
15,945 
265,055 
438,199 
65,706 
1,448,528 
 
385,770 
1,062,758 
RFS MI gross of provisions
— 
 
— 
— 
142,688 
 
18,144 
3,586 
21,730 
3,255 
167,682 
 
55 
167,627 
RFS MI provision
— 
 
— 
— 
(2,110)
 
— 
(3)
(3)
— 
— 
(2,113)
 
n/a 
(2,113)
Group
76,137 
 
463,060 
140,371 
744,009 
 
267,254 
19,528 
286,782 
441,454 
65,715 
1,614,097 
 
385,825 
1,228,272 

For notes relating to this table refer to page 128.

Key points
·  
Financial assets, after taking account of netting and offset arrangements, decreased from £974 billion at 2010 to £903 billion at 2011 (£923 billion including disposal groups), principally reflecting reductions in loans and advances, including planned reductions of £29 billion in Non-Core reflecting disposal strategy as well as reductions in securities. Debt securities declined by £8 billion reflecting lower government and financial institution bond holdings. Equity shares decreased by £7 billion reflecting closure of GBM's global index and emerging markets positions in order to mitigate the potential impact of unfavourable market conditions.

·  
In terms of sector concentration, 37% of net financial assets related to financial institutions, including central banks, down from 38% in 2010. However, overall balances increased, principally reflecting higher central bank deposits in the Group's liquidity portfolio.
 
·  
Central and local government assets represented 16% of total financial assets, broadly unchanged from 2010, predominantly reflecting the Group's government bond holdings, most of which are issued by G10 governments, despite a reduction in holdings in both Group Treasury and GBM.

·  
Personal sector lending (residential mortgages and other lending) remained broadly flat.

·  
Commercial and other property related lending declined from £102.1 billion to £86.2 billion, including disposal groups (£4.7 billion). The decline was driven by Non-Core reductions.
 
 
121

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Credit concentration: Sector and geographical region continued

Loans and advances to banks and customers by geographical region
The table below analyses loans and advances, including reverse repos, gross of provisions by geographical region (location of office).

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Loans and advances to banks (1)
     
  - UK
55,061 
70,400 
59,348 
  - US
7,976 
9,810 
8,537 
  - Europe
8,865 
10,655 
5,535 
  - RoW
11,531 
9,778 
10,611 
Group before RFS MI
83,433 
100,643 
84,031 
RFS MI
— 
7,879 
 
83,433 
100,645 
91,910 
       
Loans and advances to customers
     
  - UK
351,147 
374,822 
386,798 
  - US
90,329 
90,752 
93,209 
  - Europe
74,045 
83,586 
102,571 
  - RoW
19,845 
24,155 
28,132 
Group before RFS MI
535,366 
573,315 
610,710 
RFS MI
— 
— 
134,809 
 
535,366 
573,315 
745,519 
       
Group before RFS MI
618,799 
673,958 
694,741 
RFS MI
— 
142,688 
Group
618,799 
673,960 
837,429 

Note:
(1)
Loans and advances to banks includes £95 million of accrued interest (2010 - £36 million; 2009 - £339 million).

Key points
·  
Gross loans and advances declined by £55.2 billion during 2011 of which £19.4 billion related to the transfer to disposal groups.

·  
Customer lending declined £37.9 billion, principally reflecting the transfer to disposal groups and the Non-Core disposal strategy
- UK down £23.7 billion
- US down £0.4 billion
- Europe down £9.5 billion
- Rest of the World down £4.3 billion

 
122

 
Business review Risk and balance sheet management continued
 
The tables on pages 123 to 128 analyse financial assets by geographical region (location of office) and sector.
 
 
Reverse 
repos
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core
Non-Core
Total
 
Debt
Equity
Total
Derivatives
Other (1)
Total
 
Net 
2011
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
UK
                             
Central and local government
2,130 
 
8,012 
25 
8,037 
 
78,892 
78,900 
5,282 
548 
94,897 
 
1,098 
93,799 
Finance - banks
25,204 
 
29,575 
207 
29,782 
 
1,950 
— 
1,950 
— 
40,365 
97,301 
 
18,653 
78,648 
              - other (3)
39,154 
 
30,874 
2,361 
33,235 
 
25,779 
4,462 
30,241 
301,125 
3,259 
407,014 
 
312,007 
95,007 
Residential mortgages
— 
 
99,303 
1,423 
100,726 
 
— 
— 
— 
48 
— 
100,774 
 
— 
100,774 
Personal lending
— 
 
20,080 
127 
20,207 
 
— 
— 
— 
51 
24 
20,282 
 
20,275 
Property
— 
 
31,141 
24,610 
55,751 
 
278 
137 
415 
4,332 
— 
60,498 
 
1,265 
59,233 
Construction
— 
 
5,291 
1,882 
7,173 
 
20 
26 
46 
895 
— 
8,114 
 
1,115 
6,999 
Manufacturing
254 
 
9,641 
835 
10,476 
 
499 
1,908 
2,407 
2,259 
— 
15,396 
 
2,205 
13,191 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
11,071 
1,441 
12,512 
 
574 
2,616 
3,190 
952 
18 
16,672 
 
1,647 
15,025 
  - transport and storage
436 
 
8,589 
3,439 
12,028 
 
145 
67 
212
2,217 
— 
14,893 
 
200 
14,693 
  - health, education and recreation
— 
 
8,734 
757 
9,491 
 
72 
80 
756 
— 
10,327 
 
965 
9,362 
  - hotels and restaurants
— 
 
5,599 
569 
6,168 
 
23 
— 
23 
664 
— 
6,855 
 
178 
6,677 
  - utilities
— 
 
2,462 
922 
3,384 
 
1,150 
513 
1,663 
3,207 
30 
8,284 
 
450 
7,834 
  - other
— 
 
13,963 
1,644 
15,607 
 
1,017 
3,459 
4,476 
3,988 
593 
24,664 
 
830 
23,834 
Agriculture, forestry and fishing
— 
 
2,660 
76 
2,736 
 
18 
10 
28 
111 
— 
2,875 
 
117 
2,758 
Finance lease and instalment credit
— 
 
5,618 
5,598 
11,216 
 
1
3
73 
— 
11,292 
 
16 
11,276 
Interest accruals
126 
 
375 
— 
375 
 
474 
— 
474 
— 
— 
975 
 
— 
975 
Group
67,304 
 
292,988 
45,916 
338,904 
 
110,892 
13,216 
124,108 
325,960 
44,837 
901,113 
 
340,753 
560,360 
                               
US
                             
Central and local government
— 
 
177 
14 
191 
 
22,936 
317 
23,253 
23,454 
 
— 
23,454 
Finance - banks
7,289 
 
671 
15 
686 
 
1,245 
— 
1,245 
— 
29,426 
38,646 
 
15 
38,631 
              - other (3)
17,368 
 
8,993 
341 
9,334 
 
29,885 
681 
30,566 
165,879 
3,496 
226,643 
 
168,601 
58,042 
Residential mortgages
— 
 
20,311 
2,926 
23,237 
 
— 
— 
— 
— 
— 
23,237 
 
— 
23,237 
Personal lending
— 
 
7,505 
936 
8,441 
 
— 
— 
— 
— 
— 
8,441 
 
— 
8,441 
Property
— 
 
2,413 
1,370 
3,783 
 
26 
23 
49 
38 
— 
3,870 
 
— 
3,870 
Construction
— 
 
412 
45 
457 
 
21 
3
24 
11 
— 
492 
 
— 
492 
Manufacturing
— 
 
6,782 
42 
6,824 
 
101 
12 
113 
452 
— 
7,389 
 
— 
7,389 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
4,975 
98 
5,073 
 
52 
— 
52 
63 
— 
5,188 
 
— 
5,188 
  - transport and storage
— 
 
1,832 
937 
2,769 
 
26 
1
27 
1,084 
— 
3,880 
 
— 
3,880 
  - health, education and recreation
— 
 
2,946 
88 
3,034 
 
74 
4
78 
93 
— 
3,205 
 
— 
3,205 
  - hotels and restaurants
— 
 
627 
57 
684 
 
93 
3
96 
1
— 
781 
 
— 
781 
  - utilities
— 
 
1,033 
28 
1,061 
 
243 
16 
259 
322 
— 
1,642 
 
— 
1,642 
  - other
23 
 
4,927 
394 
5,321 
 
429 
105 
534 
1,421 
— 
7,299 
 
— 
7,299 
Agriculture, forestry and fishing
— 
 
27 
— 
27 
 
7
— 
7
6
— 
40 
 
— 
40 
Finance lease and instalment credit
— 
 
2,471 
— 
2,471 
 
17 
— 
17 
— 
— 
2,488 
 
— 
2,488 
Interest accruals
 
181 
45 
226 
 
259 
— 
259 
— 
— 
491 
 
— 
491 
Group
24,686 
 
66,283 
7,336 
73,619 
 
55,414 
1,165 
56,579 
169,379 
32,923 
357,186 
 
168,616 
188,570 

For notes relating to this table refer to page 128.
 
 
123

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Credit concentration: Sector and geographical region continued
 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2011
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
Europe
                             
Central and local government
— 
 
116 
715 
831 
 
13,362 
13,365 
60 
— 
14,256 
 
— 
14,256 
Finance - banks
247 
 
8,361 
250 
8,611 
 
10,859 
— 
10,859 
— 
6,701 
26,418 
 
— 
26,418 
              - other (3)
— 
 
2,534 
474 
3,008 
 
4,521 
240 
4,761 
289 
90 
8,148 
 
8,147 
Residential mortgages
— 
 
18,393 
553 
18,946 
 
— 
— 
— 
— 
— 
18,946 
 
— 
18,946 
Personal lending
— 
 
1,972 
492 
2,464 
 
— 
— 
— 
— 
28 
2,492 
 
— 
2,492 
Property
— 
 
4,846 
11,538 
16,384 
 
— 
— 
— 
168 
— 
16,552 
 
16,543 
Construction
— 
 
1,019 
735 
1,754 
 
— 
22 
22 
18 
— 
1,794 
 
24 
1,770 
Manufacturing
— 
 
4,383 
3,732 
8,115 
 
57 
62 
23 
— 
8,200 
 
8,191 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
3,992 
772 
4,764 
 
16 
18 
23 
— 
4,805 
 
24 
4,781 
  - transport and storage
— 
 
5,667 
862 
6,529 
 
143 
— 
143 
15 
— 
6,687 
 
6,681 
  - health, education and recreation
— 
 
1,235 
349 
1,584 
 
164 
169 
— 
1,755 
 
1,747 
  - hotels and restaurants
— 
 
892 
535 
1,427 
 
— 
— 
— 
— 
1,433 
 
1,427 
  - utilities
— 
 
1,569 
530 
2,099 
 
124 
127 
85 
— 
2,311 
 
— 
2,311 
  - other
— 
 
2,966 
1,555 
4,521 
 
131 
70 
201 
34 
— 
4,756 
 
25 
4,731 
Agriculture, forestry and fishing
— 
 
699 
53 
752 
 
— 
— 
754 
 
31 
723 
Finance lease and instalment credit
— 
 
260 
435 
695 
 
— 
— 
— 
— 
— 
695 
 
— 
695 
Interest accruals
7
 
101 
71 
172 
 
437 
— 
437 
— 
— 
616 
 
— 
616 
Group
254 
 
59,005 
23,651 
82,656 
 
29,814 
351 
30,165 
724 
6,819 
120,618 
 
143 
120,475 
                               
RoW
                             
Central and local government
117 
 
54 
629 
683 
 
11,414 
— 
11,414 
190 
92 
12,496 
 
— 
12,496 
Finance - banks
6,605 
 
4,767 
147 
4,914 
 
2,886 
— 
2,886 
— 
2,777 
17,182 
 
25 
17,157 
              - other (3)
1,956 
 
4,051 
53 
4,104 
 
268 
235 
503 
30,700 
592 
37,855 
 
27,872 
9,983 
Residential mortgages
— 
 
502 
200 
702 
 
— 
— 
— 
— 
— 
702 
 
— 
702 
Personal lending
— 
 
1,510 
1,511 
 
— 
— 
— 
— 
1,512 
 
— 
1,512 
Property
— 
 
304 
546 
850 
 
269 
15 
284 
61 
1,196 
 
— 
1,196 
Construction
— 
 
59 
10 
69 
 
11 
22 
— 
102 
 
— 
102 
Manufacturing
— 
 
2,395 
322 
2,717 
 
13 
20 
1,052 
306 
4,095 
 
— 
4,095 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
1,276 
28 
1,304 
 
34 
37 
96 
— 
1,437 
 
— 
1,437 
  - transport and storage
— 
 
366 
239 
605 
 
225 
231 
443 
— 
1,279 
 
35 
1,244 
  - health, education and recreation
— 
 
358 
225 
583 
 
— 
4
34 
— 
621 
 
— 
621 
  - hotels and restaurants
— 
 
25 
—  
25 
 
— 
— 
— 
27 
 
— 
27 
  - utilities
— 
 
1,479 
369 
1,848 
 
13 
22 
35 
94 
— 
1,977 
 
— 
1,977 
  - other
— 
 
2,372 
179 
2,551 
 
78 
259 
337 
857 
3,747 
 
— 
3,747 
Agriculture, forestry and fishing
— 
 
85 
— 
85 
 
— 
— 
— 
— 
88 
 
— 
88 
Finance lease and instalment credit
— 
 
91 
26 
117 
 
127 
— 
127 
— 
246 
 
— 
246 
Interest accruals
12 
 
18 
— 
18 
 
49 
— 
49 
— 
— 
79 
 
— 
79 
Group
8,690 
 
19,712 
2,974 
22,686 
 
15,348 
592 
15,940 
33,555 
3,770 
84,641 
 
27,932 
56,709 
 
For notes relating to this table refer to page 128.
 
 
124

 
Business review Risk and balance sheet management continued
 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2010
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
UK
                             
Central and local government
611 
 
5,728 
173 
5,901 
 
72,427 
72,428 
7,300 
173 
86,413 
 
3,916 
82,497 
Finance - banks
28,370 
 
41,541 
481 
42,022 
 
5,381 
— 
5,381 
— 
28,097 
103,87
 
24,489 
79,381 
              - other (3)
33,186 
 
27,995 
6,023 
34,018 
 
27,737 
18,645 
46,382 
249,324 
5,390 
368,300 
 
232,460 
135,840 
Residential mortgages
— 
 
99,928 
1,665 
101,593 
 
— 
— 
— 
— 
101,599 
 
14 
101,585 
Personal lending
— 
 
23,035 
585 
23,620 
 
— 
23 
23,653 
 
11 
23,642 
Property
— 
 
34,970 
30,492 
65,462 
 
2,302 
175 
2,477 
3,739 
28 
71,706 
 
1,041 
70,665 
Construction
— 
 
7,041 
2,310 
9,351 
 
39 
— 
39 
741 
— 
10,131 
 
1,392 
8,739 
Manufacturing
389 
 
12,300 
1,510 
13,810 
 
354 
— 
354 
2,159 
— 
16,712 
 
2,150 
14,562 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
12,554 
1,853 
14,407 
 
343 
11 
354 
874 
— 
15,635 
 
2,452 
13,183 
  - transport and storage
— 
 
8,105 
5,015 
13,120 
 
241 
244 
1,573 
— 
14,937 
 
219 
14,718 
  - health, education and recreation
— 
 
13,502 
1,039 
14,541 
 
160 
22 
182 
877 
— 
15,600 
 
1,047 
14,553 
  - hotels and restaurants
— 
 
6,558 
808 
7,366 
 
172 
— 
172 
518 
— 
8,056 
 
249 
7,807 
  - utilities
— 
 
3,101 
1,035 
4,136 
 
1,040 
1,045 
2,112 
7,295 
 
985 
6,310 
  - other
 
14,445 
1,991 
16,436 
 
549 
447 
996 
1,986 
335 
19,754 
 
1,354 
18,400 
Agriculture, forestry and fishing
— 
 
2,872 
67 
2,939 
 
— 
— 
— 
35 
— 
2,974 
 
94 
2,880 
Finance lease and instalment credit
— 
 
5,589 
7,785 
13,374 
 
13 
15 
14 
— 
13,403 
 
134 
13,269 
Interest accruals
56 
 
415 
98 
513 
 
501 
— 
501 
— 
— 
1,070 
 
— 
1,070 
Group
62,613 
 
319,679 
62,930 
382,609 
 
111,26
19,311 
130,571 
271,267 
34,048 
881,108 
 
272,007 
609,101 
                               
US
                             
Central and local government
— 
 
263 
53 
316 
 
24,975 
766 
25,741 
112 
26,174 
 
— 
26,174 
Finance - banks
8,978 
 
820 
12 
832 
 
1,951 
— 
1,951 
— 
19,455 
31,216 
 
184 
31,032 
              - other (3)
16,023 
 
9,522 
587 
10,109 
 
21,958 
126 
22,084 
121,717 
4,950 
174,883 
 
123,678 
51,205 
Residential mortgages
— 
 
20,548 
3,653 
24,201 
 
— 
— 
— 
— 
— 
24,201 
 
— 
24,201 
Personal lending
— 
 
6,816 
2,704 
9,520 
 
— 
— 
— 
— 
— 
9,520 
 
— 
9,520 
Property
— 
 
1,611 
3,318 
4,929 
 
95 
99 
23 
— 
5,051 
 
— 
5,051 
Construction
— 
 
442 
78 
520 
 
— 
16 
— 
541 
 
— 
541 
Manufacturing
— 
 
5,459 
143 
5,602 
 
412 
22 
434 
583 
— 
6,619 
 
— 
6,619 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
4,264 
237 
4,501 
 
132 
— 
132 
68 
— 
4,701 
 
— 
4,701 
  - transport and storage
— 
 
1,786 
1,408 
3,194 
 
99 
101 
929 
— 
4,224 
 
— 
4,224 
  - health, education and recreation
— 
 
2,380 
313 
2,693 
 
1,308 
1,311 
292 
— 
4,296 
 
— 
4,296 
  - hotels and restaurants
— 
 
486 
136 
622 
 
104 
— 
104 
— 
729 
 
— 
729 
  - utilities
— 
 
1,117 
53 
1,170 
 
567 
569 
272 
— 
2,011 
 
— 
2,011 
  - other
124 
 
4,042 
577 
4,619 
 
789 
279 
1,068 
1,200 
42 
7,053 
 
— 
7,053 
Agriculture, forestry and fishing
— 
 
31 
— 
31 
 
28 
— 
28 
— 
62 
 
— 
62 
Finance lease and instalment credit
— 
 
2,315 
— 
2,315 
 
— 
— 
— 
— 
— 
2,315 
 
— 
2,315 
Interest accruals
 
183 
73 
256 
 
240 
— 
240 
— 
— 
503 
 
— 
503 
Group
25,132 
 
62,085 
13,345 
75,430 
 
52,663 
1,204 
53,867 
125,111 
24,559
304,099
 
123,862 
180,237 

For notes relating to this table refer to page 128.
 
 
125

 
 
Business review Risk and balance sheet management continued

Risk management: Credit risk continued
Balance sheet analysis: Credit concentration: Sector and geographical region continued

 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2010
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
Europe
                             
Central and local government
— 
 
365 
1,017 
1,382 
 
18,648 
— 
18,648 
66 
— 
20,096 
 
— 
20,096 
Finance - banks
94 
 
10,219 
313 
10,532 
 
11,843 
— 
11,843 
— 
7,936 
30,405 
 
— 
30,405 
              - other (3)
— 
 
2,642 
1,019 
3,661 
 
4,886 
347 
5,233 
746 
53 
9,693 
 
9,692 
Residential mortgages
— 
 
19,473 
621 
20,094 
 
— 
— 
— 
— 
— 
20,094 
 
20,089 
Personal lending
— 
 
2,270 
600 
2,870 
 
62 
— 
62 
— 
25 
2,957 
 
— 
2,957 
Property
— 
 
5,139 
12,636 
17,775 
 
— 
43 
43 
— 
— 
17,818 
 
17,813 
Construction
— 
 
1,014 
873 
1,887 
 
— 
27 
27 
— 
1,915 
 
14 
1,901 
Manufacturing
— 
 
5,853 
4,181 
10,034 
 
18 
87 
105 
39 
— 
10,178 
 
10,172 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
4,126 
999 
5,125 
 
32 
34 
33 
— 
5,192 
 
15 
5,177 
  - transport and storage
— 
 
5,625 
1,369 
6,994 
 
141 
22 
163 
— 
7,159 
 
7,154 
  - health, education and recreation
— 
 
1,442 
496 
1,938 
 
27 
36 
— 
— 
1,974 
 
— 
1,974 
  - hotels and restaurants
— 
 
1,055 
535 
1,590 
 
— 
120 
120 
— 
— 
1,710 
 
1,706 
  - utilities
— 
 
1,412 
623 
2,035 
 
74 
188 
262 
10 
— 
2,307 
 
— 
2,307 
  - other
— 
 
3,877 
2,050 
5,927 
 
109 
176 
285 
54 
1
6,267 
 
23 
6,244 
Agriculture, forestry and fishing
— 
 
849 
68 
917 
 
— 
— 
918 
 
21 
897 
Finance lease and instalment credit
— 
 
370 
744 
1,114 
 
— 
— 
— 
— 
— 
1,114 
 
— 
1,114 
Interest accruals
28 
 
143 
101 
244 
 
575 
— 
575 
— 
— 
847 
 
— 
847 
Group before RFS MI
122 
 
65,874 
28,245 
94,119 
 
36,415 
1,022 
37,437 
951 
8,015 
140,644 
 
99 
140,545 
RFS MI
— 
 
— 
— 
2
 
— 
— 
— 
— 
— 
2
 
— 
2
Group
122 
 
65,874 
28,245 
94,121 
 
36,415 
1,022 
37,437 
951 
8,015 
140,646 
 
99 
140,547 
                               
RoW
                             
Central and local government
34 
 
425 
428 
853 
 
14,073 
— 
14,073 
189 
15,155 
 
— 
15,155 
Finance - banks
5,129 
 
4,453 
197 
4,650 
 
3,299 
— 
3,299 
— 
1,526 
14,604 
 
— 
14,604 
              - other (3)
2,088 
 
6,751 
22 
6,773 
 
145 
444 
589 
27,531 
1,792 
38,773 
 
22,575 
16,198 
Residential mortgages
— 
 
410 
203 
613 
 
— 
— 
— 
— 
— 
613 
 
— 
613 
Personal lending
— 
 
1,460 
1,462 
 
— 
— 
— 
— 
1,468 
 
— 
1,468 
Property
— 
 
735 
1,205 
1,940 
 
303 
15 
318 
68 
— 
2,326 
 
— 
2,326 
Construction
— 
 
183 
91 
274 
 
12 
16 
22 
— 
312 
 
— 
312 
Manufacturing
— 
 
2,185 
686 
2,871 
 
— 
448 
— 
3,323 
 
— 
3,323 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
1,030 
102 
1,132 
 
13 
28 
41 
149 
— 
1,322 
 
1,321 
  - transport and storage
— 
 
430 
403 
833 
 
398 
27 
425 
199 
— 
1,457 
 
— 
1,457 
  - health, education and recreation
— 
 
132 
17 
149 
 
— 
29 
— 
186 
 
— 
186 
  - hotels and restaurants
— 
 
90 
13 
103 
 
— 
— 
110 
 
— 
110 
  - utilities
— 
 
1,468 
399 
1,867 
 
33 
34 
67 
97 
— 
2,031 
 
— 
2,031 
  - other
 
2,100 
912 
3,012 
 
85 
270 
355 
1,004 
4,380 
 
4,379 
Agriculture, forestry and fishing
— 
 
— 
 
— 
— 
— 
— 
 
— 
Finance lease and instalment credit
— 
 
47 
— 
47 
 
— 
— 
— 
— 
— 
47 
 
— 
47 
Interest accruals
— 
 
90 
96 
 
82 
— 
82 
— 
— 
178 
 
— 
178 
Group
7,252 
 
21,995 
4,686 
26,681 
 
18,443 
837 
19,280 
29,748 
3,332 
86,293 
 
22,577 
63,716 

For notes relating to this table refer to page 128.

 
126

 
Business review Risk and balance sheet management continued
 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2009
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
UK
                             
Central and local government
129 
 
4,353 
276 
4,629 
 
79,662 
79,663 
6,752 
91,177 
 
1,725 
89,452 
Finance - banks
21,955 
 
36,741 
424 
37,165 
 
2,355 
— 
2,355 
— 
20,693 
82,168 
 
2,483 
79,685 
              - other (3)
29,240 
 
29,278 
6,004 
35,282 
 
38,135 
5,676 
43,811 
257,109 
5,492 
370,934 
 
236,443 
134,491 
Residential mortgages
— 
 
90,688 
1,896 
92,584 
 
— 
— 
— 
11 
— 
92,595 
 
92,588 
Personal lending
— 
 
24,613 
1,137 
25,750 
 
— 
22 
25,782 
 
21 
25,761 
Property
— 
 
36,407 
35,387 
71,794 
 
3,303 
458 
3,761 
4,086 
104 
79,745 
 
1,114 
78,631 
Construction
— 
 
6,964 
3,640 
10,604 
 
48 
306 
354 
849 
62 
11,869 
 
1,450 
10,419 
Manufacturing
182 
 
14,462 
3,255 
17,717 
 
640 
1,003 
1,643 
4,222 
102 
23,866 
 
3,184 
20,682 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
13,412 
2,672 
16,084 
 
445 
263 
708 
819 
29 
17,640 
 
2,549 
15,091 
  - transport and storage
— 
 
10,066 
5,319 
15,385 
 
369 
163 
532 
988 
15 
16,920 
 
201 
16,719 
  - health, education and recreation
22 
 
15,551 
1,225 
16,776 
 
303 
164 
467 
1,005 
— 
18,270 
 
1,057 
17,213 
  - hotels and restaurants
— 
 
7,575 
1,033 
8,608 
 
320 
573 
893 
824 
86 
10,411 
 
284 
10,127 
  - utilities
— 
 
2,626 
1,652 
4,278 
 
1,142 
2,308 
3,450 
2,321 
259 
10,308 
 
445 
9,863 
  - other
— 
 
13,516 
3,964 
17,480 
 
1,608 
2,621 
4,229 
1,892 
353 
23,954 
 
1,274 
22,680 
Agriculture, forestry and fishing
— 
 
2,946 
138 
3,084 
 
43 
209 
252 
39 
3,384 
 
76 
3,308 
Finance lease and instalment credit
— 
 
5,343 
10,843 
16,186 
 
291 
294 
16 
— 
16,496 
 
39 
16,457 
Interest accruals
321 
 
713 
178 
891 
 
457 
— 
457 
— 
— 
1,669 
 
— 
1,669 
Group before RFS MI
51,849 
 
315,254 
79,043 
394,297 
 
129,122 
13,748 
142,870 
280,942 
27,230 
897,188 
 
252,352 
644,836 
RFS MI
— 
 
— 
— 
444 
 
49 
50 
494 
— 
988 
 
— 
988 
Group
51,849 
 
315,254 
79,043 
394,741 
 
129,171 
13,749 
142,920 
281,436 
27,230 
898,176 
 
252,352 
645,824 
                               
US
                             
Central and local government
— 
 
196 
 64 
260 
 
23,841 
779 
24,620 
141 
25,030 
 
— 
25,030 
Finance - banks
7,466 
 
982 
76 
1,058 
 
1,473 
— 
1,473 
— 
7,533 
17,530 
 
63 
17,467 
              - other (3)
9,912 
 
9,524 
1,771 
11,295 
 
25,592 
85 
25,677 
125,599 
5,779 
178,262 
 
113,607 
64,655 
Residential mortgages
— 
 
21,842 
4,317 
26,159 
 
— 
— 
— 
— 
— 
26,159 
 
— 
26,159 
Personal lending
— 
 
7,373 
3,599 
10,972 
 
— 
— 
— 
— 
— 
10,972 
 
— 
10,972 
Property
— 
 
1,498 
3,788 
5,286 
 
56 
— 
56 
30 
— 
5,372 
 
— 
5,372 
Construction
— 
 
490 
132 
622 
 
71 
72 
50 
— 
744 
 
— 
744 
Manufacturing
— 
 
5,895 
1,200 
7,095 
 
218 
25 
243 
580 
— 
7,918 
 
— 
7,918 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
3,897 
422 
4,319 
 
142 
— 
142 
108 
— 
4,569 
 
— 
4,569 
  - transport and storage
— 
 
1,679 
1,525 
3,204 
 
108 
109 
738 
— 
4,051 
 
— 
4,051 
  - health, education and recreation
— 
 
1,595 
1,356 
2,951 
 
1,698 
— 
1,698 
272 
— 
4,921 
 
— 
4,921 
  - hotels and restaurants
— 
 
772 
88 
860 
 
98 
— 
98 
— 
965 
 
— 
965 
  - utilities
— 
 
1,178 
46 
1,224 
 
113 
— 
113 
204 
— 
1,541 
 
— 
1,541 
  - other
280 
 
4,957 
1,068 
6,025 
 
944 
216 
1,160 
1,157 
— 
8,622 
 
— 
8,622 
Agriculture, forestry and fishing
— 
 
27 
— 
27 
 
— 
— 
30 
 
— 
30 
Finance lease and instalment credit
— 
 
2,417 
— 
2,417 
 
— 
— 
— 
— 
— 
2,417 
 
— 
2,417 
Interest accruals
16 
 
204 
94 
298 
 
334 
— 
334 
— 
— 
648 
 
— 
648 
Group before RFS MI
17,674 
 
64,526 
19,546 
84,072 
 
54,689 
1,107 
55,796 
128,756 
13,453 
299,751 
 
113,670 
186,081 
RFS MI
— 
 
— 
— 
360 
 
— 
— 
— 
— 
— 
360 
 
— 
360 
Group
17,674 
 
64,526 
19,546 
84,432 
 
54,689 
1,107 
55,796 
128,756 
13,453 
300,111 
 
113,670 
186,441 

For notes relating to this table refer to page 128.
 
 
127

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Credit concentration: Sector and geographical region continued
 
 
Reverse 
repos 
 
Loans and advances
 
Securities
       
Netting and 
offset (2)
 
   
Core 
Non-Core 
Total 
 
Debt 
Equity 
Total 
Derivatives 
Other (1)
Total 
 
Net 
2009
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
Europe
                             
Central and local government
— 
 
334 
1,164 
1,498 
 
25,328 
— 
25,328 
68 
24 
26,918 
 
— 
26,918 
Finance - banks
— 
 
4,905 
529 
5,434 
 
17,390 
— 
17,390 
— 
22,792 
45,616 
 
— 
45,616 
              - other (3)
189 
 
4,095 
905 
5,000 
 
5,097 
426 
5,523 
1,699 
43 
12,454 
 
— 
12,454 
Residential mortgages
— 
 
15,055 
6,718 
21,773 
 
— 
— 
— 
— 
— 
21,773
 
— 
21,773 
Personal lending
— 
 
1,877 
1,009 
2,886 
 
— 
— 
— 
— 
17 
2,903 
 
— 
2,903 
Property
— 
 
10,812 
9,417 
20,229 
 
— 
17 
20,251 
 
— 
20,251 
Construction
— 
 
1,946 
1,167 
3,113 
 
— 
3,116 
 
— 
3,116 
Manufacturing
— 
 
7,311 
8,609 
15,920 
 
19 
23 
42 
123 
— 
16,085 
 
— 
16,085 
Service industries and business activities
                             
  - retail, wholesale and repairs
— 
 
5,464 
1,661 
7,125 
 
15 
16 
— 
7,148 
 
— 
7,148 
  - transport and storage
— 
 
4,385 
1,463 
5,848 
 
15 
19 
— 
5,869 
 
— 
5,869 
  - health, education and recreation
— 
 
1,419 
1,121 
2,540 
 
54 
63 
— 
— 
2,603 
 
— 
2,603 
  - hotels and restaurants
— 
 
1,221 
568 
1,789 
 
— 
19 
19 
— 
1,812 
 
— 
1,812 
  - utilities
— 
 
1,816 
786 
2,602 
 
30 
34 
37 
2,679 
 
— 
2,679 
  - other
12 
 
4,783 
4,284 
9,067 
 
156 
24 
180 
75 
9,342 
 
— 
9,342 
Agriculture, forestry and fishing
— 
 
737 
356 
1,093 
 
— 
— 
— 
1,094
 
— 
1,094 
Finance lease and instalment credit
— 
 
379 
1,094 
1,473 
 
— 
12 
12 
— 
— 
1,485 
 
— 
1,485 
Interest accruals
102 
 
168 
245 
413 
 
706 
— 
706 
— 
— 
1,221 
 
— 
1,221 
Group before RFS MI
303 
 
66,707 
41,096 
107,803 
 
48,784 
551 
49,335 
1,996 
22,932 
182,369 
 
— 
182,369 
RFS MI
— 
 
— 
— 
140,098 
 
21,681 
3,232 
24,913 
165,020 
— 
330,031 
 
— 
330,031 
Group
303 
 
66,707 
41,096 
247,901 
 
70,465 
3,783 
74,248 
167,016 
22,932 
512,400 
 
— 
512,400 
                               
RoW
                             
Central and local government
131 
 
1,245 
28 
1,273 
 
13,201 
— 
13,201 
169 
36 
14,810  
 
— 
14,810 
Finance - banks
5,277 
 
4,946 
331 
5,277 
 
3,332 
— 
3,332 
— 
1,243 
15,129 
 
— 
15,129 
              - other (3)
847 
 
7,776 
1,033 
8,809 
 
— 
440 
440 
25,045 
796 
35,937 
 
19,747 
16,190 
Residential mortgages
— 
 
390 
391 
 
— 
— 
— 
— 
— 
391 
 
— 
391 
Personal lending
— 
 
1,450 
613 
2,063 
 
— 
— 
— 
29 
2,093 
 
— 
2,093 
Property
— 
 
337 
1,780 
2,117 
 
669 
10 
679 
51 
— 
2,847 
 
— 
2,847 
Construction
— 
 
102 
319 
421 
 
176 
12 
188 
23 
— 
632 
 
— 
632 
Manufacturing
— 
 
2,604 
1,338 
3,942 
 
25 
26 
428 
14 
4,410 
 
— 
4,410
Service industries and
  business activities
                             
  - retail, wholesale and repairs
— 
 
612 
327 
939 
 
— 
19 
19 
62 
— 
1,020 
 
1,019 
  - transport and storage
— 
 
563 
505 
1,068 
 
115 
30 
145 
94 
— 
1,307 
 
— 
1,307 
  - health, education and recreation
— 
 
232 
41 
273 
 
— 
15 
15 
23 
— 
311 
 
— 
311 
  - hotels and restaurants
— 
 
131 
21 
152 
 
— 
— 
156 
 
— 
156 
  - utilities
— 
 
1,152 
622 
1,774 
 
39 
41 
80 
82 
— 
1,936 
 
— 
1,936 
  - other
 
1,836 
1,869 
3,705 
 
106 
221 
327 
495 
4,529 
 
— 
4,529 
Agriculture, forestry and fishing
— 
 
16 
59 
75 
 
— 
— 
— 
— 
78 
 
— 
78 
Finance lease and instalment credit
— 
 
19 
27 
 
— 
— 
— 
— 
— 
27 
 
— 
27 
Interest accruals
55 
 
94 
32 
126 
 
74 
— 
74 
— 
— 
255 
 
— 
255 
Group before RFS MI
6,311 
 
23,494 
8,938 
32,432 
 
17,713 
816 
18,529 
26,505 
2,091 
85,868 
 
19,748 
66,120 
RFS MI
— 
 
— 
— 
1,786 
 
— 
22 
22 
1,808 
— 
3,616 
 
— 
3,616 
Group
6,311 
 
23,494 
8,938 
34,218 
 
17,713 
838 
18,551 
28,313 
2,091 
89,484 
 
19,748 
69,736 

Notes:
(1)
Includes cash and balances at central banks of £79,269 million (2010 - £57,014 million; 2009 - £52,261 million) and settlement balances of £7,771 million (2010 - £11,605 million; 2009 - £12,033 million).
(2)
This shows the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
(3)
Loans made by the Group's consolidated conduits to asset owning companies are included within Finance.
 
 
128

 
Business review Risk and balance sheet management continued

Cross border exposures

Cross border exposures are loans and advances including finance leases and instalment credit receivables and other monetary assets, such as debt securities, including non-local currency claims of overseas offices on local residents.

The Group monitors the geographical breakdown of these exposures based on the country of domicile of the borrower or guarantor of ultimate risk. Cross border exposures exclude exposures to local residents in local currencies.
 
The table below sets out the Group’s cross border exposures greater than 0.5% of the Group’s total assets. None of these countries have experienced repayment difficulties that have required restructuring of outstanding debt.
 
2011
Government 
£m 
Banks 
£m 
Other 
£m 
Total 
£m 
Short positions 
£m 
Net of short  
positions 
£m 
United States
20,932 
7,300 
38,721 
66,953 
13,329 
53,624 
Germany
34,615 
5,952 
9,787 
50,354 
2,946 
47,408 
France
11,633 
14,800 
8,189 
34,622 
5,903 
28,719 
Japan
8,350 
7,505 
3,375 
19,230 
3,141 
16,089 
Netherlands
4,466 
2,210 
10,711 
17,387 
982 
16,405 
Spain
340 
3,656 
10,282 
14,278 
973 
13,305 
Italy
5,190 
548 
1,489 
7,227 
4,826 
2,401 
Republic of Ireland
665 
3,287 
2,759 
6,711 
68 
6,643 
Switzerland
1,335 
3,282 
1,492 
6,109 
25 
6,084 
China
1,589 
2,669 
1,849 
6,107 
6,107 
Cayman Islands
— 
15 
4,194 
4,209 
4,207 
Belgium
1,662 
1,285 
1,222 
4,169 
726 
3,443 
             
2010
           
United States
21,201 
14,382 
36,813 
72,396 
14,240 
58,156 
Germany
22,962 
6,276 
10,467 
39,705 
4,685 
35,020 
France
17,293 
16,007 
6,756 
40,056 
4,285 
35,771 
Japan
7,983 
6,962 
7,542 
22,487 
409 
22,078 
Netherlands
2,900 
3,055 
10,824 
16,779 
951 
15,828 
Spain
1,401 
4,248 
11,589 
17,238 
1,357 
15,881 
Italy
6,409 
1,083 
2,188 
9,680 
3,183 
6,497 
Republic of Ireland
199 
3,789 
3,101 
7,089 
131 
6,958 
Switzerland
4
1,714 
2,944 
4,662 
12 
4,650 
China
553 
1,775 
1,561 
3,889 
3,884 
Cayman Islands
94 
7,330 
7,426 
44 
7,382 
Belgium
1,461 
752 
2,806 
5,019 
606 
4,413 

 
129

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis continued

Asset quality
The asset quality analysis presented below is based on the Group’s internal asset quality ratings which have ranges for the probability of default as set out below. Customers are assigned credit grades, based on various credit grading models that reflect the key drivers of default for the customer type. All credit grades across the Group map to both a Group level asset quality scale, used for external financial reporting, and a master grading scale for wholesale exposures used for internal management reporting across portfolios. Debt securities are analysed by external ratings and are therefore excluded from the table below and are set out on pages 133 and 134.


Asset quality band
Probability of default range
AQ1
0% - 0.034%
AQ2
0.034% - 0.048%
AQ3
0.048% - 0.095%
AQ4
0.095% - 0.381%
AQ5
0.381% - 1.076%
AQ6
1.076% - 2.153%
AQ7
2.153% - 6.089%
AQ8
6.089% - 17.222%
AQ9
17.222% - 100%
AQ10
100%


 
Cash and 
balances 
at central 
 banks 
Loans and 
advances 
 to banks (1) 
Loans and 
advances to 
 customers 
Settlement 
balances 
Derivatives 
Other 
financial 
instruments 
Commitments 
Contingent 
liabilities 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Total
                 
AQ1
78,592 
74,192 
113,437 
4,582 
481,622 
556 
75,356 
14,076 
842,413 
AQ2
342 
1,881 
15,622 
93 
8,177 
— 
24,269 
3,154 
53,538 
AQ3
196 
1,981 
32,830 
546 
10,819 
— 
23,471 
4,427 
74,270 
AQ4
19 
1,612 
103,617 
760 
14,421 
— 
40,071 
5,847 
166,347 
AQ5
90 
1,261 
112,537 
79 
6,516 
45 
34,593 
4,301 
159,422 
AQ6
9
188 
47,892 
46 
2,221 
— 
17,153 
1,662 
69,171 
AQ7
8
432 
31,379 
13 
2,393 
— 
19,163 
1,037 
54,425 
AQ8
7
30 
11,871 
19 
1,252 
— 
4,159 
276 
17,614 
AQ9
5
83 
16,006 
4
1,150 
320 
2,286 
943 
20,797 
AQ10
164 
570 
6
1,047 
— 
2,354 
221 
4,363 
Past due
— 
2
10,995 
1,623 
— 
— 
— 
— 
12,620 
Impaired
— 
137 
38,610 
— 
— 
414 
— 
— 
39,161 
Impairment provision
— 
(123)
(19,760)
— 
— 
(26)
— 
— 
(19,909)
Group
79,269 
81,840 
515,606 
7,771 
529,618 
1,309 
242,875 
35,944 
1,494,232 

2010
                 
AQ1
56,655 
91,952 
126,444 
6,815 
408,489 
658 
78,728 
9,745 
779,486 
AQ2
14 
598 
13,282 
1,271 
2,659 
26,128 
1,980 
45,935 
AQ3
48 
2,197 
25,981 
156 
3,317 
— 
25,731 
4,337 
61,767 
AQ4
188 
639 
95,777 
571 
3,391 
41,027 
6,522 
148,121 
AQ5
99 
2,322 
114,796 
64 
4,860 
144 
38,612 
5,169 
166,066 
AQ6
159 
65,497 
34 
1,070 
— 
25,991 
2,230 
94,984 
AQ7
178 
46,072 
857 
69 
18,752 
2,456 
68,387 
AQ8
— 
15 
16,573 
14 
403 
— 
9,289 
9,545 
35,839 
AQ9
— 
115 
14,263 
450 
80 
3,889 
932 
19,731 
AQ10
355 
5,644 
1,581 
— 
2,829 
407 
10,823 
Accruing past due
10 
13,430 
2,675 
— 
— 
— 
— 
16,115 
Impaired
 
145 
35,556 
— 
— 
375 
— 
— 
36,076 
Impairment provision
(127)
(18,055)
— 
— 
(29)
— 
— 
(18,211)
Group before RFS MI
57,014 
98,558 
555,260 
11,605 
427,077 
1,306 
270,976 
43,323 
1,465,119 
RFS MI
— 
— 
— 
— 
— 
  — 
32 
34 
Group
57,014 
98,560 
555,260 
11,605 
427,077 
1,306 
270,976 
43,355 
1,465,153 

For the note relating to this table refer to page 132.

 
130

 
Business review Risk and balance sheet management continued

 
Cash and 
balances 
at central 
 banks 
Loans and 
 advances 
 to banks (1) 
Loans and 
advances to 
 customers 
Settlement 
balances 
Derivatives 
Other 
financial 
instruments 
Commitments 
Contingent 
liabilities 
Total 
2009
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
AQ1
51,521 
72,384 
106,062 
6,582 
389,019 
754 
62,085 
9,446 
697,853 
AQ2
1,725 
10,780 
306 
11,550 
9
27,598 
4,526 
56,494 
AQ3
1
2,175 
29,958 
199 
10,791 
— 
28,364 
6,088 
77,576 
AQ4
23 
1,357 
102,922 
605 
8,296 
— 
52,496 
14,948 
180,647 
AQ5
2
2,497 
124,724 
149 
8,270 
37 
43,239 
7,387 
186,305 
AQ6
1
424 
94,513 
40 
2,548 
— 
30,847 
2,448 
130,821 
AQ7
— 
110 
46,928 
33 
2,181 
98 
26,724 
2,352 
78,426 
AQ8
— 
137 
23,593 
— 
1,448 
— 
12,507 
1,008 
38,693 
AQ9
— 
184 
16,025 
— 
2,030 
— 
5,141 
1,279 
24,659 
AQ10
— 
277 
9,142 
2,026 
— 
3,618 
507 
15,573 
Accruing past due
— 
36 
14,475 
3,910 
40 
— 
— 
— 
18,461 
Impaired
— 
206 
31,588 
197 
— 
— 
— 
— 
31,991 
Impairment provision
— 
(157)
(15,016)
— 
— 
— 
— 
(15,173)
Group before RFS MI
51,548 
81,355 
595,694 
12,024 
438,199 
898 
292,619 
49,989 
1,522,326 
RFS MI
713 
7,865 
132,699 
3,255 
— 
5,022 
4,031 
153,594 
Group
52,261 
89,220 
728,393 
12,033 
441,454 
898 
297,641 
54,020 
1,675,920 

2011
                 
Core
                 
AQ1
78,534 
73,689 
94,704 
4,566 
477,746 
468 
69,220 
13,247 
812,174 
AQ2
342 
1,877 
13,970 
91 
7,500 
— 
23,404 
3,122 
50,306 
AQ3
56 
1,967 
30,082 
546 
10,360 
— 
22,319 
4,354 
69,684 
AQ4
18 
1,557 
97,001 
759 
13,475 
— 
38,808 
5,655 
157,273 
AQ5
90 
1,256 
105,392 
79 
5,087 
45 
33,226 
4,092 
149,267 
AQ6
9
140 
41,476 
46 
1,987 
— 
16,118 
1,634 
61,410 
AQ7
8
432 
27,114 
13 
796 
— 
17,514 
949 
46,826 
AQ8
7
20 
9,857 
19 
666 
— 
4,068 
236 
14,873 
AQ9
5
83 
11,515 
592 
272 
1,769 
898 
15,138 
AQ10
164 
264 
339 
— 
1,274 
180 
2,228 
Past due
— 
2
9,451 
1,623 
— 
— 
— 
— 
11,076 
Impaired
— 
136 
15,17
— 
— 
413 
— 
— 
15,719 
Impairment provision
— 
(122)
(8,292)
— 
— 
(25)
— 
— 
(8,439)
Group
79,070 
81,201 
447,704 
7,752 
518,548 
1,173 
227,720 
34,367 
1,397,535 

2010
                 
AQ1
56,637 
91,298 
103,645 
6,814 
396,419 
366 
71,091 
9,651 
735,921 
AQ2
14 
550 
10,534 
1,271 
2,243 
24,923 
1,728 
41,266 
AQ3
48 
2,165 
22,851 
155 
3,132 
— 
23,546 
4,268 
56,165 
AQ4
10 
539 
85,779 
571 
3,017 
36,909 
5,070 
131,901 
AQ5
99 
2,247 
100,051 
64 
3,988 
15 
35,302 
4,924 
146,690 
AQ6
138 
53,498 
34 
805 
— 
24,050 
2,140 
80,668 
AQ7
154 
38,438 
595 
69 
17,605 
2,309 
59,173 
AQ8
— 
15 
13,290 
14 
257 
— 
8,617 
9,434 
31,627 
AQ9
— 
107 
9,898 
237 
50 
3,442 
886 
14,622 
AQ10
300 
2,777 
368 
— 
1,500 
250 
5,202 
Past due
— 
10,744 
2,629 
— 
— 
— 
— 
13,376 
Impaired
— 
144 
13,367 
— 
— 
375 
— 
— 
13,886 
Impairment provision
— 
(126)
(7,740)
— 
— 
(29)
— 
— 
(7,895)
Group
56,818 
97,534 
457,132 
11,557 
411,061 
855 
246,985 
40,660 
1,322,602 

For the note relating to this table refer to page 132.
 
 
131

 
 
Business review Risk and balance sheet management continued

Risk management: Credit risk continued
Balance sheet analysis: Asset quality continued

 
Cash and 
balances 
at central 
 banks 
Loans and 
advances 
 to banks (1) 
Loans and 
advances to 
 customers 
Settlement 
balances 
Derivatives 
Other 
financial 
instruments 
Commitments 
Contingent  
liabilities 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Non-Core
                 
AQ1
58 
503 
18,733 
16 
3,876 
88 
6,136 
829 
30,239 
AQ2
— 
4
1,652 
677 
— 
865 
32 
3,232 
AQ3
140 
14 
2,748 
— 
459 
— 
1,152 
73 
4,586 
AQ4
1
55 
6,616 
946 
— 
1,263 
192 
9,074 
AQ5
— 
5
7,145 
— 
1,429 
— 
1,367 
209 
10,155 
AQ6
— 
48 
6,416 
— 
234 
— 
1,035 
28 
7,761 
AQ7
— 
— 
4,265 
— 
1,597 
— 
1,649 
88 
7,599 
AQ8
— 
10 
2,014 
— 
586 
— 
91 
40 
2,741 
AQ9
— 
— 
4,491 
— 
558 
48 
517 
45 
5,659 
AQ10
— 
— 
306 
— 
708 
— 
1,080 
41 
2,135 
Accruing past due
— 
— 
1,544 
— 
— 
— 
— 
— 
1,544 
Impaired
— 
1
23,440 
— 
— 
1
— 
— 
23,442 
Impairment provision
— 
(1)
(11,468)
— 
— 
(1)
— 
— 
(11,470)
Group
199 
639 
67,902 
19 
11,070 
136 
15,155 
1,577 
96,697 

2010
                 
AQ1
18 
654 
22,799 
12,070 
292 
7,637 
94 
43,565 
AQ2
— 
48 
2,748 
— 
416 
— 
1,205 
252 
4,669 
AQ3
— 
32 
3,130 
185 
— 
2,185 
69 
5,602 
AQ4
178 
100 
9,998 
— 
374 
— 
4,118 
1,452 
16,220 
AQ5
— 
75 
14,745 
— 
872 
129 
3,310 
245 
19,376 
AQ6
— 
21 
11,999 
— 
265 
— 
1,941 
90 
14,316 
AQ7
— 
24 
7,634 
— 
262 
— 
1,147 
147 
9,214 
AQ8
— 
— 
3,283 
— 
146 
— 
672 
111 
4,212 
AQ9
— 
4,365 
— 
213 
30 
447 
46 
5,109 
AQ10
— 
55 
2,867 
— 
1,213 
— 
1,329 
157 
5,621 
Accruing past due
— 
2,686 
46 
— 
— 
— 
— 
2,739 
Impaired
— 
22,189 
— 
— 
— 
— 
— 
22,190 
Impairment provision
— 
(1)
(10,315)
— 
— 
— 
— 
— 
(10,316)
Group before RFS MI
196 
1,024 
98,128 
48 
16,016 
451 
23,991 
2,663 
142,517 

Note:
(1)
Excluding items in the course of collection from other banks of £1,470 million (2010 - £1,958 million; 2009 - £2,533 million).

 
132

 
Business review Risk and balance sheet management continued

Debt securities
The table below analyses debt securities by issuer and external ratings. Ratings are based on the lower of S&P, Moody’s and Fitch.

 
Central and local government
Banks 
£m 
Other 
financial 
institutions 
£m 
Corporate 
£m 
Total 
£m 
Total 
Of which 
ABS (1)
£m 
2011
UK 
£m 
US 
£m 
Other 
£m 
Total
                 
AAA
22,451 
45 
32,522 
5,155 
15,908 
452 
76,533 
37 
17,156 
AA to AA+
— 
40,435 
2,000 
2,497 
30,403 
639 
75,974 
36 
33,615 
A to AA-
— 
24,966 
6,387 
4,979 
1,746 
38,079 
18 
6,331 
BBB- to A-
— 
— 
2,194 
2,287 
2,916 
1,446 
8,843 
4,480 
Non-investment grade
— 
— 
924 
575 
5,042 
1,275 
7,816 
4,492 
Unrated
— 
39 
1,380 
411 
1,835 
1,235 
 
22,451 
40,484 
62,608 
16,940 
60,628 
5,969 
209,080 
100 
67,309 
                   
Core
                 
AAA
22,112 
45 
32,489 
4,601 
13,245 
448 
72,940 
37 
14,534 
AA to AA+
— 
40,435 
1,995 
2,434 
28,125 
565 
73,554 
38 
31,323 
A to AA-
— 
24,964 
6,302 
3,348 
1,614 
36,229 
18 
4,731 
BBB- to A-
— 
— 
2,194 
2,272 
1,727 
1,232 
7,425 
3,188 
Non-investment grade
— 
— 
723 
559 
2,542 
1,048 
4,872 
2,552 
Unrated
— 
25 
821 
260 
1,110 
785 
 
22,112 
40,484 
62,366 
16,193 
49,808 
5,167 
196,130 
100 
57,113 
                   
Non-Core
                 
AAA
339 
— 
33 
554 
2,663 
3,593 
28 
2,622 
AA to AA+
— 
— 
63 
2,278 
74 
2,420 
19 
2,292 
A to AA-
— 
— 
85 
1,631 
132 
1,850 
14 
1,600 
BBB- to A-
— 
— 
— 
15 
1,189 
214 
1,418 
11 
1,292 
Non-investment grade
— 
— 
201 
16 
2,500 
227 
2,944 
23 
1,940 
Unrated
— 
— 
14 
559 
151 
725 
450 
 
339 
— 
242 
747 
10,820 
802 
12,950 
100 
10,196 

For notes relating to this table refer to page 134.
 
 
133

 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Debt securities continued

 
Central and local government
Banks 
£m 
Other 
financial 
institutions 
£m 
Corporate 
£m 
Total 
£m 
Total (2)
Of which 
ABS (1)
£m 
2010
UK 
£m 
US 
£m 
Other 
£m 
Total
                 
AAA
13,486 
38,009 
44,123 
10,704 
39,388 
878 
146,588 
67 
51,235 
AA to AA+
— 
— 
18,025 
3,511 
6,023 
616 
28,175 
13 
6,335 
A to AA-
— 
— 
9,138 
4,926 
2,656 
1,155 
17,875 
3,244 
BBB- to A-
— 
— 
2,845 
1,324 
3,412 
2,005 
9,586 
3,385 
Non-investment grade
— 
— 
1,770 
1,528 
5,522 
2,425 
11,245 
4,923 
Unrated
— 
— 
54 
480 
2,552 
925 
4,011 
1,703 
 
13,486 
38,009 
75,955 
22,473 
59,553 
8,004 
217,480 
100 
70,825 
                   
Core
                 
AAA
13,110 
37,698 
44,101 
10,532 
35,595 
839 
141,875 
70 
47,441 
AA to AA+
— 
— 
18,025 
3,485 
3,242 
612 
25,364 
13 
3,656 
A to AA-
— 
— 
9,138 
4,420 
1,605 
1,089 
16,252 
8
1,879 
BBB- to A-
— 
— 
2,845 
1,050 
1,412 
1,903 
7,210 
4
1,108 
Non-investment grade
— 
— 
1,464 
1,444 
3,658 
2,014 
8,580 
4
3,052 
Unrated
— 
— 
53 
420 
1,375 
768 
2,616 
1
978 
 
13,110 
37,698 
75,626 
21,351 
46,887 
7,225 
201,897 
100 
58,114 
                   
Non-Core
                 
AAA
376 
311 
22 
172 
3,793 
39 
4,713 
30 
3,794 
AA to AA+
— 
— 
— 
26 
2,781 
4
2,811 
18 
2,679 
A to AA-
— 
— 
— 
506 
1,051 
66 
1,623 
11 
1,365 
BBB- to A-
— 
— 
— 
274 
2,000 
102 
2,376 
15 
2,277 
Non-investment grade
— 
— 
306 
84 
1,864 
411 
2,665 
17 
1,871 
Unrated
— 
— 
60 
1,177 
157 
1,395 
725 
 
376 
311 
329 
1,122 
12,666 
779 
15,583 
100 
12,711 

2009
                 
AAA
26,601 
28,210 
44,155 
13,208 
49,363 
4,021 
165,558 
66 
65,067 
AA to AA+
— 
— 
22,003 
4,225 
9,602 
1,474 
37,304 
15 
8,942 
A to AA-
— 
— 
13,161 
3,425 
4,563 
1,526 
22,675 
3,886 
BBB- to A-
— 
— 
3,847 
788 
4,727 
1,738 
11,100 
4,243 
Non-investment grade
— 
— 
353 
159 
3,937 
1,630 
6,079 
3,515 
Unrated
— 
— 
509 
232 
3,586 
2,052 
6,379 
1,949 
Group before RFS MI
26,601 
28,210 
84,028 
22,037 
75,778 
12,441 
249,095 
100 
87,602 
RFS MI
721 
183 
11,871 
3,803 
675 
906 
18,159 
 
580 
Group
27,322 
28,393 
95,899 
25,840 
76,453 
13,347 
267,254 
 
88,182 

Notes:
(1)
Asset-backed securities.
(2)
Percentage calculated on Group before RFS MI.
 
Key points
·  
The decrease in AAA rated debt securities relates to the downgrading of US government and agencies to AA+ by S&P during the year.

·  
The proportion of debt securities rated A to AA- increased to 18%, principally reflecting the Japanese government downgrade in 2011.
 
·  
Non-investment grade and unrated debt securities accounted for 5% of the debt securities portfolio at 31 December 2011, down from 7% in the prior year.
 
 
134

 
Business review Risk and balance sheet management continued

The table below analyses debt securities by issuer and measurement classification. The categorisation of debt securities has been revised to include asset-backed securities (ABS) by class of issuer. The main changes are to US central and local government which includes US federal agencies, and financial institutions which now includes US government sponsored agencies and securitisation entities. 2010 data are presented on the revised basis.

 
Central and local government
Banks 
Other 
financial 
institutions 
Corporate 
Total 
Of which 
ABS 
 
UK 
US 
Other 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Held-for-trading (HFT)
9,004 
19,636 
36,928 
3,400 
23,160 
2,948 
95,076 
20,816 
Designated as at fair value through profit or loss
— 
127 
53 
457 
647 
558 
Available-for-sale
13,436 
20,848 
25,552 
13,175 
31,752 
2,535 
107,298 
40,735 
Loans and receivables
10 
— 
312 
5,259 
477 
6,059 
5,200 
 
22,451 
40,484 
62,608 
16,940 
60,628 
5,969 
209,080 
67,309 
                 
Total of which US agencies
— 
4,896 
— 
— 
25,924 
— 
30,820 
28,558 
Short positions (HFT)
(3,098)
(10,661)
(19,136)
(2,556)
(2,854)
(754)
(39,059)
(352)
                 
Available-for-sale
               
Gross unrealised gains
1,428 
1,311 
1,180 
52 
913 
94 
4,978 
1,001 
Gross unrealised losses
— 
— 
(171)
(838)
(2,386)
(13)
(3,408)
(3,158)
                 
2010
               
Held-for-trading
5,097 
15,648 
42,828 
5,486 
23,711 
6,099 
98,869 
21,988 
Designated as at fair value through profit or loss
117 
262 
10 
402 
119 
Available-for-sale
8,377 
22,244 
32,865 
16,982 
29,148 
1,514 
111,130 
42,515 
Loans and receivables
11 
— 
— 
6,686 
381 
7,079 
6,203 
 
13,486 
38,009 
75,955 
22,473 
59,553 
8,004 
217,480 
70,825 
                 
Total of which US agencies
— 
6,811 
— 
— 
21,686 
— 
28,497 
25,375 
Short positions (HFT)
(4,200)
(10,943)
(18,913)
(1,844)
(3,356)
(1,761)
(41,017)
(1,335)
                 
Available-for-sale
               
Gross unrealised gains
349 
525 
700 
143 
827 
51 
2,595 
1,057 
Gross unrealised losses
(10)
(2)
(618)
(786)
(2,626)
(55)
(4,097)
(3,396)


Key points
·  
Held-for-trading debt securities decreased by £3.8 billion during the year due to a reduction in trading volumes. The reduction in sovereign exposures in the eurozone and other countries, in response to the current economic environment, was offset by an increase in US and UK government bonds.

·  
The Group’s AFS portfolio decreased by £3.8 billion. UK government bonds increased by £5.1 billion, principally in the Group Treasury portfolio.

 
135

 
Business review Risk and balance sheet management continued

Risk management: Credit risk continued
Balance sheet analysis continued

Asset-backed securities
The Group structures, originates, distributes and trades debt in the form of loan, bond and derivative instruments in all major currencies and debt capital markets in North America, Western Europe, Asia and major emerging markets. The carrying value of the Group's debt securities is detailed below.

     
2009
 
2011 
Group 
2010 
Group 
Group 
before 
RFS MI 
Group 
 
£bn 
£bn 
£bn 
£bn 
Securities issued by central and local governments
125.5 
127.5 
138.8 
151.6 
Securities issued by corporates
6.0 
8.0 
12.5 
13.3 
Securities issued by banks and other financial institutions
77.6 
82.0 
97.8 
102.4 
 
209.1 
217.5 
249.1 
267.3 
         
Asset-backed securities
67.3 
70.8 
87.6 
88.2 


The Group’s credit market activities gave rise to risk concentrations in asset-backed securities (ABS). The Group has exposures to ABS, which are predominantly debt securities, but can also be held in derivative form. ABS have an interest in an underlying pool of referenced assets. The risks and rewards of the referenced pool are passed onto investors by the issue of securities with varying seniority by a special purpose entity.

Debt securities include residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralised debt obligations (CDOs), collateralised loan obligations (CLOs) and other ABS. In many cases, the risk associated with these assets is hedged by credit derivatives. The counterparties to some of these hedge transactions are monoline insurers.

The following tables summarise the gross and net exposures and carrying values of these securities by the location of the underlying assets at 31 December 2011, 2010 and 2009. Gross exposures represent the principal amounts relating to ABS. Government sponsored or similar RMBS comprises securities that are: (a) guaranteed or effectively guaranteed by the US government, by way of its support for US federal agencies and government sponsored enterprises or (b) guaranteed by the Dutch government. Net exposures represent the carrying value after taking account of protection purchased from monoline insurers and other counterparties, but exclude the effect of counterparty credit valuation adjustments. The hedge provides credit protection of both principal and interest cash flows in the event of default by the counterparty. The value of this protection is based on the underlying instrument being protected.

 
136

 
Business review Risk and balance sheet management continued
 
Asset-backed securities by product, geography and measurement classification

           
FVTPL (1)
   
 
US 
UK 
Europe 
RoW 
Total 
HFT (2) 
DFV (3) 
AFS (4) 
LAR (5) 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Gross exposure
                 
RMBS: government sponsored or similar
27,549 
5,884 
2
33,435 
15,031 
18,404 
RMBS: prime
1,201 
3,487 
1,541 
484 
6,713 
1,090 
567 
4,977 
79 
RMBS: non-conforming
1,220 
2,197 
74 
3,491 
717 
1,402 
1,372 
RMBS: sub-prime
1,847 
427 
94 
2
2,370 
2,183 
22 
165 
MBS: covered bond
133 
203 
8,256 
8,592 
8,592 
CMBS
1,623 
1,562 
883 
1
4,069 
2,001 
862 
1,206 
CDOs
7,889 
72 
469 
8,430 
4,455 
3,885 
90 
CLOs
5,019 
156 
1,055 
6,230 
1,294 
4,734 
202 
ABS covered bond
21 
71 
948 
4
1,044 
1,044 
Other ABS
2,085 
1,844 
1,746 
992 
6,667 
1,965 
17 
2,389 
2,296 
 
48,587 
10,019 
20,950 
1,485 
81,041 
28,736 
584 
46,311 
5,410 
                   
Carrying value
                 
RMBS: government sponsored or similar
28,022 
— 
5,549 
2
33,573 
15,132 
18,441 
RMBS: prime
1,035 
3,038 
1,206 
466 
5,745 
872 
558 
4,243 
72 
RMBS: non-conforming
708 
1,897 
74 
2,679 
327 
980 
1,372 
RMBS: sub-prime
686 
144 
72 
2
904 
737 
9
158 
MBS: covered bond
136 
209 
7,175 
7,520 
7,520 
CMBS
1,502 
1,253 
635 
1
3,391 
1,513 
716 
1,162 
CDOs
1,632 
31 
294 
1,957 
315 
1,555 
87 
CLOs
4,524 
98 
719 
5,341 
882 
4,280 
179 
ABS covered bond
19 
70 
953 
4
1,046 
— 
1,046 
— 
Other ABS
1,715 
947 
1,525 
966 
5,153 
1,038 
1,945 
2,170 
 
39,979 
7,687 
18,202 
1,441 
67,309 
20,816 
558 
40,735 
5,200 
                   
Net exposure
                 
RMBS: government sponsored or similar
28,022 
— 
5,549 
2
33,573 
15,132 
18,441 
RMBS: prime
825 
3,456 
1,005 
458 
5,744 
447 
557 
4,668 
72 
RMBS: non-conforming
677 
2,225 
74 
2,976 
284 
1,320 
1,372 
RMBS: sub-prime
385 
138 
67 
2
592 
434 
— 
158 
MBS: covered bond
136 
209 
7,175 
7,520 
7,520 
CMBS
860 
1,253 
543 
1
2,657 
777 
718 
1,162 
CDOs
1,030 
31 
294 
1,355 
304 
964 
87 
CLOs
1,367 
98 
712 
2,177 
827 
1,171 
179 
ABS covered bond
19 
70 
952 
4
1,045 
1,045 
— 
Other ABS
1,456 
843 
1,527 
804 
4,630 
617 
1,941 
2,071 
 
34,777 
8,323 
17,898 
1,271 
62,269 
18,822 
557 
37,788 
5,101 

For notes relating to this table refer to page 139.
 
 
137

 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Asset-backed securities by product, geography and measurement classification continued

           
FVTPL (1)
   
 
US 
UK 
Europe 
RoW 
Total 
HFT (2) 
DFV (3) 
AFS (4) 
LAR (5) 
2010
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Gross exposure
                 
RMBS: government sponsored or similar
24,207 
16 
6,422 
— 
30,645 
13,840 
— 
16,805 
— 
RMBS: prime
1,784 
3,385 
1,118 
192 
6,479 
1,605 
4,749 
124 
RMBS: non-conforming
1,249 
2,107 
92 
— 
3,448 
708 
— 
1,313 
1,427 
RMBS: sub-prime
792 
365 
139 
221 
1,517 
819 
— 
496 
202 
MBS: covered bond
138 
208 
8,525 
— 
8,871 
— 
— 
8,871 
— 
CMBS
3,086 
1,451 
912 
45 
5,494 
2,646 
120 
1,409 
1,319 
CDOs
12,156 
128 
453 
— 
12,737 
7,951 
— 
4,687 
99 
CLOs
6,038 
134 
879 
7,060 
1,062 
— 
5,572 
426 
ABS covered bond
— 
— 
1,908 
— 
1,908 
— 
— 
1,908 
— 
Other ABS
3,104 
1,144 
963 
1,705 
6,916 
1,533 
— 
2,615 
2,768 
 
52,554 
8,938 
21,411 
2,172 
85,075 
30,164 
121 
48,425 
6,365 
                   
Carrying value
                 
RMBS: government sponsored or similar
24,390 
16 
5,958 
— 
30,364 
13,765 
— 
16,599 
— 
RMBS: prime
1,624 
3,000 
931 
192 
5,747 
1,384 
4,249 
113 
RMBS: non-conforming
1,084 
1,959 
92 
— 
3,135 
605 
— 
1,102 
1,428 
RMBS: sub-prime
638 
255 
120 
205 
1,218 
681 
— 
344 
193 
MBS: covered bond
142 
208 
7,522 
— 
7,872 
— 
— 
7,872 
— 
CMBS
2,936 
1,338 
638 
38 
4,950 
2,262 
118 
1,281 
1,289 
CDOs
3,135 
69 
254 
— 
3,458 
1,341 
— 
2,021 
96 
CLOs
5,334 
102 
635 
6,074 
691 
— 
4,958 
425 
ABS covered bond
— 
— 
1,861 
— 
1,861 
— 
— 
1,861 
— 
Other ABS
2,780 
945 
754 
1,667 
6,146 
1,259 
— 
2,228 
2,659 
 
42,063 
7,892 
18,765 
2,105 
70,825 
21,988 
119 
42,515 
6,203 
                   
Net exposure
                 
RMBS: government sponsored or similar
24,390 
16 
5,958 
— 
30,364 
13,765 
— 
16,599 
— 
RMBS: prime
1,523 
2,948 
596 
192 
5,259 
897 
4,248 
113 
RMBS: non-conforming
1,081 
1,959 
92 
— 
3,132 
602 
— 
1,102 
1,428 
RMBS: sub-prime
289 
253 
112 
176 
830 
305 
— 
332 
193 
MBS: covered bond
142 
208 
7,522 
— 
7,872 
— 
— 
7,872 
— 
CMBS
1,823 
1,336 
458 
38 
3,655 
1,188 
10 
1,230 
1,227 
CDOs
1,085 
39 
245 
— 
1,369 
743 
— 
530 
96 
CLOs
1,387 
102 
629 
2,119 
673 
— 
1,021 
425 
ABS covered bond
— 
— 
1,861 
— 
1,861 
— 
— 
1,861 
— 
Other ABS
2,293 
748 
748 
1,659 
5,448 
690 
— 
2,220 
2,538 
 
34,013 
7,609 
18,221 
2,066 
61,909 
18,863 
11 
37,015 
6,020 

For notes relating to this table refer to page 139.

 
138

 
Business review Risk and balance sheet management continued
           
FVTPL (1)
   
 
US 
UK 
Europe 
RoW 
Total 
HFT (2)
DFV (3)
AFS (4)
LAR (5) 
2009
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m  
Gross exposure
                 
RMBS: government sponsored or similar
26,644 
17 
7,016 
94 
33,771 
13,536 
— 
20,235 
— 
RMBS: prime
2,965 
5,276 
4,567 
222 
13,030 
6,274 
147 
5,761 
848 
RMBS: non-conforming
1,341 
2,138 
128 
— 
3,607 
635 
— 
1,498 
1,474 
RMBS: sub-prime
1,668 
724 
195 
561 
3,148 
1,632 
17 
1,020 
479 
MBS: covered bond
49 
297 
9,019 
— 
9,365 
— 
— 
9,365 
— 
CMBS
3,422 
1,781 
1,420 
75 
6,698 
2,936 
209 
1,842 
1,711 
CDOs
12,382 
329 
571 
27 
13,309 
9,080 
3,923 
305 
CLOs
9,092 
166 
2,169 
1,173 
12,600 
5,346 
— 
6,581 
673 
ABS covered bond
— 
— 
2,206 
— 
2,206 
— 
— 
2,206 
— 
Other ABS
3,587 
1,980 
2,825 
1,569 
9,961 
2,912 
18 
3,046 
3,985 
 
61,150 
12,708 
30,116 
3,721 
107,695 
42,351 
392 
55,477 
9,475 
                   
Carrying value
                 
RMBS: government sponsored or similar
26,984 
17 
6,870 
33 
33,904 
13,397 
— 
20,507 
— 
RMBS: prime
2,696 
4,583 
4,009 
212 
11,500 
5,133 
141 
5,643 
583 
RMBS: non-conforming
958 
1,957 
128 
— 
3,043 
389 
— 
1,180 
1,474 
RMBS: sub-prime
977 
314 
146 
387 
1,824 
779 
17 
704 
324 
MBS: covered bond
50 
288 
8,734 
— 
9,072 
— 
— 
9,072 
— 
CMBS
3,237 
1,305 
924 
43 
5,509 
2,279 
216 
1,637 
1,377 
CDOs
3,275 
166 
400 
27 
3,868 
2,064 
1,600 
203 
CLOs
6,736 
112 
1,469 
999 
9,316 
3,296 
— 
5,500 
520 
ABS covered bond
— 
— 
2,200 
— 
2,200 
— 
— 
2,200 
— 
Other ABS
2,886 
1,124 
2,169 
1,187 
7,366 
1,483 
19 
2,421 
3,443 
 
47,799 
9,866 
27,049 
2,888 
87,602 
28,820 
394 
50,464 
7,924 
                   
Net exposure
                 
RMBS: government sponsored or similar
26,984 
17 
6,870 
33 
33,904 
13,397 
— 
20,507 
— 
RMBS: prime
2,436 
3,747 
3,018 
172 
9,373 
3,167 
142 
5,480 
584 
RMBS: non-conforming
948 
1,957 
128 
— 
3,033 
379 
— 
1,180 
1,474 
RMBS: sub-prime
565 
305 
137 
290 
1,297 
529 
17 
427 
324 
MBS: covered bond
50 
288 
8,734 
— 
9,072 
— 
— 
9,072 
— 
CMBS
2,245 
1,228 
595 
399 
4,467 
1,331 
203 
1,556 
1,377 
CDOs
743 
124 
382 
26 
1,275 
521 
550 
203 
CLOs
1,636 
86 
1,104 
39 
2,865 
673 
— 
1,672 
520 
ABS covered bond
— 
— 
2,200 
— 
2,200 
— 
— 
2,200 
— 
Other ABS
2,117 
839 
2,131 
1,145 
6,232 
483 
19 
2,421 
3,309 
 
37,724 
8,591 
25,299 
2,104 
73,718 
20,480 
382 
45,065 
7,791 

Notes:
(1)
Fair value through profit or loss.
(2)
Held-for-trading.
(3)
Designated as at fair value.
(4)
Available-for-sale.
(5)
Loans and receivables.
 
 
139

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Asset-backed securities continued
The table below summarises the rating levels of ABS carrying values. Credit ratings are based on those from rating agencies Standard & Poor’s (S&P), Moody’s and Fitch and have been mapped onto the S&P scale.

 
RMBS (1)
             
 
Government 
sponsored 
or similar (2)
Prime 
Non- 
conforming 
Sub-prime 
MBS 
covered 
bond 
CMBS (3)
CDOs (4)
CLOs (5)
ABS 
covered 
bond 
Other 
ABS 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
AAA
4,169 
3,599 
1,488 
105 
2,595 
647 
135 
2,171 
625 
1,622 
17,156 
AA to AA+
29,252 
669 
106 
60 
379 
710 
35 
1,533 
321 
550 
33,615 
A to AA-
131 
506 
110 
104 
2,567 
1,230 
161 
697 
100 
725 
6,331 
BBB- to A-
39 
288 
93 
1,979 
333 
86 
341 
1,321 
4,480 
Non-investment grade
21 
784 
658 
396 
415 
1,370 
176 
672 
4,492 
Unrated
148 
29 
146 
56 
170 
423 
263 
1,235 
 
33,573 
5,745 
2,679 
904 
7,520 
3,391 
1,957 
5,341 
1,046 
5,153 
67,309 
                       
2010
                     
AAA
28,835 
4,355 
1,754 
317 
7,107 
2,789 
444 
2,490 
988 
2,156 
51,235 
AA to AA+
1,529 
147 
144 
116 
357 
392 
567 
1,786 
681 
616 
6,335 
A to AA-
— 
67 
60 
212 
408 
973 
296 
343 
192 
693 
3,244 
BBB- to A-
— 
82 
316 
39 
— 
500 
203 
527 
— 
1,718 
3,385 
Non-investment grade
— 
900 
809 
458 
— 
296 
1,863 
332 
— 
265 
4,923 
Unrated
— 
196 
52 
76 
— 
— 
85 
596 
— 
698 
1,703 
 
30,364 
5,747 
3,135 
1,218 
7,872 
4,950 
3,458 
6,074 
1,861 
6,146 
70,825 
                       
2009
                     
AAA
33,779 
9,211 
1,981 
578 
8,645 
3,441 
615 
2,718 
1,933 
2,166 
65,067 
AA to AA+
125 
676 
197 
121 
360 
599 
944 
4,365 
267 
1,288 
8,942 
A to AA-
— 
507 
109 
306 
67 
1,022 
254 
607 
— 
1,014 
3,886 
BBB- to A-
— 
547 
160 
87 
— 
298 
944 
260 
— 
1,947 
4,243 
Non-investment grade
— 
558 
594 
579 
— 
147 
849 
636 
— 
152 
3,515 
Unrated
— 
153 
— 
262 
730 
— 
799 
1,949 
 
33,904 
11,500 
3,043 
1,824 
9,072 
5,509 
3,868 
9,316 
2,200 
7,366 
87,602 

Notes:
(1)
Residential mortgage-backed securities.
(2)
Includes US agency and Dutch government guaranteed securities.
(3)
Commercial mortgage-backed securities.
(4)
Collateralised debt obligations.
(5)
Collateralised loan obligations.


Key points
·  
Carrying value of total ABS decreased by £3.5 billion during 2011. US government sponsored RMBS increased by £3.6 billion, reflecting a move towards G10 governments generally, partially off-set by decrease in European exposure. There were reductions across all other portfolios.

·  
The decrease in AAA rated debt securities mainly relates to the downgrading of US government and agencies to AA+ by S&P during the year.
 
·  
CDOs and CLOs decreased by £2.2 billion principally reflecting asset reductions in Non-Core.

·  
The decrease in CMBS of £1.6 billion, primarily reflecting restructuring of certain monoline exposures.

·  
The average mark of total ABS was 83%, broadly the same as 2010 and 2009.

 
140

 
Business review Risk and balance sheet management continued

Non-investment grade and unrated ABS
The table below summarises the carrying values by accounting classification of non-investment grade or not publicly rated ABS.

 
Non-investment grade
 
Unrated
 
HFT 
AFS 
LAR 
Total 
 
HFT 
AFS 
LAR 
Total 
2011
£m 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
RMBS: G10 governments
— 
21 
— 
21 
 
— 
— 
— 
— 
RMBS: prime
312 
417 
54 
783 
 
148 
— 
— 
148 
RMBS: non-conforming
279 
372 
7
658 
 
28 
— 
— 
28 
RMBS: sub-prime
387 
9
— 
396 
 
146 
— 
— 
146 
CMBS
307 
10 
98 
415 
 
56 
— 
— 
56 
CDOs
116 
1,215 
40 
1,371 
 
130 
40 
— 
170 
CLOs
131 
— 
44 
175 
 
284 
139 
— 
423 
Other ABS
150 
12 
511 
673 
 
12 
70 
182 
264 
 
1,682 
2,056 
754 
4,492 
 
804 
249 
182 
1,235 
                   
2010
                 
RMBS: prime
354 
535 
11 
900 
 
196 
— 
— 
196 
RMBS: non-conforming
389 
414 
809 
 
52 
— 
— 
52 
RMBS: sub-prime
437 
21 
— 
458 
 
76 
— 
— 
76 
CMBS
198 
17 
81 
296 
 
— 
— 
— 
— 
CDOs
691 
1,151 
21 
1,863 
 
85 
— 
— 
85 
CLOs
239 
88 
332 
 
267 
329 
— 
596 
Other ABS
148 
17 
100 
265 
 
191 
162 
345 
698 
 
2,456 
2,160 
307 
4,923 
 
867 
491 
345 
1,703 
                   
2009
                 
RMBS: prime
120 
430 
558 
 
— 
— 
RMBS: non-conforming
253 
341 
— 
594 
 
— 
— 
RMBS: sub-prime
339 
240 
— 
579 
 
153 
— 
— 
153 
CMBS
89 
55 
147 
 
— 
CDOs
487 
300 
62 
849 
 
143 
119 
— 
262 
CLOs
269 
359 
636 
 
207 
523 
— 
730 
Other ABS
78 
63 
11 
152 
 
270 
134 
395 
799 
 
1,635 
1,736 
144 
3,515 
 
774 
779 
396 
1,949 

 
141

 
 
Business review Risk and balance sheet management continued

Risk management: Credit risk continued
Balance sheet analysis continued

Residential mortgage-backed securities
RMBS are securities that represent an interest in a portfolio of residential mortgages. Repayments made on the underlying mortgages are used to make payments to holders of the RMBS. The risk of the RMBS will vary primarily depending on the quality and geographic region in which the underlying mortgage assets are located and the credit enhancement of the securitisation structure. Several tranches of notes are issued, each secured against the same portfolio of mortgages, but providing differing levels of seniority to match the risk appetite of investors. The most junior (or equity) notes will suffer early capital and interest losses experienced by the referenced mortgage collateral, with each more senior note benefiting from the protection provided by the subordinated notes below. Additional credit enhancements may be provided to the holder of senior RMBS notes, including provided by monoline insurers.
 
The main categories of mortgages that serve as collateral to RMBS held by the Group with related vintages are set out below and described in the Glossary on pages 440 to 447. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for the Group's RMBS categorisation.

The Group classifies RMBS as sub-prime or Alt-A based on industry standard criteria, including Fair Isaac Corporation scores (FICO), level of documentation and loan-to-value (LTV) ratios of the underlying mortgage loans. RMBS are classified as sub-prime if the mortgage portfolio comprises loans with FICO scores between 500 and 650 with full or limited documentation. Mortgages in Alt-A RMBS portfolios have FICO scores of 640 to 720, limited documentation and an original LTV of 70% to 95%. The FICO score is the determining factor in the classification of the Group’s RMBS as sub-prime or Alt-A.

The table below analyses the vintage of the Group's carrying value of RMBS portfolios by geography and classification.


 
By geography
 
By classification
 
US
UK
Other
Europe
RoW
Total
Government sponsored
Covered
bond
Prime
Non-
conforming
Sub-prime
2011
£m
£m
£m
£m
£m
£m
£m
£m
£m
£m
2004 and earlier
2,435
56
1,054
42
3,587
2,344
622
428
80
113
2005
1,661
161
3,262
26
5,110
1,652
2,333
539
382
204
2006
575
1,407
4,944
97
7,023
1,681
3,272
1,224
628
218
2007
1,540
2,689
3,874
36
8,139
3,588
1,293
1,560
1,482
216
2008
1,154
24
373
127
1,678
1,428
173
75
2
2009
1,364
58
7
1
1,430
1,209
163
7
51
2010 and later
21,858
893
562
141
23,454
21,671
1,658
25
100
 
30,587
5,288
14,076
470
50,421
33,573
7,520
5,745
2,679
904
                     
2010
                   
2004 and earlier
4,405
175
1,057
50
5,687
4,148
641
678
90
130
2005
2,579
176
3,435
28
6,218
2,379
2,410
634
567
228
2006
1,082
2,249
5,460
121
8,912
2,106
3,451
2,129
736
490
2007
2,576
2,370
4,135
33
9,114
4,774
1,352
1,280
1,477
231
2008
2,314
58
420
155
2,947
2,598
18
223
104
4
2009 and later
14,922
410
116
10
15,458
14,359
803
161
135
 
27,878
5,438
14,623
397
48,336
30,364
7,872
5,747
3,135
1,218
                     
2009
                   
2004 and earlier
8,504
293
1,760
33
10,590
7,951
752
1,460
99
328
2005
4,221
783
4,252
74
9,330
3,801
2,582
2,173
510
264
2006
1,847
3,116
7,449
216
12,628
2,691
4,135
4,514
690
598
2007
1,844
2,957
5,916
60
10,777
4,394
1,585
2,842
1,529
427
2008 and later
15,249
10
510
249
16,018
15,067
18
511
215
207
 
31,665
7,159
19,887
632
59,343
33,904
9,072
11,500
3,043
1,824
 
 
142

 
Business review Risk and balance sheet management continued
 
Derivatives
The Group's derivative assets by internal asset quality rating and residual maturity are analysed below. Master netting arrangements in respect of mark-to-market (mtm) positions and collateral shown below do not result in a net presentation on the Group’s balance sheet under IFRS.

 
2011
 
2010
 
 
0-
months 
£m 
3-
months 
£m 
6-12 
months 
£m 
1-
years 
£m 
Over 5 
years 
£m 
Total 
£m 
 
0-
months 
£m 
3-
months 
£m 
6-12 
months 
£m 
1-
years 
£m 
Over 5 
years 
£m 
Total 
£m 
2009 
Total 
£m 
AQ1
24,580 
10,957 
17,180 
126,105 
302,800 
481,622 
 
30,840 
10,755 
17,554 
135,311 
214,029 
408,489 
389,019 
AQ2
326 
236 
431 
2,046 
5,138 
8,177 
 
319 
105 
212 
1,561 
462 
2,659 
11,550 
AQ3
975 
390 
459 
2,811 
6,184 
10,819 
 
1,284 
391 
626 
610 
406 
3,317 
10,791 
AQ4
1,465 
782 
713 
4,093 
7,368 
14,421 
 
989 
155 
240 
1,726 
281 
3,391 
8,296 
AQ5
890 
93 
219 
1,787 
3,527 
6,516 
 
1,016 
81 
201 
1,447 
2,115 
4,860 
8,270 
AQ6
121 
30 
81 
803 
1,186 
2,221 
 
134 
46 
71 
653 
166 
1,070 
2,548 
AQ7
101 
29 
56 
1,674 
533 
2,393 
 
150 
29 
44 
375 
259 
857 
2,181 
AQ8
16 
21 
11 
143 
1,061 
1,252 
 
10 
118 
272 
403 
1,448 
AQ9
254 
876 
1,150 
 
104 
39 
110 
189 
450 
2,030 
AQ10
13 
20 
35 
658 
321 
1,047 
 
170 
11 
52 
353 
995 
1,581 
2,026 
Accruing past due
— 
— 
— 
— 
— 
— 
 
— 
— 
— 
— 
— 
— 
40 
 
28,492 
12,566 
19,192 
140,374 
328,994 
529,618 
 
35,008 
11,582 
19,049 
142,264 
219,174 
427,077 
438,199 
RFS MI
         
— 
           
— 
3,255 
Group
         
529,618 
           
427,077 
441,454 
Counterparty mtm netting
     
(441,626)
           
(330,397)
(358,917)
Cash collateral held against derivative exposures (1)
 
(37,222)
           
(31,096)
(33,667)
Net exposure
     
50,770 
           
65,584 
48,870 

At 31 December 2011 the Group also held collateral in the form of securities of £5.3 billion (2010 - £2.9 billion; 2009 - £3.6 billion).

 
2011
 
2010
 
2009
Contract type
Notional 
£bn 
Assets 
£m 
Liabilities 
£m 
 
Notional 
£bn 
Assets 
£m 
Liabilities 
£m 
 
Notional 
£bn 
Assets 
£m 
Liabilities 
£m 
Interest rate
38,722 
422,156 
406,709 
 
39,760 
311,731 
299,209 
 
43,230 
323,592 
311,415 
Exchange rate
4,479 
74,492 
80,980 
 
4,854 
83,253 
89,375 
 
3,842 
69,283 
63,919 
Credit derivatives
1,054 
26,836 
26,743 
 
1,357 
26,872 
25,344 
 
1,621 
41,748 
39,127 
Equity and commodity
123 
6,134 
9,551 
 
179 
5,221 
10,039 
 
188 
6,831 
9,680 
   
529,618 
523,983 
   
427,077 
423,967 
   
441,454 
424,141 

Key points
·  
Net exposure, after taking account of position and collateral netting arrangements, declined by 23% despite an increase in derivative carrying values, primarily due to the increased use of netting arrangements.

·  
Interest rate contracts increased due to continued reductions in interest rate yields and the depreciation of sterling against the US dollar. This was partially offset by the appreciation of sterling against the euro.
 
·  
Exchange rate contracts decreased due to a reduction in trade volumes and the appreciation of sterling against the euro. This was partially offset by the depreciation of sterling against the US dollar.

·  
Credit derivatives remained flat as the increase from the widening of credit spreads and the depreciation of sterling against the US dollar was offset by a reduction in trade volume.

 
143

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: Derivatives continued
The tables below analyse the Group’s derivative assets by contract type and residual maturity and the effect of position netting and collateral.

 
0-3
months 
£m 
3-6
months 
£m 
6-12 
months 
£m 
1-5
years 
£m 
Over 5 
years 
£m 
Total 
£m 
Counterparty 
mtm netting 
£m 
Net 
exposure 
£m 
2011
Exchange rate
23,838 
8,434 
9,766 
19,176 
13,278 
74,492 
(57,511)
16,981 
Interest rate
3,977 
3,197 
7,672 
102,163 
305,147 
422,156 
(356,325)
65,831 
Credit derivatives
135 
332 
626 
15,675 
10,068 
26,836 
(23,980)
2,856 
Equity and commodity
542 
603 
1,128 
3,360 
501 
6,134 
(3,810)
2,324 
 
28,492 
12,566 
19,192 
140,374 
328,994 
529,618 
(441,626)
87,992 
                 
Cash collateral held against derivative exposures (1)
         
(37,222)
Net exposure
             
50,770 
                 

2010
               
Exchange rate
28,938 
7,820 
9,360 
23,174 
13,961 
83,253 
(69,509)
13,744 
Interest rate
4,822 
3,533 
7,927 
104,026 
191,423 
311,731 
(236,513)
75,218 
Credit derivatives
497 
99 
313 
12,374 
13,589 
26,872 
(22,728)
4,144 
Equity and commodity
751 
130 
1,449 
2,69
201 
5,221 
(1,647)
3,574 
 
35,008 
11,582 
19,049 
142,264 
219,174 
427,077 
(330,397)
96,680 
           
Cash collateral held against derivative exposures (1)
       
(31,096)
Net exposure
             
65,584 

2009
               
Exchange rate
19,127 
5,824 
7,603 
23,831 
11,967 
68,352 
(47,885)
20,467 
Interest rate
8,415 
8,380 
16,723 
111,144 
176,799 
321,461 
(270,791)
50,670 
Credit derivatives
201 
112 
390 
19,859 
21,186 
41,748 
(36,411)
5,337 
Equity and commodity
1,562 
436 
1,109 
3,057 
474 
6,638 
(3,830)
2,808 
 
29,305 
14,752 
25,825 
157,891 
210,426 
438,199 
(358,917)
79,282 
RFS MI
         
3,255 
— 
3,255 
Group
   
441,454 
(358,917)
82,537 
Cash collateral held against derivative exposures (1)
       
(33,667)
Net exposure
             
48,870 
                 

Note:
(1)
At 31 December 2011, in addition to cash collateral the Group holds collateral in the form of securities of £5.3 billion (2010 - £2.9 billion; 2009 - £3.6 billion) against derivative positions.

 
144

 
Business review Risk and balance sheet management continued

Credit derivatives
The Group trades credit derivatives as part of its client led business and to mitigate credit risk. The Group’s credit derivative exposures relating to proprietary trading are minimal. The table below analyses the Group’s bought and sold protection.

 
2011
 
2010
 
Notional
 
Fair value
 
Notional
 
Fair value
 
Bought 
Sold 
 
Bought 
Sold 
 
Bought 
Sold 
 
Bought 
Sold 
 
£bn 
£bn 
 
£bn 
£bn 
 
£bn 
£bn 
 
£bn 
£bn 
Client-led trading and residual risk
401.0 
390.5 
 
17.0 
16.5 
 
386.7 
362.5 
 
8.4 
6.7 
Credit hedging - banking book (1)
15.6 
4.7 
 
0.1 
0.1 
 
16.3 
21.8 
 
0.1 
Credit hedging - trading book
                     
  - Rates
21.2 
17.1 
 
0.9 
1.7 
 
21.9 
10.4 
 
(0.9)
0.2 
  - Credit and mortgage markets
42.9 
28.4 
 
2.3 
1.7 
 
168.1 
172.7 
 
3.5 
3.1 
  - Other
0.9 
0.1 
 
— 
— 
 
0.7 
0.1 
 
— 
Total excluding APS
481.6 
440.8 
 
20.3 
20.0 
 
593.7 
567.5 
 
11.0 
10.1 
APS
131.8 
— 
 
(0.2)
— 
 
195.8 
— 
 
0.6 
— 
 
613.4 
440.8 
 
20.1 
20.0 
 
789.5 
567.5 
 
11.6 
10.1 

Core
                     
Client-led trading
371.0 
369.4 
 
14.6 
14.0 
 
347.5 
343.0 
 
5.2 
4.4 
Credit hedging - banking book
2.2 
1.0 
 
— 
0.1 
 
1.1 
1.0 
 
(0.2)
— 
Credit hedging - trading book
                     
  - Rates
19.9 
16.2 
 
0.9 
1.7 
 
21.7 
10.3 
 
(0.8)
0.2 
  - Credit and mortgage markets
4.6 
4.0 
 
0.3 
0.2 
 
4.4 
4.3 
 
0.2 
0.3 
  - Other
0.7 
0.1 
 
— 
— 
 
0.6 
0.1 
 
— 
— 
 
398.4 
390.7 
 
15.8 
16.0 
 
375.3 
358.7 
 
4.4 
4.9 

Non-Core
                     
Residual risk
30.0 
21.1 
 
2.4 
2.5 
 
39.2 
19.5 
 
3.2 
2.3 
Credit hedging - banking book
13.4 
3.7 
 
0.1 
— 
 
15.2 
20.8 
 
0.
0.
Credit hedging - trading book
                     
  - Rates
1.3 
0.9 
 
— 
— 
 
0.
0.
 
(0.1)
— 
  - Credit and mortgage markets
38.3 
24.4 
 
2.0 
1.5 
 
163.7 
168.4 
 
3.3 
2.8 
  - Other
0.2 
— 
 
— 
— 
 
0.
— 
 
— 
— 
 
83.2 
50.1 
 
4.5 
4.0 
 
218.4 
208.8 
 
6.6 
5.2 
 
The table below analyses the Group’s credit derivative bought and sold, by counterparty

Counterparty
                     
Central and local government - APS
131.8 
— 
 
(0.2)
— 
 
195.8 
— 
 
0.6 
— 
Monoline insurers
8.6 
— 
 
0.6 
— 
 
14.9 
— 
 
1.5 
— 
CDPCs
24.5 
— 
 
0.9 
— 
 
25.0 
— 
 
0.8 
— 
Banks
204.1 
202.1 
 
8.5 
10.2 
 
370.7 
370.6 
 
5.0 
5.7 
Other financial institutions
234.8 
231.6 
 
10.5 
9.5 
 
176.6 
195.0 
 
4.4 
4.3 
Corporates
9.6 
7.1 
 
(0.2)
0.
 
6.5 
1.9 
 
(0.7)
0.1 
 
613.4 
440.8 
 
20.1 
20.0 
 
789.5 
567.5 
 
11.6 
10.1 

Note:
(1)
Credit hedging in the banking book principally relates to portfolio management in Non-Core.
 
 
145

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis continued

Monoline insurers
The table below summarises the Group's exposure to monolines, all of which are in Non-Core.

 
2011 
£m 
2010 
£m 
2009 
£m 
Gross exposure to monolines
1,888 
4,023 
6,170 
Hedges with financial institutions
(71)
(71)
(531)
Credit valuation adjustment
(1,198)
(2,443)
(3,796)
Net exposure to monolines
619 
1,509 
1,843 
       
Credit valuation adjustment as a % of gross exposure
63% 
61% 
62% 
  
     
Counterparty and credit risk RWAs*
£3.6bn 
£17.8bn 
£13.7bn 


The net income statement effect relating to monoline exposures is detailed below.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Credit valuation adjustment at 1 January
(2,443)
(3,796)
(5,988)
Credit valuation adjustment at 31 December
(1,198)
(2,443)
(3,796)
Decrease in credit valuation adjustment
1,245 
1,353 
2,192 
Net debit relating to realisations, hedges, foreign exchange and other movements
(1,878)
(844)
(3,290)
Net credit/(debit) relating to reclassified debt securities
197 
(305)
(1,468)
Net (debit)/credit to income statement (1)
(436)
204 
(2,566)

Note:
(1)
Comprises the following elements:
-  a loss of £670 million (2010 - £5 million; 2009 - £2,387 million) in income from trading activities;
-  impairment (losses)/reversals of £(1) million (2010 - £71 million; 2009 - £(239) million); and
-  other income of £235 million (2010 - £138 million; 2009 - £60 million) relating to reclassified debt securities.
 
The table below summarises monoline exposures by rating. Credit ratings are based on those from rating agencies S&P and Moody's. Where the ratings differ, the lower of the two is taken.

2011
Notional:
protected
assets
£m
Fair value:
reference
protected
assets
£m
Gross
exposure
£m
Credit
valuation
adjustment
£m
Hedges
£m
Net
exposure
£m
A to AA-
4,939
4,243
696
252
444
Non-investment grade
3,623
2,431
1,192
946
71
175
 
8,562
6,674
1,888
1,198
71
619
Of which:
           
CMBS
946
674
272
247
   
CDOs
500
57
443
351
   
CLOs
4,616
4,166
450
177
   
Other ABS
1,998
1,455
543
334
   
Other
502
322
180
89
   
 
8,562
6,674
1,888
1,198
   
 
* unaudited

 
146

 
Business review Risk and balance sheet management continued


2010
Notional:
protected
assets
£m
Fair value:
reference
protected
assets
£m
Gross
exposure
£m
Credit
valuation
adjustment
£m
Hedges
£m
Net
exposure
£m
A to AA-
6,336
5,503
833
272
561
Non-investment grade
8,555
5,365
3,190
2,171
71
948
 
14,891
10,868
4,023
2,443
71
1,509
Of which:
           
CMBS
4,149
2,424
1,725
1,253
   
CDOs
1,133
256
877
593
   
CLOs
6,724
6,121
603
210
   
Other ABS
2,393
1,779
614
294
   
Other
492
288
204
93
   
 
14,891
10,868
4,023
2,443
   

2009
           
A to AA-
7,143
5,875
1,268
378
890
Non-investment grade
12,598
7,696
4,902
3,418
531
953
 
19,741
13,571
6,170
3,796
531
1,843
Of which:
           
CMBS
4,253
2,034
2,219
1,562
   
CDOs
2,284
797
1,487
1,059
   
CLOs
10,007
8,584
1,423
641
   
Other ABS
2,688
1,861
827
412
   
Other
509
295
214
122
   
 
19,741
13,571
6,170
3,796
   

Key points
·  
The exposure to monolines declined during the year, primarily due to the restructuring of some exposures, partially offset by lower prices of underlying reference instruments.

·  
The CVA decreased in line with the reduction in exposure partially offset by the impact of wider credit spreads.

·  
The reduction in the Group’s RWA requirements was driven by the decrease in exposure to monolines.*
 
A number of debt instruments with monoline protection were reclassified from HFT to AFS in 2008. Changes in the fair value of these securities since the reclassification are recognised in the income statement to the extent that they are considered to be impaired. Changes in the fair value of the related monoline CDSs continue to be recorded in the income statement.
 
The fair value of these reclassified debt securities at 31 December 2011 was £4,453 million (1 July 2008 - £5,071 million after adjusting for both principal based cash flows and foreign exchange effects between 1 July 2008 and 31 December 2011). As a result of these reclassifications, total cumulative losses of £254 million have not been recognised in the income statement.
 
 
147

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis continued
The Group also has indirect exposures to monoline insurers through wrapped securities and other assets with credit enhancement from monoline insurers. These securities are traded with the benefit of this credit enhancement. Any deterioration in the credit rating of the monoline is reflected in the fair value of these assets.

Credit derivative product companies (CDPCs)
A summary of the Group's exposure to CDPCs, all of which are in Non-Core, is detailed below.
 
2011 
£m 
2010 
£m 
2009 
£m 
Gross exposure to CDPCs
1,896 
1,244 
1,275 
Credit valuation adjustment
(1,034)
(490)
(499)
Net exposure to CDPCs
862 
754 
776 
       
Credit valuation adjustment as a % of gross exposure
55% 
39% 
39% 
       
Counterparty and credit risk RWAs*
£8.4bn 
£7.2bn 
£7.5bn 
       
Capital deductions
£245m 
£280m 
£347m 

The table below details CDPC exposures by rating.
2011
Notional: 
protected 
assets 
£m 
Fair value: 
reference 
protected 
assets 
£m 
Gross 
exposure 
£m 
Credit 
valuation 
adjustment 
£m 
Net 
exposure 
£m 
AAA
213 
212 
— 
A to AA-
646 
632 
14 
11 
Non-investment grade
19,671 
18,151 
1,520 
788 
732 
Unrated
3,974 
3,613 
361 
243 
118 
 
24,504 
22,608 
1,896 
1,034 
862 

2010
         
AAA
213 
212 
— 
A to AA-
644 
629 
15 
11 
Non-investment grade
20,066 
19,050 
1,016 
401 
615 
Unrated
4,165 
3,953 
212 
85 
127 
 
25,088 
23,844 
1,244 
490 
754 

2009
         
AAA
1,658 
1,637 
21 
16 
BBB- to A-
1,070 
1,043 
27 
18 
Non-investment grade
17,696 
16,742 
954 
377 
577 
Unrated
3,926 
3,653 
273 
108 
165 
 
24,350 
23,075 
1,275 
499 
776 

The table below details the net income statement effect arising from CDPC exposures.
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Credit valuation adjustment at 1 January
(490)
(499)
(1,311)
Credit valuation adjustment at 31 December
(1,034)
(490)
(499)
(Increase)/decrease in credit valuation adjustment
(544)
812 
Net credit/(debit) relating to realisations, hedges, foreign exchange and other movements
459 
(150)
(1,769)
Loss from trading activities
(85)
(141)
(957)

Key points
·  
The exposure to CDPCs has increased during the year. This was primarily driven by wider credit spreads of the underlying reference loans and bonds.
 
·  
The CVA increased in line with the increase in exposure.

·  
Counterparty and credit RWAs increased in line with the increase in the exposure.*
 
* unaudited
 
 
148

 
Business review Risk and balance sheet management continued

Other counterparties
The net income statement effect arising from the change in the level of credit valuation adjustments (CVA) for all other counterparties and related trades is shown in the table below.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Credit valuation adjustment at 1 January
(1,714)
(1,588)
(1,738)
Credit valuation adjustment at 31 December
(2,254)
(1,714)
(1,588)
(Increase)/decrease in credit valuation adjustment
(540)
(126)
150 
Net credit/(debit) relating to realisations, hedges, foreign exchange and other movements
244 
(19)
(841)
Loss from trading activities
(296)
(145)
(691)

Key point
·  
The CVA held against exposures to other counterparties increased during the year, primarily due to wider credit spreads.

Risk elements in lending, provisions and reserves
Risk elements in lending (REIL) comprises impaired loans and accruing loans past due 90 days or more as to principal or interest.

Impaired loans are all loans for which an impairment provision has been established; for collectively assessed loans, impairment loss provisions are not allocated to individual loans and the entire portfolio is included in impaired loans.

Loans are classified as accruing loans past due 90 days or more where they are past due 90 days but where no impairment provision is recognised. This category is used for fully collateralised non revolving credit facilities.
 
 
2011
 
2010
 
2009
 
Core 
£m
Non-Core 
£m 
Total 
£m 
   
Core 
£m 
 
Non-Core 
£m 
Total 
£m
 
Group before 
 RFS MI 
£m
Total 
£m
Impaired loans
                   
  - UK
8,291 
7,284 
15,575 
 
8,575 
7,835 
16,410 
 
13,869 
13,872 
  - overseas
7,015 
16,157 
23,172 
 
4,936 
14,355 
19,291 
 
17,942 
21,153 
 
15,306 
23,441 
38,747 
 
13,511 
22,190 
35,701 
 
31,811 
35,025 
                     
Accruing loans past due 90 days or more
                   
  - UK
1,192 
508 
1,700 
 
1,434 
939 
2,373 
 
2,235 
2,235 
  - overseas
364 
34 
398 
 
262 
262 
524 
 
943 
989 
 
1,556 
542 
2,098 
 
1,696 
1,201 
2,897 
 
3,178 
3,224 
Total REIL
16,862 
23,983 
40,845 
 
15,207 
23,391 
38,598 
 
34,989 
38,249 
                     
REIL as a % of gross loans and advances (1)
4.4% 
30.1% 
8.6% 
 
3.7% 
20.8% 
7.3% 
 
6.1% 
5.4% 
Closing provision for impairment as a % of total REIL (1)
50% 
48% 
49% 
 
52% 
44% 
47% 
 
44% 
46% 

Note:
(1)
Includes assets of disposal groups and loans excluding reverse repos.

Potential problem loans
Potential problem loans (PPL) are loans for which an impairment event has taken place but no impairment provision is required. This category is used for fully collateralised advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.

 
2011 
£m 
2010 
£m 
2009 
£m 
Potential problem loans
739 
633 
1,009 


Both REIL and PPL are reported gross and take no account of the value of any security held which could reduce the eventual loss should it occur, nor of any provision marked. Therefore impaired assets which are highly collateralised, such as mortgages, will have a low coverage ratio of provisions held against the reported  impaired balance.
 
 
149

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

REIL by division
The tables below analyse loans and advances (excluding reverse repos and disposal groups) and related REIL, provisions, impairments, amounts written-off and coverage ratios by division.
 
 
Gross loans 
to banks 
Gross loans 
 to customer 
REIL
Provisions
REIL as a %
of gross
customer loans
Provisions
 as a %
of REIL
Impairment 
charge 
 Amounts 
 written-off 
2011
£m 
£m 
£m
£m
%
%
£m 
£m 
UK Retail
628 
103,377 
4,087
2,344
4.0
57
788 
823
UK Corporate
672 
96,647 
3,972
1,608
4.1
40
782 
653
Wealth
2,422 
16,913 
211
81
1.2
38
25 
11
Global Transaction Services
3,464 
15,767 
218
234
1.4
107
166 
79
Ulster Bank
2,079 
34,052 
5,523
2,749
16.2
50
1,384 
124
US Retail & Commercial
208 
51,436 
1,006
451
2.0
45
247 
371
Retail & Commercial
9,473 
318,192 
15,017
7,467
4.7
50
3,392 
2,061
Global Banking & Markets
30,072 
75,493 
1,845
947
2.4
51
11 
76
RBS Insurance and other
3,829 
929 
— 
Core
43,374 
394,614 
16,862
8,414
4.3
50
3,403 
2,137
Non-Core
619 
79,258 
23,983
11,469
30.3
48
3,838 
2,390
Group before RFS MI
43,993 
473,872 
40,845
19,883
8.6
49
7,241 
4,527
RFS MI
(8)
Group
43,993 
473,872 
40,845
19,883
8.6
49
7,233 
4,527
                 
                 
2010
               
UK Retail
408 
108,405 
4,620
2,741
4.3
59
1,160 
1,135 
UK Corporate
72 
111,672 
3,967
1,732
3.6
44
761 
349 
Wealth
2,220 
16,130 
223
66
1.4
30
18 
Global Transaction Services
3,047 
14,437 
146
147
1.0
101
49 
Ulster Bank
2,928 
36,858 
3,619
1,633
9.8
45
1,161 
48 
US Retail & Commercial
145 
48,516 
913
505
1.9
55
483 
547 
Retail & Commercial
8,820 
336,018 
13,488
6,824
4.0
51
3,591 
2,137 
Global Banking & Markets
46,073 
75,981 
1,719
1,042
2.3
61
146 
87 
RBS Insurance and other
2,140 
601 
— 
— 
Core
57,033 
412,600 
15,207
7,866
3.7
52
3,737 
2,224 
Non-Core
1,003 
108,203 
23,391
10,316
21.6
44
5,407 
3,818 
Group before RFS MI
58,036 
520,803 
38,598
18,182
7.4
47
9,144 
6,042 
RFS MI
— 
42 
— 
Group 
58,038 
520,803 
38,598
18,182
7.4
47
9,186 
6,042 
                 
                 
2009
               
UK Retail
818 
102,994 
4,641
2,677
4.5
58
1,679 
1,150 
UK Corporate
91 
111,580 
2,330
1,271
2.1
55
923 
352 
Wealth
1,841 
13,684 
218
55
1.6
25
33 
12 
Global Transaction Services
1,476 
12,670 
197
189
1.6
96
39 
23 
Ulster Bank
2,637 
39,707 
2,260
962
5.7
43
649 
34 
US Retail & Commercial
30 
48,907 
643
478
1.3
74
702 
546 
Retail & Commercial
6,893 
329,542 
10,289
5,632
3.1
55
4,025 
2,117 
Global Banking & Markets
38,788 
92,110 
1,800
1,289
2.0
72
542 
169 
RBS Insurance and other
1,893 
755 
— 
— 
Core
47,574 
422,407 
12,089
6,921
2.9
57
4,567 
2,286 
Non-Core
1,360 
147,263 
22,900
8,252
15.6
36
8,523 
4,192 
Group before RFS MI
48,934 
569,670 
34,989
15,173
4.4
43
13,090 
6,478 
RFS MI
7,879 
134,809 
3,260
2,110
2.4
65
1,044 
461 
Group 
56,813 
704,479 
38,249
17,283
5.4
45
14,134 
6,939 
 
 
150

 
Business review Risk and balance sheet management continued

 
Movement in REIL
The table below details the movement in REIL during the year ended 31 December 2011.

 
Impaired loans
 
Other loans (1)
 
REIL
 
Core 
Non-Core 
Total 
 
Core 
Non-Core 
Total 
 
Core 
Non-Core 
Total 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
At 1 January 2011
13,511 
22,190 
35,701 
 
1,696 
1,201 
2,897 
 
15,207 
23,391 
38,598 
Transfers to disposal groups
(1,287)
— 
(1,287)
 
(238)
— 
(238)
 
(1,525)
— 
(1,525)
Intra-group transfers
300 
(300)
— 
 
149 
(149)
— 
 
449 
(449)
— 
Currency translation and
  other adjustments
(158)
(496)
(654)
 
(14)
— 
(14)
 
(172)
(496)
(668)
Additions
8,379 
8,698 
17,077 
 
2,585 
1,059 
3,644 
 
10,964 
9,757 
20,721 
Transfers
645 
381 
1,026 
 
(362)
(352)
(714)
 
283 
29 
312 
Disposals and restructurings
(407)
(1,470)
(1,877)
 
(9)
(97)
(106)
 
(416)
(1,567)
(1,983)
Repayments
(3,540)
(3,172)
(6,712)
 
(2,251)
(1,120)
(3,371)
 
(5,791)
(4,292)
(10,083)
Amounts written-off
(2,137)
(2,390)
(4,527)
 
— 
— 
— 
 
(2,137)
(2,390)
(4,527)
At 31 December 2011
15,306 
23,441 
38,747 
 
1,556 
542 
2,098 
 
16,862 
23,983 
40,845 

Note:
(1)
Accruing loans past due 90 days or more (also see table below).
 
Key points
·  
REIL increased by £2.2 billion in the year. REIL at 31 December 2011 excludes £1.5 billion (impaired loans £1.3 billion; accruing loans £0.2 billion) in relation to the UK branch-based businesses being sold to Santander UK plc, of which £1.0 billion was in UK Corporate and £0.5 billion in UK Retail.

·  
Ulster Bank Group’s non-performing loans increased significantly by £3.5 billion (Core - £1.9 billion; Non-Core - £1.6 billion). This principally related to residential mortgages (£0.6 billion, 39% increase) and commercial real estate (£2.4 billion, 25% increase), reflecting the continued deterioration in the property sectors in Ireland. The Non-Core REIL increase related to Ulster Bank was partially offset by run off in other Non-Core donating divisions in the year.


Past due analysis
The table below shows loans and advances to customers that were past due at the balance sheet date but are not considered impaired.

         
2009
 
2011
 
2010
 
Group before 
 
 
Core 
Non-Core 
Total 
 
Core 
Non-Core 
Total 
 
RFS MI 
Total 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
Past due 1-29 days
5,518 
724 
6,242 
 
6,401 
822 
7,223 
 
6,587 
7,796 
Past due 30-59 days
1,472 
171 
1,643 
 
1,725 
392 
2,117 
 
2,300 
2,724 
Past due 60-89 days
907 
107 
1,014 
 
922 
271 
1,193 
 
2,410 
2,587 
Past due 90 days or more
1,556 
542 
2,098 
 
1,696 
1,201 
2,897 
 
3,178 
3,224 
 
9,453 
1,544 
10,997 
 
10,744 
2,686 
13,430 
 
14,475 
16,331 

 
 
151

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

Loans, REIL and impairments by sector and geographical region
The tables below analyse gross loans and advances (excluding reverse repos and disposal groups), and related REIL, provisions, impairment charges and amounts written-off, by sector and geographical region (by location of lending office).

 
Total
 
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
 gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
2011
Central and local government
9,742 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
43,993 
137 
123 
0.3 
90 
0.3 
— 
— 
  - other
49,681 
1,049 
719 
2.1 
69 
1.4 
89 
87 
Residential mortgages
143,611 
5,084 
1,362 
3.5 
27 
0.9 
1,076 
516 
Personal lending
32,623 
2,737 
2,172 
8.4 
79 
6.7 
782 
1,286 
Property
76,768 
21,655 
8,862 
28.2 
41 
11.5 
3,670 
1,171 
Construction
9,453 
1,762 
703 
18.6 
40 
7.4 
139 
244 
Manufacturing
28,132 
881 
504 
3.1 
57 
1.8 
227 
215 
Service industries and business activities
               
  - retail, wholesale and repairs
23,653 
1,007 
516 
4.3 
51 
2.2 
180 
172 
  - transport and storage
21,931 
589 
146 
2.7 
25 
0.7 
78 
43 
  - health, education and recreation
14,692 
1,077 
458 
7.3 
43 
3.1 
304 
98 
  - hotels and restaurants
8,304 
1,437 
643 
17.3 
45 
7.7 
334 
131 
  - utilities
8,392 
88 
23 
1.0 
26 
0.3 
  - other
28,000 
2,403 
1,095 
8.6 
46 
3.9 
799 
373 
Agriculture, forestry and fishing
3,600 
145 
63 
4.0 
43 
1.8 
(7)
18 
Finance leases and instalment credit
14,499 
794 
508 
5.5 
64 
3.5 
112 
170 
Interest accruals
791 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
1,986 
— 
— 
— 
(545)
— 
 
517,865 
40,845 
19,883 
7.9 
49 
3.8 
7,241 
4,527 
                 
of which:
               
UK
               
  - residential mortgages
100,726 
2,076 
397 
2.1 
19 
0.4 
180 
25 
  - personal lending
20,207 
2,384 
1,925 
11.8 
81 
9.5 
645 
1,007 
  - property
55,751 
7,880 
2,859 
14.1 
36 
5.1 
1,413 
490 
  - other
162,220 
4,935 
3,040 
3.0 
62 
1.9 
699 
886 
Europe
               
  - residential mortgages
18,946 
2,205 
713 
11.6 
32 
3.8 
467 
10 
  - personal lending
2,464 
209 
180 
8.5 
86 
7.3 
25 
126 
  - property
16,384 
13,073 
5,751 
79.8 
44 
35.1 
2,296 
508 
  - other
44,862 
5,192 
3,206 
11.6 
62 
7.1 
1,205 
289 
US
               
  - residential mortgages
23,237 
770 
240 
3.3 
31 
1.0 
426 
481 
  - personal lending
8,441 
143 
66 
1.7 
46 
0.8 
112 
153 
  - property
3,783 
329 
92 
8.7 
28 
2.4 
(2)
138 
  - other
38,158 
656 
913 
1.7 
139 
2.4 
(166)
197 
RoW
               
  - residential mortgages
702 
33 
12 
4.7 
36 
1.7 
— 
  - personal lending
1,511 
0.1 
100 
0.1 
— 
— 
  - property
850 
373 
160 
43.9 
43 
18.8 
(37)
35 
  - other
19,623 
586 
328 
3.0 
56 
1.7 
(25)
182 
Group before RFS MI
517,865 
40,845 
19,883 
7.9 
49 
3.8 
7,241 
4,527 
RFS MI
— 
— 
— 
— 
— 
— 
(8)
— 
Group
517,865 
40,845 
19,883 
7.9 
49 
3.8 
7,233 
4,527 
 
 
152

 
Business review Risk and balance sheet management continued

 
 
Total
 
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
  as a % 
of REIL 
Provisions 
as a % of 
gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
2010
Central and local government
8,452 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
58,036 
145 
127 
0.2 
88 
0.2 
(13)
12 
  - other
54,561 
1,129 
595 
2.1 
53 
1.1 
198 
141 
Residential mortgages
146,501 
4,276 
877 
2.9 
21 
0.6 
1,014 
669 
Personal lending
37,472 
3,544 
2,894 
9.5 
82 
7.7 
1,370 
1,577 
Property
90,106 
19,584 
6,736 
21.7 
34 
7.5 
4,682 
1,009 
Construction
12,032 
2,464 
875 
20.5 
36 
7.3 
530 
146 
Manufacturing
32,317 
1,199 
503 
3.7 
42 
1.6 
(92)
1,547 
Service industries and business activities
               
  - retail, wholesale and repairs
25,165 
1,157 
572 
4.6 
49 
2.3 
334 
161 
  - transport and storage
24,141 
248 
118 
1.0 
48 
0.5 
87 
39 
  - health, education and recreation
19,321 
1,055 
319 
5.5 
30 
1.7 
159 
199 
  - hotels and restaurants
9,681 
1,269 
504 
13.1 
40 
5.2 
321 
106 
  - utilities
9,208 
91 
23 
1.0 
25 
0.2 
14 
  - other
29,994 
1,438 
749 
4.8 
52 
2.5 
378 
310 
Agriculture, forestry and fishing
3,893 
152 
86 
3.9 
57 
2.2 
31 
Finance leases and instalment credit
16,850 
847 
554 
5.0 
65 
3.3 
252 
113 
Interest accruals
1,109 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
2,650 
— 
— 
— 
(121)
— 
 
578,839 
38,598 
18,182 
6.7 
47 
3.1 
9,144 
6,042 
                 
of which:
               
UK
               
  - residential mortgages
101,593 
2,062 
314 
2.0 
15 
0.3 
169 
17 
  - personal lending
23,620 
3,083 
2,518 
13.1 
82 
10.7 
1,046 
1,153 
  - property
65,462 
7,986 
2,219 
12.2 
28 
3.4 
1,546 
397 
  - other
191,934 
5,652 
3,580 
2.9 
63 
1.9
1,197 
704 
Europe
               
  - residential mortgages
20,094 
1,551 
301 
7.7 
19 
1.5 
221 
  - personal lending
2,870 
401 
316 
14.0 
79 
11.0 
66 
24 
  - property
17,775 
10,534 
4,199 
59.3 
40 
23.6 
2,828 
210 
  - other
53,380 
3,950 
2,454 
7.4 
62 
4.6 
763 
1,423 
US
               
  - residential mortgages
24,201 
640 
253 
2.6 
40 
1.0 
615 
645 
  - personal lending
9,520 
55 
55 
0.6 
100 
0.6 
160 
271 
  - property
4,929 
765 
202 
15.5 
26 
4.1 
321 
220 
  - other
36,780 
870 
1,133 
2.4 
130 
3.1 
(76)
524 
RoW
               
  - residential mortgages
613 
23 
3.8 
39 
1.5 
  - personal lending
1,462 
0.3 
100 
0.3 
98 
129 
  - property
1,940 
299 
116 
15.4 
39 
6.0 
(13)
182 
  - other
22,666 
722 
508 
3.2 
70 
2.2 
194 
136 
Group before RFS MI
578,839 
38,598 
18,182 
6.7 
47 
3.1 
9,144 
6,042 
RFS MI
— 
— 
— 
— 
— 
42 
— 
Group
578,841 
38,598 
18,182 
6.7 
47 
3.1 
9,186 
6,042 
 
 
 
153

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

 
Total
2009
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
  as a % 
of REIL 
Provisions 
as a % of 
gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
7,660 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
48,934 
206 
157 
0.4 
76 
0.3 
34 
— 
  - other
60,386 
1,539 
419 
2.5 
27 
0.7 
886 
692 
Residential mortgages
140,907 
3,284 
551 
2.3 
17 
0.4 
909 
642 
Personal lending
41,671 
3,940 
2,926 
9.5 
74 
7.0 
2,517 
2,002 
Property
99,426 
14,318 
3,422 
14.4 
24 
3.4 
3,296 
650 
Construction
14,760 
2,232 
519 
15.1 
23 
3.5 
479 
287 
Manufacturing
44,674 
3,131 
2,088 
7.0 
67 
4.7 
1,520 
784 
Service industries and business activities
134,076 
5,308 
1,860 
4.0 
35 
1.4 
1,964 
1,281 
Agriculture, forestry and fishing
4,279 
137 
73 
3.2 
53 
1.7 
30 
Finance leases and instalment credit
20,103 
894 
418 
4.4 
47 
2.1 
271 
135 
Interest accruals
1,728 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
2,740 
— 
— 
— 
1,184 
— 
 
618,604 
34,989 
15,173 
5.7 
43 
2.5 
13,090 
6,478 
                 
of which:
               
UK
394,297 
16,104 
6,922 
4.1 
43 
1.8 
5,593 
2,924 
Europe
107,803 
13,390 
5,449 
12.4 
41 
5.1 
3,270 
427 
US
84,072 
4,115 
2,020 
4.9 
49 
2.4 
3,273 
2,656 
RoW
32,432 
1,380 
782 
4.3 
57 
2.4 
954 
471 
Group before RFS MI
618,604 
34,989 
15,173 
5.7 
43 
2.5 
13,090 
6,478 
RFS MI
142,688 
3,260 
2,110 
2.3 
65 
1.5 
1,044 
461 
Group
761,292 
38,249 
17,283 
5.0 
45 
2.3 
14,134 
6,939 

 
154

 
Business review Risk and balance sheet management continued

 
Core
2011
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
8,359 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
43,374 
136 
122 
0.3 
90 
0.3 
— 
— 
  - other
46,452 
732 
572 
1.6 
78 
1.2 
207 
44 
Residential mortgages
138,509 
4,704 
1,182 
3.4 
25 
0.9 
776 
198 
Personal lending
31,067 
2,627 
2,080 
8.5 
79 
6.7 
715 
935 
Property
38,704 
3,686 
1,001 
9.5 
27 
2.6 
470 
167 
Construction
6,781 
660 
228 
9.7 
35 
3.4 
178 
143 
Manufacturing
23,201 
458 
221 
2.0 
48 
1.0 
106 
125 
Service industries and business activities
               
  - retail, wholesale and repairs
21,314 
619 
312 
2.9 
50 
1.5 
208 
119 
  - transport and storage
16,454 
325 
52 
2.0 
16 
0.3 
47 
29 
  - health, education and recreation
13,273 
576 
213 
4.3 
37 
1.6 
170 
55 
  - hotels and restaurants
7,143 
952 
354 
13.3 
37 
5.0 
209 
60 
  - utilities
6,543 
22 
0.3 
— 
— 
— 
  - other
24,228 
1,095 
591 
4.5 
54 
2.4 
553 
189 
Agriculture, forestry and fishing
3,471 
98 
36 
2.8 
37 
1.0 
(15)
Finance leases and instalment credit
8,440 
172 
110 
2.0 
64 
1.3 
31 
68 
Interest accruals
675 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
1,339 
— 
— 
— 
(252)
— 
 
437,988 
16,862 
8,414 
3.8 
50 
1.9 
3,403 
2,137 
                 
of which:
               
UK
               
  - residential mortgages
99,303 
2,024 
386 
2.0 
19 
0.4 
174 
24 
  - personal lending
20,080 
2,347 
1,895 
11.7 
81 
9.4 
657 
828 
  - property
31,141 
2,475 
568 
7.9 
23 
1.8 
379 
113 
  - other
142,464 
2,637 
1,536 
1.9 
58 
1.1 
525 
537 
Europe
               
  - residential mortgages
18,393 
2,121 
664 
11.5 
31 
3.6 
437 
10 
  - personal lending
1,972 
143 
125 
7.3 
87 
6.3 
(8)
22 
  - property
4,846 
1,038 
367 
21.4 
35 
7.6 
162 
11 
  - other
33,794 
2,551 
1,891 
7.6 
74 
5.6 
928 
182 
US
               
  - residential mortgages
20,311 
526 
120 
2.6 
23 
0.6 
162 
164 
  - personal lending
7,505 
136 
59 
1.8 
43 
0.8 
66 
85 
  - property
2,413 
111 
24 
4.6 
22 
1.0 
16 
43 
  - other
36,054 
443 
584 
1.2 
132 
1.6 
26 
101 
RoW
               
  - residential mortgages
502 
33 
12 
6.6 
36 
2.4 
— 
  - personal lending
1,510 
0.1 
100 
0.1 
— 
— 
  - property
304 
62 
42 
20.4 
68 
13.8 
(87)
— 
  - other
17,396 
214 
140 
1.2 
65 
0.8 
(37)
17 
Group before RFS MI
437,988 
16,862 
8,414 
3.8 
50 
1.9 
3,403 
2,137 
 
 
155

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

 
Core
2010
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
6,781 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
57,033 
144 
126 
0.3 
88 
0.2 
(5)
  - other
46,910 
567 
402 
1.2 
71 
0.9 
191 
53 
Residential mortgages
140,359 
3,999 
693 
2.8 
17 
0.5 
578 
243 
Personal lending
33,581 
3,131 
2,545 
9.3 
81 
7.6 
1,157 
1,271 
Property
42,455 
3,287 
818 
7.7 
25 
1.9 
739 
98 
Construction
8,680 
610 
222 
7.0 
36 
2.6 
189 
38 
Manufacturing
25,797 
555 
266 
2.2 
48 
1.0 
119 
124 
Service industries and business activities
               
  - retail, wholesale and repairs
21,974 
611 
259 
2.8 
42 
1.2 
199 
103 
  - transport and storage
15,946 
112 
40 
0.7 
36 
0.3 
40 
35 
  - health, education and recreation
17,456 
507 
134 
2.9 
26 
0.8 
145 
64 
  - hotels and restaurants
8,189 
741 
236 
9.0 
32 
2.9 
165 
49 
  - utilities
7,098 
22 
0.3 
14 
— 
— 
  - other
24,464 
583 
276 
2.4 
47 
1.1 
137 
98 
Agriculture, forestry and fishing
3,758 
94 
57 
2.5 
61 
1.5 
24 
Finance leases and instalment credit
8,321 
244 
140 
2.9 
57 
1.7 
63 
42 
Interest accruals
831 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
1,649 
— 
— 
— 
(5)
— 
 
469,633 
15,207 
7,866 
3.2 
52 
1.7 
3,737 
2,224 
                 
of which:
               
UK
               
  - residential mortgages
99,928 
2,010 
307 
2.0 
15 
0.3 
164 
16 
  - personal lending
23,035 
2,888 
2,341 
12.5 
81 
10.2 
1,033 
1,142 
  - property
34,970 
2,454 
500 
7.0 
20 
1.4 
394 
43 
  - other
161,746 
2,657 
1,743 
1.6 
66 
1.1 
689 
318 
Europe
               
  - residential mortgages
19,473 
1,506 
280 
7.7 
19 
1.4 
184 
  - personal lending
2,270 
203 
164 
8.9 
81 
7.2 
43 
19 
  - property
5,139 
631 
240 
12.3 
38 
4.7 
241 
  - other
38,992 
1,565 
1,343 
4.0 
86 
3.4 
468 
85 
US
               
  - residential mortgages
20,548 
460 
97 
2.2 
21 
0.5 
225 
221 
  - personal lending
6,816 
35 
35 
0.5 
100 
0.5 
81 
110 
  - property
1,611 
144 
43 
8.9 
30 
2.7 
84 
54 
  - other
33,110 
388 
649 
1.2 
167 
2.0 
35 
171 
RoW
               
  - residential mortgages
410 
23 
5.6 
39 
2.2 
— 
  - personal lending
1,460 
0.3 
100 
0.3 
— 
— 
  - property
735 
58 
35 
7.9 
60 
4.8 
20 
— 
  - other
19,390 
180 
75 
0.9 
42 
0.4 
71 
38 
Group before RFS MI
469,633 
15,207 
7,866 
3.2 
52 
1.7 
3,737 
2,224 

 
156

 
Business review Risk and balance sheet management continued

 
Core
2009
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
gross loans 
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
6,128 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
47,574 
168 
135 
0.4 
80 
0.3 
12 
— 
  - other
50,673 
1,038 
259 
2.0 
25 
0.5 
256 
113 
Residential mortgages
127,975 
2,670 
341 
2.1 
13 
0.3 
305 
146 
Personal lending
35,313 
3,344 
2,560 
9.5 
77 
7.2 
1,816 
1,398 
Property
49,054 
1,766 
468 
3.6 
27 
1.0 
417 
37 
Construction
9,502 
457 
131 
4.8 
29 
1.4 
58 
30 
Manufacturing
30,272 
491 
191 
1.6 
39 
0.6 
136 
93 
Service industries and business activities
100,438 
1,762 
669 
1.8 
38 
0.7 
500 
365 
Agriculture, forestry and fishing
3,726 
90 
46 
2.4 
51 
1.2 
24 
Finance leases and instalment credit
8,147 
303 
116 
3.7 
38 
1.4 
52 
100 
Interest accruals
1,179 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
2,005 
— 
— 
— 
991 
— 
 
469,981 
12,089 
6,921 
2.6 
57 
1.5 
4,567 
2,286 
                 
of which:
               
UK
315,254 
7,704 
4,209 
2.4 
55 
1.3 
2,884 
1,645 
Europe
66,707 
2,607 
1,709 
3.9 
66 
2.6 
750 
46 
US
64,526 
1,497 
876 
2.3 
59 
1.4 
813 
576 
RoW
23,494 
281 
127 
1.2 
45 
0.5 
120 
19 
Group before RFS MI
469,981 
12,089 
6,921 
2.6 
57 
1.5 
4,567 
2,286 
 
 
157

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

 
Non-Core
 
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
 gross loans 
%
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
2011
Central and local government
1,383 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
619 
0.2 
100 
0.2 
— 
— 
  - other
3,229 
317 
147 
9.8 
46 
4.6 
(118)
43 
Residential mortgages
5,102 
380 
180 
7.4 
47 
3.5 
300 
318 
Personal lending
1,556 
110 
92 
7.1 
84 
5.9 
67 
351 
Property
38,064 
17,969 
7,861 
47.2 
44 
20.7 
3,200 
1,004 
Construction
2,672 
1,102 
475 
41.2 
43 
17.8 
(39)
101 
Manufacturing
4,931 
423 
283 
8.6 
67 
5.7 
121 
90 
Service industries and business activities
               
  - retail, wholesale and repairs
2,339 
388 
204 
16.6 
53 
8.7 
(28)
53 
  - transport and storage
5,477 
264 
94 
4.8 
36 
1.7 
31 
14 
  - health, education and recreation
1,419 
501 
245 
35.3 
49 
17.3 
134 
43 
  - hotels and restaurants
1,161 
485 
289 
41.8 
60 
24.9 
125 
71 
  - utilities
1,849 
66 
22 
3.6 
33 
1.2 
  - other
3,772 
1,308 
504 
34.7 
39 
13.4 
246 
184 
Agriculture, forestry and fishing
129 
47 
27 
36.4 
57 
20.9 
13 
Finance leases and instalment credit
6,059 
622 
398 
10.3 
64 
6.6 
81 
102 
Interest accruals
116 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
647 
— 
— 
— 
(293)
— 
 
79,877 
23,983 
11,469 
30.0 
48 
14.4 
3,838 
2,390 
                 
of which:
               
UK
               
  - residential mortgages
1,423 
52 
11 
3.7 
21 
0.8 
  - personal lending
127 
37 
30 
29.1 
81 
23.6 
(12)
179 
  - property
24,610 
5,405 
2,291 
22.0 
42 
9.3 
1,034 
377 
  - other
19,756 
2,298 
1,504 
11.6 
65 
7.6 
174 
349 
Europe
               
  - residential mortgages
553 
84 
49 
15.2 
58 
8.9 
30 
— 
  - personal lending
492 
66 
55 
13.4 
83 
11.2 
33 
104 
  - property
11,538 
12,035 
5,384 
104.3 
45 
46.7 
2,134 
497 
  - other
11,068 
2,641 
1,315 
23.9 
50 
11.9 
277 
107 
US
               
  - residential mortgages
2,926 
244 
120 
8.3 
49 
4.1 
264 
317 
  - personal lending
936 
0.7 
100 
0.7 
46 
68 
  - property
1,370 
218 
68 
15.9 
31 
5.0 
(18)
95 
  - other
2,104 
213 
329 
10.1 
154 
15.6 
(192)
96 
RoW
               
  - residential mortgages
200 
— 
— 
— 
— 
— 
— 
— 
  - personal lending
— 
— 
— 
— 
— 
— 
— 
  - property
546 
311 
118 
57.0 
38 
21.6 
50 
35 
  - other
2,227 
372 
188 
16.7 
51 
8.4 
12 
165 
Group before RFS MI
79,877 
23,983 
11,469 
30.0 
48 
14.4 
3,838 
2,390 

 
158

 
Business review Risk and balance sheet management continued

 
Non-Core
2010
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
 gross loans 
%
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
1,671 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
1,003 
0.1 
100 
0.1 
(8)
11 
  - other
7,651 
562 
193 
7.3 
34 
2.5 
88 
Residential mortgages
6,142 
277 
184 
4.5 
66 
3.0 
436 
426 
Personal lending
3,891 
413 
349 
10.6 
85 
9.0 
213 
306 
Property
47,651 
16,297 
5,918 
34.2 
36 
12.4 
3,943 
911 
Construction
3,352 
1,854 
653 
55.3 
35 
19.5 
341 
108 
Manufacturing
6,520 
644 
237 
9.9 
37 
3.6 
(211)
1,423 
Service industries and business activities
               
  - retail, wholesale and repairs
3,191 
546 
313 
17.1 
57 
9.8 
135 
58 
  - transport and storage
8,195 
136 
78 
1.7 
57 
1.0 
47 
  - health, education and recreation
1,865 
548 
185 
29.4 
34 
9.9 
14 
135 
  - hotels and restaurants
1,492 
528 
268 
35.4 
51 
18.0 
156 
57 
  - utilities
2,110 
69 
20 
3.3 
29 
0.9 
13 
  - other
5,530 
855 
473 
15.5 
55 
8.6 
241 
212 
Agriculture, forestry and fishing
135 
58 
29 
43.0 
50 
21.5 
Finance leases and instalment credit
8,529 
603 
414 
7.1 
69 
4.9 
189 
71 
Interest accruals
278 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
1,001 
— 
— 
— 
(116)
— 
 
109,206 
23,391 
10,316 
21.4 
44 
9.4 
5,407 
3,818 
                 
of which:
               
UK
               
  - residential mortgages
1,665 
52 
3.1 
13 
0.4 
  - personal lending
585 
195 
177 
33.3 
91 
30.3 
13 
11 
  - property
30,492 
5,532 
1,719 
18.1 
31 
5.6 
1,152 
354 
  - other
30,188 
2,995 
1,837 
9.9 
61 
6.1 
508 
386 
Europe
               
  - residential mortgages
621 
45 
21 
7.2 
47 
3.4 
37 
— 
  - personal lending
600 
198 
152 
33.0 
77 
25.3 
23 
  - property
12,636 
9,903 
3,959 
78.4 
40 
31.3 
2,587 
209 
  - other
14,388 
2,385 
1,111 
16.6 
47 
7.7 
295 
1,338 
US
               
  - residential mortgages
3,653 
180 
156 
4.9 
87 
4.3 
390 
424 
  - personal lending
2,704 
20 
20 
0.7 
100 
0.7 
79 
161 
  - property
3,318 
621 
159 
18.7 
26 
4.8 
237 
166 
  - other
3,670 
482 
484 
13.1 
100 
13.2 
(111)
353 
RoW
               
  - residential mortgages
203 
— 
— 
— 
— 
— 
  - personal lending
— 
— 
— 
— 
— 
98 
129 
  - property
1,205 
241 
81 
20.0 
34 
6.7 
(33)
182 
  - other
3,276 
542 
433 
16.5 
80 
13.2 
123 
98 
Group before RFS MI
109,206 
23,391 
10,316 
21.4 
44 
9.4 
5,407 
3,818 
 
 
159

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

 
Non-Core
2009
Gross 
loans 
£m 
REIL 
£m 
Provisions 
£m 
REIL 
as a % of 
gross loans 
Provisions 
as a % 
of REIL 
Provisions 
as a % of 
 gross loans 
%
Impairment 
charge 
£m 
Amounts 
written-off 
£m 
Central and local government
1,532 
— 
— 
— 
— 
— 
— 
— 
Finance
               
  - banks
1,360 
38 
22 
2.8 
58 
1.6 
22 
— 
  - other
9,713 
501 
160 
5.2 
32 
1.6 
630 
579 
Residential mortgages
12,932 
614 
210 
4.7 
34 
1.6 
604 
496 
Personal lending
6,358 
596 
366 
9.4 
61 
5.8 
701 
604 
Property
50,372 
12,552 
2,954 
24.9 
24 
5.9 
2,879 
613 
Construction
5,258 
1,775 
388 
33.8 
22 
7.4 
421 
257 
Manufacturing
14,402 
2,640 
1,897 
18.3 
72 
13.2 
1,384 
691 
Service industries and business activities
33,638 
3,546 
1,191 
10.5 
34 
3.5 
1,464 
916 
Agriculture, forestry and fishing
553 
47 
27 
8.5 
57 
4.9 
Finance leases and instalment credit
11,956 
591 
302 
4.9 
51 
2.5 
219 
35 
Interest accruals
549 
— 
— 
— 
— 
— 
— 
— 
Latent
— 
— 
735 
— 
— 
— 
193 
— 
 
148,623 
22,900 
8,252 
15.4 
36 
5.6 
8,523 
4,192 
                 
of which:
               
UK
79,043 
8,400 
2,713 
10.6 
32 
3.4 
2,709 
1,279 
Europe
41,096 
10,783 
3,740 
26.2 
35 
9.1 
2,520 
381 
US
19,546 
2,618 
1,144 
13.4 
44 
5.9 
2,460 
2,080 
RoW
8,938 
1,099 
655 
12.3 
60 
7.3 
834 
452 
Group before RFS MI
148,623 
22,900 
8,252 
15.4 
36 
5.6 
8,523 
4,192 


Impairment loss provision methodology
A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.

For retail loans, which are segmented into collective, homogenous portfolios, time-based measures, such as days past due, are typically used as evidence of impairment. For these portfolios, the Group recognises an impairment at 90 days past due.

For corporate portfolios, given their complexity and nature, the Group relies not only on time-based measures but also on management judgement to identify evidence of impairment. Other factors considered may include: significant financial difficulty of the borrower; a breach of contract; a loan restructuring; a probable bankruptcy; and any observable data indicating a measurable decrease in estimated future cash flows.

Depending on various factors as explained below, the Group uses one of the following three different methods to assess the amount of provision required: individual; collective; and latent.

·  
Individually assessed provisions: provisions required for individually significant impaired assets are assessed on a case-by-case basis. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the assets carrying amount and the present value of the estimated future cash flows discounted at the financial asset’s original effective interest rate. Future cash flows are estimated through a case-by-case analysis of individually assessed assets.

 
This assessment takes into account the benefit of any guarantee or other collateral held. The value and timing of cash flow receipts are based on available estimates in conjunction with facts available at that time. Timings and amounts of cash flows are reviewed on subsequent assessment dates, as new information becomes available. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off.
 
 
160

 
Business review Risk and balance sheet management continued


·  
Collectively assessed provisions: provisions on impaired credits below an agreed threshold are assessed on a portfolio basis to reflect the homogeneous nature of the assets. The Group segments impaired credits in its collectively assessed portfolios according to asset type, such as credit cards, personal loans, mortgages and smaller homogenous wholesale portfolios, such as business or commercial banking. A further distinction is made between those impaired assets in collections and those in recoveries (refer to Problem debt management on page 97 for a discussion of the collections and recoveries functions).

 
The provision is determined based on a quantitative review of the relevant portfolio, taking account of the level of arrears, the value of any security, historical and projected cash recovery trends over the recovery period. The provision also incorporates any adjustments that may be deemed appropriate given current economic and credit conditions. Such adjustments may be determined based on: a review of the current cash collections profile performance against historical trends; updates to metric inputs - including model recalibrations; and monitoring of operational processes used in managing exposures - including the time taken to process non-performing exposures.

·  
Latent loss provisions: a separate approach is taken for provisions held against impairments in the performing portfolio that have been incurred as a result of events occurring before the balance sheet date but which have not been identified at the balance sheet date.

 
The Group’s methodologies to estimate latent loss provisions reflect:
 
- the probability that the performing customer will default;
 
- historical loss experience, adjusted, where appropriate, given current economic and credit conditions; and
 
- the emergence period, defined as the period between an impairment event occurring and a loan being identified and reported as impaired.

Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as the repayment terms and the duration of the loss mitigation and recovery processes. They are based on internal systems and processes within the particular portfolio and are reviewed regularly.

As with collectively assessed impaired portfolios, the Group segments its performing portfolio according to asset type.

Provisions and AFS reserves
The Group's consumer portfolios, which consist of high volume, small value credits, have highly efficient largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods. Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements.

Provisions are assessed on a case by case basis by experienced specialists with input from professional valuers and accountants. The Group operates a transparent provisions governance framework, setting thresholds to trigger enhanced oversight and challenge.

Analyses of provisions are set out on page 162 and 163.

Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs and are subsequently measured at fair value with changes in fair value reported in owners’ equity until disposal, at which stage the cumulative gain or loss is recognised in profit or loss. When there is objective evidence that an available-for-sale financial asset is impaired, any decline in its fair value below original cost is removed from equity and recognised in profit or loss.

The Group reviews its portfolios of available-for-sale financial assets for evidence of impairment, which includes: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and it becoming probable that the issuer will enter bankruptcy or other financial reorganisation. However, the disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not evidence of impairment. Furthermore, a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment. Determining whether objective evidence of impairment exists requires the exercise of management judgment. The unrecognised losses on the Group’s available-for-sale debt securities are concentrated in its portfolios of mortgage-backed securities. The losses reflect the widening of credit spreads as a result of the reduced market liquidity in these securities and the current uncertain macroeconomic outlook in the US and Europe. The underlying securities remain unimpaired.

Analyses of AFS debt securities and related AFS reserves are set out on page 164.
 
 
161

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

Movement in loan impairment provisions
The movement in impairment provisions by division is shown in the table below.

 
UK 
 Retail 
UK 
Corporate 
Wealth 
GTS (1)
Ulster 
Bank 
US 
R&C (2)
 
Total 
R&C (2)
GBM (3)
 
Total 
Core 
Non-Core 
RFS MI 
Group 
2011
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
 £m
 
£m 
£m 
£m 
£m 
At 1 January
2,741 
1,732 
66 
147 
1,633 
505 
 
6,824 
1,042 
 
7,866 
10,316 
— 
18,182 
Intra-group transfers
— 
177 
— 
— 
— 
— 
 
177 
— 
 
177 
(177)
— 
— 
Transfers to disposal
  groups
(335)
(436)
— 
(2)
— 
— 
 
(773)
— 
 
(773)
— 
— 
(773)
Currency translation
  and other adjustments
— 
25 
(79)
(6)
 
(55)
(21)
 
(76)
(207)
— 
(283)
Disposal of subsidiaries
— 
— 
— 
— 
— 
— 
 
— 
— 
 
— 
— 
Amounts written-off
(823)
(653)
(11)
(79)
(124)
(371)
 
(2,061)
(76)
 
(2,137)
(2,390)
— 
(4,527)
Recoveries of amounts
  previously written-off
68 
17 
— 
— 
76 
 
162 
 
167 
360 
— 
527 
Charged to income
  statement
                           
  - continuing operations
788 
782 
25 
166 
1,384 
247 
 
3,392 
11 
 
3,403 
3,838 
— 
7,241 
  - discontinued operations
— 
— 
— 
— 
— 
— 
 
— 
— 
 
— 
— 
(8)
(8)
Unwind of discount (4)
(96)
(36)
(2)
— 
(66)
— 
 
(200)
(13)
 
(213)
(271)
— 
(484)
At 31 December
2,343 
1,608 
81 
234 
2,749 
451 
 
7,466 
948 
 
8,414 
11,469 
— 
19,883 
                             
Individually assessed
                           
  - banks
— 
— 
— 
— 
 
113 
 
122 
— 
123 
  - customers
— 
679 
70 
193 
991 
73 
 
2,006 
668 
 
2,674 
9,960 
— 
12,634 
Collectively assessed
2,157 
662 
— 
17 
1,282 
161 
 
4,279 
— 
 
4,279 
861 
— 
5,140 
Latent
186 
267 
17 
476 
217 
 
1,172 
167 
 
1,339 
647 
— 
1,986 
 
2,343 
1,608 
81 
234 
2,749 
451 
 
7,466 
948 
 
8,414 
11,469 
— 
19,883 
                             
2010
                           
At 1 January
2,677 
1,271 
55 
189 
962 
478 
 
5,632 
1,289 
 
6,921 
8,252 
2,110 
17,283 
Intra-group transfers
— 
— 
— 
— 
(351)
— 
 
(351)
(217)
 
(568)
568 
— 
— 
Transfers to disposal
  groups
— 
— 
— 
— 
— 
— 
 
— 
— 
 
— 
(72)
— 
(72)
Currency translation
  and other adjustments
— 
71 
(2)
(22)
19 
 
70 
(86)
 
(16)
59 
— 
43 
Disposal of subsidiaries
— 
— 
— 
— 
 
 
(20)
(2,152)
(2,172)
Amounts written-off
(1,135)
(349)
(9)
(49)
(48)
(547)
 
(2,137)
(87)
 
(2,224)
(3,818)
— 
(6,042)
Recoveries of amounts
  previously written-off
128 
— 
72 
 
210 
 
213 
198 
— 
411 
Charged to income
  statement
                           
  - continuing operations
1,160 
761 
18 
1,161 
483 
 
3,591 
146 
 
3,737 
5,407 
— 
9,144 
  - discontinued operations
— 
— 
— 
— 
— 
— 
 
— 
— 
 
— 
— 
42 
42 
Unwind of discount (4)
(89)
(30)
(2)
— 
(70)
— 
 
(191)
(6)
 
(197)
(258)
— 
(455)
At 31 December
2,741 
1,732 
66 
147 
1,633 
505 
 
6,824 
1,042 
 
7,866 
10,316 
— 
18,182 
                             
Individually assessed
                           
  - banks
— 
— 
— 
— 
 
117 
 
126 
— 
127 
  - customers
— 
546 
57 
111 
502 
56 
 
1,272 
676 
 
1,948 
8,161 
— 
10,109 
Collectively assessed
2,526 
689 
— 
14 
733 
177 
 
4,139 
— 
 
4,139 
1,157 
— 
5,296 
Latent
215 
497 
15 
398 
272 
 
1,404 
249 
 
1,653 
997 
— 
2,650 
 
2,741 
1,732 
66 
147 
1,633 
505 
 
6,824 
1,042 
 
7,866 
10,316 
— 
18,182 

For the notes relating to this table refer to page 163.

 
162

 
Business review Risk and balance sheet management continued

 
UK 
 Retail 
UK 
Corporate 
Wealth 
GTS (1)
Ulster 
Bank 
US 
R&C (2)
 
Total 
R&C (2)
GBM (3)
 
Total 
Core 
Non-Core 
RFS MI 
Group 
2009
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
 £m
 
£m 
£m 
£m 
£m 
At 1 January
2,086 
696 
34 
43 
491 
298 
 
3,648 
621 
 
4,269 
5,182 
1,565 
11,016 
Transfers to disposal
  groups
— 
— 
— 
— 
— 
— 
 
(16)
 
(16)
(305)
(3)
(324)
Currency translation
  and other adjustments
67 
128 
(109)
(34)
 
58 
365 
 
423
(851)
(102)
(530)
Disposal of subsidiaries
— 
— 
— 
— 
— 
— 
 
— 
(62)
 
(62)
(3)
— 
(65)
Amounts written-off
(1,150)
(352)
(12)
(23)
(34)
(546)
 
(2,117)
(169)
 
(2,286)
(4,192)
(461)
(6,939)
Recoveries of
  amounts previously
  written-off
97 
20 
— 
58 
 
178 
11 
 
189 
136 
74 
399 
Charged to income
  statement
                           
  - continuing operations
1,679 
923 
33 
39 
649 
702 
 
4,025 
542 
 
4,567 
8,523 
— 
13,090 
  - discontinued operations
— 
— 
— 
— 
— 
— 
 
— 
— 
 
— 
— 
1,044 
1,044 
Unwind of discount (4)
(102)
(21)
(1)
— 
(36)
— 
 
(160)
(3)
 
(163)
(238)
(7)
(408)
At 31 December
2,677 
1,271 
55 
189 
962 
478 
 
5,632 
1,289 
 
6,921
8,252 
2,110 
17,283
                             
Individually assessed
                           
  - banks
— 
— 
— 
— 
 
10 
125 
 
135 
22 
— 
157 
  - customers
— 
205 
44 
156 
280 
14 
 
699 
573 
 
1,272 
6,229 
1,295 
8,796 
Collectively assessed
2,475 
475 
— 
17 
412 
130 
 
3,509 
— 
 
3,509 
1,266 
479 
5,254 
Latent
202 
591 
270 
334 
 
1,414 
591 
 
2,005 
735 
336 
3,076 
 
2,677 
1,271 
55 
189 
962 
478 
 
5,632 
1,289 
 
6,921 
8,252 
2,110 
17,283 

Notes:
(1)
Global Transaction Services.
(2)
Retail & Commercial.
(3)
Global Banking & Markets.
(4)
Recognised in interest income.

Analysis of loan impairment charge
The following table analyses impairment losses.
 
2011 
£m 
2010 
£m 
2009 
£m 
 
Latent loss
(545)
(121)
1,184 
Collectively assessed
2,591 
3,070 
3,994 
Individually assessed
5,195 
6,208 
7,878 
Customer loans
7,241 
9,157 
13,056 
Bank loans
— 
(13)
34 
Securities
1,468 
112 
809 
Charge to income statement
8,709 
9,256 
13,899 
       
Charge relating to customer loans as a % of gross customer loans (1)
1.5%
1.7%
2.3%

Note:
(1)
Customer loan impairment charge as a percentage of gross loans and advances to customers including assets of disposal groups and excluding reverse repos.


Key points
·  
Impairment provisions, net of £0.8 billion relating to disposal groups, increased by £1.7 billion during 2011.

·  
Ulster Bank Group’s provisions increased by £3.1 billion during the year (Core - £1.1 billion; Non-Core - £2.0 billion), with provision coverage increasing to 53% (Core - 50%; Non-Core - 54%) from 44% at the end of 2010, predominantly reflecting the deterioration in the value of the commercial real estate development portfolio.
 
 
163

 
 
Business review Risk and balance sheet management continued
 
Risk management: Credit risk continued
Balance sheet analysis: REIL, provisions and reserves continued

 
2011
 
2010
 
2009
 
Core 
Non-Core 
RFS 
MI 
Total 
 
Core 
Non-Core 
Total 
 
Core
Non-Core
Total
 
£m 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m
£m
£m
Loan impairment losses
                       
  - customers
3,403 
3,838 
— 
7,241 
 
3,742 
5,415 
9,157 
 
4,555
8,501
13,056
  - banks
— 
— 
— 
— 
 
(5)
(8)
(13)
 
12
22
34
 
3,403 
3,838 
— 
7,241 
 
3,737 
5,407 
9,144 
 
4,567
8,523
13,090
                         
Impairment losses on securities
                       
  - debt securities
1,381 
50 
1,433 
 
40 
41 
81 
 
98
503
601
  - equity securities
31 
— 
35 
 
27 
31 
 
13
195
208
 
1,385 
81 
1,468 
 
44 
68 
112 
 
111
698
809
                         
Charge to income statement
4,788 
3,919 
8,709 
 
3,781 
5,475 
9,256 
 
4,678
9,221
13,899


Key points
·  
The impairment charge, excluding securities, decreased by £1.9 billion or 21% compared with 2010, driven largely by a £1.6 billion reduction in Non-Core, despite continuing challenges in Ulster Bank and corporate real estate portfolios.

·  
The Group’s customer loan impairment charge as a percentage of loans and advances was 1.5% compared with 1.7% for 2010.

·  
The securities impairment in 2011 primarily reflects an impairment charge of £1.3 billion in respect of the Group’s holdings of Greek sovereign bonds and related interest rate hedges.

Available-for-sale debt securities and reserves
The table below analyses available-for-sale debt securities and related reserves, gross of tax.

 
2011
 
2010
 
US 
UK 
Other (1)
Total 
 
US 
UK 
Other (1)
Total 
 
£m 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
Central and local government
20,848 
13,436 
25,552 
59,836 
 
22,244 
8,377 
32,865 
63,486 
Banks
376 
1,391 
11,408 
13,175 
 
704 
4,297 
11,981 
16,982 
Other financial institutions
17,453 
3,100 
11,199 
31,752 
 
15,973 
1,662 
11,513 
29,148 
Corporate
131 
1,105 
1,299 
2,535 
 
65 
438 
1,011 
1,514 
Total
38,808 
19,032 
49,458 
107,298 
 
38,986 
14,774 
57,370 
111,130 
                   
Of which ABS
20,256 
3,659 
16,820 
40,735 
 
20,872 
4,002 
17,641 
42,515 
                   
AFS reserves (gross)
486 
845 
(1,815)
(484)
 
(304)
158 
(2,559)
(2,705)

Note:
(1)
Includes eurozone countries as detailed on pages 169 to 186.
 
 
164

 
Business review Risk and balance sheet management continued
 
Available-for-sale debt securities: gross unrealised losses
The table below shows the fair value of available-for-sale debt securities that were in an unrealised loss position at 31 December and the related gross unrealised losses.
 
 
Less than 12 months
 
More than 12 months
 
Total
 
Fair value 
Gross 
unrealised 
losses 
 
Fair value 
Gross 
unrealised 
losses 
 
Fair value 
Gross 
unrealised 
losses 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government - Other
2,878 
65 
 
778 
106 
 
3,656 
171 
Banks
3,924 
49 
 
5,676 
789 
 
9,600 
838 
Other financial institutions
472 
41 
 
6,504 
2,345 
 
6,976 
2,386 
Corporate
204 
11 
 
78 
 
282 
13 
Total
7,478 
166 
 
13,036 
3,242 
 
20,514 
3,408 
                 
Of which ABS
878 
54 
 
11,908 
3,104 
 
12,786 
3,158 
                 
2010
               
Central and local government
               
  - UK
716 
10 
 
 
716 
10 
  - US
74 
 
163 
 
237 
  - Other
4,328 
 
1,738 
612 
 
6,066 
618 
Banks
1,655 
16 
 
6,202 
770 
 
7,857 
786 
Other financial institutions
2,993 
73 
 
6,972 
2,553 
 
9,965 
2,626 
Corporate
163 
32 
 
114 
23 
 
277 
55 
Total
9,929 
138 
 
15,189 
3,959 
 
25,118 
4,097 
                 
Of which ABS
2,519 
101 
 
12,867 
3,296 
 
15,386 
3,397 
 
 
165

 
 
Business review 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 and 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.

External risk environment*
2011 was another year of heightened country risks. However, trends were divergent, with conditions deteriorating among vulnerable eurozone countries facing growth impediments and higher public debt burdens, while many emerging markets continued to enjoy relative stability, seeing net inflows of capital for the full year and lower spreads despite some risk aversion in the second half. In the US, notwithstanding a more challenging political environment and a sovereign downgrade from a rating agency, a deal was secured to increase the sovereign debt ceiling, and yields on government debt remain low.

Eurozone risks
Europe was at the centre of rising global risks, owing to a combination of slower growth among some of its major economies and a further deepening of the ongoing sovereign crisis, which in turn harmed financial sector health. Risks in Greece rose as a deeper than expected contraction in GDP impacted the fiscal adjustment programme and hit debt sustainability. Negotiations on a voluntary restructuring of public debt held by the private sector commenced in the first half and a deal was eventually reached in February 2012, with more punitive write-offs for private investors than previously envisaged. This in turn led to an agreement by eurozone leaders on a further borrowing programme for the Greek government.

In May 2011, Portugal’s new government agreed a borrowing programme with the European Union and International Monetary Fund (EU-IMF) after a sharp deterioration in sovereign liquidity. Ireland's performance under its EU-IMF programme was good and the announcement of a bank restructuring deal without defaults on senior debt obligations helped improve market confidence. This was reflected in a compression in bond spreads in the second half of the year.

Despite the announcement of significant new support proposals by eurozone leaders in July 2011, investor worries over risks to their implementation rose and market conditions worsened markedly as a result. Risk aversion towards Spanish and Italian assets picked up and despite a policy response by both countries, yields remained elevated, prompting the ECB to intervene to support their bonds in secondary markets for the first time. Contagion affected bank stocks and asset prices.
 
Eurozone leaders responded by stepping up anti-crisis efforts, focusing largely on agreeing fiscal reform, bolstering bank capital and strengthening capacity to offer financing support to sovereigns losing market access. The ECB continued to buy sovereign debt in the secondary market and increased liquidity support to banks with the introduction of an emergency three-year long-term refinancing operation in December. This helped ease interbank funding tensions somewhat and may have contributed to some relief in sovereign debt markets late in the year, as yields on new issuance by Spain and Italy dropped.

Emerging markets
Emerging markets continued to perform relatively well. In Asia, despite slowing growth, China and India continued to post strong overall expansion, while generally large external savings levels reinforced balance of payments stability. In China specifically, measures to curb house price growth began to have a more noticeable impact, with real estate prices falling in many cities. Efforts are underway to address some bank asset quality concerns linked to rapid lending growth in 2009.

In emerging Europe, Russia experienced some contagion into asset markets from weaker commodity prospects and a challenging investment climate, but the sovereign balance sheet remained quite robust. Foreign exchange debts remained a risk factor in a number of Eastern European economies. Elsewhere, Turkey’s economy cooled in the second half of 2011, helping to narrow the current account deficit sharply, though external vulnerabilities persisted.

The Middle East and North Africa witnessed political instability in a number of the relatively lower-income countries. The path of any transition has yet to become fully clear in most cases. Excluding Bahrain, pressures for change were more contained in the Gulf Co-Operation Council countries.

Latin America remained characterised by relative stability owing to balance sheet repair by a number of countries following crises in previous decades. Capital inflows contributed to currency appreciation, but overheating pressures have so far proven contained, including in Brazil where credit growth slowed from high levels.

Outlook
Overall, the outlook for 2012 remains challenging with risks likely to remain elevated but divergent. Much will depend on the success of EU efforts to contain contagion from the sovereign crisis (where downside risks are high) and whether growth headwinds in larger advanced economies persist. Emerging market balance sheet risks remain lower, despite ongoing structural and political constraints, but these economies will continue to be affected by events elsewhere through financial markets and trade channels.

* unaudited
 
 
166

 
Business review Risk and balance sheet management continued

Governance*
All country exposures are covered by the Group's country risk framework. In this framework, a limited number of advanced countries are under risk-based monitoring, with all other countries placed under limit control using the Group’s country risk watchlist process either when these have been identified as exhibiting signs of stress, or when it is considered appropriate. Detailed portfolio reviews are undertaken to align country risk profiles to the Group’s country risk appetite in light of evolving economic and political developments.

The framework for the Group’s appetite for country risk is set by the Executive Risk Forum (ERF) in the form of country risk appetite ceilings by sovereign risk grade for both total and medium-term exposure. Authority is delegated to the Group Country Risk Committee to manage exposures within the framework, with escalation where needed to ERF.

Total and medium-term exposure limits are set for individual countries based on a risk assessment taking into account the country’s economic situation and outlook as well as the Group’s franchise and business mix in that country. Additional limitations (for example, on foreign-currency exposure and product types with higher potential for loss in case of country events) may be established to address specific vulnerabilities in the context of a country's outlook and/or the Group's business strategy in a particular country.

Monitoring, management and mitigation*
A country watchlist framework is in place to proactively monitor emerging issues and facilitate the development of mitigation strategies.

Management of country risk was further strengthened in 2011 with intensified stress testing, portfolio actions on a number of countries and enhancements to risk appetite setting and management systems, contributing inter alia to a reduction in exposures to a range of countries.

During 2011, the Group conducted an analysis of its country risk profile. The outcome of this analysis was used to define more specific scenarios to be used as trigger events in stress testing - on an ongoing basis - at both Group and divisional levels. Such risk scenarios include a major balance sheet deleveraging across Europe, a default of a eurozone sovereign, or one or more stressed member states exiting the eurozone and undergoing currency redenomination, with subsequent contagion effects.

The situation remains very uncertain and the results of stress tests are sensitive to input assumptions. As a result, estimates of the potential impact on the Group of various developments are wide-ranging. If a single country exits the eurozone, the impact could be limited. If several do, the impact is likely to be significant. Depending on the circumstances, the generally negative effect on the Group of devaluations could be offset by the impact of revaluations. Nonetheless, the extent of market disruption is very difficult to predict and could be substantial.
 
From mid-2011, the Group intensified its risk-mitigating actions at divisional level aimed at preparing the Group for a wide variety of potential eurozone stress scenarios, with a particular focus on counterparty credit risk, settlement risk and funding risk. It also carried out a detailed assessment of the potential impact of such scenarios on Group systems to ensure broad readiness.

In a few specific cases, management of the Group’s exposure was temporarily handed over to a cross-divisional country crisis team. Risk mitigation actions typically included taking guarantees or insurance, updating collateral agreements, credit documentation reviews and specified credit referral processes.

Risk appetite setting was strengthened by various measures. In addition to Greece, Ireland and Portugal, the Group brought Italy and Spain under country limit control. Belgium and Japan followed in January 2012, with other advanced countries scheduled for review in this process throughout 2012. Benchmark ratios systematically guide the setting of medium-term country exposure limits.

The Group’s regular, comprehensive and detailed country exposure reviews were further enhanced by intensified counterparty monitoring. Refer to pages 105 to 107 for discussion on banks, financial institutions and other sectors.

All of this, in combination with customers’ own efforts to reduce their debt levels, contributed to reductions in exposure to a range of countries including the vulnerable eurozone countries, Japan and countries in political transition in North Africa and the Middle East. Exposure reductions were implemented selectively, often retaining some credit lines for strategic clients and in cases of sufficient risk mitigation. Due to their nature, medium-term exposures cannot be adjusted as rapidly as short-term exposure.

Further strategic enhancements to portfolio management systems included the introduction of a comprehensive country risk management and reporting application, comprising banking and trading book exposures across the Group on a consistent basis, and taking account of country risk transfers given guarantees, insurance and collateral taken. This system supports analysing and managing the exposures to countries in the eurozone and elsewhere, by tenor bucket, currency type, sector and product type, as well as by individual counterparty names and facilities. In addition, developments in trading book management systems played a role in actual exposure reductions in trading on a number of countries.

Internal rating systems were also further developed, contributing to more accurate calculations of country-specific default probabilities and expected loss given default rates which are determinants in the calculation of risk-weighted assets and economic capital.

Other developments in country risk management in 2011 included the development of the regional and country risk view in the Group’s economic capital model and in integrated stress testing.
 
* unaudited
 
167

 
 
Business review Risk and balance sheet management continued

Risk management: Country risk continued
Monitoring, management and mitigation* continued
Going forward, the Group continues to extend country limit control to other countries within and outside the eurozone and will continue to manage medium-term exposure closer to its medium-term benchmark ratios. In addition, work is continuing on the determination of actual appetite per country, on the country risk reporting systems and their integration with credit, treasury and finance systems, on the representation of country risk aspects in rating models, economic capital models and integrated stress testing, and on the combination with actual and expected returns. All of this should help RBS determine and steer its risk profile and further optimise the Group’s global portfolio management.

Credit default swap (CDS) contracts are used for a number of purposes such as hedging of the credit trading portfolio, management of counterparty credit exposure and the mitigation of wrong-way risk. The Group generally uses CDS contracts to manage exposure on a portfolio rather than specific exposures. This may give rise to maturity mismatches between the underlying exposure and the CDS contract as well as between bought and sold CDS contracts on the same reference entity.

The terms of the Group’s CDS contracts are covered by standard ISDA documentation, which determines if a contract is triggered due to a credit event. Such events may include bankruptcy or restructuring of the reference entity or a failure of the reference entity to repay its debt or interest. Under the terms of a CDS contract, one of the regional ISDA Credit Derivatives Determinations Committees is empowered to decide whether or not a credit event has occurred.

Country risk analysis
All the data tables and related definitions in this section are audited.

The following tables show the Group’s exposure by country of incorporation of the counterparty at 31 December 2011. Countries shown are those where the Group’s balance sheet exposure to counterparties incorporated in the country exceeded £1 billion and the country had an external rating of A+ or below from S&P, Moody’s or Fitch at 31 December 2011, as well as selected eurozone countries. The numbers are stated before taking into account the impact of mitigating action, such as collateral, insurance or guarantees that may have been taken to reduce or eliminate exposure to country risk events. Exposures relating to ocean-going vessels are not included due to their multinational nature.

The following definitions apply to the tables and key points on pages 169 to 186:

Lending comprises gross loans and advances to: central and local governments; central banks, including cash balances; other banks and financial institutions, incorporating overdraft and other short-term credit lines; corporations, in large part loans and leases; and individuals, comprising mortgages, personal loans and credit card balances. Lending includes impaired loans and loans where an impairment event has taken place, but no impairment provision is recognised.

Debt securities comprise securities classified as available-for-sale (AFS), loans and receivables (LAR), held-for-trading (HFT) and designated as at fair value through profit or loss (DFV). All debt securities other than LAR securities are carried at fair value with LAR debt securities are carried at amortised cost less impairment. HFT debt securities are presented as gross long positions (including DFV securities) and short positions per country. Impairment losses and exchange differences relating to AFS debt securities, together with interest, are recognised in the income statement; other changes in the fair value of AFS securities are reported within AFS reserves, which are presented gross of tax.

Derivatives comprise the mark-to-market (mtm) value of such contracts after the effect of enforceable netting agreements, but gross of collateral. Reverse repurchase agreements (repos) comprise the mtm value of counterparty exposure arising from repo transactions net of collateral.

Balance sheet exposures comprise lending exposures, debt securities and derivatives, and repo exposures.

Contingent liabilities and commitments comprise contingent liabilities, including guarantees and committed undrawn facilities.

Credit default swap (CDS) under CDS contract the credit risk on the reference entity is transferred from the buyer to the seller. The fair value, or mtm, represents the balance sheet carrying value. The mtm value of CDSs is included within derivatives against the counterparty of the trade, as opposed to the reference entity. The notional is the par amount of the credit protection bought or sold and is included against the reference entity of the CDS contract.

The column CDS notional less fair value represents the notional less fair value amounts arising from sold positions netted against those arising from bought positions, and represents the net change in exposure for a given reference entity should the CDS contract be triggered by a credit event, assuming there is a zero recovery rate. However, in most cases, the Group expects the recovery rate to be greater than zero and the exposure change to be less than this amount.

The Group primarily transacts CDS contracts with investment-grade global financial institutions who are active participants in the CDS market. These transactions are subject to regular margining. For European peripheral sovereigns, credit protection has been purchased from a number of major European banks, predominantly outside the country of the reference entity. In a few cases where protection was bought from banks in the country of the reference entity, giving rise to wrong-way risk, this risk is mitigated through specific collateralisation. Due to their bespoke nature, exposures relating to CDPCs and related hedges have not been included, as they cannot be meaningfully attributed to a particular country or a reference entity. Exposures to CDPCs are disclosed on page 148.

The Group used CDS contracts throughout 2011 to manage both eurozone country and counterparty exposures. As shown in the individual country tables, this resulted in increases in both gross notional bought and sold eurozone CDS contracts, mainly on Italy, France and the Netherlands. The magnitude of the fair value of bought and sold CDS contracts increased over 2011 in line with the widening of eurozone CDS spreads.

‘Other eurozone’ comprises Austria, Cyprus, Estonia, Finland, Malta, Slovakia and Slovenia.

* unaudited

 
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Monitoring, management and mitigation* continued

 
Lending
                           
 
Central 
and local 
 government 
Central 
 banks 
Other 
 banks 
 
Other 
financial 
institutions 
Corporate 
Personal 
Total 
lending 
 
Of which 
Non-Core 
 
Debt 
securities 
 
Derivatives 
(gross of 
collateral)
 and repos 
 
Balance 
sheet 
exposures 
 
Contingent 
liabilities and 
commitments 
 
Total 
 
CDS 
notional 
less fair 
value 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
Eurozone
                                         
Ireland
45 
1,467 
136 
336 
18,994 
18,858 
39,836 
 
10,156 
 
886 
 
2,824 
 
43,546 
 
2,928 
 
46,474 
 
53 
Spain
206 
154 
5,775 
362 
6,509 
 
3,735 
 
6,155 
 
2,393 
 
15,057 
 
2,630 
 
17,687 
 
(1,013)
Italy
73 
233 
299 
2,444 
23 
3,072 
 
1,155 
 
1,258 
 
2,314 
 
6,644 
 
3,150 
 
9,794 
 
(452)
Greece
31 
427 
14 
485 
 
94 
 
409 
 
355 
 
1,249 
 
52 
 
1,301 
 
Portugal
10 
495 
510 
 
341 
 
113 
 
519 
 
1,142 
 
268 
 
1,410 
 
55 
Germany
18,068 
653 
305 
6,608 
155 
25,789 
 
5,402 
 
15,767 
 
16,037 
 
57,593 
 
7,527 
 
65,120 
 
(2,401)
Netherlands
2,567 
7,654 
623 
1,575 
4,827 
20 
17,266 
 
2,498 
 
9,893 
 
10,285 
 
37,444 
 
10,216 
 
47,660 
 
(1,295)
France
481 
1,273 
437 
3,761 
79 
6,034 
 
2,317 
 
7,794 
 
9,058 
 
22,886 
 
10,217 
 
33,103 
 
(2,846)
Luxembourg
101 
1,779 
2,228 
4,110 
 
1,497 
 
130 
 
3,689 
 
7,929 
 
2,007 
 
9,936 
 
(404)
Belgium
213 
287 
354 
588 
20 
1,470 
 
480 
 
652 
 
3,010 
 
5,132 
 
1,359 
 
6,491 
 
(99)
Other
121 
28 
115 
1,375 
26 
1,665 
 
324 
 
710 
 
1,971 
 
4,346 
 
1,365 
 
5,711 
 
(25)
Total
3,443 
27,282 
3,550 
5,385 
47,522 
19,564 
106,746 
 
27,999 
 
43,767 
 
52,455 
 
202,968 
 
41,719 
 
244,687 
 
(8,426)
                                           
Other countries
                                       
India
275 
610 
35 
2,949 
127 
3,996 
 
350 
 
1,530 
 
218 
 
5,744 
 
1,280 
 
7,024 
 
(105)
China
74 
178 
1,237 
17 
654 
30 
2,190 
 
50 
 
597 
 
413 
 
3,20
 
1,559 
 
4,759 
 
(62)
South Korea
812 
576 
1,397 
 
 
845 
 
404 
 
2,646 
 
627 
 
3,273 
 
(22)
Turkey
215 
193 
253 
66 
1,072 
16 
1,815 
 
423 
 
361 
 
94 
 
2,27
 
437 
 
2,707 
 
10 
Russia
36 
970 
659 
62 
1,735 
 
76 
 
186 
 
66 
 
1,987 
 
356 
 
2,343 
 
(343)
Brazil
936 
227 
1,167 
 
70 
 
790 
 
24 
 
1,981 
 
319 
 
2,300 
 
(377)
Romania
66 
145 
30 
413 
392 
1,054 
 
1,054 
 
220 
 
 
1,28
 
160 
 
1,440 
 
Mexico
233 
683 
924 
 
39 
 
83 
 
131 
 
1,138 
 
353 
 
1,491 
 
10 
Poland
35 
208 
624 
885 
 
45 
 
116 
 
56 
 
1,057 
 
701 
 
1,758 
 
(99)

* unaudited
 
 
169

 
 
Business review Risk and balance sheet management continued
Monitoring, management and mitigation* continued
Risk management: Country risk continued

 
Lending
                           
 
Central 
and local 
 government 
Central 
 banks 
Other 
 banks 
 
Other 
financial 
institutions 
Corporate 
Personal 
Total 
lending 
 
Of which 
Non-Core 
 
Debt 
securities 
 
Derivatives 
(gross of 
collateral)
 and repos 
 
Balance 
sheet 
exposures 
 
Contingent 
liabilities and 
commitments 
 
Total 
 
CDS 
notional 
less fair 
value 
2010
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
Eurozone
                                         
Ireland
61 
2,119 
87 
813 
19,886 
20,228 
43,194 
 
10,758 
 
1,323 
 
2,940 
 
47,457 
 
4,316 
 
51,773 
 
(32)
Spain
19 
166 
92 
6,991 
407 
7,680 
 
4,538 
 
7,107 
 
2,047 
 
16,834 
 
3,061 
 
19,895 
 
(964)
Italy
45 
78 
668 
418 
2,483 
27 
3,719 
 
1,901 
 
3,836 
 
2,032 
 
9,587 
 
3,853 
 
13,440 
 
(838)
Greece
14 
36 
18 
31 
191 
16 
306 
 
130 
 
974 
 
227 
 
1,507 
 
164 
 
1,671 
 
182 
Portugal
86 
63 
611 
766 
 
316 
 
242 
 
394 
 
1,402 
 
734 
 
2,136 
 
41 
Germany
10,894 
1,060 
422 
7,519 
162 
20,057 
 
6,471 
 
14,747 
 
15,266 
 
50,070 
 
8,917 
 
58,987 
 
(1,551)
Netherlands
914 
6,484 
554 
1,801 
6,170 
81 
16,004 
 
3,205 
 
12,523 
 
9,058 
 
37,585 
 
18,141 
 
55,726 
 
(1,530)
France
511 
1,095 
470 
4,376 
102 
6,557 
 
2,787 
 
14,041 
 
8,607 
 
29,205 
 
11,640 
 
40,845 
 
(1,925)
Luxembourg
25 
26 
734 
2,503 
3,291 
 
1,517 
 
378 
 
2,545 
 
6,214 
 
2,383 
 
8,597 
 
(532)
Belgium
102 
14 
441 
32 
893 
327 
1,809 
 
501 
 
803 
 
2,238 
 
4,850 
 
1,492 
 
6,342 
 
57 
Other
124 
142 
119 
1,505 
24 
1,915 
 
332 
 
535 
 
1,370 
 
3,820 
 
2,037 
 
5,857 
 
(82)
Total
1,876 
19,659 
4,320 
4,932 
53,128 
21,383 
105,298 
 
32,456 
 
56,509 
 
46,724 
 
208,531 
 
56,738 
 
265,269 
 
(7,174)
                                           
Other countries
                                       
India
1,307 
307 
2,665 
273 
4,552 
 
653 
 
1,686 
 
178 
 
6,416 
 
1,281 
 
7,697 
 
(195)
China
17 
298 
1,223 
16 
753 
64 
2,371 
 
236 
 
573 
 
252 
 
3,196 
 
1,589 
 
4,785 
 
(117)
South Korea
276 
1,033 
558 
1,874 
 
53 
 
1,353 
 
493 
 
3,720 
 
1,143 
 
4,863 
 
(159)
Turkey
282 
68 
448 
37 
1,386 
12 
2,233 
 
692 
 
550 
 
111 
 
2,894 
 
686 
 
3,58
 
(91)
Russia
110 
244 
1,181 
58 
1,600 
 
125 
 
124 
 
51 
 
1,775 
 
596 
 
2,371 
 
(134)
Brazil
825 
315 
1,145 
 
120 
 
687 
 
15 
 
1,847 
 
190 
 
2,037 
 
(369)
Romania
36 
178 
21 
21 
426 
446 
1,128 
 
1,123 
 
310 
 
 
1,446 
 
319 
 
1,765 
 
23 
Mexico
149 
999 
1,157 
 
303 
 
144 
 
122 
 
1,423 
 
840 
 
2,263 
 
84 
Poland
168 
655 
843 
 
108 
 
271 
 
69 
 
1,183 
 
1,020 
 
2,203 
 
(94)

* unaudited

 
170

 
Business review Risk and balance sheet management continued
Monitoring, management and mitigation* continued
Key points*
Reported exposures are affected by currency movements. Over the year, sterling fell 0.3% against the US dollar and rose 3.1% against the euro.

·  
Exposure to most countries shown in the table declined over 2011 as the Group maintained a cautious stance and many bank clients reduced debt levels. Decreases were seen in balance sheet and off-balance sheet exposures in many countries. Increases in derivatives and repos were in line with the Group’s strategy, driven partly by customer demand for hedging solutions and partly by market movements; risks are generally mitigated by active collateralisation.

·  
India - strong economic growth in 2011 resulted in increased exposure across most product types until the fourth quarter, when a decline took place, driven by a Global Transaction Services (GTS) exercise in the region to manage down risk-weighted assets, natural run-offs/maturities and a sharp rupee depreciation. Year-on-year increases in lending to corporate clients (£0.3 billion) and the central bank (£0.3 billion) were offset by reductions in lending to banks (£0.7 billion) and other financial institutions (£0.3 billion).

·  
China - lending to Chinese banks increased in the first three quarters of the year, supporting trade finance activities and on-shore regulatory needs, but by the end of 2011 exposure had decreased close to December 2010 levels. The Group reduced lending in the interbank money markets over the final quarter. This reduction in lending was offset by significant growth in repo trading with Chinese financial institutions helping to support the Group’s funding requirements, with highly liquid US Treasuries being the main underlying security. A reduction in off-balance sheet exposures, including guarantees and undrawn commitments, was in part due to the run-off of performance bonds in respect of shipping deliveries and also due to reduced appetite for trade finance assets.
 
·  
South Korea - exposure decreased by £1.6 billion during 2011. This was partly due to a reduction in debt securities as the Group managed its wrong-way risk exposure. The Group maintained a cautious stance given the current global economic downturn.

·  
Turkey - exposures were managed down in most categories, with the non-strategic (mid-market) portfolio significantly reduced in 2011. Nonetheless, Turkey continues to be one of the Group’s key emerging markets. The strategy remains client-centric, with the product offering tailored to selected client segments across large Turkish international corporate clients and financial institutions as well as Turkish subsidiaries of global clients.

·  
Mexico - asset sales and a number of early repayments in the corporate portfolio led to exposure falling £0.8 billion in the year. This decline also reflects the Group’s cautious approach to new business following its decision to close its onshore operation in Mexico.

·  
Eurozone periphery (Ireland, Spain, Italy, Greece and Portugal) - exposure decreased across most of the periphery, with derivatives (gross of collateral) and repos being the only component that still saw some increases (partly an effect of market movements on existing positions). Most of the Group’s country risk exposure to the eurozone periphery countries arises from the activities of GBM and Ulster Bank (with respect to Ireland). The Group has some large holdings of Spanish bank and financial institution mortgage-backed security bonds and smaller quantities of Italian bonds and Greek sovereign debt. GTS provides trade finance facilities to clients across Europe including the eurozone periphery.
 
* unaudited
 
171

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Eurozone
 
         
AFS and 
 LAR debt 
 securities 
   
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and
  local government
3,443 
 
18,406 
81 
 
19,597 
15,049 
22,954 
 
1,925 
 
28,322 
 
37,080 
36,759 
 
6,488 
(6,376)
Central banks
27,282 
 
20 
 
26 
 
5,770 
 
33,078 
 
 
Other banks
3,550 
 
8,423 
(752)
 
1,272 
1,502 
8,193 
 
29,685 
 
41,428 
 
19,736 
19,232 
 
2,303 
(2,225)
Other financial
  institutions
5,385 
 
10,494 
(1,129)
 
1,138 
471 
11,161 
 
10,956 
 
27,502 
 
17,949 
16,608 
 
693 
(620)
Corporate
47,522 
14,152 
7,267 
 
964 
23 
 
528 
59 
1,433 
 
4,118 
 
53,073 
 
76,966 
70,119 
 
2,241 
(1,917)
Personal
19,564 
2,280 
1,069 
 
— 
— 
 
— 
— 
— 
 
 
19,565 
 
— 
— 
 
— 
— 
 
106,746 
16,432 
8,336 
 
38,307 
(1,777)
 
22,541 
17,081 
43,767 
 
52,455 
 
202,968 
 
151,731 
142,718 
 
11,725 
(11,138)
                                         
2010
                                       
Central and local
  government
1,876 
— 
— 
 
23,201 
(893)
 
25,041 
14,256 
33,986 
 
1,537 
 
37,399 
 
28,825 
29,075 
 
2,899 
(2,843)
Central banks
19,659 
— 
— 
 
— 
— 
 
— 
 
6,382 
 
26,048 
 
— 
— 
 
— 
— 
Other banks
4,320 
— 
— 
 
9,192 
(916)
 
1,719 
1,187 
9,724 
 
25,639 
 
39,683 
 
16,616 
16,256 
 
1,042 
(1,032)
Other financial
  institutions
4,932 
— 
— 
 
10,583 
(737)
 
908 
83 
11,408 
 
9,025 
 
25,365 
 
12,921 
12,170 
 
173 
(182)
Corporate
53,128 
12,404 
5,393 
 
813 
45 
 
831 
260 
1,384 
 
4,141 
 
58,653 
 
70,354 
63,790 
 
(267) 
461 
Personal
21,383 
1,642 
537 
 
— 
— 
 
— 
— 
— 
 
— 
 
21,383 
 
— 
— 
 
— 
— 
 
105,298 
14,046 
5,930 
 
43,789 
(2,501)
 
28,506 
15,786 
56,509 
 
46,724 
 
208,531 
 
128,716 
121,291 
 
3,847 
(3,596)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
67,624 
5,585 
 
1,085 
131 
 
198 
23 
 
— 
 
68,907 
5,739 
Other financial institutions
79,824 
5,605 
 
759 
89 
 
2,094 
278 
 
147 
14 
 
82,824 
5,986 
Total
147,448 
11,190 
 
1,844 
220 
 
2,292 
301 
 
147 
14 
 
151,731 
11,725 

 
172

 
Business review Risk and balance sheet management continued
 
Ireland
 
         
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
 
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
           
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and
  local government
45 
 
102 
(46)
 
20 
19 
103 
 
92 
 
240 
 
2,145 
2,223 
 
466 
(481)
Central banks
1,467 
 
 
 
 
1,467 
 
 
Other banks
136 
 
177 
(39)
 
195 
14 
358 
 
1,459 
 
1,953 
 
110 
107 
 
21 
(21)
Other financial
  institutions
336 
 
61 
 
116 
35 
142 
 
855 
 
1,333 
 
523 
630 
 
64 
(74)
Corporate
18,994 
10,269 
5,689 
 
148 
 
135 
283 
 
417 
 
19,694 
 
425 
322 
 
(11)
10 
Personal
18,858 
2,258 
1,048 
 
 
 
 
18,859 
 
 
 
39,836 
12,527 
6,737 
 
488 
(82)
 
466 
68 
886 
 
2,824 
 
43,546 
 
3,203 
3,282 
 
540 
(566)
                                         
2010
                                       
Central and local
  government
61 
 
104 
(45)
 
93 
88 
109 
 
20 
 
190 
 
1,872 
2,014 
 
360 
(387)
Central banks
2,119 
 
 
 
126 
 
2,252 
 
 
Other banks
87 
 
435 
(51)
 
96 
45 
486 
 
1,523 
 
2,096 
 
317 
312 
 
103 
(95)
Other financial
  institutions
813 
 
291 
(1)
 
205 
496 
 
837 
 
2,146 
 
566 
597 
 
45 
(84)
Corporate
19,886 
8,291 
4,072 
 
91 
(2)
 
140 
225 
 
434 
 
20,545 
 
483 
344 
 
(20)
17 
Personal
20,228 
1,638 
534 
 
 
 
 
20,228 
 
 
 
43,194 
9,929 
4,606 
 
921 
(99)
 
541 
139 
1,323 
 
2,940 
 
47,457 
 
3,238 
3,267 
 
488 
(549)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
1,586 
300 
 
— 
 
— 
— 
 
— 
— 
 
1,588 
300 
Other financial institutions
1,325 
232 
 
161 
 
129 
 
— 
— 
 
1,615 
240 
Total
2,911 
532 
 
163 
 
129 
 
— 
— 
 
3,203 
540 
 
 
173

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Ireland continued

Key points*
·  
The Group’s exposure to Ireland is driven by Ulster Bank Group (87% of the Group’s Irish exposure at 31 December 2011). The portfolio is predominantly personal lending of £18.9 billion (largely mortgages) and corporate lending of £19.0 billion (largely loans to the property sector). In addition, the Group has lending and derivatives exposure to the Central Bank of Ireland, financial institutions and large international clients with funding units based in Ireland.

·  
Group exposure declined in all categories, with notable reductions in lending of £3.4 billion and in off-balance sheet items of £1.4 billion over the year, as a result of currency movements and de-risking in the portfolio.

Central and local government and central bank
·  
Exposure to the central bank fluctuates, driven by regulatory requirements and by deposits of excess liquidity as part of the Group’s assets and liabilities management. Exposures fell by £0.7 billion over the year, with most of the decline occurring in the fourth quarter.

Financial institutions
·  
GBM and Ulster Bank account for the majority of the Group’s exposure to financial institutions. Exposure to the financial sector fell by £1.1 billion during the year, caused by a £0.5 billion reduction in lending, a £0.4 billion reduction in debt securities and smaller reductions in derivatives and repos and in off-balance sheet exposure. The largest category is derivatives and repos where exposure is affected predominantly by market movements and transactions are typically collateralised.
 
Corporate
·  
Corporate lending exposure fell approximately £0.9 billion over the year, driven by a combination of exchange rate movements and write-offs. At the end of 2011, lending exposure was highest in the property sector (£11.6 billion), which is also the sector that experienced the largest year-on-year reduction (£0.4 billion). REIL and impairment provisions rose by £2.0 billion and £1.6 billion respectively over the year.

Personal
·  
The Ulster Bank retail portfolio mainly consists of mortgages (approximately 95% of Ulster Bank personal lending at 31 December 2011), with the remainder comprising credit card and other personal lending. Overall personal lending exposure fell approximately £1.4 billion over the year as a result of exchange rate movements, amortisation, a small amount of write-offs and a lack of demand in the market.

Non-Core (included above)
Refer to tables on pages 169 and 170 for details.
·  
Ireland Non-Core lending exposure was £10.2 billion at 31 December 2011, down by £0.6 billion or 6% since 31 December 2010. The remaining lending portfolio largely consists of exposures to real estate (79%), retail (7%) and leisure (4%).

* unaudited
 
 
174

 
Business review Risk and balance sheet management continued
 
Spain
 
               
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold  
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and
  local government
 
33 
(15)
 
360 
751 
(358)
 
35 
 
(314)
 
5,151 
5,155 
 
538 
(522)
Central banks
 
 
 
 
 
 
Other banks
206 
 
4,892 
(867)
 
162 
214 
4,840 
 
1,622 
 
6,668 
 
1,965 
1,937 
 
154 
(152)
Other financial
  institutions
154 
 
1,580 
(639)
 
65 
1,637 
 
282 
 
2,073 
 
2,417 
2,204 
 
157 
(128)
Corporate
5,775 
1,190 
442 
 
— 
 
27 
36 
 
454 
 
6,265 
 
4,831 
3,959 
 
448 
(399)
Personal
362 
 
 
 
 
362 
 
 
 
6,509 
1,190 
442 
 
6,514  
(1,521)
 
614  
973 
6,155 
 
2,393 
 
15,057 
 
14,364 
13,255 
 
1,297 
(1,201)
                                         
2010
                                       
Central and local
  government
19 
 
88 
(7)
 
1,172 
1,248 
12 
 
53 
 
84 
 
3,820 
3,923 
 
436 
(435)
Central banks
 
 
 
 
 
 
Other banks
166 
 
5,264 
(834)
 
147 
118 
5,293 
 
1,482 
 
6,941 
 
2,087 
2,159 
 
133 
(135)
Other financial
  institutions
92 
 
1,724 
(474)
 
34 
1,751 
 
22 
 
1,865 
 
1,648 
1,388 
 
72 
(45)
Corporate
6,991 
1,871 
572 
 
38 
 
50 
51 
 
490 
 
7,532 
 
5,192 
4,224 
 
231 
(168)
Personal
407 
 
 
 
 
407 
 
 
 
7,680 
1,872 
572 
 
7,085 
(1,277)
 
1,403 
1,381 
7,107 
 
2,047 
 
16,834 
 
12,747 
11,694 
 
872 
(783)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
6,595 
499 
 
68 
 
32 
 
— 
— 
 
6,695 
508 
Other financial institutions
7,238 
736 
 
162 
 
269 
50 
 
— 
— 
 
7,669 
789 
Total
13,833 
1,235 
 
230 
 
301 
54 
 
— 
— 
 
14,364 
1,297 
 
 
175

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Spain continued

Key points*
·  
The Group maintains strong relationships with Spanish government entities, banks, other financial institutions and large corporate clients. The exposure to Spain is driven by corporate lending and a large MBS covered bond portfolio.

·  
Exposure fell in most categories in 2011, particularly in corporate lending, as a result of steps to de-risk the portfolio.

Central and local government and central bank
·  
The Group’s exposure to the government was negative at 31 December 2011, reflecting net short held-for-trading debt securities.

Financial institutions
·  
A sizeable covered bond portfolio of £6.5 billion is the Group’s largest exposure to the Spanish financial sector. The portfolio continued to perform satisfactorily in 2011. Stress analysis conducted to date on these available-for-sale debt securities indicated that this exposure is unlikely to suffer material credit losses. However, the Group continues to monitor the situation closely.

·  
A further £1.9 billion of the Group’s exposure to financial institutions consists of derivatives exposure to Spanish international banks and a few of the large regional banks, the majority of which is collateralised. This increased £0.4 billion in 2011, due partly to market movements.

·  
Lending to banks consists mainly of short-term uncommitted credit lines with the top two international Spanish banks.

Corporate
·  
Exposure to corporate clients declined during 2011, with reductions in lending of £1.2 billion and in off-balance sheet items of £0.4 billion, driven by reductions in exposure to property, transport and technology, media and telecommunications sectors. The majority of REIL relates to commercial real estate lending and decreased over the year, reflecting disposals and restructurings.

Non-Core (included above)
Refer to tables on pages 169 and 170 for details.
·  
As at 31 December 2011, Non-Core had lending exposure of £3.7 billion to Spain, a reduction of £0.8 billion or 18% since 31 December 2010. The real estate (66%), construction (11%), electricity (7%) and land transport (3%) sectors account for the majority of this lending exposure.

* unaudited
 
 
176

 
Business review Risk and balance sheet management continued
 
Italy
 
         
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
 
HFT
debt securities
Total debt 
 securities 
 
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
                 
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
 
704 
(220)
 
4,336 
4,725 
315 
 
90 
 
405 
 
12,125 
12,218 
 
1,750 
(1,708)
Central banks
73 
 
 
 
 
73 
 
 
Other banks
233 
 
119 
(14)
 
67 
88 
98 
 
1,064 
 
1,395 
 
6,078 
5,938 
 
1,215 
(1,187)
Other financial institutions
299 
 
685 
(15)
 
40 
13 
712 
 
686 
 
1,697 
 
872 
762 
 
60 
(51)
Corporate
2,444 
361 
113 
 
75 
 
58 
133 
 
474 
 
3,051 
 
4,742 
4,299 
 
350 
(281)
Personal
23 
 
 
 
 
23 
 
 
 
3,072 
361 
113 
 
1,583 
(249)
 
4,501 
4,826 
1,258 
 
2,314 
 
6,644 
 
23,817 
23,217 
 
3,375 
(3,227)
                                         
2010
                                       
Central and local government
45 
 
906 
(99)
 
5,113 
3,175 
2,844 
 
71 
 
2,960 
 
8,998 
8,519 
 
641 
(552)
Central banks
78 
 
 
 
 
78 
 
 
Other banks
668 
 
198 
(11)
 
67 
16 
249 
 
782 
 
1,699 
 
4,417 
4,458 
 
421 
(414)
Other financial institutions
418 
 
646 
(5)
 
49 
695 
 
759 
 
1,872 
 
723 
697 
 
21 
(13)
Corporate
2,483 
314 
141 
 
20 
 
36 
48 
 
420 
 
2,951 
 
4,506 
3,966 
 
150 
(88)
Personal
27 
 
 
 
 
27 
 
 
 
3,719 
314 
141 
 
1,770 
(115)
 
5,265 
3,199 
3,836 
 
2,032 
 
9,587 
 
18,644 
17,640 
 
1,233 
(1,067)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
12,904 
1,676 
 
487 
94 
 
61 
10 
 
— 
— 
 
13,452 
1,780 
Other financial institutions
10,138 
1,550 
 
 
219 
43 
 
— 
— 
 
10,365 
1,595 
Total
23,042 
3,226 
 
495 
96 
 
280 
53 
 
— 
— 
 
23,817 
3,375 


Key points*
·  
The Group maintains strong relationships with Italian government entities, banks, other financial institutions and large corporate clients. Since the start of 2011, the Group has taken steps to reduce its risks through strategic exits where appropriate, or to mitigate these risks through increased collateral requirements, in line with its evolving appetite for Italian risk. As a result, the Group reduced lending exposure to Italian counterparties by £0.6 billion over 2011 to £3.1 billion.

Central and local government and central bank
·  
The Group is an active market-maker in Italian government bonds, resulting in large gross long and short positions in held-for-trading securities. Given this role, the Group left itself in a relatively modest long position at 31 December 2011 to avoid being temporarily over exposed as a result of its expected participation in the purchase of new government bonds being issued in January 2012.

·  
Over 2011, the total government debt securities position declined by £2.5 billion to £0.3 billion, reflecting a rebalancing of the trading portfolio.

Financial institutions
·  
The majority of the Group’s exposure to Italian financial institutions relates to the top five banks. The Group’s product offering consists largely of collateralised trading products and, to a lesser extent, short-term uncommitted lending lines for liquidity purposes.

Corporate
·  
Lending exposure fell slightly during 2011, with reductions in lending to the property industry offset by increased lending to manufacturing companies, particularly in the fourth quarter.

Non-Core (included above)
Refer to tables on pages 169 and 170 for details.
·  
Non-Core lending exposure was £1.2 billion at 31 December 2011, a £0.7 billion (39%) reduction since 31 December 2010. The remaining lending exposure comprises mainly commercial real estate finance (22%), leisure (20%), unleveraged funds (16%), electricity (15%) and industrials (10%).
 
* unaudited
 
 
177

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Greece
 
 
Lending 
REIL 
Provisions 
 
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
   
Total debt 
 securities 
 
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
HFT
debt securities
Notional
 
Fair value
Long 
Short 
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
 
312 
 
102 
409 
 
 
416 
 
3,158 
3,165 
 
2,228 
(2,230)
Central banks
 
 
 
 
 
 
Other banks
 
 
 
290 
 
290 
 
22 
22 
 
(3)
Other financial institutions
31 
 
 
 
 
33 
 
34 
34 
 
(8)
Corporate
427 
256 
256 
 
 
 
63 
 
490 
 
434 
428 
 
144 
(142)
Personal
14 
 
 
 
 
14 
 
 
 
485 
256 
256 
 
312 
 
102 
409 
 
355 
 
1,249 
 
3,648 
3,649 
 
2,383 
(2,383)
                                         
2010
                                       
Central and local government
14 
 
895 
(694)
 
118 
39 
974 
 
 
995 
 
2,960 
3,061 
 
854 
(871)
Central banks
36 
 
 
 
 
36 
 
 
Other banks
18 
 
 
 
167 
 
185 
 
21 
19 
 
(3)
Other financial institutions
31 
 
 
 
 
34 
 
35 
35 
 
11 
(11)
Corporate
191 
48 
48 
 
 
 
50 
 
241 
 
511 
616 
 
44 
(49)
Personal
16 
 
 
 
 
16 
 
 
 
306 
48 
48 
 
895 
(694)
 
118 
39 
974 
 
227 
 
1,507 
 
3,527 
3,731 
 
912 
(934)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
2,001 
1,345 
 
 
— 
— 
 
— 
— 
 
2,002 
1,346 
Other financial institutions
1,507 
945 
 
63 
45 
 
76 
47 
 
— 
— 
 
1,646 
1,037 
Total
3,508 
2,290 
 
64 
46 
 
76 
47 
 
— 
— 
 
3,648 
2,383 


Key points*
·  
The Group has reduced its effective exposure to Greece and continues to actively manage its exposure to the country, in line with the de-risking strategy that has been in place since early 2010. Much of the remaining exposure is collateralised or guaranteed.

Central and local government and central bank
·  
As a result of the continued deterioration in Greece’s fiscal position, coupled with the potential for the restructuring of Greek sovereign debt, the Group recognised an impairment charge in respect of available-for-sale Greek government bonds.

Financial institutions
·  
Activity with Greek financial companies is under close scrutiny; exposure is minimal.

·  
Due to market movements, the gross derivatives exposure to banks increased by £0.1 billion during the year. The portfolio is largely collateralised.
 
Corporate
·  
At the start of 2011, the Group reclassified the domicile of exposures to a number of defaulted clients, resulting in an increase in reported exposure to Greek corporate clients as well as increases in REIL and impairment provisions.

·  
The Group’s focus is now on short-term trade facilities to the domestic subsidiaries of international clients, increasingly supported by parental guarantees.

Non-Core (included above)
Refer to tables on pages 169 and 170 for details.
·  
The Non-Core division’s lending exposure to Greece was £0.1 billion at 31 December 2011, a reduction of 28% since 31 December 2010. The remaining lending portfolio primarily consists of the following sectors: financial intermediaries (33%), construction (20%), other services (16%) and electricity (14%).
 
* unaudited
 
 
178

 
Business review Risk and balance sheet management continued

Portugal
 
         
AFS and 
 LAR debt 
 securities 
   
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
 
56 
(58)
 
36 
152 
(60)
 
19 
 
(41)
 
3,304 
3,413 
 
997 
(985)
Other banks
10 
 
91 
(36)
 
12 
101 
 
389 
 
500 
 
1,197 
1,155 
 
264 
(260)
Other financial institutions
 
 
12 
 
30 
 
42 
 
 
(1)
Corporate
495 
27 
27 
 
42 
 
18 
60 
 
81 
 
636 
 
366 
321 
 
68 
(48)
Personal
 
 
 
 
 
 
 
510 
27 
27 
 
194  
(94)
 
73 
154 
113 
 
519 
 
1,142 
 
4,875 
4,894 
 
1,330 
(1,294)
                                         
2010
                                       
Central and local government
86 
 
92 
(26)
 
68 
122 
38 
 
29 
 
153 
 
2,844 
2,923 
 
471 
(460)
Other banks
63 
 
106 
(24)
 
46 
150 
 
307 
 
520 
 
1,085 
1,107 
 
231 
(243)
Other financial institutions
 
47 
 
54 
 
 
61 
 
 
(1)
Corporate
611 
27 
21 
 
 
 
51 
 
662 
 
581 
507 
 
48 
(29)
Personal
 
 
 
 
 
 
 
766 
27 
21 
 
245 
(49)
 
121 
124 
242 
 
394 
 
1,402 
 
4,519 
4,543 
 
749 
(732)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
2,922 
786 
 
46 
12 
 
— 
— 
 
— 
— 
 
2,968 
798 
Other financial institutions
1,874 
517 
 
— 
— 
 
33 
15 
 
— 
— 
 
1,907 
532 
Total
4,796 
1,303 
 
46 
12 
 
33 
15 
 
— 
— 
 
4,875 
1,330 


Key points*
·  
In early 2011, RBS closed its local operations in Portugal, leaving the Group with modest overall exposure of £1.4 billion by year-end. The portfolio, now managed out of Spain, is focused on corporate lending and derivatives trading with the largest local banks. Medium-term activity has ceased with the exception of that carried out under a Credit Support Annex.

Central and local government and central bank
·  
During 2011, the Group’s exposure to the Portuguese government was reduced to a very small derivatives position, the result of decreases in contingent and lending exposures to public sector entities by way of facility maturities. The Group’s exposure to the government was negative at 31 December 2011, reflecting net short held-for-trading debt securities.
 
Financial institutions
·  
A major proportion of the remaining exposures is focused on the top four systemically important financial groups. Exposures generally consist of collateralised trading products.

Corporate
·  
The largest non-financial corporate exposure is to the energy and transport sectors. The Group’s exposure is concentrated on a few large, highly creditworthy clients.

Non-Core (included above)
Refer to tables on pages 169 and 170 for details.
·  
The Non-Core division’s lending exposure to Portugal was £0.3 billion at 31 December 2011, an increase of 8% in the portfolio since 31 December 2010, due to an infrastructure project drawing committed facilities. The portfolio comprises lending exposure to the land transport and logistics (52%), electricity (30%) and commercial real estate (14%) sectors. There is no exposure to central or local government.
 
* unaudited
 
 
179

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Germany
 
         
AFS and 
 LAR debt 
 securities 
   
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
 
12,035 
523 
 
4,136 
2,084 
14,087 
 
423 
 
14,510 
 
2,631 
2,640 
 
76 
(67)
Central banks
18,068 
 
 
 
5,704 
 
23,772 
 
 
Other banks
653 
 
1,376 
 
294 
761 
909 
 
6,003 
 
7,565 
 
4,765 
4,694 
 
307 
(310)
Other financial institutions
305 
 
563 
(33)
 
187 
95 
655 
 
3,321 
 
4,281 
 
3,653 
3,403 
 
(2)
Corporate
6,608 
191 
80 
 
109 
 
14 
7
116 
 
586 
 
7,310 
 
20,433 
18,311 
 
148 
(126)
Personal
155 
19 
19 
 
 
 
 
155 
 
 
 
25,789 
210 
99 
 
14,083 
504 
 
4,631 
2,947 
15,767 
 
16,037 
 
57,593 
 
31,482 
29,048 
 
538 
(505)
                                         
2010
                                       
Central and local government
 
10,648 
 
5,964 
4,124 
12,488 
 
160 
 
12,648 
 
2,056 
2,173 
 
25 
(19)
Central banks
10,894 
 
 
 
6,233 
 
17,127 
 
 
Other banks
1,060 
 
1,291 
 
567 
481 
1,377 
 
6,289 
 
8,726 
 
3,848 
3,933 
 
73 
(88)
Other financial institutions
422 
 
494 
(47)
 
195 
17 
672 
 
1,951 
 
3,045 
 
2,712 
2,633 
 
(18)
18 
Corporate
7,519 
163 
44 
 
219 
 
44 
53 
210 
 
633 
 
8,362 
 
20,731 
19,076 
 
(382)
372 
Personal
162 
 
 
 
 
162 
 
 
 
20,057 
163 
44 
 
12,652 
(39)
 
6,770 
4,675 
14,747 
 
15,266 
 
50,070 
 
29,347 
27,815 
 
(302)
283 

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
14,644 
171 
 
163 
 
— 
 
— 
— 
 
14,815 
175 
Other financial institutions
16,315 
357 
 
18 
— 
 
334 
 
— 
— 
 
16,667 
363 
Total
30,959 
528 
 
181 
 
342 
 
— 
— 
 
31,482 
538 
 
 
 
180

 
Business review Risk and balance sheet management continued
 
Netherlands
 
         
AFS and 
 LAR debt 
 securities 
     
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
2,567 
 
1,447 
74 
 
849 
591 
1,705 
 
41 
 
4,313 
 
1,206 
1,189 
 
31 
(31)
Central banks
7,654 
 
 
 
 
7,667 
 
 
Other banks
623 
 
802 
217 
 
365 
278 
889 
 
7,574 
 
9,086 
 
965 
995 
 
41 
(42)
Other financial institutions
1,575 
 
6,804 
(386)
 
290 
108 
6,986 
 
1,914 
 
10,475 
 
5,772 
5,541 
 
142 
(131)
Corporate
4,827 
621 
209 
 
199 
 
113 
307 
 
749 
 
5,883 
 
15,416 
14,238 
 
257 
(166)
Personal
20 
 
 
 
 
20 
 
 
 
17,266 
624 
211 
 
9,252 
(89)
 
1,623 
982 
9,893 
 
10,285 
 
37,444 
 
23,359 
21,963 
 
471 
(370)
                                         
2010
                                       
Central and local government
914 
 
3,469 
16 
 
1,426 
607 
4,288 
 
46 
 
5,248 
 
1,195 
999 
 
(2)
(4)
Central banks
6,484 
 
 
 
 
6,484 
 
 
Other banks
554 
 
984 
 
223 
275 
932 
 
5,021 
 
6,507 
 
784 
789 
 
12 
(10)
Other financial institutions
1,801 
 
6,612 
(185)
 
344 
12 
6,944 
 
3,116 
 
11,861 
 
4,210 
3,985 
 
48 
(46)
Corporate
6,170 
388 
149 
 
264 
 
152 
57 
359 
 
875 
 
7,404 
 
12,330 
11,113 
 
(72)
177 
Personal
81 
 
 
 
 
81 
 
 
 
16,004 
391 
152 
 
11,329 
(164)
 
2,145 
951 
12,523 
 
9,058 
 
37,585 
 
18,519 
16,886 
 
(14)
117 

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
7,605 
107 
 
88 
 
 
 
7,699 
108 
Other financial institutions
14,529 
231 
 
308 
37 
 
676 
81 
 
147 
14 
 
15,660 
363 
Total
22,134 
338 
 
396 
38 
 
682 
81 
 
147 
14 
 
23,359 
471 


 
181

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
France
 
         
AFS and 
 LAR debt 
 securities 
   
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
481 
 
2,648 
(14)
 
8,705 
5,669 
5,684 
 
357 
 
6,522 
 
3,467 
2,901 
 
228 
(195)
Central banks
 
20 
 
20 
 
12 
 
35 
 
 
Other banks
1,273 
 
889 
(17)
 
157 
75 
971 
 
7,271 
 
9,515 
 
4,232 
3,995 
 
282 
(236)
Other financial institutions
437 
 
642 
(40)
 
325 
126 
841 
 
675 
 
1,953 
 
2,590 
2,053 
 
136 
(117)
Corporate
3,761 
128 
74 
 
240 
 
72 
34 
278 
 
743 
 
4,782 
 
23,224 
21,589 
 
609 
(578)
Personal
79 
 
 
 
 
79 
 
 
 
6,034 
128 
74 
 
4,439 
(62)
 
9,259 
5,904 
7,794 
 
9,058 
 
22,886 
 
33,513 
30,538 
 
1,255 
(1,126)
                                         
2010
                                       
Central and local government
511 
 
5,912 
40 
 
10,266 
3,968 
12,210 
 
362 
 
13,083 
 
2,225 
2,287 
 
87 
(92)
Central banks
 
 
 
15 
 
18 
 
 
Other banks
1,095 
 
774 
 
410 
204 
980 
 
7,183 
 
9,258 
 
3,631 
3,071 
 
63 
(43)
Other financial institutions
470 
 
666 
(22)
 
42 
23 
685 
 
375 
 
1,530 
 
1,722 
1,609 
 
— 
(2)
Corporate
4,376 
230 
46 
 
71 
 
185 
90 
166 
 
672 
 
5,214 
 
19,771 
18,466 
 
(181)
159 
Personal
102 
 
 
 
 
102 
 
 
 
6,557 
230 
46 
 
7,423 
19 
 
10,903 
4,285 
14,041 
 
8,607 
 
29,205 
 
27,349 
25,433 
 
(31)
22 

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
13,353 
453 
 
162 
13 
 
79 
 
 
13,594 
474 
Other financial institutions
19,641 
758 
 
24 
 
254 
22 
 
 
19,919 
781 
Total
32,994 
1,211 
 
186 
14 
 
333 
30 
 
 
33,513 
1,255 

 
182

 
Business review Risk and balance sheet management continued
 
Luxembourg
 
         
AFS and 
 LAR debt 
 securities 
   
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
 
Balance 
sheet 
exposures 
 
Credit default protection (reference entity)
         
AFS 
 reserves 
 
Total debt 
 securities 
     
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Other banks
101 
 
10 
 
17 
 
546 
 
664 
 
 
Other financial institutions
1,779 
 
54 
(7)
 
82 
80 
56 
 
2,963 
 
4,798 
 
2,080 
1,976 
 
118 
(108)
Corporate
2,228 
897 
301 
 
 
58 
57 
 
180 
 
2,465 
 
2,478 
2,138 
 
146 
(116)
Personal
 
 
 
 
 
 
 
4,110 
897 
301 
 
69 
(7)
 
147 
86 
130 
 
3,689 
 
7,929 
 
4,558 
4,114 
 
264 
(224)
                                         
2010
                                       
Central and local government
 
 
24 
— 
24 
 
 
24 
 
 
Central banks
25 
 
 
 
 
25 
 
 
Other banks
26 
 
30 
(1)
 
45 
— 
75 
 
499 
 
600 
 
 
Other financial institutions
734 
 
99 
(3)
 
32 
19 
112 
 
1,800 
 
2,646 
 
1,296 
1,220 
 
(5)
1
Corporate
2,503 
807 
206 
 
 
183 
21 
167 
 
246 
 
2,916 
 
2,367 
1,918 
 
(16)
13
Personal
 
 
 
 
 
 
 
3,291 
807 
206 
 
134 
(3)
 
284 
40 
378 
 
2,545 
 
6,214 
 
3,663 
3,138 
 
(21)
14

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
1,535 
93 
 
16 
 
 
 
1,551 
93 
Other financial institutions
2,927 
164 
 
10 
 
70 
 
 
3,007 
171 
Total
4,462 
257 
 
26 
 
70 
 
 
4,558 
264 


 
183

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Belgium
 
               
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
     
Credit default protection (reference entity)
         
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
 
Total debt 
 securities 
   
Balance 
sheet 
exposures 
 
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
213 
 
742 
(116)
 
608 
722 
628 
 
89 
 
93
 
1,612 
1,505 
 
120 
(110)
Central banks
 
 
 
 
11 
 
 
Other banks
287 
 
 
 
2,450 
 
2,741 
 
312 
302 
 
14 
(13)
Other financial institutions
354 
 
 
4
(3)
 
191 
 
542 
 
 
Corporate
588 
31 
21 
 
 
20 
23 
 
277 
 
888 
 
563 
570 
 
12 
(12)
Personal
20 
— 
 
 
 
 
20 
 
 
 
1,470 
31 
21 
 
749 
(116)
 
629  
726 
652 
 
3,010 
 
5,132 
 
2,487 
2,377 
 
146 
(135)
                                         
2010
                                       
Central and local government
102 
 
763 
(54)
 
529 
602 
690 
 
92 
 
884 
 
880 
986 
 
53 
(57)
Central banks
14 
 
 
 
 
21 
 
 
Other banks
441 
 
39 
 
66 
103 
 
1,822 
 
2,366 
 
278 
266 
 
(1)
Other financial institutions
32 
 
 
 
126 
 
158 
 
 
Corporate
893 
27 
27 
 
 
11 
10 
 
191 
 
1,094 
 
628 
594 
 
(6)
6
Personal
327 
 
 
 
 
327 
 
 
 
1,809 
27 
27 
 
803 
(53)
 
606 
606 
803 
 
2,238 
 
4,850 
 
1,786 
1,846 
 
49 
(52)

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
1,602 
97 
 
 
12 
 
 
1,616 
98 
Other financial institutions
866 
48 
 
 
— 
 
 
871 
48 
Total
2,468 
145 
 
 
16 
1
 
 
2,487 
146 

 
184

 
Business review Risk and balance sheet management continued

Rest of eurozone (1)
 
               
HFT
debt securities
   
Derivatives 
 (gross of 
 collateral) and repos 
     
Credit default protection (reference entity)
         
AFS and 
 LAR debt 
 securities 
AFS 
 reserves 
 
Total debt 
 securities 
   
Balance 
sheet 
exposures 
 
Notional
 
Fair value
 
Lending 
REIL 
Provisions 
   
Long 
Short 
     
Bought 
Sold 
 
Bought 
Sold 
2011
£m 
£m 
£m 
 
£m 
£m 
  
£m 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
£m 
Central and local government
121 
 
327 
(47)
 
445 
331 
441 
 
779 
 
1,341 
 
2,281 
2,350 
 
54 
(47)
Central banks
 
 
 
44 
 
44 
 
 
Other banks
28 
 
63 
(1)
 
13 
70 
 
1,017 
 
1,051 
 
90 
87 
 
(1)
Other financial institutions
115 
 
100 
(9)
 
25 
2
123 
 
37 
 
275 
 
 
Corporate
1,375 
181 
55 
 
134 
(4)
 
13 
7
14
 
94 
 
1,609 
 
4,054 
3,944 
 
70 
(59)
Personal
26 
 
 
 
 
26 
 
 
 
1,665 
181 
55 
 
624 
(61)
 
496 
410 
71
 
1,971 
 
4,346 
 
6,425 
6,381 
 
126 
(107)
                                         
2010
                                       
Central and local government
124 
 
324 
(25)
 
268 
283 
309 
 
697 
 
1,130 
 
1,975 
2,190 
 
(26)
34 
Central banks
 
 
 
 
 
 
Other banks
142 
 
71 
(1)
 
52 
44 
79 
 
564 
 
785 
 
148 
142 
 
Other financial institutions
119 
 
 
(1)
 
29 
 
147 
 
 
Corporate
1,505 
238 
67 
 
133 
(1)
 
30 
15 
148 
 
79 
 
1,732 
 
3,254 
2,966 
 
(63)
51 
Personal
24 
 
 
 
 
24 
 
 
 
1,915 
238 
67 
 
532 
(27)
 
350 
347 
535 
 
1,37
 
3,82
 
5,377 
5,298 
 
(88)
85 

CDS bought protection: counterparty analysis by internal asset quality band

 
AQ1
 
AQ2-AQ3
 
AQ4-AQ9
 
AQ10
 
Total
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
 
Notional 
Fair value 
2011
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
 
£m 
£m 
Banks
2,877 
58 
 
5
 
 
 
2,927 
59 
Other financial institutions
3,464 
67 
 
4
 
30 
 
 
3,498 
67 
Total
6,341 
125 
 
54 
 
30 
 
 
6,425 
126 

Note:
(1)
Comprises Austria, Cyprus, Estonia, Finland, Malta, Slovakia and Slovenia.
 

 
185

 
 
Business review Risk and balance sheet management continued
 
Risk management: Country risk continued
Eurozone non-periphery

Key points*
·  
Due to credit risk and capital considerations, the Group increased exposure to central banks (particularly in Germany and the Netherlands) by depositing with them higher levels of surplus liquidity on a short-term basis, given the limited alternative investment opportunities.

·  
During 2011, in anticipation of widening credit spreads and for reasons of general risk management, the Group reduced its holdings in French and Dutch AFS sovereign bonds. The Group concurrently increased its holdings of German AFS sovereign debt in line with internal liquidity and risk management strategies.

Financial institutions
·  
France - approximately half of the lending to banks is to the top three banks.

·
Luxembourg - lending to non-bank financial institutions increased by £1.0 billion during 2011 reflecting collateral relating to derivatives and repos.

Corporate
·  
Netherlands - corporate lending fell £1.3 billion over 2011, driven by the manufacturing, natural resources and services sectors. The relatively large contingent liabilities and commitments declined £7.9 billion.

Non-Core
Refer to tables on pages 169 and 170 for details.
·  
Non-Core lending exposure has been generally reduced in line with the Group’s Strategic Plan. Lending exposure in France was £2.3 billion at 31 December 2011, having declined £0.5 billion during 2011. The lending portfolio mainly comprises property (45%) and sovereign and quasi-sovereign (20%) exposures.

·  
Non-Core lending exposure in Germany was £5.4 billion at 31 December 2011, down £1.1 billion since 31 December 2010. The lending portfolio is mostly in the property (44%) and transport (35%) sectors.

·  
Non-Core lending exposure in the Netherlands was £2.5 billion at 31 December 2011, down £0.7 billion. The portfolio mainly comprises exposures to the property (66%) and technology, media and telecommunications (19%) sectors.
 
* unaudited
 
 
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Business review Risk and balance sheet management continued


Market risk
All the disclosures in this section (pages 187 to 193) are audited, unless indicated otherwise with an asterisk (*).

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 guidance in the form of comprehensive policy statements, dealing authorities, limits based on, but not limited to, value-at-risk (VaR), stress testing, positions and sensitivity analyses.

Governance
Business structure
The primary focus of the Group’s trading activities is to provide an extensive range of debt and equity financing, risk management and investment services to its customers, including major corporations and financial institutions around the world. The Group undertakes these activities organised within the principal business lines: money markets, rates flow trading, currencies and commodities, equities, credit markets and portfolio management and origination.

Financial instruments held in the Group’s trading portfolios include, but are not limited to: debt securities, loans, deposits, equities, securities sale and repurchase agreements and derivative financial instruments.

The Group undertakes transactions in financial instruments that are traded or cleared on an exchange, including interest rate swaps, futures and options. Holders of exchange traded instruments provide margin on a daily basis with cash or other security at the exchange.

The Group also undertakes transactions in financial instruments that are traded over-the-counter (OTC) rather than on a recognised exchange. These instruments range from commoditised transactions in derivative markets, to trades where the specific terms are tailored to meet customer requirements.

Assets and liabilities in the trading book are measured at their fair value. Fair value is the amount at which the instrument could be exchanged in a current transaction. The fair values are determined following IAS 39 guidance, which requires banks to use quoted market prices or, where this is not possible, valuation techniques (models) that make appropriate use of available observable inputs. When marking to market using a model, the valuation methodologies are approved by all stakeholders (trading, finance, market risk, model development and model review) prior to use for profit and loss and risk management purposes. Any profits or losses on the revaluation of positions are recognised in the daily profit and loss.

Organisation structure
Independent oversight and support is provided to the business by the Global Head of Market & Insurance Risk, assisted by the Group and business Market Risk teams. The head of each business, assisted by a business market risk management team, is accountable for all market risks associated with its activities. The Global Market Risk Committee reviews and makes recommendations concerning the market risk profile across the Group, including risk appetite, risk policy, models, methodology and market risk development issues. The committee meets monthly and is chaired by the Global Head of Market & Insurance Risk. Attendees include respective business market risk managers and Group Market Risk.

Risk management
Key principles
The Group’s qualitative market risk appetite is set out in policy statements, which outline the governance, responsibilities and requirements surrounding the identification, measurement, analysis, management and communication of market risk arising from the trading and non-trading investment activities of the Group. All teams involved in the management and control of market risk are required to fully comply with the policy statements to ensure the Group is not exposed to market risk beyond the qualitative and quantitative risk appetite. The control framework covers the following principles:

·  
Clearly defined responsibilities and authorities for the primary groups involved in market risk management in the Group;

·  
An independent market risk management process;

·  
A market risk measurement methodology that captures correlation effects and allows aggregation of market risk across risk types, markets and business lines;

·  
Daily monitoring, analysis and reporting of market risk exposures against market risk limits;

·  
Clearly defined limit structure and escalation process in the event of a market risk limit excess;

·  
Use of VaR as a measure of the one-day market risk exposure of all trading positions;

·  
Use of non-VaR based limits and other controls;

·  
Use of stress testing and scenario analysis to support the market risk measurement and risk management process by assessing how portfolios and global business lines perform under extreme market conditions;

·  
Use of back-testing as a diagnostic tool to assess the accuracy of the VaR model and other risk management techniques;

·  
Adherence to the risks not in VaR (RNIV) framework to identify and quantify risks not captured within the VaR model; and

·  
A new product approval process that requires market risk teams to assess and quantify market risk associated with proposed new products.

 
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Business review Risk and balance sheet management continued


Risk management: Market risk continued
Quantitative risk appetite
The Executive Risk Forum (ERF) approves the quantitative market risk appetite for trading and non-trading activities. The Global Head of Market & Insurance Risk, under delegated authority from the ERF, sets and populates a limit framework, which is cascaded down through legal entity, division, business and desk level market risk limits.

At the Group level, the risk appetite is expressed in the form of a combination of VaR, sensitivity and stress testing limits.

A daily report summarises the Group’s market risk exposures against the agreed limits. This daily report is sent to the Head of Restructuring & Risk, Global Head of Market & Insurance Risk, business Chief Risk Officers and appropriate business market risk managers.

Legal entities, divisions and lower levels in the business also have an appropriate market risk framework of controls and limits in place to cover all material market risk exposures.

The specific market risk metrics that are appropriate for controlling the positions of a desk will be more granular than the Group level limits and tailored to the particular business.

In line with the overall business strategy to reduce risk exposures, the Group’s market risk limits were adjusted down during 2011.

The majority of the Group’s market risk exposure is in the GBM and Non-Core divisions and Group Treasury. The Group is also exposed to market risk through interest rate risk on its non-trading activities. There are additional non-trading market risks in the retail and commercial businesses of the Group, principally interest rate risk and foreign exchange risk. These aspects are discussed in more detail in Balance sheet management - Interest rate risk on pages 189 and 190 and structural foreign currency exposures on page 191.

Risk models
VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at a given confidence level. For internal risk management purposes, the Group’s VaR assumes a time horizon of one trading day and a confidence level of 99%. The Group's VaR model is based on a historical simulation model, utilising data from the previous two years.

The VaR model has been approved by the FSA to calculate regulatory capital for the trading book. The approval covers general market risk in interest rate, foreign exchange, equity and specified commodity products and specific risk in interest rate and equity products.

The VaR model is an important market risk measurement and control tool. It is used for determining a significant component of the market risk capital and, as such, it is regularly assessed. The main approach employed is the technique known as back-testing, which counts the number of days when a loss (as defined by the FSA) exceeds the corresponding daily VaR estimate, measured at a 99% confidence level.

The FSA categorises a VaR model as green, amber or red. A green model status is consistent with a good working model and is achieved for models that have four or fewer back-testing exceptions in a 12-month period. For the Group’s trading book, a green model status was maintained throughout 2011.

The Group’s VaR should be interpreted in light of the limitations of the methodology used, as follows:

·  
Historical simulation VaR may not provide the best estimate of future market movements. It can only provide a prediction of the future based on events that occurred in the two-year time series. Therefore, events that are more severe than those in the historical data series cannot be predicted.

·  
The use of a 99% confidence level does not reflect the extent of potential losses beyond that percentile.

·  
The use of a one-day time horizon will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day.

·  
The Group computes the VaR of trading portfolios at the close of business. Positions may change substantially during the course of the trading day and, if so, intra-day profit and losses will be incurred.

These limitations mean that the Group cannot guarantee that losses will not exceed the VaR.

The RNIV framework has been developed to quantify those market risks not adequately captured by the market standard VaR methodology. Where risks are not included in the model, various non-VaR controls (for example, portfolio size limits, sensitivity limits, triggers or stress limits) are in place.

Risk models are developed both within business units and by Group functions. Risk models are also subject to independent review and sign-off to the same standard as pricing models. Meetings are held with the FSA every quarter to discuss the traded market risk, including changes in models, management, back-testing results, risks not included in the VaR framework and other model performance statistics.

A number of VaR model and methodology enhancements were introduced during 2011. The quality of the market data time series used in the ABS mortgage trading business was improved, moving from interpolated weekly data to daily observed time series. This change has improved the accuracy of the correlation between the different time series in the daily data. Additionally, the basis modelling between cash and derivatives has been refined by introducing additional time series for the sub-prime and subordinated residential bonds, reducing the over-reliance on the commercial mortgage basis which was used as a conservative proxy.


 
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Business review Risk and balance sheet management continued


A more appropriate time series for the Dutch RMBS portfolio was adopted to better reflect the risk in the portfolio as more granular data became available. In addition, collateralised based discounting has been implemented for the vast majority of the collateralised positions in place of the previous LIBOR-based discounting approach.

Following the implementation of CRD III, three new models - for stressed VaR, incremental risk charge and all price risk (see more below) - have been fully approved by the UK regulator and form part of the capital and risk management framework from 31 December 2011 onwards.

Basel 2.5 (CRD III)*
The aim of CRD III is to improve the financial strength of institutions by increasing the financial resources required against certain risks in the trading book.

The Group is required to calculate: (i) an additional capital charge based on a stressed calibration of the VaR model - stressed VaR; (ii) an incremental risk charge to capture the default and migration risk for credit risk positions in the trading book; and (iii) an all price risk measure for correlation trading positions, subject to a capital floor that is based on standardised securitisation charges.

The capital charges associated with these new models at 31 December 2011 are shown in the table below:

 
Total 
£m 
Stressed VaR
1,682 
Incremental risk
469 
All price risk
297 

All other aspects of the CRD III rule changes have also been implemented.

Pricing models
Pricing models are developed and owned by the front office. Where pricing models are used as the basis of books and records valuations, they are subject to oversight and approval by asset level modelled product review committees (ALMPRCs). These committees prioritise models for independent validation by Group Risk Analytics (GRA) taking into consideration both the materiality of risk booked against the model and an assessment of the degree of model risk (i.e. valuation uncertainty arising from choice of modelling assumptions). The GRA review aims to quantify model risk by comparing model outputs against those of alternative independently developed models, the results of which are used by Market Risk to inform risk limits and by Finance to inform model reserves.

In 2011, updated Group Standards for the development, testing and validation of derivative pricing models were agreed and implemented. Revisions to the model validation framework ensure that all new models and model changes are reviewed by Market Risk and Finance and, subject to materiality, independently validated by GRA. Model governance is through the ALMPRCs, which are newly established sub-committees of the overall GBM Modelled Product Review Committee (previously called the Group Model Product Review Committee).

Stress testing
The Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from extreme market events. Stress testing measures the impact of exceptional changes in market rates and prices on the fair value of the Group’s trading portfolios. The Group calculates sensitivity analysis, historical stress tests and bottom-up stress testing.

Sensitivity analysis measures the sensitivity of the current portfolio of positions to defined market risk factor movements. These stresses are of a smaller magnitude compared to historical or bottom-up stress testing and are subject to the Group Market Risk limit framework.

Historical stress tests calculate the changes in the portfolio valuations that would be generated if the market movements that occurred during historical market events were repeated.

Bottom-up stress testing is based on analysing the market risk exposures by risk factors and stressing each risk factor based on consultation with risk managers, economists and front office. The tests may be based on an economic scenario that is translated into risk factor shocks by an economist or by risk managers and front office as a means of assessing the vulnerabilities of their book.

The Global Market Risk Stress Testing Committee reviews and discusses all matters relating to market risk stress testing. Stress test exposures are discussed with senior management and relevant information is reported to the Group Risk Committee, the ERF and the Board. Breaches in the Group’s market risk stress testing limits are monitored and reported.

In 2011, the market risk stress testing framework was further developed and enhanced. Reverse stress testing has been implemented, which is designed to assess the plausibility of stressing market risk factors until the loss reaches a given threshold.

In addition to VaR and stress testing, the Group calculates a wide range of sensitivity and position risk measures, for example interest rate ladders or option revaluation matrices. These measures provide valuable additional controls, often at individual desk or strategy level.


* unaudited

 
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Business review Risk and balance sheet management continued

Risk management: Market risk continued
GBM traded revenues*


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

Key points*
·  
GBM trading revenue was adversely affected by ongoing concerns around the European sovereign crisis and an overall uncertain macroeconomic environment. High volatility in the markets and increasingly risk-averse sentiment reduced levels of trading activity.

·  
The average daily revenue earned by GBM’s trading activities in 2011 was £19 million, compared with £25 million in 2010. The standard deviation of the daily revenues for 2011 was £21 million, down from £22 million in 2010. The standard deviation measures the variation of daily revenues about the mean value of those revenues.

·  
The number of days with negative revenue increased from 22 days in 2010 to 42 days in 2011, primarily due to the market and economic conditions referred to above.

·  
The most frequent result is daily revenue of between £25 million and £30 million with 30 occurrences in 2011, compared with 37 occurrences in 2010.


Daily VaR graph*




*unaudited

 
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Business review Risk and balance sheet management continued
 
Trading VaR
The Group has disclosed separately the Counterparty Exposure Management (CEM) trading book exposure and the exposure of Core excluding CEM.
The CEM desk manages the counterparty risk associated with over-the-counter derivatives on behalf of GBM. This risk is centrally controlled and actively managed to reduce excessive concentrations and unwanted counterparty exposures. The hedge positions are reported in the trading books and, thus, included in market risk VaR calculations for the Group, whereas the market value of the counterparty credit risk does not contribute to VaR for regulatory capital. The CEM VaR is disclosed separately, to allow a clear representation of the risk exposure of the trading book including and excluding these hedge activities.

The table below analyses the VaR for the Group’s trading portfolios segregated by type of market risk exposure.

 
2011
 
2010
 
2009
Trading VaR
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum 
£m 
 
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum 
£m 
 
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum
£m
Interest rate
53.4 
68.1 
79.2 
27.5 
 
51.6 
57.0 
83.0 
32.5 
 
57.0 
50.5 
112.8 
28.1
Credit spread
82.7 
74.3 
151.1 
47.4 
 
166.3 
133.4 
243.2 
110.2 
 
148.3 
174.8 
231.2 
66.9
Currency
10.3 
16.2 
19.2 
5.2 
 
17.9 
14.8 
28.0 
8.4 
 
17.9 
20.7 
35.8 
9.2
Equity
9.4 
8.0 
17.3 
4.6 
 
9.5 
10.9 
17.9 
2.7 
 
13.0 
13.1 
23.2 
2.7
Commodity
1.4 
2.3 
7.0 
— 
 
9.5 
0.5 
18.1 
0.5 
 
14.3 
8.9 
32.1 
6.5
Diversification (1)
 
(52.3)
       
(75.6)
       
(86.1)
   
 
105.5 
116.6 
181.3 
59.7 
 
168.5 
141.0 
252.1 
103.0 
 
155.2 
181.9 
229.0 
76.8
                             
Core (total)
75.8 
89.1 
133.9 
41.7 
 
103.6 
101.2 
153.4 
58.3 
 
101.5 
127.3 
137.8 
54.8
Core CEM
36.8 
52.4 
54.1 
21.9 
 
53.3 
54.6 
82.4 
30.3 
 
29.7 
38.6 
41.3 
11.5
Core excluding CEM
59.2 
42.1 
106.2 
35.3 
 
82.8 
78.7 
108.7 
53.6 
 
86.7 
97.4 
128.5 
54.9
                             
Non-Core
64.4 
34.6 
128.6 
30.0 
 
105.7 
101.4 
169.4 
63.2 
 
86.3 
84.8 
162.1 
29.3

Note:
(1)
The Group benefits from diversification, which reflects the risk reduction achieved by allocating investments across various financial instrument types, industry counterparties, currencies and regions. The extent of diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. Diversification has an inverse relationship with correlation. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR.


Key points
·  
The Group’s market risk profile in 2010 was equally split across Non-Core and Core divisions, with a concentrated exposure to credit spread risk factors. The credit spread risk exposure significantly decreased in 2011, primarily due to the reduction in ABS trading inventory in Core and the restructuring of some monoline hedges for banking book exposures in Non-Core, in line with the overall business strategy to reduce risk exposures.

·  
The credit spread VaR also decreased due to the adoption of a more appropriate daily time series for sub-prime/subordinated RMBS and as the period of high volatility relating to the 2008/2009 financial crisis dropped out of the VaR calculation.

·  
Overall the average interest rate trading VaR was relatively unchanged between 2011 and 2010.

·  
At the end of 2010, the commodity VaR was materially lower than the average for that year as a result of the completion of the sale of the Group’s interest in the RBS Sempra Commodities joint venture. The commodity VaR increased slightly from mid-September 2011, due to improvements in capturing risk for commodity futures and indices.





 
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Business review Risk and balance sheet management continued

Risk management: Market risk continued
Non-trading portfolios

The table below analyses the risk for the Group’s non-trading portfolios.

VaR is not always the most appropriate measure of risk for assets in the banking book and particularly for those in Non-Core, which will diminish over time as the asset inventory is sold down.

In order to better represent the risk of the non-traded portfolios, the table below analyses the VaR for the non-trading portfolios but excludes the Non-Core structured credit portfolio (SCP). These assets are shown separately on a drawn notional and fair value basis by maturity profile and asset class. The risk in this portfolio is managed on both a third party asset and RWA basis.

Also excluded from the non-traded VaR are the loans and receivable products that are managed within the credit risk management framework.



 
2011
 
2010
 
2009
Non-trading VaR
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum 
£m 
 
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum 
£m 
 
Average 
£m 
Period end 
£m 
Maximum 
£m 
Minimum 
£m 
Interest rate
8.8 
9.9 
11.1 
5.7 
 
8.7 
10.4 
20.5 
4.4 
 
13.0 
13.9 
26.3 
7.7 
Credit spread
18.2 
13.6 
39.3 
12.1 
 
32.0 
16.1 
101.2 
15.4 
 
81.7 
100.3 
131.5 
39.7 
Currency
2.1 
4.0 
5.9 
0.1 
 
2.1 
3.0 
7.6 
0.3 
 
1.4 
0.6 
7.0 
0.2 
Equity
2.1 
1.9 
3.1 
1.6 
 
1.2 
3.1 
4.6 
0.2 
 
3.3 
2.2 
5.8 
1.6 
Diversification (1)
 
(13.6)
       
(15.9)
       
(20.4)
   
 
19.7 
15.8 
41.6 
13.4 
 
30.9 
16.7 
98.0 
13.7 
 
80.4 
96.6 
126.9 
46.8 
                             
Core
19.3 
15.1 
38.9 
13.5 
 
30.5 
15.6 
98.1 
12.8 
 
78.4 
95.9 
126.9 
46.8 
Non-Core
3.4 
2.5 
4.3 
2.2 
 
1.3 
2.8 
4.1 
0.2 
 
3.5 
1.9 
16.9 
— 

Note:
(1)
The Group benefits from diversification, which reflects the risk reduction achieved by allocating investments across various financial instrument types, industry counterparties, currencies and regions. The extent of diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. Diversification has an inverse relationship with correlation. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR.


Key points
·  
The Group’s total non-trading VaR at 31 December 2011 was significantly lower than at 31 December 2010, due to the exceptional volatility of the 2008/2009 financial crisis dropping out of the two-year time series data used in the VaR calculation.

·  
The maximum credit spread VaR was considerably lower in 2011 than in 2010. This was due to the implementation in early 2011 of the relative price-based mapping scheme for the Dutch RMBS portfolio. The availability of more granular data provided a better reflection of the risk in the portfolio.


 
192

 
Structured credit portfolios

 
Drawn notional
 
Fair value
 
CDOs 
CLOs 
MBS (1)
Other ABS 
Total 
 
CDOs 
CLOs 
MBS (1) 
Other ABS 
Total 
2011
£m 
£m 
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
1-2 years
— 
— 
— 
27 
27 
 
— 
— 
— 
22 
22 
2-3 years
— 
— 
10 
196 
206 
 
— 
— 
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 
                       
2010
                     
1-2 years
— 
— 
— 
47 
47 
 
— 
— 
— 
42 
42 
2-3 years
85 
19 
44 
98 
246 
 
81 
18 
37 
91 
227 
3-4 years
 
41 
20 
205 
266 
 
— 
37 
19 
191 
247 
4-5 years
16 
— 
— 
— 
16 
 
15 
— 
— 
— 
15 
5-10 years
98 
466 
311 
437 
1,312 
 
87 
422 
220 
384 
1,113 
>10 years
412 
663 
584 
550 
2,209 
 
161 
515 
397 
367 
1,440 
 
611 
1,189 
959 
1,337 
4,096 
 
344 
992 
673 
1,075 
3,084 

2009
                     
1-2 years
— 
— 
— 
81 
81 
 
— 
— 
— 
68 
68 
2-3 years
40 
— 
— 
19 
59 
 
24 
— 
— 
18 
42 
3-4 years
19 
18 
42 
99 
178 
 
16 
17 
31 
76 
140 
4-5 years
17 
47 
36 
332 
432 
 
41 
29 
275 
348 
5-10 years
107 
685 
424 
521 
1,737 
 
9
594 
251 
394 
1,329 
>10 years
594 
1,114 
820 
573 
3,101 
 
193 
896 
468 
325 
1,882 
 
777 
1,864 
1,322 
1,625 
5,588 
 
326 
1,548 
779 
1,156 
3,809 

Note:
(1)
Mortgage-backed securities (MBS) include sub-prime residential mortgage-backed securities (RMBS) with a drawn notional amount of £401 million (31 December 2010 - £471 million) and a fair value of £252 million (31 December 2010 - £329 million), all with residual maturities of greater than 10 years.

The structured credit portfolio is within Non-Core. The risk on 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 RWA basis.


Key points
·  
The increase in total and collateralised debt obligation (CDO) drawn notional year-on-year is due to the inclusion of banking book exposures that were previously hedged by monoline protection. As a result of the restructuring of some monoline protection, those previously protected assets are now reported on a drawn notional and fair value basis.
 
·  
The overall reduction in collateralised loan obligation (CLO), MBS and other ABS drawn notional is due to the amortisations and pay-downs over the year in line with expected amortisation profiles. In addition to this, fair value has declined due to falling market prices.
 
 
 
193

 
Business review Risk and balance sheet management continued

 
Risk management continued
All the disclosures in this section (pages 194 to 204) are unaudited as indicated with an asterisk (*).

Insurance risk*
Insurance risk is the largest inherent risk faced by RBS Insurance. It arises through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting. It can be caused by any of the following core activities:

·  
Pricing and underwriting;

·  
Claims management;

·  
Reserving; and

·  
Reinsurance.

RBS Insurance has continued to develop its approach to risk management, including enhancing its risk function, to help ensure that insurance risks are better identified, controlled, managed, monitored, reported and mitigated. This is being achieved through the embedding of an enterprise-wide risk management framework, with associated risk appetite and policy frameworks. These are expected to have the following benefits:

·  
a consistent and disciplined approach to risk management;

·  
a universal view of risk across the business;

·  
the ability to influence decision-making and shape behaviours;

·  
a reduction in loss events;

·  
the improved use and allocation of capital; and

·  
enhanced return on risk adjusted capital.

Steps taken in 2010 and 2011 to enhance risk management have resulted in RBS Insurance showing improved results in 2011 relative to 2010, although refocusing the division’s risk appetite has reduced business volumes.

Governance and culture
RBS Insurance has developed a robust governance structure to control the way it manages insurance risk. This structure includes various forums and committees with associated delegated authorities for the management of insurance risk.

Control and management
The internal economic capital model is rigorously controlled, with robust validation processes applied to the inputs, the model and all outputs to ensure that such data may be used confidently by the business in its decision-making processes.

Stress testing and scenario analysis
Stress testing and scenario analysis take place on a regular basis to support both the division’s individual capital assessment and the agreed risk appetite. It is also employed prior to the deployment of new products/lines of business.

Monitoring and reporting
A clear framework is in place for the monitoring and reporting of insurance risk within RBS Insurance, with well-defined processes and procedures for the escalation and management of risks and issues.

Key insurance risks are monitored monthly at the Insurance Risk Forum and loss ratio committees, with comprehensive management information being presented regularly (i.e. monthly or quarterly) at the Executive Committee, the Board and the divisional risk and audit committees.

In addition, comprehensive reporting of pricing strength occurs on a monthly basis. Significant enhancements have also been made in the reporting and monitoring of claims management and reserving. Further enhancements are underway, including the launch of a risk management system in late 2011.

Mitigation
The business has well-defined procedures in place to address any issues, such as breaches of risk appetite, that are identified through monitoring and reporting activities. In such cases, an action plan to address the issue is developed, implemented and monitored through the appropriate bodies, with a view to ensuring the risk is adequately mitigated or a considered decision at the correct levels is taken to accept it.

Operational risk*
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. It is an integral and unavoidable part of the Group’s business as it is inherent in the processes it operates to provide services to customers and meet strategic objectives.

Operational risk management
The objective of operational risk management is not to remove operational risk altogether, but to manage it to an acceptable level, taking into account the cost of minimising the risk against the resultant reduction in exposure. Strategies to manage operational risk include avoidance, transfer, acceptance and mitigation by controls.

The Group made significant improvements in its operational risk framework during 2011, enhancing its management of operational risks. This is particularly evident in respect of risk appetite, the Group Policy Framework, risk assessment, scenario analysis and statistical modelling for capital requirements. Further development will continue in 2012.

Details of these, and other elements of operational risk management, including developments undertaken and planned, are set out below along with the key processes through which the Group manages operational risk.

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Governance, structure and risk appetite
Governance and structure
Group Operational Risk is an independent function reporting to the Deputy Group Chief Risk Officer. Group Operational Risk is responsible for the design and maintenance of the operational risk policy standards (ORPS).

The ORPS are incorporated in the Group Policy Framework (GPF), they provide the direction for delivering effective operational risk management and are designed to allow the consistent identification, assessment, management, monitoring and reporting of operational risk across the Group.

The Operational Risk Executive Committee which was formed in January 2011, oversees the operational risk framework and profile of the Group in line with the agreed risk appetite. It provides guidance, oversight and advice. It also escalates and reports any issues or areas of concern to the Board Risk Committee and to other senior committees.

Risk appetite
The Group’s operational risk appetite statement is agreed by the Group Board. It comprises a number of specific measures of risk, such as:

·  
the maximum operational risk losses the Group is prepared to accept. This is expressed as a percentage of the Group’s estimated gross income for the year ahead; or

·  
the value of a single extreme but plausible operational impact.  These are identified and assessed through the scenario analysis programme (refer to Scenario analysis below).

To ensure the Group operates within the set risk appetite, the high-level statements are supplemented by specific tolerances for different types of operational risk. The GPF sets out how to manage risk within acceptable limits, which in turn enables the Group to operate within the overall risk appetite and the specific tolerances. The Group has a zero tolerance for risks such as breaches of laws and regulations.

Operational risk cycle and key management tools
The operational risk cycle comprises four stages:

·  
Identification of risks;

·  
Assessment or measurement of the scale of risks;

·  
Management or control of risks to prevent their recurrence or minimise the potential impact; and

·  
Monitoring and reporting of risks.

Although the operational risk tools encompass all stages of the risk cycle, they can be broadly categorised as follows:


Identification and assessment
Risk and control assessments
Controls that are effective without being excessive ensure the Group retains its reputation for efficient customer service and security. Risk and control assessments are used to identify and assess material operational risks and key controls across all business areas. The process is designed to ensure that risks are effectively managed in line with stated risk appetite, prioritised and documented. Controls are tested frequently with a view to ensuring they remain fit for purpose and operate effectively. The Group’s risk assessment methodology was enhanced during 2011 to ensure a more consistent approach to identifying risks and their associated controls and measuring expected loss. Risk assessments consider the new firm-wide taxonomy and will soon be captured in the Group-wide repository for operational risk.

Risk assessments are often conducted in a workshop environment, bringing together subject matter experts from across the division and key functions. By sharing expertise, they can identify improvements to risk identification, measurement and control. Risk governance is reviewed regularly ensuring that there is clarity and ownership of key risk areas.
Through coming together and sharing knowledge, participants gain a broader understanding of how their work fits together.

Group new product approval process
The Group’s new product approval process ensures there is a consistent process to identify, assess and approve the risks associated with new products.

Following the conclusion of reviews conducted during 2011, enhancements will be made during 2012 to the product governance forums, to provide earlier engagement between the business, Group and divisional risk teams and subject matter experts when assessing whether the risks associated with new products are in line with appetite. The forums will be supported by an upgrade to the Group’s key tools used to manage and report on new product approval.

Scenario analysis
Scenario analysis is used to assess the possible impact of extreme but plausible operational risk loss events. It provides a forward-looking basis for managing exposures beyond the Group's risk appetite. The methodology provides a structured and consistent approach to scenario scoping and measurement. A significant portfolio of scenarios was developed in 2011 across divisions, covering material risks to which the Group is exposed. Group-wide scenarios are centrally scoped and workshops are facilitated by Group Operational Risk in conjunction with functions and policy owners, before being assessed by divisions to derive specific impact estimates. This also allows the Group to review operational risk impacts as they arise from macroeconomic stresses (e.g. eurozone distress) in a time-efficient and effective manner.

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By assessing extreme but plausible events, scenario analysis is an important component in the operational risk framework, providing senior management with valuable insight into systemic risk that could significantly impact its financial performance if these events were to occur. Using its forward-looking nature, senior management cross-examines various risk topics against a range of circumstances and assumptions.

Similar to risk assessments, scenarios are run in a workshop environment, bringing business, risk and control experts together and thereby ensuring that risk management is approached holistically.

Stress testing
During the economic downturn, there has been an increase in large operational risk losses within the banking industry.

Consequently, the Group enhanced its approach to assessing the impact of the economic cycle on its operational risk losses in 2011, by specifically assessing the impact of the FSA's published Anchor II scenario, which describes a series of country-specific shocks around the world on:

·  
Expected levels of operational risk losses; and

·  
Unexpected levels of operational risk losses, by stressing its existing portfolio of operational risk scenarios.

The impact of the FSA Anchor II scenario on the Group's operational risk capital, as calculated under the standardised approach, was also projected based on the outputs of the Group’s stress-testing exercises.

During 2012, additional operational risk scenarios will be run, further broadening the Group's understanding of its exposures to tail risks.

Management, monitoring and reporting
Issues management
The objective of the operational risk issues management framework is the adoption of a consistent approach to the identification, capture, classification, monitoring, closure and acceptance of operational risk issues and associated actions across the Group, in accordance with the Group’s three lines of defence model.

Significant enhancements were made to the issues management process during 2010 including rollout of a single repository for capturing issues and actions; mapping issues to GPF; and a tightening of governance over issue management. These improvements were further embedded during 2011, through training and assurance reviews.
 
The enhancements have improved risk management by allowing Group-wide analyses of all operational risk issues. In certain cases, this has resulted in global assurance reviews focused on specific areas, helping to identify operational risks to be mitigated.

Event and loss data management
Event and loss data management ELDM covers the discovery, escalation, capture, investigation, approval and closure, and reporting and analysis of operational risk events and loss data. It also provides for the clear, simple, quick and consistent communication of operational risk events that meet defined threshold criteria to those members of the Group’s senior management and Executives who need to know of these events.

During 2011, an enhanced ELDM process was launched to promote consistency in the management of operational risk events and the collection of loss data across the Group. It included the introduction of a single repository to capture all events and loss data in the Group and the establishment of thresholds above which operational risk events will trigger a risk assessment.

The improvements in approach, and use of a single Group-wide database, have enhanced the completeness and accuracy of the Group’s internal loss data, and therefore better inform the Group’s operational risk profile.

At the start of 2012, the robustness of the historic data migrated into the new repository will be reviewed to confirm its suitability as an input to capital modelling. In addition, the process will be further enhanced to ensure continued compliance with changing regulatory and industry standards regarding the collection of internal loss data.

Insurance
The Group purchases insurance to provide the business with financial protection against specific losses and to comply with statutory or contractual requirements. Insurance is used as a risk mitigation tool in controlling the Group’s exposures, providing protection against financial loss once a risk has crystallised.

Reporting and monitoring
Reporting and monitoring forms an integral part of all of the Group’s operational risk management processes, which are designed to ensure that risks and issues are identified, escalated and managed on a timely basis. Exposures for each division are reported through monthly risk and control reports, which provide detail on the risk exposures and action plans. Enhancements made to reporting and monitoring during the year include analysing operational risk events, losses and issues against the GPF components; this has led to better identification of areas requiring management focus and remediation.


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Control environment certification
Control environment certification (CEC) is used by the Group Executive management to review and assess its internal control framework, and provide a self-certification of its current state. It demonstrates that the Group is operating a robust control framework, with mechanisms in place to understand and manage its risks, and to drive action to resolve areas of weakness or concern.

CEC provides a twice-yearly assessment of the robustness of the Group’s internal control environment including:

·  
compliance with the GPF and key divisional/functional policy standards;

·  
compliance with the requirements of the UK Corporate Governance Code; and

·  
effectiveness of the risk frameworks, culture and governance structures for each division or function.

CEC was enhanced during 2011 to improve the quality and depth of certification, and to implement a risk-based approach to the analysis of policy compliance. The enhancements have delivered a greater degree of analysis of the key risk areas for each business and Group policy standard owner. Improved alignment with Group Internal Audit has been delivered through the implementation of a common rating system for the assessment of the control environment, and CEC outcomes are reported at both the divisional risk and audit committees and Group Audit Committee.

Capital model development
At the end of 2011, the Group started to develop a statistical modelling capability for operational risk based on the requirements set out under the Basel II advanced measurement approach. The model is a hybrid encompassing internal and external loss data as well as scenarios. Business environment and internal control factors will be utilised when constructing scenarios and allocating capital. Development activities in 2011 focused on building the standalone loss data and scenario components within the model; integration activities, correlation and allocation will continue in 2012. Final model validation is expected to take place during 2012.


Compliance risk*
Compliance risk arises from non-compliance with national and international laws, rules and regulations. The Group believes that being a compliant organisation is fundamental to protecting sustainable growth, rebuilding its reputation and maintaining stakeholder confidence.

The regulatory environment remained highly challenging during 2011, as policymakers and regulators continued to strengthen regulation and supervision in response to the events of 2007/2008 and subsequent economic and financial stress.

The regulatory agenda - largely framed by the G20 but with many instances of EU and national initiatives - constitutes the most sweeping set of changes seen in many decades. At 31 December 2011, the Group was managing some 140 major regulatory or legislative policy initiatives; during the year as a whole, it had also reviewed over 300 consultations in its core markets. In addition to these changes, many supervisory authorities also continued to intensify their ongoing level of scrutiny and intervention.

These trends have posed multiple challenges for banking groups, including RBS, namely:

·  
tracking, analysing and engaging with policymakers on proposed changes;

·  
implementing change programmes to ensure compliance with new requirements;

·  
revisiting strategy, business and operating models in response to the new environment; and

·  
driving through cultural and other changes to minimise compliance and enforcement risks.

Below is an outline of some of the key developments in the regulatory environment that took place during 2011. An explanation of how the Group manages compliance risk begins on page 200.

Global regulatory developments
The global agenda continues to be guided by the G20, drawing on the original action plan for strengthening financial stability agreed by G20 leaders at the November 2008 Washington summit. During 2011, G20 countries continued to implement various elements of this action plan, culminating in the G20 leaders’ summit held in Cannes in November 2011.





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A progress report on the action plan was issued at the Cannes summit. Key developments during 2011 included the following:

Basel III
Following publication by the Basel Committee on Banking Supervision in December 2010 of rules for the new Basel III capital and liquidity framework, work during 2011 focused on finalising the remaining elements of policy and preparing for implementation. Highlights were:

·  
The issuance of minimum requirements regarding the loss absorbency of capital instruments at the point of non-viability (January 2011);

·  
The finalisation of rules for the capital treatment of counterparty credit risk in bilateral trades (June 2011);

·  
Technical changes to Basel III relating to the treatment of trade finance, aimed at helping promote trade with low-income countries (October 2011);

·  
Further work on the capitalisation of bank exposures to central counterparties (November 2011); and

·  
A Basel Committee paper proposing that debit valuation adjustments for over-the-counter derivatives and securities financing transactions should be fully deducted from Common Equity Tier 1 capital (December 2011). The Group is evaluating the potential impact of this proposal.

Systemic financial institutions
The main focus of policy development at the global level during 2011 was delivering on the G20-mandated target of agreeing a framework by the end of 2011 for dealing with global systemically important financial institutions (G-SIFIs). This target was met, with the Cannes summit endorsing:

·  
A new Financial Stability Board (FSB) international standard, “The Key Attributes of Effective Resolution Regimes for Financial Institutions”, which amongst other things provides a benchmark for national resolution regimes, as well as mandatory requirements for resolvability assessments and recovery and resolution plans for each G-SIFI; and

·  
A new Basel Committee framework for identifying an initial list of global systemically important banks (G-SIBs), and applying to these an additional common equity capital requirement, above the Basel III minimum standards, rising from 1% to 2.5% of risk-weighted assets in line with their systemic impact.

The names of the initial list of G-SIBs (though not their ranking) were published by the FSB at the end of the summit: RBS is included in the 29 names.

Shadow banking
In response to concerns, that heightened regulation of banks should not lead to risks being displaced into unregulated sectors, regulatory authorities started to pay growing attention to the “shadow banking” system during 2011. This term broadly refers to entities and financial transactions that fall outside the scope of existing financial (banking) regulation, such as hedge funds, money market funds and structured investment vehicles.

Work was initiated in five areas to assess the need for regulatory intervention, and this topic is likely to attract even more attention during 2012, when recommendations for action are expected.

The five areas include: banks’ interactions with shadow banking entities; ways to reduce the susceptibility of money market funds to runs; the regulation of other shadow banking entities on prudential grounds; retention requirements and transparency in securitisation; and the possible regulation of margins and haircuts in securities lending and repos.

Other
During 2011, the authorities started to pay more attention to the consistent implementation of G20 and FSB financial reforms, with plans developed to focus more on monitoring and the public reporting of implementation progress. Although a priority, little progress was made during 2011 on developing a global policy framework for over-the-counter derivative reform, so as to help align ongoing activity in this space, particularly in the US and the EU (see below).

EU regulatory developments
The EU regulatory agenda in 2011 continued to focus mainly on prudential and market structure measures; retail issues also started receiving more attention and are likely to come under increased focus in 2012. Key highlights were as follows:

New regulatory architecture
2011 saw the implementation of a new EU regulatory architecture, with the start of operations of the ESRB and three supervisory authorities: the European Banking Authority (EBA), the European Securities and Markets Authority, and the European Insurance and Occupational Pensions Authority.

The new framework marks a significant transfer of power to the three supervisory authorities, particularly with respect to detailed rule-making, where over time they will be issuing “binding technical standards” across a range of policy areas that will replace national rules.

However, an early preoccupation of the new regulatory authorities was the eurozone crisis. In particular, the EBA was heavily engaged in overseeing the stress testing of EU banks, including UK groups.

 
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Prudential and related reforms
A key focus during 2011 was work on amending the EU’s Capital Requirements Directive (CRD): a key step in that process was the publication of draft legislative text in September 2011, the CRD IV package, which is expected to be finalised during 2012 and will implement Basel III in the EU.

Another key area of work was the EU’s “crisis management” legislative package, aimed at dealing with issues similar to those addressed by the FSB work on G-SIFIs. An early 2011 EU Commission consultation included proposals on enhanced supervision and early powers of intervention; recovery and resolution planning; resolution frameworks; resolution funds and debt write-down (but not capital surcharges). Draft legislation to implement these measures was at the time of writing expected to be issued in early 2012, after several postponements.

Other initiatives in the prudential space have included, notably, continued work on developing the Solvency II framework for insurers; the development of legislative proposals on corporate governance in financial institutions; and the further development and UK implementation of the EU’s common reporting framework (COREP) for banks.

Market and structural reforms
Key developments in this space included:

·  
European Markets Infrastructure Regulation (EMIR) - negotiations continued during 2011 on this draft Regulation on OTC derivatives, central counterparties and trade repositories, which represents a major element of the financial crisis regulatory response agenda. Agreement was close to being reached in early 2012.

·  
Markets in Financial Instruments Directive Review (MiFID2) - the EU review of this directive, which sets the framework for investment markets, culminated in the publication of draft legislative text in October 2011.

·  
Financial Transaction Tax (FTT) - the EU Commission published proposals for an FTT, which would see trades in bonds and shares taxed at 0.1% and complex derivatives taxed at 0.01%. However, the proposal requires approval from all 27 EU members, but is opposed by some, including notably the UK, which reduces the likelihood of it being imposed.

·  
Other initiatives - these have included changes to the market abuse regime and prospectus requirements, initiatives on short-selling, further legislative developments impacting credit rating agencies and changes to depositor and investor protection.


EU retail market reforms
Notwithstanding the focus on prudential and market reforms in response to the financial crisis, the EU Commission during 2011 also continued to work on a wide range of retail agenda initiatives. These included a draft legislative proposal for a mortgage credit directive, with a focus on responsible lending and borrowing; the development of proposals on collective redress; and ongoing discussions with the banking industry to improve the transparency and comparability of bank fees. The Group also continued to work on implementing the requirements coming into force at the end of 2011, contained in the EU Payment Services Directive.

UK regulatory developments
UK regulatory developments during 2011 continued to be extensively determined by global and EU developments, with UK regulators working to implement requirements coming into force, such as the CRD III package of reforms, and actively participating in policy development at the EU and global levels. In addition, there were a number of developments specific to the UK.

Independent Commission on Banking (ICB)
The ICB was appointed by the UK Government in June 2010 to review possible structural measures to reform the UK banking system in order to promote, amongst other things, stability and competition. It published its final report to the Cabinet Committee on Banking Reform on 12 September 2011 (the ‘Final Report’), which set out the ICB’s views on possible reforms to improve stability and competition in UK banking.

The Final Report made a number of recommendations, including in relation to: (i) the implementation of a ring-fence of retail banking operations; (ii) increased loss-absorbency (including bail-in, i.e. the ability to write-down debt or convert it into an issuer’s ordinary shares in certain circumstances); and (iii) promotion of competition.

On 19 December 2011, the UK Government published its response to the Final Report and indicated its support and intention to implement the recommendations set out in the Final Report substantially as proposed. The Government indicated that it would work towards putting in place the necessary legislation by May 2015, requiring compliance as soon as practicable thereafter and a final deadline for full implementation of 2019.

The Group will continue to participate in the debate and to consult with the UK Government on the implementation of the recommendations set out in the Final Report and in the Government’s response.

Regulatory architecture reforms
Work on the UK coalition government’s plans for reforming the UK’s regulatory structure continued during 2011, with major consultations from HM Treasury, a number of calls for evidence from parliamentary committees and the publication of a draft Bill for pre-legislative scrutiny purposes in June 2011. In addition, the FSA and Bank of England published policy documents setting out initial high-level policy thinking on the new regulatory bodies; and an interim version of the Financial Policy Committee started to meet in advance of legislation being enacted. However, the timescale for completing the legislative process and fully implementing the new framework has been delayed until 2013 (from the end of 2012).

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Payment Protection Insurance (PPI)
The Judicial Review requested by the British Bankers’ Association (BBA) in respect of the FSA’s policy statement on PPI complaints and guidance published by the Financial Ombudsman Service concluded in April 2011 with an adverse ruling. The BBA and the banks concerned decided not to appeal and the UK banks including the Group have moved towards settling claims in accordance with the FSA’s revised principles. Under the terms of a waiver granted by the FSA, the Group, along with the rest of the industry, has had to deal with the backlog of complaints within specified timescales.

Retail conduct issues
In addition to EU retail initiatives, the UK authorities continued to pursue additional issues during 2011. These included initiatives relating to financial inclusion, where the Government is seeking to widen access to bank accounts; the implementation of the recommendations of the Retail Distribution Review relating to the provision of investment advice; ongoing work on the Mortgage Market Review; the establishment of a Steering Group by HM Treasury to devise a suite of simple financial products; and a review of the insurance products that form part of packaged current accounts.

Supervisory developments
In line with that of other regulatory authorities, the FSA’s supervisory scrutiny has intensified in response to the financial crisis and ongoing market stresses. Front-end supervisory resources have been increased and existing tools have been used more frequently and robustly – evidenced, for instance, in terms of the heightened number of information requests, the increased deployment by the FSA of skilled person reports as well as the increased fines charged against the industry. Across the industry fines for 2011 totalled £66.1 million versus £5.3 million in 2007. In addition, the FSA continued to develop new supervisory approaches, notably its Core Prudential Programme for those major financial institutions it oversees, which includes in-depth rolling thematic assessments on governance, business models, risk management, capital and liquidity.

US regulatory developments
In the US, activity was dominated by rulemaking following the 2010 Dodd-Frank Act. Although there was some slippage on, for example, derivatives rules, output from the authorities has still been considerable.

Key final rules were issued on a range of issues, including living wills, the Collins Amendment (which floors capital requirements at the level of Basel II advanced approaches), rights for shareholders to have an advisory “say on pay”, and limits on debit card interchange fees. Meanwhile the new Consumer Financial Protection Bureau was established on the Act’s first anniversary on 21 July 2011.

High-profile draft rules that were published included the Volcker Rule (limiting proprietary trading and investments in private equity or hedge funds), the securitisation risk retention rule and rules applicable to Nationally Recognized Statistical Rating Organizations (credit rating agencies).

Compliance risk management
The Group manages its compliance risk through a regulatory affairs and compliance framework that seeks to ensure it complies with all banking, securities, insurance and anti-money laundering regulations, defined by over 120 different regulatory bodies and central banks, wherever the Group operates. This framework is managed by the Group’s Regulatory Affairs and Compliance functions and includes: the tracking and management of regulatory developments; regulatory relationship management; the implementation of global compliance risk policies; assurance and monitoring; training and awareness; and mitigation activity.

Against the backdrop of intensified regulatory pressure, Group Regulatory Affairs has managed the increased levels of scrutiny and legislation by increasing the capacity of its team, as well as improving and refining its operating model, tools, systems and processes. Simultaneously, in response to enforcement actions against the Group in 2010 and 2011, Group Compliance initiated and led large-scale remediation and infrastructure changes, driving both the definition and the proactive management of conduct risk.

Management of regulatory change
The early identification and effective management of changes in legislative, regulatory and other requirements that may impact the Group is critical to the successful mitigation of compliance risk.

Group Regulatory Affairs maintains a well-established policy and supporting processes for the identification and management of such changes across the Group. Group Board and Executive Committee oversight is supported by a Prudential Regulatory Developments Executive Steering Group, which was formed in early 2010 to provide a specific focus on a range of key regulatory changes. Communication and coordination were strengthened in 2011 with the formalisation of two Group-wide forums, one focusing on prudential and wholesale market issues, the other on retail conduct issues. In addition, a divisional Heads of Regulatory Developments forum was established, and RBS Americas’ regional governance strengthened.

Reporting and internal communications activity expanded in 2011 in response to the growing regulatory change agenda. This included:

·  
The enhancement of quarterly reporting to the Group Audit Committee, with a particular focus on tracking progress on compliance readiness programmes implementing new requirements;

·  
Six-monthly reporting to the Board Risk Committee, in addition to the standard monthly risk reports produced for the Board and other governance committees; and

·  
Increased communications, such as the development of a fortnightly Regulatory Affairs Flash Report, circulated widely across the Group, which captures key regulatory developments and relationship topics.

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Regulatory relationship management
The Regulatory Relations Forum, chaired by Group Regulatory Affairs, meets fortnightly and now has global coverage with representatives from all divisions and regions. It facilitates the sharing of key regulatory engagements and the lessons learned from them.

Quarterly reporting to the Group Audit Committee captures all material regulatory reviews and investigations and upstream regulatory developments worldwide, as well as tracking the status and trends in key regulatory relationships.

Other key regulatory policies, specifically ‘Group Relationships with Regulators’ and ‘Political, Legislative and Regulatory Environment’, were reviewed and re-launched. Each incorporates a new risk appetite statement, a benchmarking exercise against the Group's peer banks and, for the latter, an end-to-end review and mapping of the upstream risk management process.

Recovery and resolution planning
The Group considers effective resolution regimes, coordination between regulators, and recovery and resolution planning, to be important components of an extensive reform agenda to improve safety and stability within the banking industry. Accordingly, the Group recognises the potential value of Recovery and Resolution Plans (RRPs) as mechanisms for preparing banks to deal with: severe stress events (through a range of developed recovery options in the Recovery Plan); and ensuring authorities will have all the critical information they need to identify and carry out appropriate resolutions in the event of failure (the Resolution Plan).

To ensure effective management of financial stability across jurisdictions, and to avoid duplication and inefficiency for cross-border banks, it is important that the approach, content and role of RRPs are globally consistent across jurisdictions.

The Group intends to sustain its strong momentum on the development of RRPs. As well as working with the UK authorities, the Group will continue to work with global policy developers in order to contribute to the development of RRPs in other jurisdictions, in particular within the EU and the US. The timeframes for the development of RRPs in these regions are considerably longer than in the UK, and it will be important to ensure that a consistent policy approach and format are adopted if the RRPs of UK-based global banks are to meet local requirements, and do not have to be redrawn or duplicated.
 
Global compliance risk and compliance policies
Within the Group Policy Framework, compliance risk and compliance policies define minimum standards to which all businesses must adhere. The policies are primarily driven by the rules and regulations set by the FSA, the Group’s lead regulator. However, these global minimum standards are supplemented, where appropriate, by divisional policies to meet local product or market requirements.

In compliance risk management, the term ‘conduct risk’ is used to refer to the risk of breaches of: (a) regulation or law; or (b) regulatory expectation. This is distinguished from ‘prudential risk’, i.e. compliance risks related to capital management, liquidity, credit risk, operational risk and market risk. A significantly enhanced compliance/conduct policy structure was outlined during 2011. It is aligned to a new Conduct Risk Appetite statement as well as the expected direction of the new Financial Conduct Authority, which will be one of the successors of the FSA. As a result, in future, it will be possible to assess the pan-Group risk profile for conduct risk against its risk appetite. In addition, it will be possible to provide more detailed policy direction to divisions on key areas of conduct risk.

Assurance and monitoring
Assurance and monitoring activities are essential to ensure that the Group can demonstrate compliance with existing rules and regulations.

During 2011, a ‘heatmap’ of the key inherent conduct risks across all the Group’s global businesses, reflecting both internal and external change and divisional priorities, was developed. This, in turn, drove a comprehensive programme of assurance reviews across the Group. These reviews introduced a global, end-to-end thematic approach, looking at customer outcomes as well as process adherence. In addition to immediate issues, for which action plans were developed, the reviews identified a number of wider themes that required a more strategic approach.

Training and awareness
Maintaining compliance with existing rules and regulations requires continued investment in professional training, as well as maintaining risk awareness. During 2011, the Group focused on strengthening the capabilities of its compliance risk functions at both Group and divisional level. The Group facilitates extensive compliance training through computer-based Group Policy Learning modules, with each one designed to promote the relevant regulatory Group Policy Standard.

To support the professional development of the Group’s compliance teams, it also has a comprehensive and progressive training programme that is deployed globally. All of the Group’s regulatory staff are actively engaged in compliance e-learning, which incorporates a mandatory ‘essentials’ course, and the RBS Risk Academy, through which all staff are required to complete foundation courses in other risk disciplines, such as operational risk, market risk and retail credit risk. Formal training is supplemented by more informal regulatory familiarisation; this is designed to share knowledge, and support both personal development and technical training across the wider risk community.



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Anti-Money Laundering
During 2011, RBS continued to enhance its Anti Money Laundering (AML) Change Programme across the Group. Key developments include:

·  
A new cohesive target operating model to support the capability required and reviewed divisional AML capabilities against the target operating model to identify and analyse gaps;

·  
A framework for understanding and managing compliance and conduct risk, including the introduction of a clear Group-level conduct risk appetite statement and the design of a new conduct risk policy framework; and

·  
An enhanced global whistle-blowing service ‘Right Call’ that allows all employees, irrespective of location, to escalate any concerns outside of their normal line management. Whistle-blowing call volumes have increased since the launch and the new framework is a further positive step to help the Group identify and manage compliance risk.

Reputational risk*
Reputational risk is the risk of brand damage arising from financial and non-financial events due to a failure to meet stakeholders’ expectations of the Group’s performance and behaviour.

Such loss in reputation has the potential to put the entire business at risk. It could also lead to negative publicity, loss of revenue, costly litigation or a decline in the customer base.

Reputational risk can arise from actions taken by the Group or a failure to take action, such as failing to assess the environmental, social or ethical impacts of clients or projects to which the Group has provided products or services.

The Group seeks to safeguard its reputation by considering the impact on the value of its franchise from how it conducts business, its choice of customers and the way stakeholders view the Group. Managing the Group’s reputation is the joint responsibility of all employees, and reputational considerations should, as part of standard practice, be integrated into the Group’s day-to-day decision making structures.

Currently the Group manages reputational risk through a number of functions, such as divisions, Group Communications, Group Sustainability and an Environmental, Social and Ethical (ESE) risk management function. The latter function is responsible for assessing ESE risks associated with business engagements and business divisions.

The Board has ultimate responsibility for managing any impact on the reputation of the Group arising from its operations. The Group Sustainability Committee (established at the beginning of 2010) sets the overall strategy and approach for the management of Group sustainability. However, all parts of the Group take responsibility for reputation management.

The risk is viewed as material given the central nature of the Group’s market reputation in the strategic risk objectives.

Business risk*
Business risk is the potential risk of revenues being lower than expected and/or operating costs being higher than expected. It is influenced by a variety of factors, including pricing, sales volumes, input costs, regulations and the prevailing market and economic environment.

The Group seeks to minimise its exposure to business risk, subject to its wider strategic objectives (e.g. return on equity). As a large financial services group, it recognises and values the potential diversification benefits associated with differences in the nature and timing of potential business risk across its portfolio of businesses.

Business risk is identified, measured and managed through the Group’s bi-annual strategic planning cycles. Expected profiles for revenues and costs are determined, on a bottom-up basis, through strategic plans and expectations of the external environment. These profiles are tested against a range of stress scenarios and factors to identify the key risk drivers behind any potential volatility, along with management actions to address and manage them.

The Group Board has ultimate responsibility for the impact of any volatility in revenues and costs on the Group’s performance. Business risk is incorporated within the Group’s risk appetite target for earnings volatility, with an assessment of volatility in revenues and costs a key component in determining whether the Group and its underlying businesses are within risk appetite.

The management of business risk lies primarily with divisional and business unit strategic teams, with oversight at the Group level from the Finance, Strategy and Risk functions. Elements of business risk (e.g. regulatory changes) also overlap with other areas and are managed by the appropriate risk functions.

The risk is viewed as material given the central nature of unexpected changes in revenues and costs on the Group’s ability to achieve its strategic objectives.


* unaudited

 
202

 
Business review Risk and balance sheet management continued
 
Pension risk*
The Group is exposed to risk from its defined benefit pension schemes to the extent that the assets of the schemes do not fully match the timing and amount of the schemes’ liabilities. Pension scheme liabilities vary with changes to long-term interest rates, inflation, pensionable salaries and the longevity of scheme members as well as changes in legislation. The Group is exposed to the risk that the market value of the schemes’ assets, together with future returns and any additional future contributions could be considered insufficient to meet the liabilities as they fall due. In such circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes.

The RBS Group Pension Fund (‘Main scheme’) is the largest of the schemes and the main source of pension risk. The Main scheme operates under a trust deed under which the corporate trustee, RBS Pension Trustees Limited, is a wholly owned subsidiary of The Royal Bank of Scotland plc and the trustee board comprises six directors selected by the Group and four directors nominated by members.

The trustee is solely responsible for the investment of the Main scheme’s assets which are held separately from the assets of the Group. Significant changes to asset strategy are discussed with the Groups Pension Risk Committee which was established in 2011. The Group and the trustee must agree on the Main scheme funding plan.

In October 2006, the Main scheme was closed to new employees. In November 2009, the Group confirmed that it was making changes to the Main scheme and a number of other defined benefit schemes including the introduction of a limit of 2% per annum (or the annual change in the Consumer Price Index, if lower) to the amount of any salary increase that will count for pensionable purposes.

Risk appetite and investment policy are agreed by the trustee with quantitative and qualitative input from the scheme actuaries and investment advisers. The trustee also consults with the Group to obtain its view on the appropriate level of risk within the pension fund.

Risk management framework
From a sponsor perspective, the Group manages this risk using a framework that encompasses risk reporting and monitoring, stress testing, modelling and an associated governance structure that helps ensure the Group is able to fulfil its obligation to support the defined benefit pension schemes to which it has exposure.

Reporting and monitoring
The Group maintains an independent review of risk from a sponsor perspective within its pension funds. It achieves this through underlying regular pension risk reporting and monitoring to the Group Board, Group Board Risk Committee and Group Risk Committee on the material pension schemes that the Group has an obligation to support.
 
Stress testing and modelling
Throughout 2011, various pension risk stress testing initiatives were undertaken, focused both on internally defined scenarios and on scenarios undertaken to meet integrated EBA, IMF and FSA stress testing requirements. On an annual basis, the Internal Capital Adequacy Assessment Process is also modelled; this entails assessing changes in pension asset and liability values over a 12-month horizon under various stresses and scenarios.

Governance
A key component of the pension risk framework is the Pension Risk Committee, which was established in 2011 and has the authority to articulate the Group’s view of risk appetite for the various RBS pension schemes. The Pension Risk Committee also serves as a formal link between the Group and the Trustee of the Group’s largest pension schemes on risk management asset strategy and financing issues and, during 2011, facilitated an agreement between the two on mechanisms for reducing risk within the RBS Group Pension Fund.

Improvements in 2011 and next steps
As part of the continuing development of the pension risk management framework within RBS Group, key achievements in 2011 focused on improved stress testing and risk governance mechanisms. The framework will continue to be developed in 2012 with improvements in risk reporting and monitoring, modelling and stress testing capability along with the embedding of the pension risk governance structure implemented in 2011.

Main scheme
The most recent funding valuation, at 31 March 2010, was agreed during 2011. It showed that the value of liabilities exceeded the value of assets by £3.5 billion at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the Group has agreed to pay additional contributions each year over the period 2011 to 2018. These contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. Further details are given in Note 4 of the consolidated accounts.

The assets of the Main scheme, which represent 84% of Group pension plan assets at 31 December 2011, are invested in a diversified portfolio of quoted and private equity, government and corporate fixed interest and index-linked bonds, and other assets including property and hedge funds. The trustee has taken measures to partially mitigate inflation and interest rate risks both by investment in suitable physical assets and by entering into inflation and interest rate swaps. The Main scheme also uses derivatives within its portfolio to manage the allocation to asset classes and to manage risk within asset classes.

* unaudited

 
203

 
Business review Risk and balance sheet management continued
 
Risk management: Pension risk* continued
The table below shows the sensitivity of the Main scheme’s assets and liabilities (measured according to IAS 19 ‘Employee Benefits’) to changes in interest rates and equity values at the year end, taking account of the current asset allocation and hedging arrangements.


 
Change 
 in value 
of assets 
£m 
Change  
in value of  
 liabilities  
£m  
Increase in net 
 pension 
 obligations 
£m 
At 31 December 2011
     
Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields
106 
200 
(94)
Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields
557 
911 
(354)
Fall in credit spreads of 0.25% at all durations with no change in nominal or real swap yields
104 
1,118 
(1,014)
Fall in equity values of 10%
(935)
— 
(935)

At 31 December 2010
     
Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields
67 
193 
(126)
Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields
355 
799 
(444)
Fall in credit spreads of 0.25% at all durations with no change in nominal or real swap yields
98 
1,005 
(907)
Fall in equity values of 10%
(1,083)
— 
(1,083)





* unaudited
 
 
 
204

 
Business review Risk and balance sheet management continued



Asset Protection Scheme*

All disclosures in this section (pages 205 to 207) are unaudited and are marked with an asterisk (*).

Key aspects of the Scheme
On 22 December 2009, the Group acceded to the Asset Protection Scheme (APS or ‘the Scheme’) with HM Treasury acting on behalf of the UK Government. Under the Scheme, the Group purchased credit protection over a portfolio of specified assets and exposures (“covered assets”) from HM Treasury. The portfolio of covered assets had a par value of approximately £282 billion at 31 December 2008 and the protection is subject to a first loss of £60 billion and covers 90% of subsequent losses net of recoveries. Once through the first loss, when a covered asset has experienced a trigger event, losses and recoveries in respect of that asset are included in the balance receivable under the APS. Receipts from HM Treasury will, over time, amount to 90% of cumulative losses (net of cumulative recoveries) on the portfolio of covered assets less the first loss amount.

The Group has the right to terminate the Scheme at any time provided that the Financial Services Authority has confirmed in writing to HM Treasury that it has no objection. On termination, the Group is liable to pay HM Treasury a termination fee, which comprises the difference between £2.5 billion (or, if higher, a sum related to the economic benefit of regulatory capital relief obtained from the APS) and the aggregate fees paid. In addition, the Group would have to repay any amounts received from HM Treasury under the terms of the APS. The Group has paid APS premiums totalling £2,225 million (2011 - £125 million; 2010 - £700 million; 2009 - £1,400 million). From 31 December 2011 premiums of £125 million are payable quarterly until the earlier of 2099 and the date the Group leaves the Scheme.

Losses are recognised when a covered asset has experienced a trigger event which comprises failure to pay subject to grace periods, bankruptcy and restructuring.
 
APS assets are spread across the Group’s main divisions. High volume commercial and retail exposures were selected on a portfolio basis where assets were high risk and in arrears at 31 December 2008. Large corporate and GBM exposures were selected at the counterparty/asset level based on individual risk reviews and defaulted assets in the workout/restructuring unit.

HM Treasury has the right to appoint step-in managers to carry out any oversight, management or additional functions on their behalf, to ensure that the covered assets are managed and administered in compliance with the agreed terms and conditions. This right is exercisable if certain step-in triggers occur. These include:

·  
losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds;

·  
a breach of specified obligations in the APS rules or the accession agreement;

·  
the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight, and such failure is persistent and material or it is evidence of a systematic problem; and

·  
material or systematic data deficiencies in the information provided to HM Treasury in accordance with the terms of the APS.

HM Treasury may at any time elect to cease to exercise its step-in rights in whole or part when it is satisfied that the step-in triggers have been remedied.



* unaudited

 
205

 
Business review Risk and balance sheet management continued


Risk management: Asset Protection Scheme* continued
Covered assets

The table below shows the movement in covered assets.

 
£bn 
At 1 January 2009
282.0 
Disposals
(3.0)
Non-contractual early repayments
(8.9)
Maturities and amortisation
(26.1)
Rollovers and covered amount cap adjustments
(1.7)
Currency translation and other adjustments
(11.8)
At 31 December 2009
230.5 
Disposals
(9.7)
Maturities, amortisation and early repayments
(28.7)
Reclassified assets
3.1 
Withdrawals
(2.9)
Currency translation and other adjustments
2.4 
At 31 December 2010
194.7 
Disposals
(5.3)
Maturities, amortisation and early repayments
(42.4)
Withdrawals
(12.4)
Currency translation and other adjustments
(2.8)
At 31 December 2011
131.8 

Key points
·  
The reduction in covered assets was due to run-off of the portfolio, disposals, early repayments and maturing loans.

·  
The Group continues to take advantage of market conditions and execute sales from a number of its portfolios.

·  
The Group withdrew £12.4 billion of covered assets with a lower than average risk profile from the Scheme.


Credit impairments and write-downs
The table below analyses the credit impairment provision (adjusted for write-downs) and adjustments to par value (including available-for-sale reserves) relating to covered assets.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Loans and advances
20,586 
18,033 
14,240 
Debt securities
10,703 
11,747 
7,816 
Derivatives
3,056 
2,043 
6,834 
 
34,345 
31,823 
28,890 
       
Core
7,626 
6,646 
5,552 
Non-Core
26,719 
25,177 
23,338 
 
34,345 
31,823 
28,890 

Key points
·  
The increase in Non-Core impairments of £1.5 billion accounted for the majority of the increase in credit impairments and write-downs in 2011.

·  
The increase in Core is largely accounted for by impairments offset by asset withdrawals.





* unaudited

 
206

 
Business review Risk and balance sheet management continued

Asset Protection Scheme* continued
First loss utilisation

The Group has agreed with HM Treasury modifications to the Scheme rules, which affect most APS portfolios in Global Banking & Markets and an APS portfolio in UK Corporate that relates to larger clients. All other APS portfolios in the Group are unaffected. The overall economic aspects of the Scheme are unchanged, including value and term of cover, credit derivative valuation and capital effects.


The modified rules for recognition of triggered assets align more closely to the Group’s normal accounting and risk management procedures and will reduce the administrative burden of operating the Scheme. For the portfolios subject to these changes, the calculation of loss now takes into account expected recoveries in addition to those already received. This has resulted in a reduction in first loss utilisation. A comparison of losses arising under the original Scheme rules with those arising under the modified Scheme rules is set out below. This covers the period from the Scheme inception to 31 March 2011 (the last point at which the original rules applied for the affected assets).

 
£m 
Original first loss utilisation
38,961 
Assets not triggered under modified rules (1)
(4,126)
Assets triggered under modified rules (2)
997 
Expected recoveries (3)
(6,272)
Revised first loss utilisation
29,560 

Notes:
(1)
Assets that had triggered under the original Scheme rules but were not impaired or defaulted are not triggered under the modified rules.
(2)
Assets that had not yet triggered under the original Scheme rules but had impaired or defaulted are triggered under the modified rules.
(3)
For assets which have triggered under both original and modified rules, this amount represents the excess of expected recoveries over cash recoveries received to date.

The table below shows the first loss utilisation under the original and modified rules.

 
2011
 
2010
 
Original Scheme rules 
 
Modified 
 Scheme rules 
     
Original Scheme rules 
 
Modified 
 Scheme rules 
   
 
Gross loss 
amount 
Cash 
recoveries 
to date 
 
Net 
triggered 
loss 
 
Net 
 triggered 
total 
 
Gross loss 
amount 
Cash 
recoveries 
to date 
 
Net 
triggered 
loss 
 
Net 
 triggered 
 total 
 
£m 
£m 
 
£m 
 
£m 
 
£m 
£m 
 
£m 
 
£m 
Core
8,451 
(2,240)
 
1,567 
 
7,778 
 
6,865 
(1,042)
 
1,559 
 
7,382 
Non-Core
17,486 
(2,992)
 
8,158 
 
22,652 
 
13,946 
(1,876)
 
6,923 
 
18,993 
 
25,937 
(5,232)
 
9,725 
 
30,430 
 
20,811 
(2,918)
 
8,482 
 
26,375 
Loss credits
         
1,802 
           
1,241 
           
32,232 
           
27,616 

Key points
·  
The cumulative first loss is £32.2 billion however, the Group does not expect to claim under the Scheme, which has a first loss of £60 billion.

·  
The Group received loss credits of £0.6 billion in 2011 which related to disposals. Cumulative loss credits at 31 December 2011 were £1.8 billion.

·  
The Group continues to expect an average recovery rate of approximately 40% across all portfolios.


Risk-weighted assets
The table below analyses risk-weighted assets (RWAs) covered by the APS.
 
2011
2010
2009
 
£bn
£bn
£bn
Core
40.2
54.7
76.1
Non-Core
28.9
50.9
51.5
APS RWAs
69.1
105.6
127.6

Key point
·  
The decrease of £36.5 billion in RWAs covered by the Scheme reflects pool movements, assets moving into default and changes in risk parameters.


* unaudited


 
207

 
 
Governance report
 
209
Letter from the Chairman
210
Our governance structure
211
Our Board
215
Executive Committee
216
Corporate governance
221
Report of the Group Audit Committee
226
Report of the Board Risk Committee
230
Directors’ remuneration report
252
Other remuneration disclosure
254
Compliance report
257
Report of the directors
262
Directors’ interests in shares
263
Statement of directors’ responsibilities
 
 

 
 
208

 
 
Letter from the Chairman


Dear Shareholder,

I am pleased to present our Corporate governance report for the 2011 financial year.

2011 has been a challenging year for the Group given the continued pressure on financial markets and the Eurozone challenges as well as UK developments such as the recommendations from the Independent Commission on Banking. During 2011, key areas of focus for the Board were: financial performance; strategy; risk; and regulatory developments and reports. The Board was supported by the work of key Board committees.

Further details on the role and principal activities of the Board are contained within the Corporate governance report on pages 210 to 253. Individual reports from the Group Audit Committee, Board Risk Committee and Group Remuneration Committee are also included.

Corporate governance in RBS
The Group is working hard to achieve a very challenging and complex turnaround and good corporate governance is a key element of supporting delivery of our strategy and underpinning cultural change across the Group.

In May 2011, the Board introduced a new Corporate Governance Policy to demonstrate that we are committed to the highest standards of governance, integrity and professionalism throughout the Group. The policy comprises ten principles and related guidance that apply across the Group in all divisions and jurisdictions. The principles cover areas such as decision making, individual and collective responsibility, identifying and managing risks, risk and reward and escalation and transparency. We want to ensure we have the right structures and systems in place so that sound business decisions are made and it is important to us that we demonstrate high standards of governance in all of our activities. A clear corporate governance policy is helping us achieve this and we will be monitoring compliance with the policy on a continuing basis.

Our statement of compliance with the UK Corporate Governance Code issued by the Financial Reporting Council in May 2010 (the “Code”) is set out on page 254.

The Board
During 2011, we were pleased to welcome three new independent non-executive directors to the Board: Alison Davis, Tony Di Iorio and Baroness Noakes. They have brought with them a wealth of relevant and diverse experience in both the public and private sectors, along with a strong global perspective and have made a significant contribution to the work of the Board since joining. Their appointments have also strengthened the membership of a number of Board committees with Alison Davis joining the Group Remuneration Committee, Tony Di Iorio joining the Group Audit Committee and Board Risk Committee, and Baroness Noakes joining the Group Audit Committee. In addition to our new Board members, Colin Buchan retired as a director in August 2011 following nine years on the Board and John McFarlane will step down from the Board on 31 March 2012. We have greatly appreciated the experience, commitment and knowledge they brought to the Board and Committees.

Leadership and Board effectiveness
As Chairman, I am responsible for ensuring we have an effective Board and for leading the Board. I am supported by the Group Nominations Committee in reviewing Board composition and the recruitment of new directors and by the Group Secretary on induction, continuing professional development, Board process and evaluation.

A key part of my role in leading the Board is to ensure that directors develop a good understanding of the Group’s business so that the Board is able to provide input to help shape future strategy. This is achieved through site visits, in-depth board presentations and, for new directors, their induction programme. I believe it is important to encourage a culture and environment in the boardroom that facilitates debate and where non-executive directors are able to provide constructive challenge to the executive team.

We conduct an annual evaluation of the effectiveness of the Board and this year’s evaluation was conducted internally, led by the Group Secretary. I also evaluate the individual performance of each of the non-executive directors and all directors stand for re-election annually. Further details on performance evaluation are set out on page 218. During 2011, we saw further improvements to the flow of information to the Board both in terms of the quality of papers and the use of new technology to deliver these to directors. The Board continued to focus on strategic priorities and the composition of the Board, including succession planning for senior executives, was kept under review by the Group Nominations Committee.

Diversity
The diversity agenda has remained a key priority for RBS in 2011. The Group made a public statement on its website www.rbs.com in September 2011 regarding its aspirations in relation to gender diversity in the boardroom. We expect to meet the aspirational target of 25 per cent female board representation in 2012. In December 2011, the Board approved a formal boardroom diversity policy which aims to promote diversity in the composition of the Board. Under this policy, all Board appointments will be made on the basis of individual competence, skills and expertise measured against identified objective criteria. Further details on the boardroom diversity policy can be found on page 220.

I would like to thank both the executive and non-executive directors for their outstanding commitment and their contributions to the Board and Committees in 2011. This year is shaping up to be another challenging year for the Group and the Board but I am confident that we are on track to restore the performance of the Group in all material aspects.

 
Philip Hampton
Chairman
22 February 2012
 
 
209

 
 
Our governance structure
 

 
Group Board and Board committee structure
 

Group Board is the main decision making forum at Group level, setting the strategic direction of the Group and ensuring that the Group manages risk effectively. The Group Board is accountable to shareholders for financial and operational performance.

Group Audit Committee assists the Group Board in discharging its responsibilities for the disclosure of the financial affairs of the Group. It reviews the accounting policies, financial reporting and regulatory compliance practices of the Group and the Group’s system and standards of internal controls, and monitors the Group’s processes for internal audit and external audit.

Board Risk Committee provides oversight and advice to the Group Board on current and potential future risk exposures of the Group and risk strategy. It reviews the Group’s performance on risk appetite and oversees the operation of the Group Policy Framework.
 
Group Remuneration Committee has oversight of the Group’s policy on remuneration. It also considers senior executive remuneration and makes recommendations to the Group Board on remuneration of executive directors.

Group Nominations Committee assists the Group Board in the selection and appointment of directors. It reviews the structure, size and composition of the Group Board, and membership and chairmanship of Group Board committees.

Group Sustainability Committee is responsible for reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues.

Executive Committee is responsible for managing Group-wide issues and those operational issues that affect the broader Group. It reviews strategic issues and initiatives, monitors financial performance and capital allocations and considers risk strategy, policy and risk management.
 
 
 
210

 

Our Board

Chairman
       
 
 
Philip Hampton (age 58)
Date of appointment: appointed to the Board on 19 January 2009 and to the position of Chairman on 3 February 2009
 
Previously chairman of J Sainsbury plc and group finance director at Lloyds TSB Group, BT Group plc, BG Group plc, British Gas and British Steel plc, an executive director of Lazards and a non-executive director of RMC Group plc and Belgacom SA. He is also a former chairman of UK Financial Investments Limited, which manages the UK Government’s shareholdings in banks.
 
 
External appointments
· Non-executive director of Anglo American plc
 
Board Committee membership
· Group Nominations Committee (Chair)
 
Executive directors
       
Group Chief Executive
 
 
Stephen Hester (age 51)
Date of appointment: appointed to the Board on 1 October 2008 and to the position of Group Chief Executive on 21 November 2008
 
Previously chief executive of The British Land Company PLC, chief operating officer of Abbey National plc and prior to that held positions with Credit Suisse First Boston including chief financial officer, head of fixed income and co-head of European investment banking. In 2008 he served as a non-executive director of Northern Rock plc.
 
 
External appointments
· Trustee of The Foundation and Friends of the Royal Botanical Gardens, Kew
 
Board Committee membership
· Executive Committee
 
Group Finance Director
 
 
Bruce Van Saun (age 54)
Date of appointment: 1 October 2009
 
Over 25 years of financial services experience. From 1997 to 2008 he held a number of senior positions with Bank of New York and later Bank of New York Mellon, most recently as vice-chairman and chief financial officer and before that was responsible for Asset Management and Market Related businesses. Prior to that he held senior positions with Deutsche Bank, Wasserstein Perella Group and Kidder Peabody & Co. He has served on several corporate boards as a non-executive director and has been active in numerous community organisations.
 
External appointments
· ConvergEx Holdings, LLC
 
Board Committee membership
· Executive Committee
 

 
211

 
 
Our Board continued
 
Independent non-executive directors
       
 
 
Sandy Crombie (age 63)
Senior Independent Director
Date of appointment: 1 June 2009
 
Previously group chief executive of Standard Life plc. He was also previously a director of the Association of British Insurers, a member of the former Chancellor of the Exchequer’s High Level Group on Financial Services and Chairman of the Edinburgh World City of Literature Trust. In 2007 he was the Prince of Wales’ Ambassador for Corporate Social Responsibility in Scotland.
 
External appointments
· Chairman of Creative Scotland
· Member and vice-chairman of the Board of Governors of The Royal Conservatoire of Scotland
· President of the Cockburn Association
 
Board Committee membership
· Group Sustainability Committee (Chair)
· Board Risk Committee
· Group Nominations Committee
· Group Remuneration Committee
 
 
 
Alison Davis (age 50)
Date of appointment: 1 August 2011
 
Former director of First Data Corporation and chair of the board of LECG Corporation.  She previously worked at McKinsey & Company, AT Kearney, as chief financial officer at Barclays Global Investors (now BlackRock) and managing partner of Belvedere Capital, a private equity firm focused on buy-outs in the financial services sector.
 
 
External appointments
· Member of the Advisory Board of City National Bank
· Non-executive director of Unisys Corporation
· Chair of the Governing Board of Women’s Initiative for Self Employment
 
Board Committee membership
· Group Nominations Committee
· Group Remuneration Committee
 
 
 
Tony Di Iorio (age 68)
Date of appointment: 1 September 2011
 
Has worked for a variety of financial institutions starting with Peat Marwick (now KPMG) and then Goldman Sachs, ultimately as controller of the global firm. He was chief financial officer of the investment bank of NationsBank (now Bank of America) before joining Paine Webber and then Deutsche Bank where he became chief financial officer in 2006.  After retiring in 2008 he served as senior adviser to Ernst & Young working with the firm’s financial services partners in the UK, Europe, the Middle East and Africa.
 
 
External appointments
· None
 
Board Committee membership
· Board Risk Committee
· Group Audit Committee
· Group Nominations Committee
 
 
 
Penny Hughes, CBE (age 52)
Date of appointment: 1 January 2010
 
Previously a director and chairman of the Remuneration Committee of Skandinaviska Enskilda Banken AB and a non-executive director of Home Retail Group plc and chairman of its Remuneration Committee. She spent the majority of her executive career at Coca-Cola where she held a number of leadership positions, latterly as President, Coca-Cola Great Britain and Ireland. Former non-executive directorships include Vodafone Group plc, Reuters Group PLC and The Gap Inc.
 
 
External appointments
· Senior independent director of Cable & Wireless Worldwide plc
· Non-executive director of Wm Morrison Supermarkets plc
· Trustee of the British Museum
 
Board Committee membership
· Group Remuneration Committee (Chair)
· Group Nominations Committee

 
212

 
Our Board continued

Independent non-executive directors
       
 
 
Joe MacHale (age 60)
Date of appointment: 1 September 2004
 
Held a number of senior executive positions with J.P. Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region. Previously held non-executive roles at The Morgan Crucible Company plc and Brit Insurance Holdings plc. He is a fellow of the Institute of Chartered Accountants.
 
 
External appointments
· Trustee of MacMillan Cancer Support
· Chairman of Prytania Holdings LLP
 
Board Committee membership
· Board Risk Committee
· Group Nominations Committee
 
 
 
John McFarlane (age 64)
Date of appointment: 1 October 2008
 
Former chief executive officer of Australia and New Zealand Banking Group Limited.  Previously he was a group executive director of Standard Chartered and head of Citicorp/Citibank in the UK and Ireland. Former president of the International Monetary Conference and a former chairman of the Australian Bankers Association and has previously served as a director of the London Stock Exchange and a member of the Auditing Practices Board.
 
 
External appointments
· Non-executive director of Westfield Holdings Limited
· Deputy chairman and chairman designate of Aviva plc
 
Board Committee membership
· Group Nominations Committee
· Group Remuneration Committee
 
 
 
Brendan Nelson (age 62)
Date of appointment: 1 April 2010
 
Former global chairman, financial services for KPMG. Previously held senior leadership roles within KPMG including as a member of the KPMG UK board from 1999 to 2006 and as vice chairman from 2006. Chairman of the Audit Committee of the Institute of Chartered Accountants of Scotland from 2005 to 2008.
 
 
External appointments
· Non-executive director and chairman of the Audit Committee of BP plc
· Board member of Financial Skills Partnership
· Member of the Financial Reporting Review Panel
· Vice President of the Institute of Chartered Accountants of Scotland
 
Board Committee membership
· Group Audit Committee (Chair)
· Board Risk Committee
· Group Nominations Committee
 
 
Baroness Noakes, DBE (age 62)
Date of appointment: 1 August 2011
 
An experienced director on UK listed company boards with extensive and varied political and public sector experience. A qualified chartered accountant, she previously headed KPMG’s European and International Government practices and has been President of the Institute of Chartered Accountants in England and Wales. She was appointed to the House of Lords in 2000 and has served on the Conservative front bench in various roles including as shadow treasury minister between 2003 and May 2010. Previously held non-executive roles on the Court of the Bank of England, Hanson, ICI, John Laing and SThree.
 
External appointments
· Non-executive director and chairman of Audit Committee of Severn Trent plc
· Senior independent director and chairman of Audit and Nominations Committees of Carpetright plc
· Trustee of the Thomson Reuters Founders Share Company Ltd
 
Board Committee membership
· Group Audit Committee
· Group Nominations Committee
 

 
213

 
 
Our Board continued
 
 
Independent non-executive directors
       
 
 
Arthur ‘Art’ Ryan (age 69)
Date of appointment: 1 October 2008
 
Former chairman, chief executive officer and president of Prudential Financial Inc.  Previously he held senior positions with Chase Manhattan Bank N.A. and was a founding member of the Financial Services Forum. He is a non-executive director of Citizens Financial Group, Inc.
 
 
 
External appointments
· Non-executive director of Regeneron Pharmaceuticals Inc.
· Active member of numerous community boards
 
Board Committee membership
· Group Nominations Committee
 
 
 
Philip Scott (age 58)
Date of appointment: 1 November 2009
 
Wide-ranging experience of financial services and risk management, including previous responsibility for Aviva’s continental European and International life and long-term savings businesses. He held a number of senior executive positions during his career at Aviva including his role as group finance director until January 2010. President Elect of the Institute and Faculty of Actuaries and Fellow of the Association of Certified Public Accountants.
 
 
External appointments
· Non-executive director and chairman of the Audit Committee of Diageo plc
 
Board Committee membership
· Board Risk Committee (Chair)
· Group Audit Committee
· Group Nominations Committee
 
Group Secretary
       
 
 
Aileen Taylor (age 39)
Date of appointment: 1 May 2010
 
A qualified solicitor, joined RBS in 2000. She was appointed Deputy Group Secretary and Head of Group Secretariat in 2007, and prior to that held various legal, secretariat and risk roles including Head of External Risk, Retail, Head of Regulatory Risk, Retail Direct and Head of Legal and Compliance at Direct Line Financial Services.
 
 
 
 
She is a fellow of the Chartered Institute of Bankers in Scotland, a fellow of the Industry and Parliament Trust and a member of the European Corporate Governance Council.
 
 
 
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Executive Committee

Stephen Hester, Group Chief Executive
Bruce Van Saun, Group Finance Director
For biographies see page 211

Ellen Alemany (age 56)
Chief Executive, Citizens and Head of Americas
Ellen Alemany joined the RBS Group in June 2007 as Head of RBS Americas. She became Chief Executive Officer of Citizens Financial Group, Inc. in March 2008 and Chairman in March 2009. Prior to these appointments, Ellen was the chief executive officer for Global Transaction Services at Citigroup, one of Citi’s 12 publicly reported product lines. Ellen joined Citibank in 1987 and held various positions including executive vice-president for Commercial Business Group, chairman and chief executive officer for Citibank International plc and Citibank’s European bank. She also served on the Citibank, N.A., Board of Directors. Ellen was elected to serve on the Board of Directors of Automatic Data Processing, Inc., beginning in January 2012.

Nathan Bostock (age 51)
Head of Restructuring & Risk
Nathan Bostock joined the RBS Group in June 2009. He is Head of Restructuring and Risk with responsibility for Risk Management, Legal & Regulatory Affairs, Global Restructuring Group and the Asset Protection Scheme.  Before joining RBS, Nathan spent eight years with Abbey National plc in several roles and was latterly the chief financial officer and main board director responsible for Products & Marketing, HR, Insurance and Cards. Before joining Abbey in 2001, Nathan spent ten years with RBS in a number of roles, including Chief Operating Officer of Treasury and Capital Markets and Group Risk Director. A Chartered Accountant, Nathan worked with Coopers & Lybrand, before starting his career in banking. He spent seven years in Chase Manhattan Bank in a variety of areas and functions.  He also holds a BSc (Hons) in Mathematics.

Paul Geddes (age 42)
Chief Executive, RBS Insurance
Paul Geddes was appointed as Chief Executive of RBS Insurance in August 2009, and is leading a significant transformation of the business ahead of its planned divestment from the Group. Prior to his move to Insurance, Paul was CEO of RBS Group's UK retail banking business, having joined RBS Retail in 2004 as Managing Director with responsibility for products and marketing. Before financial services, Paul held a number of senior roles in multi-channel retailing in the GUS and Kingfisher groups. Paul started his career in Marketing with Procter & Gamble in UK and European roles. Paul read PPE at Oxford, graduating in 1990, and remains a supporter of his college through music scholarships. He is a Fellow of the Chartered Institute of Bankers in Scotland, a member of the ABI Board and a member of the FSA Practitioner Panel.

Brian Hartzer (age 45)
Chief Executive, UK Retail, Wealth and Ulster Bank
Brian Hartzer has been the Chief Executive Officer for Retail, Wealth and Ulster Bank since August 2009. He joined RBS from ANZ in Australia, where he was chief executive officer Australia, as well as global segment lead for retail and wealth. Brian joined ANZ in 1999 as managing director, consumer finance, and later ran ANZ’s personal banking division. Prior to joining ANZ, Brian spent ten years as a financial services consultant in New York, San Francisco, and Melbourne. Brian is a graduate of Princeton University and holds joint US and Australian citizenship. Brian will leave the RBS Group in summer 2012.

John Hourican (age 41)
Chief Executive, Markets & International Banking
John Hourican was appointed Chief Executive, Markets & International Banking in January 2012 having served as Chief Executive of its predecessor, Global Banking & Markets, since October 2008. Prior to this John held a variety of positions across the RBS Group, including Chief Financial Officer of ABN AMRO Group, Head of Leveraged Finance and Chief Operating Officer of Global Banking & Markets. John received a degree in Economics and Sociology from the National University of Ireland and received a Postgraduate Diploma in Accounting from Dublin City University before starting his career at Price Waterhouse, where he worked in Dublin, London and Hong Kong. He is a fellow of the Institute of Chartered Accountants in Ireland.

Chris Sullivan (age 54)
Chief Executive, UK Corporate
Chris Sullivan was appointed Chief Executive of the UK Corporate Banking Division (including Global Transaction Services) in August 2009. His previous role was Chief Executive of RBS Insurance. Prior to this, Chris was Chief Executive of Retail and Deputy Chief Executive of Retail Markets. Chris is a member of the CBI President’s Committee, vice-chairman of the Global Banking Alliance for Women, a governor of the IFS and a governor of Ashridge Management College. Chris is also chairman of the Interalpha group of banks. He spent five years as chief executive of Lombard Asset Finance and under his leadership it attained a leading position in the UK and Europe. Chris Sullivan earned his Fellowship of the Chartered Institute of Bankers in Scotland for his services to Scottish Banking.

Ron Teerlink (age 51)
Chief Administrative Officer
Ron Teerlink joined the RBS Group in April 2008 as Chief Executive of Business Services, becoming the Group Chief Administrative Officer in February 2009. At the same time he was re-appointed to the Managing Board of ABN AMRO to oversee the integration programme. Ron started his career with ABN Bank in 1986 as an IT/Systems analyst and held various functional positions before becoming Chief Operating Officer of the Wholesale Clients Business in 2002. He was appointed Chief Executive Officer of Group Shared Services in 2004 and joined ABN AMRO’s Managing Board in January 2006, where he was responsible for Services and Market Infrastructure. Ron holds a Masters degree in Economics from Amsterdam’s Vrije Universiteit.

Management Committee
The Management Committee, comprising our major business and functional leaders, meets regularly, up to four times annually, as a vehicle for strategy and business performance review.

It comprises members of the Executive Committee plus a number of other senior executives. Full details of membership of the Management Committee can be found on the Group’s website www.rbs.com.
 
 
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Corporate governance

The Role of the Board
The Board is the main decision-making forum for the company. It is collectively responsible for the long-term success of the company and is accountable to shareholders for financial and operational performance.

The Board has overall responsibility for:

·  
establishment of Group strategy and consideration of strategic challenges;

·  
management of the business and affairs of the Group;

·  
ensuring the Group manages risk effectively through the approval and monitoring of the Group’s risk appetite;

·  
considering stress scenarios and agreed mitigants and identifying longer term strategic threats to the Group’s business operations;

·  
the allocation and raising of capital; and

·  
the preparation and approval of the Group’s annual report and accounts.

The Board’s terms of reference includes key aspects of the company’s affairs reserved for the Board’s decision and are reviewed bi-annually. The terms of reference are available on the Group’s website www.rbs.com.

There are a number of areas where the Board has delegated specific responsibility to management, including the Group Chief Executive and the Group Finance Director. These include responsibility for the operational management of the Group’s businesses as well as reviewing high level strategic issues and considering risk appetite, risk policies and risk management strategies in advance of these being considered by the Board and/or its Committees. Specific delegated authorities are also in place in relation to business commitments across the Group.

All directors participate in discussing strategy, performance and the financial and risk management of the company. Meetings of the Board are structured to allow sufficient time for consideration of all items and the Chairman encourages constructive challenge and debate.

Membership of the Board
The Board currently comprises the Chairman, two executive directors and ten independent non-executive directors, one of whom is the Senior Independent Director. The Board functions effectively and efficiently and is considered to be of an appropriate size. The directors provide the Group with the knowledge, mix of skills and experience required. The Board Committees comprise directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.

The names and biographical details of the members of the Board are shown on pages 211 to 214.
 
The Board is aware of the other commitments of its directors and is satisfied that all directors allocate sufficient time to enable them to discharge their responsibilities effectively.

The Board has established procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest are being operated effectively. With effect from 1 October 2008, the Companies Act 2006 introduced a statutory duty on directors to avoid conflicts of interest unless authorised. Since that date, the Board has considered, and where appropriate authorised, any actual or potential conflicts of interest that directors may have. The Board reviews its conflicts register annually.

Election and re-election of directors
In accordance with the provisions of the Code, all directors of the company, with the exception of John McFarlane, will stand for election or re-election by shareholders at the company’s Annual General Meeting. John McFarlane will step down from the Board on 31 March 2012. Further information in relation to the company’s Annual General Meeting can be found in the Chairman’s letter to shareholders which accompanies the notice of meeting.

Board balance and independence
The roles of Chairman and Group Chief Executive are distinct and separate, with a clear division of responsibilities. The Chairman leads the Board and ensures the effective engagement and contribution of all executive and non-executive directors. The Group Chief Executive has responsibility for all Group businesses and acts in accordance with the authority delegated by the Board.

The non-executive directors combine broad business and commercial experience with independent and objective judgement. The non-executive directors provide independent challenge to the executive directors and leadership team. The balance between non-executive and executive directors enables the Board to provide clear and effective leadership and maintain the highest standards of integrity across the Group’s business activities.

The Board considers that the Chairman was independent on appointment and that all non-executive directors are independent for the purposes of the Code. The standard terms and conditions of appointment of non-executive directors are available on the Group’s website www.rbs.com and copies are available on request from RBS Secretariat.
 
 
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Corporate governance continued

Board meetings
In 2011, nine Board meetings were scheduled and individual attendance by directors at these meetings is shown in the following table. Two of the Board meetings took place overseas during Board visits to the Netherlands in May 2011 and the United States in September 2011.

In addition to the nine scheduled meetings, 24 additional meetings of the Board and Committees of the Board were held, including meetings to consider and approve financial statements. The Chairman and the non-executive directors meet at least once per year without executive directors present.

Total number of Board meetings in 2011
Attended/
scheduled
Sandy Crombie
9/9
Alison Davis (1)
4/4
Tony Di Iorio (2)
3/3
Philip Hampton
9/9
Stephen Hester
9/9
Penny Hughes
9/9
Joe MacHale
9/9
John McFarlane
8/9
Brendan Nelson
9/9
Baroness Noakes (1)
4/4
Art Ryan
9/9
Philip Scott
9/9
Bruce Van Saun
9/9
   
Former director
 
Colin Buchan (3)
6/6

Notes:
(1)
Joined the Board on 1 August 2011.
(2)
Joined the Board on 1 September 2011.
(3)
Retired from the Board on 5 August 2011.

Principal activities of the Board during 2011
In advance of each Board meeting, the directors were supplied with comprehensive papers in hard copy and electronic form.

At each Board meeting, the Chairman provided a verbal update and the Group Chief Executive provided a written report on business activities.

The directors also received reports on the Group’s financial performance, capital, funding and liquidity position, risk management and government lending commitments together with regular reports on strategy, risk appetite, litigation and treating customers fairly. Specific strategy sessions and updates were considered in June, August and December.

Members of the executive management team attend and make regular presentations at meetings of the Board to give the directors greater insight into the business areas.

An annual programme of divisional presentations is agreed by the Board each year. During 2011, the Board received in-depth presentations from Global Transaction Services, Non-Core division, Global Banking & Markets, RBS Insurance, Citizens, UK Retail and Ulster Bank. These presentations enhance the Board’s knowledge of the Group’s key divisions and afford directors the opportunity for discussion and debate with divisional senior management. Other key areas of focus for the Board during 2011 included the Independent Commission on Banking reports, Recovery and Resolution Planning and other regulatory reports and updates and these will continue to be key areas of focus for the Board during 2012.

Board Committees
In order to provide effective oversight and leadership, the Board has established a number of Board Committees with particular responsibilities. The Committee chairmanship and membership are reviewed on a regular basis. The names and biographies of all Board Committee members are set out on pages 211 to 214.

The terms of reference of the undernoted committees are available on the Group’s website www.rbs.com and copies are available on request.

The Board Committees are discussed in their individual reports:

Group Audit Committee - pages 221 to 225
Board Risk Committee - pages 226 to 229
Group Remuneration Committee - pages 230 to 251

Information, induction and professional development
All directors receive accurate, timely and clear information on all relevant matters. All directors also have access to the advice and services of the Group Secretary who is responsible to the Board for ensuring that Board procedures are followed and for advising on all governance matters. In addition, all directors are able, if necessary, to obtain independent professional advice at the company’s expense.

In line with the recommendations of the Walker Review of Governance in Banks and Financial Institutions (the Walker Review) and the Code, the Group Secretary has reviewed the induction programme for new directors. Each new director receives a formal induction on joining the Board, including visits to the Group’s major divisions and meetings with directors and senior management and key stakeholders. The induction is tailored to the director’s specific requirements.

Drawing on the previous experiences of the new directors appointed to the Group Board in 2011, the Group Secretary created tailored induction programmes for each of Alison Davis, Baroness Noakes and Tony Di Iorio which were designed to give them an in-depth insight into the range of businesses of the Group. Each induction programme included a mandatory element which comprised 12 meetings, visits and sessions. The remainder of the induction programme included in excess of 30 meetings with key executives and their teams, stakeholders and visits to divisions, businesses and Group Functions, both in the UK and overseas.

 
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Corporate governance continued

The Group Secretary also provides a comprehensive and ongoing professional development programme for directors. Directors are advised of appropriate external training and professional development opportunities and undertake the training and professional development they consider necessary to assist them to carry out their duties as directors. Internal training is also provided, tailored to the business of the Group. As part of their ongoing development in 2011, the directors received briefings on the UK Bribery Act 2010, the European Commission Green Paper on the EU Corporate Governance Framework, various Financial Reporting Council Consultations, amendments to the Code, the Capital Requirements Directive IV, a Group Treasury presentation on Balance Sheet Management and Capital Management & Term Funding and participated in a business visit to Group Technology.

Business visits are also arranged as part of the Group Audit Committee and Board Risk Committee schedule and all non-executive directors are invited to attend. During 2011, visits were made to Group Internal Audit, RBS N.V., Restructuring and Risk and RBS Insurance.

Performance evaluation
In accordance with the Code, an external evaluation of the Board takes place every three years with the last externally facilitated evaluation having taken place in 2009.

The 2010 evaluation was conducted internally and a number of initiatives were implemented aimed at improving the overall performance and effectiveness of the Board. These included further improvements to the flow of information to the Board, both in terms of the quality of papers and the use of new technology to deliver these to directors. The 2011 evaluation concluded that the recommendations from the 2010 evaluation had been implemented in full.

Performance evaluation process
The directors agreed that the 2011 evaluation of the Board and its key Board Committees be conducted internally, led by the Group Secretary. The Group Secretary undertook a formal and rigorous evaluation by:

·  
circulating a detailed framework of questions to all directors and regular meeting attendees;

·  
collating the responses and conducting structured individual meetings with each director and regular meeting attendees;

·  
discussing the outcomes and recommendations with the Chairman; and

·  
agreeing the recommendations and outcomes with the Board and Board Committee members.

Amongst the areas reviewed were Board role and composition, Group strategy, risk management, Board meetings and processes, external relationships, Board committees, directors’ support and information, and continuing professional development.
 
Findings of performance evaluation 2011
The Board has considered and discussed reports on the outcomes of the evaluation and is satisfied with the way in which the evaluation was conducted.

The evaluation concluded that the Board is strong, operating effectively and meeting its objectives. Headed by an excellent Chairman, the Board is currently viewed as an appropriate size, although Board composition should be kept under continual review. Meetings are of an appropriate length and frequency with sufficient opportunity for debate and discussion, although it was suggested the Board continue to make use of evening and lunch slots to facilitate further debate and discussion on key areas such as strategy and risk management.

A summary of the objectives and actions proposed to be taken to address the objectives arising from the 2011 performance evaluation is set out below:

Key themes
Proposed action
Board role and composition
In light of John McFarlane stepping down from the Board in March 2012 the composition of the Board and Board committees should be reviewed to ensure the current balance of skills, experiences, independence and knowledge is maintained.
Strategy
The Board should continue the focus on Group strategy in the short, medium and long term to ensure the strategy is appropriate and sustainable in the current environment.
Risk management
Risk reporting should continue to be developed to ensure the Group Board has adequate oversight of risk management and risk appetite.
Succession planning
Group executives should be invited to the Group Board to discuss bench strength and succession planning in their respective functions.

Individual director and Chairman effectiveness reviews
Within the performance evaluation questionnaires, directors were asked to provide feedback on their fellow directors. This feedback was shared with each director by the Chairman, who met with each director individually to discuss their own performance and ongoing professional development. Separately, the Senior Independent Director canvassed the views of the executive directors and met with the non-executive directors as a group, without the Chairman present, to consider the Chairman’s performance. Feedback was sought on governance and stewardship of the Group, relationships with key external and internal stakeholders, execution of the Group’s Strategic Plan and delivery of value and return to shareholders. The Senior Independent Director also canvassed views from United Kingdom Financial Investments Limited (UKFI), the FSA and the Asset Protection Agency. The results of the Chairman effectiveness review were then shared with the Chairman who agreed to consider the points raised and provide separate responses in due course.

 
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Corporate governance continued


Group Nominations Committee
Role of the Group Nominations Committee
The Group Nominations Committee is responsible for:

·  
reviewing the structure, size and composition of the Board and making recommendations to the Board on any appropriate changes;

·  
assisting the Board in the formal selection and appointment of directors (executive and non-executive) having regard to the overall balance of skills, knowledge, experience and diversity on the Board;

·  
reviewing membership and chairmanship of Group Board Committees;

·  
considering succession planning for the Chairman and the executive and non-executive directors, taking into account the skills and expertise which will be needed on the Board in the future. No director is involved in decisions regarding his or her own succession; and

·  
making recommendations to the Board concerning the re-election by shareholders of directors under the provisions of the Code. In so doing, they will have due regard to their performance and ability to continue to contribute to the Board in light of the knowledge, skills and experience required and the need for progressive refreshing of the Board.

The terms of reference of the Group Nominations Committee are available on the Group’s website www.rbs.com.

The Group Nominations Committee engages with external consultants, considers potential candidates and recommends appointments of new directors to the Board.

Membership of the Group Nominations Committee
All non-executive directors are members of the Group Nominations Committee which is chaired by the Chairman of the Group. The Group Chief Executive is invited to attend meetings. The Group Nominations Committee holds at least two scheduled meetings per year, and also meets on an ad hoc basis as required. In 2011, five meetings of the Group Nominations Committee were held. The Chairman and members of the Committee during 2011, together with their attendance at meetings in 2011, is shown below.

Total number of meetings in 2011
Attended/
scheduled
Philip Hampton (Chairman)
5/5
Sandy Crombie
5/5
Penny Hughes
4/5
Joe MacHale
5/5
John McFarlane
5/5
Brendan Nelson
5/5
Art Ryan
5/5
Philip Scott
5/5
   
Former member
 
Colin Buchan (1)
5/5

Note:
(1)
Retired from the Board on 5 August 2011.

The table below sets out the tenure of non-executive directors.
 


Principal activity of the Group Nominations Committee during 2011
Appointment of new non-executive directors
During 2011, the Group Nominations Committee focussed on changes to the Board’s composition and succession planning for the executive directors.

The Group Nominations Committee reviewed the structure, size and composition of the Board and agreed that the composition of the Board could be enhanced with the recruitment of candidates with financial services expertise and experience of European and regulatory issues.  It was also agreed that non-UK based candidates should be considered, ideally from the US or Europe. It was recognised that investment banking as well as governmental experience would be useful.

To ensure the Group had access to a wide pool of suitable candidates, the Chairman and Group Secretary contacted two executive search firms with a role profile and a description of the skills required to enhance the Board composition.  The Chairman considered a number of candidates before submitting several shortlists to the Group Nominations Committee for consideration. Following discussion, it was agreed that the combination of skills, knowledge and experience of Alison Davis, Baroness Noakes and Tony Di Iorio would enhance the composition of the Board.

Board and Committee membership
When considering the appointment of Alison Davis, Baroness Noakes and Tony Di Iorio, and the retirement of Colin Buchan, the Group Nominations Committee also reviewed the membership of the Group Board Committees. Based on the expertise of the incoming non-executive directors, the Group Nominations Committee agreed to strengthen the Group Board Committees with additional members.

 
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Corporate governance continued

Diversity
At its meeting in June 2011, the Group Nominations Committee considered a letter from Lord Davies recommending that a Board discussion be held prior to the announcement of aspirational diversity targets in September 2011. The statement released in September 2011 announced that the Group is supportive of Lord Davies’ recommendations and aspires to meet the target of 25 per cent female board representation in 2012 as set out in Lord Davies’ report and confirmed that the Group will continue to meet or exceed this standard. In December 2011, in accordance with the recommendations contained within Lord Davies’ report, the Board established a boardroom diversity policy including measurable objectives for implementing the policy.

The Group understands the importance of diversity and recognises the importance of women having greater representation at key decision making points in organisations. The search for Board candidates will continue to be conducted, and nominations/appointments made, with due regard to the benefits of diversity on the Board. However, all appointments to the Group Board are based on merit, measured against objective criteria, and the skills and experience the individual can bring to the Group Board.

The balance of skills, experience, independence, knowledge and diversity on the Board, and how the Board operates together as a unit is reviewed annually as part of the Board evaluation. Where appropriate, findings from the evaluation will be considered in the search, nomination and appointment process. If appropriate, additional targets on diversity will be developed in due course.

Further details on the Group’s approach to diversity can be found on page 258.

Succession planning
The Group Nominations Committee considers succession planning on an ongoing basis. The Board considered talent and succession planning for the Group Chief Executive and each member of the Executive Committee at a meeting in June 2011. The meeting concluded that the executive team was extremely strong and the Board should continue to monitor the position as industry developments progress.

Group Sustainability Committee
The Group Sustainability Committee (GSC) is chaired by the Senior Independent Director and meets quarterly. The GSC is responsible for reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues. All key business areas are represented on the GSC and it is attended by the Group Chairman. Further details of the Group’s sustainability policies are available on the Group’s website www.rbs.com/sustainability and in the Annual Sustainability Report.
 
Relations with shareholders
The Chairman is responsible for ensuring effective communication with shareholders. The company communicates with shareholders through the Annual Report and Accounts and by providing information in advance of the Annual General Meeting. Individual shareholders can raise matters relating to their shareholdings and the business of the Group at any time throughout the year by letter, telephone or email via the Group’s website www.rbs.com/ir.

Shareholders are given the opportunity to ask questions at the Annual General Meeting or can submit written questions in advance. Directors including the chairs of the Group Audit, Board Risk, Group Remuneration and Group Nominations Committees are available to answer questions at the Annual General Meeting. The Senior Independent Director is also available.

Communication with the company's largest institutional shareholders is undertaken as part of the Investor Relations programme:

·  
the Group Chief Executive and Group Finance Director meet regularly with UKFI, the organisation set up to manage the Government’s investments in financial institutions, to discuss the strategy and financial performance of the Group. The Group Chief Executive and Group Finance Director also undertake an extensive annual programme of meetings with the company’s largest institutional shareholders.

·  
the Chairman independently meets with the Group’s largest institutional shareholders annually to hear their feedback on management, strategy, business performance and corporate governance. Additionally, the Chairman, Senior Independent Director and chairs of the Board Committees met with the governance representatives of a number of institutional shareholders during the year.

·  
the Senior Independent Director is available if any shareholder has concerns that they feel are not being addressed through the normal channels.

·  
the Chair of the Group Remuneration Committee consults extensively with institutional shareholders in respect of the Group’s remuneration policy.

Throughout the year, the Chairman, Group Chief Executive, Group Finance Director and Chair of the Group Remuneration Committee communicate shareholder feedback to the Board and the directors receive independent analyst notes and reports reviewing share price movements and the Group’s performance against the sector. Detailed market and shareholder feedback is also provided to the Board after major public announcements such as results announcements. The arrangements used to ensure that directors develop an understanding of the views of major shareholders are considered as part of the annual Board evaluation.
 
 
 
220

 
Report of the Group Audit Committee

Letter from Brendan Nelson,
Chairman of the Group Audit Committee


Dear Shareholder,

I am pleased to bring you this report following my first full year as Chairman of the Group Audit Committee.

I would like to begin by welcoming Baroness Noakes and Tony Di Iorio who joined the Committee in August and September 2011, respectively; coinciding with Colin Buchan’s retirement from the Group Board. They bring with them a wealth of experience and knowledge. I am grateful to Colin for his commitment to the Committee.

2011 has been a difficult year for the industry and for the Group and the Committee has concentrated its efforts on key emerging issues. In particular, it has considered and, where appropriate, made recommendations to the Group Board in respect of:

·  
the continued market turmoil and its effect on the Group’s businesses, in particular the GBM division;

·  
the ongoing Eurozone crisis and impairment of the Group’s sovereign debt exposure;

·  
impairment charges in the UK Corporate and Ulster Bank divisions;

·  
Payment Protection Insurance (PPI) provision;

·  
the implications, including the capital, risk and control assumptions and dependencies of the proposed structured transfer of the assets and liabilities of RBS N.V. to RBS plc;

·  
the adequacy of internal change processes and controls;

·  
the activity, performance and findings of Internal and External Audit; and

·  
the quality and transparency of disclosures contained in external financial statements.
 
The oversight role of the Committee in these areas is explained in more detail in the Committee’s full report given below.

It is clear that 2012 will be as challenging as 2011. External conditions, internal change and the remediation of known and future issues, while managing the regulatory agenda, will make ‘business as usual’ extremely challenging. The Committee will continue to monitor compliance with the Group’s current regulatory requirements and monitor the implications of proposed future regulatory change, including the Independent Commission on Banking’s recommendations as they develop through 2012. Internal organisational change will also present challenges and the Committee will provide oversight of the revised control framework within the new Markets and International Banking division as it fully embeds.

I am pleased to report the recent appointment of Nicholas Crapp as our new Head of Group Internal Audit. Nicholas joined the Group at the beginning of 2012 and I look forward to his contribution to this challenging agenda. Overall, I am confident that with the continued commitment of my fellow colleagues and the support of the Group executive, the Committee is well placed to meet the challenges of 2012.
 

Brendan Nelson
Chairman of the Group Audit Committee
22 February 2012

 
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Report of the Group Audit Committee continued
 
 
Report of the Group Audit Committee
The role and responsibilities of the Group Audit Committee
The Group Audit Committee’s primary responsibilities, as set out in its terms of reference, are to assist the Board in discharging its responsibilities in respect of: financial reporting and policy; systems of internal control; processes for Internal and External Audit and oversight of the Group’s relationship with its regulators. The terms of reference of the Group Audit Committee are reviewed annually by the Group Audit Committee and approved by the Board. They are available on the Group’s website www.rbs.com.

Meetings and visits
A total of seven meetings of the Group Audit Committee were held in 2011, including meetings held immediately before the submission of the annual and interim financial statements and the quarterly Interim Management Statements to the Board. Group Audit Committee meetings are attended by relevant executive directors, the Internal and External Auditors and Finance and Risk management executives. Other executives, subject matter experts and external advisers are also invited to attend the Group Audit Committee, as required, to present and advise on reports commissioned by the Committee. At least twice per annum the Group Audit Committee meets privately with the External Auditors. The Committee also meets privately with the Internal Audit function.

The annual programme of joint visits by the Group Audit and Board Risk Committees to the Group's business divisions and control functions continued in 2011. The object of the programme is to promote the Committees’ understanding of the Group; invitations to attend are extended to all non-executive directors. The programme of visits is considered annually. The Group Audit Committee and the Board Risk Committee undertook four visits - to Group Internal Audit, RBS N.V., Restructuring and Risk and RBS Insurance - during 2011.

Membership of the Group Audit Committee
The Group Audit Committee comprises at least three independent non-executive directors. The Chairman and members of the Committee, together with their attendance at meetings, are shown below.

   
Attended/
scheduled
Brendan Nelson (chairman)
Independent
7/7
Tony Di Iorio (1)
Independent
2/2
Baroness Noakes (2)
Independent
3/3
Philip Scott
Independent
7/7
     
Former member
   
Colin Buchan (3)
Independent
5/5

Notes:
(1)
Joined the Committee on 1 September 2011.
(2)
Joined the Committee on 1 August 2011.
(3)
Retired from the Committee on 5 August 2011.

Brendan Nelson, Tony Di Iorio and Philip Scott are also members of the Board Risk Committee facilitating the effective governance of finance and risk issues and the alignment of agendas. The Group Audit and Board Risk Committees also have strong links with the Group Remuneration Committee ensuring that levels of compensation reflect relevant finance and risk considerations.

The members of the Group Audit Committee are selected with a view to the expertise and experience of the Group Audit Committee as a whole. The Board is satisfied that all Group Audit Committee members have recent and relevant financial experience, and that each member of the Group Audit Committee is an ‘Audit Committee Financial Expert' and is independent, each as defined in the SEC rules under the US Securities  Exchange Act of 1934 (“Exchange Act”) and related guidance. Full biographical details are set out on pages 211 to 214.

Principal activity of the Group Audit Committee during 2011
Financial reporting
During 2011, the Group Audit Committee received regular updates on accounting issues and developments from both the Group Chief Accountant and from the External Auditors who presented for approval their audit plan, their audit fee proposal and engagement letter, as well as confirmation of their independence and a comprehensive report of all non-audit fees.

The Group Audit Committee focused on a number of salient judgments and reporting issues in the preparation of the 2011 accounts, including:

·  
valuation methodologies and assumptions for financial instruments carried at fair value including the Group's credit market exposures;

·  
disclosures, including those in relation to forbearance and sovereign debt;

·  
impairment losses in the Group's loans and advances and available-for-sale securities; with particular emphasis on Eurozone issues, sovereign debt exposures, Ulster Bank and UK Corporate impairment;

·  
PPI provision;

·  
actuarial assumptions for the Group Pension Fund and the Group’s general insurance claims reserves;

·  
impairment of goodwill; and

·  
the Group’s tax position, including the recognition of deferred tax assets.

The Committee sought to understand and to challenge in a robust manner management’s accounting judgments and estimates. It reviewed the conclusions of the External Auditors and, where applicable, other experts and satisfied itself that disclosures in the financial statements about these judgements and estimates are transparent and appropriate.

 
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Report of the Group Audit Committee continued

Internal Control
In 2011, the Group Audit Committee tracked progress in the development and implementation of the new Group Policy Framework across the Group and will continue to monitor progress in embedding the framework throughout 2012. It will review the results of assurance activity in respect of the new framework in the latter half of the year.

The Group Audit Committee reviewed the control framework in place to ensure that it is operating effectively and specifically reviewed progress against its plan for a number of large strategic initiatives such as the Finance and Risk Transformation Programme. It also tracked progress in relation to mandatory and remedial projects including the Group’s Anti-Money Laundering Programme and the progress of the Group’s US regulatory initiatives.

The Committee reviewed the effectiveness of the Group New Product Approval Process, the Credit Quality Assurance Process and considered the operation of the Group Notifiable Event Process as it applies in specific circumstances.

The Committee received reports and considered the Group’s compliance with the requirements of the Sarbanes-Oxley Act of 2002. It was regularly advised of: whistle-blowing events which occurred within the Group; complaints raised with members of the Group’s executive team; and significant internal investigations undertaken within the Group.

Divisional Risk and Audit Committees have been established with responsibility for reviewing the business of each division and reporting to the Group Audit Committee and Board Risk Committee. Given the size and complexity of the Group, these committees are an essential component of the governance framework that supports the effective operation of the Group Audit Committee and Board Risk Committee across the organisation. The Committee has agreed changes to the Divisional Risk Reporting framework and these improvements will be implemented during 2012. Quarterly reports are received by the Group Audit Committee and Board Risk Committee from each Divisional Committee.

Internal audit
The Group Audit Committee oversees the work of Group Internal Audit, and receives a quarterly report from the Head of Group Internal Audit. This report rates the quality of the control environment of all the Group’s divisions and of management’s level of awareness on these matters.  It offers the Group Audit Committee oversight of Group Internal Audit’s work, and allows the Group Audit Committee to monitor the level of internal control within the Group by reporting on areas where improvements are required to the control environment.

During 2011, the Committee sought to enhance further management responsiveness to Group Internal Audit findings and has developed a process to invite management to respond, either directly or in writing, to the Committee regarding identified deficiencies. The Group Audit Committee monitors these findings and management responses ensuring that issues raised are dealt with in a timely and appropriate manner.
 
The Group Audit Committee also considers Group Internal Audit’s annual plan and the adequacy of its resources and budget.  During 2011, the Group Audit Committee actively supported the development of the Internal Audit vision and strategy and the transition to thematic reporting and the development of centres of excellence. It has supported increased resources for the function and has been directly involved in the process for the appointment of the new Head of Group Internal Audit.

An external review of the effectiveness of Group Internal Audit takes place every three to five years, in line with best practice, with internal reviews continuing in intervening years. In January 2012, the Group Audit Committee undertook an internal evaluation of Group Internal Audit.  The evaluation concluded that Group Internal Audit had operated effectively throughout 2011.

External audit
Deloitte LLP have been the company’s auditors since March 2000. There are no contractual obligations restricting the company's choice of external auditor.

During 2011, the External Auditors provided the Group Audit Committee with reports summarising their main observations and conclusions arising from their year end audit, their half year review and their work in connection with the first and third quarters and their recommendations for enhancements to the Group’s reporting and controls. Deloitte also presented for approval to the Committee their audit plan, their audit fee proposal and engagement letter, as well as confirmation of their independence and a comprehensive report of all non-audit fees.

The Group Audit Committee undertakes an annual evaluation to assess the independence and objectivity of the External Auditors and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The annual evaluation is carried out following completion of the annual accounts and audit. In assessing the effectiveness of the Group’s External Auditors, the Group Audit Committee has regard to:

·  
the experience and expertise of the senior members of the engagement team;

·  
the proposed scope of the audit work planned and executed;

·  
the quality of dialogue between the External Auditors, the Committee and senior management;

·  
the clarity, quality and robustness of written reports presented to the Committee setting out the External Auditors’ findings arising form the audit;

·  
the quality of observations provided to the company by the External Auditor on the Group’s systems of internal control; and

·  
the views of management on the performance of the External Auditors.

 
223

 
 
Report of the Group Audit Committee continued

In addition to the annual evaluation performed by the Group Audit Committee, the External Auditors also conduct their own annual review of audit quality. Twelve service criteria for the audit have been defined by the External Auditors to measure their performance against the quality commitments set out in their annual audit plan, under the headings of ‘quality of audit, approach and conduct’, ‘independence and objectivity’, ‘quality of the team’ and ‘value added’. Feedback will be obtained and discussed with the relevant internal stakeholders. The results of this exercise will be presented to the Group Audit Committee, with actions defined and agreed to address any areas where performance has fallen below expected standards.

The Group Audit Committee is responsible for making recommendations to the Board in relation to the appointment, re-appointment and removal of the External Auditors. In order to make a recommendation to the Board, the Group Audit Committee considers and discusses the performance of the External Auditor in the previous year, taking account of the outcomes of the annual evaluation carried out. The Board submits the Group Audit Committee's recommendations to shareholders for their approval at the Annual General Meeting. The Board has endorsed the Group Audit Committee's recommendation that shareholders be requested to approve the reappointment of Deloitte LLP as External Auditors at the Annual General Meeting in 2012. The Group Audit Committee has considered the proposals for reform of the audit market as published by the EU Commission. It will continue to monitor developments in this regard including the potential implications for External Auditor appointment in the UK.

The Group Audit Committee approves the terms of engagement of the External Auditors. The Group Audit Committee also fixes the remuneration of the External Auditors as authorised by shareholders at the Annual General Meeting.

Audit and non-audit services
The Group Audit Committee has adopted a policy on the engagement of the External Auditors to supply audit and non-audit services, which takes into account relevant legislation regarding the provision of such services by an external audit firm.

In particular, the Group may not engage the External Auditors to provide any of the non-audit services described below:

·  
bookkeeping or other services related to the accounting records or financial statements;

·  
financial information systems design and implementation;

·  
appraisal or valuation services, fairness opinions or contribution-in-kind reports;

·  
actuarial services;

·  
internal audit outsourcing services;

·  
management functions or human resources;

·  
broker or dealer, investment adviser, or investment banking services;

·  
legal services and expert services unrelated to the audit; or

·  
other services determined to be impermissible by the US Public Company Accounting Oversight Board.

The Group Audit Committee reviews the policy annually and prospectively approves the provision of audit services and certain non-audit services by the External Auditors. Annual audit services include all services detailed in the annual engagement letter including the annual audit and interim reviews (including US reporting requirements) and periodic profit verifications.

Annual audit services also include statutory or non-statutory audits required by any Group companies that are not incorporated in the UK. Terms of engagement for these audits are agreed separately with management, and are consistent with those set out in the audit engagement letter insofar as local regulations permit. During 2011, prospectively approved non-audit services included the following classes of service:

·  
capital raising, including consents, comfort letters and relevant reviews of registration statements;

·  
provision of accounting opinions relating to the financial statements of the Group;

·  
provision of reports that, according to law or regulation, must be rendered by the External Auditors;

·  
tax compliance services;

·  
permissible services relating to companies that will remain outside the Group;

·  
restructuring services relating to the Group's customers; and

·  
reports providing assurance to third parties over certain of the Group's internal controls prepared under US Statement of Auditing Standards 70 or similar auditing standards in other jurisdictions.

For all other permitted non-audit services, Group Audit Committee approval must be sought, on a case by case basis, before the provision of the service commences. The Group Audit Committee reviews and monitors the independence and objectivity of the External Auditors when it approves non-audit work, taking into consideration relevant legislation, ethical guidance and the level of non-audit services relative to audit services. The approval process is rigorously applied to prevent the External Auditors from functioning in the role of management, auditing their own work, or serving in an advocacy role.
 
 
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Report of the Group Audit Committee continued

 
During 2011, the Group Audit Committee approved changes to the Group’s non-audit services policy. Tax compliance services, permissible services to companies that will remain outwith the Group and restructuring services will require ad hoc approval of the Group Audit Committee in 2012. In addition, a competitive tender process will be required for all proposed engagements where the fees are expected to exceed £100,000. Engagements below £100,000 may be approved by the Chairman of the Group Audit Committee; as an additional governance control all engagements have to be approved by the Group Chief Accountant and Group Sourcing and Vendor Management. Ad hoc approvals of non-audit services are ratified by the Group Audit Committee each quarter. During 2011, the External Auditor was approved to undertake certain significant engagements which are categorised and explained more fully below:

Summary of category of engagement
Reason for selection of External Auditor
Provision of advice, best-practice options and support to management on a number of projects (four engagements)
 
 
The External Auditor was appointed in relation to these engagements because it was the market leader in the subject matter or because the external audit team included personnel who were uniquely positioned, experienced and qualified to provide the necessary advice.
 
A full tender process was undertaken in relation to two engagements and the External Auditor was appointed following presentation of a thorough proposal and a willingness to leverage existing knowledge to ensure a competitive price proposition.
Assurance testing RBS, NatWest and Ulster Bank customer charters and the Group’s Corporate Governance Policy
(three engagements)
 
The External Auditors prior experience and ability to make use of previous work made them a competitive choice for the assurance of the various customer charters.
 
A selective tender was undertaken to provide support and advice to the Group Secretary for the assurance of the Group Corporate Governance Policy. The External Auditor was judged to be both financially competitive and provided the clearest, and most comprehensive approach to supporting the Group Secretary in this assignment.
Agreed upon procedures (AUP) review for Wealth Management
(one engagement)
 
The External Auditor was experienced in this field and had performed three previous AUP reviews.  Timing was also an issue for this request but a competitive tender process will be considered prior to the next review.
Tax and accounting advice
(two engagements)
 
The External Auditor was appointed for one of the engagements following submission of a detailed proposal document, formal presentation and lengthy discussion with RBS management. Given the nature of the engagement it was determined that appointment of the External Auditor was appropriate.
 
Following a tender process in the other instance the External Auditor was judged to be the best firm to employ and was agreed by the co-sponsors to the engagement.

Information on fees paid in respect of audit and non-audit services carried out by the External Auditors is detailed in Note 5 on the Group’s consolidated accounts.

Group’s relationship with its regulators
The Group Audit Committee has a responsibility to monitor the Group’s relationship with the Financial Services Authority (FSA) and other regulatory bodies.  During 2011, it received regular reports on the Group’s relationship with all its regulators and significant developments or changes to those interactions. It receives reports on regulatory actions and investigations. Over the course of the year the chairmen of the Group’s Senior Board Committees met with the FSA on an individual basis and also participated in certain Regulatory College meetings with the Group’s primary regulators. The non-executive directors also collectively participated in meetings with the FSA on two occasions and the FSA were invited to attend certain discussions of the Board.

The non-executive directors closely monitor the Group’s relationship with its international regulators and during 2011 significant time has been dedicated in particular to understanding the regulatory requirements in the US and the implications on the Group’s US operations and structure.
The Group Board met with the Federal Reserve Bank of Boston collectively in this regard during 2011. The Chairman of the Group Audit Committee also met with the US regulator on an individual basis.

Performance evaluation
An external review evaluating the effectiveness of the Group Audit Committee takes place every three to five years, with internal reviews by the Board in intervening years. An internal review took place during 2011 covering the role of the Committee; its composition, meetings and processes, performance and reporting, policy and procedures; induction and continuing professional development; communication; and divisional committees. Overall the review concluded that the Committee continued to operate effectively.

Brendan Nelson,
Chairman of the Group Audit Committee
22 February 2012

 
225

 

Report of the Board Risk Committee
 
Letter from Philip Scott,
Chairman of the Board Risk Committee
 
 
 
Dear Shareholder,

I am pleased to bring you this report on the activity of the Board Risk Committee during 2011.

As one would expect, managing the risks presented by the challenging external market conditions that have continued throughout 2011 has been a key priority of the Committee. Market, credit and liquidity risk have featured prominently in the discussions of the members in the period. The regulatory agenda has continued to exert pressures on the organisation and the Committee has sought to understand the global implications of proposed regulation while managing and overseeing remediation of known issues. The Committee has continued to build upon existing relationships with the Group’s regulators globally, wherever possible.

Tony Di Iorio joined the Committee with effect from 1 September 2011. It is my pleasure to welcome Tony to the Committee. I am certain that his broad background in financial services and global investment banking will prove to be immensely useful to the Committee, particularly in managing the complex risks presented by the Group’s new Markets and International Banking Division. Colin Buchan retired from the Group Board in August 2011 and I would like to thank Colin for his contribution to the Committee during the first half of the year.

The Board Risk Committee was created in January 2010 following the recommendations set out in the Walker Review and it is therefore a relatively new committee to the Group. Notwithstanding the challenges presented by external market forces, it was important that the Committee, during its second year of operation, continued to fully refine and enhance its approach to risk oversight and its interaction with other senior Board Committees. I am pleased to report that during 2011 the Committee has made progress in the following areas:

·  
further development of a risk appetite framework and methodology;

·  
development of a new conduct risk appetite framework;

·  
enhancement of the Group Policy Framework.  This has been a major project for the Group in 2011 and the Board Risk Committee has provided oversight of the project which has now completed its critical initial phase;
 
·  
interaction with the Group Remuneration Committee. Penny Hughes, Chair of the Group Remuneration Committee, and I sponsored a project in 2011 to review and improve interaction between both committees. This has led to clarification of responsibilities, improved planning and the identification of additional trigger points outwith pay cycles where risk should be taken into consideration;

·  
improvement of reporting standards;

·  
promotion of a risk awareness culture; and

·  
oversight of the enhancement of the risk governance framework that supports the Committee at an executive level.

The activity of the Committee is set out more fully in the Report of the Board Risk Committee below. However, while progress has been made, the work of the Committee is in no way complete and these risk areas will remain a key area of focus and refinement in 2012. The risk appetite framework must be fully embedded across divisions and the Committee recognises that development of an economic capital model must be prioritised in 2012. Furthermore, the difficulties being experienced in Europe and the US will necessitate a continued focus on market and sovereign risk in the year ahead.

It is not yet possible to determine the impact of the recommendations contained within the Report of the Independent Commission on Banking.  The recommendations are complex and it will take time to fully consider what they mean for the Group and any corresponding strategic and organisational change. The Board Risk Committee will monitor developments and will fully consider the risk implications of any decision in this regard.

 
Philip Scott
Chairman of the Board Risk Committee
22 February 2012

 
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Report of the Board Risk Committee continued

Report of the Board Risk Committee
Role of the Board Risk Committee
The Board Risk Committee is responsible for providing oversight and advice to the Board in relation to current and potential future risk exposures of the Group and future risk strategy, including determination of risk appetite and tolerance. The Committee reviews the performance of the Group relative to risk appetite and provides oversight of the effectiveness of key Group policies. The Board Risk Committee has responsibility for promoting a risk awareness culture within the Group.

Authority is delegated to the Board Risk Committee by the Group Board and the Committee will report and make recommendations to the Group Board as required. The terms of reference of the Board Risk Committee are available on the Group’s website www.rbs.com and these are considered annually by the Board Risk Committee and approved by the Board.

Meetings and visits
The Board Risk Committee held six scheduled meetings and three additional ad hoc meetings in 2011. Meetings are held alongside Group Audit Committee meetings to ensure that the work of the two Committees is coordinated and consistent. Board Risk Committee meetings are attended by relevant executive directors, risk management and finance executives and the internal auditors. External advice may be sought by the Board Risk Committee where considered appropriate. During 2011, the members of Board Risk Committee in conjunction with the members of the Group Audit Committee took part in an annual programme of visits to the Group's business divisions and control functions. Details about the programme of visits is set out in the Report of the Group Audit Committee on page 222.

Membership
The Board Risk Committee is comprised of at least three independent non-executive directors. The Chairman and members of the Committee, together with their attendance at meetings, are shown below.

 
Attended/
scheduled
Philip Scott (chairman)
Independent
6/6
Sandy Crombie
Independent
5/6
Tony Di Iorio (1)
Independent
1/1
Joe MacHale
Independent
6/6
Brendan Nelson
Independent
6/6
     
Former member
   
Colin Buchan (2)
Independent
4/5

Notes:
(1) Joined the Committee on 1 September 2011.
(2) Retired from the Committee on 5 August 2011.

Philip Scott, Tony Di Iorio and Brendan Nelson are also members of the Group Audit Committee. This common membership ensures effective governance across all Finance and Risk issues, and that agendas are aligned and overlap is avoided.
 
Principal activity of the Board Risk Committee during 2011
Risk strategy and policy
The Board Risk Committee is fully engaged in the risks deriving from the recently announced organisational changes to form the new Markets and International Banking division and consideration of the impact of the FSA’s Recovery and Resolution programme and where possible the ICB proposals on the wider Group, will be a priority of the Committee over the course of 2012 and beyond.

Development of the Group Policy Framework has been a major project for the Group in 2011 and the Board Risk Committee has provided oversight and direction to the project. Standards have now been developed, benchmarked and are now being implemented across the organisation. The Board Risk Committee will continue to ensure that the standards are properly embedded globally and will review the output of assurance testing to ensure that the standards are operating effectively.  Risk governance across the Group, including the operation of the Board Risk Committee, will be reviewed pursuant to the Corporate Governance Policy standard and the Committee will take forward any recommendations from that review during the course of 2012.

The Committee has overseen the development of a conduct risk appetite statement and framework during 2011. The Committee regards conduct risk to be a fundamental tenet of risk and will receive reports in 2012 on the implementation of the standard and framework across the organisation, including how conduct risk is considered from the point of product inception to conclusion of a relationship with a customer. The terms of reference of the Committee have been extended to cover conduct risk specifically.

Risk profile
The Committee receives a detailed report on key risks and metrics at each meeting and receives an oral report from the Chief Risk Officer at each meeting on the key risks to the organisation. This enables the Committee to identify the key risk areas where more focus should be directed. The Committee reported to the Board following each meeting on its consideration of the risk profile of the Group and any longer term macro or perceived strategic threats to the Group and made recommendations as appropriate.

The Board Risk Committee has assumed responsibility on behalf of the Group Board for considering key areas of risk in a deeper level of granularity. In particular, during 2011 it has played an important governance role in the oversight and remediation of regulatory issues in the RBS Americas region. Brendan Nelson has personally provided oversight of the Executive Steering Group established with responsibility for remediation of known issues in the region and the Committee receives regular reports on progress.

In response to market events, the Committee has reviewed its controls for potential weaknesses from a rogue trading perspective. This review identified that most controls were effective and the Committee will oversee the remedial work that is underway to resolve all potential weaknesses identified.

 
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Report of the Board Risk Committee continued

The Committee has also considered the risks inherent within large strategic transactions such as the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank.

The Committee reviewed the capital and liquidity position of the Group regularly during 2011 in light of external conditions and has reviewed the output of stress tests, including the Group results under the EU wide stress testing exercise of the European Banking Authority, the results of which were published in July 2011.  It has considered and made recommendations to the Group Board in relation to the Individual Liquidity Adequacy Assessment and the Individual Capital Adequacy Assessment required by the FSA.

Regulatory risk has featured highly on the agenda of the Committee. The members have received reports on the status of ongoing regulatory investigations and have considered individual remuneration impacts (if any), as those investigations progress. Regulatory developments have been monitored and the regulatory risks associated with the sale of complex products to certain customers have been considered. Operational risks inherent in the Groups processes have also been considered and the Committee has specifically considered continuity and data control.

The difficulties being experienced in Europe and the US necessitated a continued focus on market and sovereign risk over the course of 2011.  The Committee received additional reports in this regard and will continue to closely monitor and manage these risks in 2012.

Risk appetite, framework and limits
The Committee has kept the Group Board appraised of the considerable progress made in relation to development of a risk appetite framework and methodology during 2011 and it has made recommendations to the Board in this regard. The Committee will ensure this framework is fully aligned with the conduct risk framework and is rolled out and embedded across divisions in 2012.

As set out in the Group Audit Committee report on page 223 a framework of Divisional Risk and Audit Committees are responsible for reviewing the business of each division and reporting to the Group Audit Committee and Board Risk Committee. The risk agenda of these committees continues to evolve alongside the Board Risk Committee agenda. In 2011, a quarterly risk assessment process was introduced to raise awareness and understanding of risk appetite at divisional level. While this assessment has had some success, risk reporting at a divisional level has been further refined and aligned with regulatory process. A new Material Risk Assessment process will be implemented within the divisions in 2012 and will be overseen by the Divisional Risk and Audit Committees. This will streamline reporting and standardise structure across the divisions. Progress will be closely monitored by the Board Risk Committee in 2012.
 
While some progress has been made, significant work is still required to fully develop an operational economic capital model for the Group.  This will be an area of focus for the Committee over the coming year.

Risk management operating model
Culture is key to driving the correct behaviours from a risk perspective.   In recognition of this, the Committee received regular updates during 2011 on the One Risk programme, including the risk management vision and values. The Committee has reviewed the calibre of senior risk personnel and succession planning arrangements. It has also reviewed the adequacy of that resource alongside its review of the scope and nature of work undertaken by the risk management function.

During 2011, the risk governance model has been extensively reviewed and streamlined at executive level. The role of the Executive Risk Forum has been clarified. The Executive Risk Forum has responsibility for consideration of strategic risk and policy issues in advance of the Board Risk Committee and aims to provide an effective filter of the key risks for the consideration of the Board Risk Committee.

Risk architecture
The Committee has sought continually to drive improvements to reporting standards and has implemented new guidance for the presentation of papers for the consideration of the Committee. It has held separate discussions to refine and enhance the quality of the key risk report and metrics and following those discussions a revised risk report will be operational in 2012. Work is ongoing to develop risk reporting at entity level (in addition to reporting at a Group and divisional level).

The Committee has monitored the standards of data quality across the Group and the programmes in place to improve management information and reporting. In particular, the Committee has tracked progress of the Finance and Risk Transformation Programme designed to develop a golden source of data for use in reporting across the Group.

Remuneration
The Board Risk Committee has continued to strengthen its relationship with the Group Remuneration Committee with the aim of ensuring that risk is adequately reflected in objectives and compensation arrangements and decisions. Significant improvements have been made in 2011 including clarification of responsibilities, improved planning and the identification of additional trigger points outwith pay cycles where risk should be taken into consideration. This improved interaction has led to a number of additional meetings of the Board Risk Committee specifically to consider the risk implications of remuneration decisions.


 
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Report of the Board Risk Committee continued

Performance evaluation
An internal review of the effectiveness of the Board Risk Committee during 2011 was conducted. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, performance and reporting, policy and procedures, divisional committees, induction and continuing professional development and communication. The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted, the conclusions and the recommendations for action. The outcomes of the evaluation have been reported to the Board, and during 2012, the Committee will place focus on driving improvements to:

·  
the structure of the agendas to ensure the Committee is focused on consideration of the key issues - while recognising the remit of the Committee is extremely onerous;

·  
Divisional Risk and Audit Committees: implementing the changes to the risk assessment process and reporting;

·  
enhance the bench strength of the Risk Management function; and

·  
the Committee’s interaction with the Executive Risk Forum.







Philip Scott
Chairman of the Board Risk Committee
22 February 2012


 
229

 
Directors’ remuneration report
 
 
Letter from Penny Hughes
Chair of the Group Remuneration Committee
 

Dear Shareholder,

Remuneration in banks continues to be an important and sensitive topic and this is particularly true at RBS. And so it has been another eventful and challenging year for the Group Remuneration Committee.

It is worth reiterating that since 2008, there has been a complete change of the executive leadership team at RBS. Those who were responsible for the problems of the past have been replaced by a team charged with fixing them.  On pay, we operate with a strong sense of restraint but it's important that our people believe that they'll be treated fairly and competitively. We consider that this is in the best interests of our shareholders and customers. We aim to set pay and incentives based on performance and market conditions, appropriate to the different markets in which our people operate, the objectives we set them and results we get from them, and a desire to minimise costs where consistent with our wider goals.  We are a commercially run bank and that principle must apply to how we pay all of our employees. Overall, our pay is towards the lower end of market norms in aggregate.

My priority as Chair of the Group Remuneration Committee is to implement a remuneration policy that serves the long-term interests of our shareholders including, of course, the UK taxpayer. We recognise the duty of public accountability and therefore the need to be sensitive to the public’s views on pay, particularly for senior people. It is a difficult balance that we are trying to achieve in reconciling the, at times, conflicting objectives of our various stakeholders.

Financial Performance
A key factor in the Committee’s deliberations is the financial performance of the Group. RBS is a unique recovery challenge and success must be measured by the progress we are making towards being a safer, stronger and more sustainable bank. Effectively we are asking our management team to do two jobs; to successfully compete with strong banking competitors across our ongoing businesses AND to recover RBS from its legacy risk profile, itself the largest corporate restructuring on record.  In 2011 the Group put even greater priority on actions to strengthen its balance sheet and reduce risks in the face of difficult economic and financial market conditions, as it continued to work through the restructuring plan embarked upon in 2009.  Key financial achievements for 2011 were:

·  
Core Bank Operating Profit of £6.1 billion represents a strong performance and compares well with other similar sized banks;

·  
Core Bank’s Return on Equity (ROE) was 10.5%, with Retail & Commercial ROE at 11.3%, or 16.6% excluding Ulster Bank. Our investment bank’s ROE was 7.7%, notwithstanding the challenging market conditions;

·  
The Group funded balance sheet decreased by £49 billion to £977 billion;

·  
The Core Tier 1 ratio of 10.6% and tangible net asset value per share of 50.1p were broadly stable over the year, in spite of de-risking costs and regulatory impacts;

·  
Group operating profit was £1.9 billion, up 11% after adjusting for the disposal of Global Merchant Services at the end of 2010;

·  
Group expenses were 7% lower in 2011 than in 2010 at £15.5 billion; with staff costs down 9%;

·  
Impairment losses totalled £7.4 billion, which is down 20% from 2010; and

·  
Targets for reducing Non-Core assets have been exceeded, reducing by £44 billion to £94 billion in 2011.

As well as the financial achievements above, the Committee takes into account the Group's performance against a range of broader strategic objectives, including support to personal and business customers in the communities in which it operates. In 2011 gross new lending to business increased by 22%, with lending to SMEs up 4%, exceeding the Group's Merlin targets. The Committee also considers the scale of the businesses our leadership team are managing.  For example, during 2011, our 2,000 UK retail branches served 18 million customers; our corporate banking division accounted for almost half of all new lending to UK SMEs; and our investment bank operated in 38 countries and arranged €12 billion of loans and €10 billion of bonds for UK corporates.

Whilst there is still much to do to deliver an overall profitable business as we pay for the costs of repair, we are already much better positioned as a safer, stronger bank.

Executive directors
Events at the start of 2012 put the difficulty of balancing our stakeholders’ interests firmly into the public spotlight. The bonus for Stephen Hester in relation to the 2011 performance year attracted considerable attention from the media and politicians and I wanted to explain the reasons behind that decision.

We have been very clear over recent years that pay for performance, not failure, is at the heart of our remuneration policy. Under the leadership of the current executive directors, RBS has made significant progress in exceptionally difficult circumstances. In recognition of this, the Board believed, and still believe, that the award to its Group Chief Executive was justified in the context of the market and appropriate based on achievement against the performance objectives that had been set (see page 240 for further details).  The Board’s decision was well-balanced and took into account all the circumstances, including the fall in share price over 2011, which was mirrored in most other banks. The award was offered on terms that are arguably amongst the most reformed in our industry and endorsed at the 2011 AGM by over 99% of our shareholders.  The award would have been delivered entirely in shares, been deferred and subject to clawback.
 
230

 
Directors’ remuneration report continued

Stephen Hester subsequently decided to waive his bonus because the attention it received had become a damaging distraction for him and the Group. Since this announcement, many of our major shareholders have expressed overwhelming support for all members of our leadership team and are supportive of the Group Remuneration Committee’s efforts to ensure that these individuals are fairly rewarded as they continue to lead the turnaround of the Group. There is significant concern that the alternative - attempting to operate on a less-than-commercial basis - would be value destructive if RBS becomes an unattractive place to work.

I am convinced that the remuneration approach that we have developed will serve all our stakeholders well in the long term.

Group-wide remuneration arrangements
It is not only the executive directors’ interests that the Committee considers. It is also tasked with recognising the work of all our employees, whilst maintaining a balance and showing restraint.  Examples of where we have shown such restraint are as follows:

·  
More than 10,000 of the Group’s most senior employees will not receive a pay increase for 2012;

·  
Average salary increases for 2012 will be less than 1%;

·  
85% of employees eligible for a bonus will receive less than £10,000. The majority of employees eligible for a bonus will receive less than £2,000;

·  
The investment bank bonus pool is down by 58% over the last year.  This follows a 33% reduction between 2009 and 2010; and

·  
There has been a 43% reduction at Group level in variable compensation. Details of our variable compensation can be found in Note 3 on the consolidated accounts on page 291.

The Committee recognises the importance of driving cultural change, not just through pay, but in the wider sense.  As Group Remuneration Committee Chair, I am actively involved in the Group’s initiatives relating to diversity, graduate recruitment and management development.  I’m impressed by the quality and depth of these initiatives around the Group, many of which have received award-winning recognition.

Another area of focus for the Group Remuneration Committee in 2011 has been how value is shared between investors and employees. Shareholders have rightly questioned whether banks, and in particular investment banks, have got this right in the past. We are working hard to get this right now and in the future. A balance is always required between minimising compensation costs, and so maximising profits in the year, and protecting the business from which future profits can flow.

We have sought to strike this balance fairly, while erring on the side of restraint, reflecting the nature of our ownership. In this context, I am pleased to report that the returns achieved in our investment bank, while below our targets, compare favourably to our competitors. Yet our compensation ratios are among the lowest and this has been the position for the last three years.

We do consider that pay at all investment banks became overheated during the exuberant period of growth pre-financial crisis.   It is clear that the industry as a whole delivered results in 2011 below the cost of capital.  This is an unsustainable position with further significant costs of regulation to come. We are committed to taking necessary action on pay alongside the other strategic business decisions we make around the reduced size and scope of our activities in order to build a sustainable business, capable of serving customers and delivering fair and adequate returns for shareholders and employees.

Our restrained approach to pay is not without risk. Employees at all levels of RBS have choices about where they work. If we allow a sizeable gap to open up between how we pay and how others pay, then it will affect our ability to attract and retain good, well-motivated people to work here. We do not believe that this would be in the interests of our shareholders, our customers, or the taxpayer.

We believe we are getting the balance right in difficult circumstances. Under the leadership of Stephen Hester and his team, RBS is a challenging but inspiring place to work. Employee engagement continues to improve, which demonstrates the pride our people have in helping to fix and recover from one of the biggest failures in corporate history.  Whilst the road to recovery is proving more challenging than probably any of us envisaged, our people are working hard to help return the Group to financial strength and the Group Remuneration Committee remains committed to helping create an environment in which they can meet their ambitions.

The remuneration process undertaken by the Group Remuneration Committee is thorough and robust. This year’s report contains more detail on the decision process to demonstrate to you how engaged and committed the Committee is to making the best decisions for the benefit of shareholders, employees and wider stakeholders.

Finally, let me thank my fellow Committee members for their extensive contributions and all those who supported the Committee to help us  weigh up all the relevant factors and seek the right balance in our decision-making.



Penny Hughes
Chair of the Group Remuneration Committee
22 February 2012
 
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Report of the Group Remuneration Committee
The role and responsibilities of the Group Remuneration Committee
The Group Remuneration Committee is responsible for setting the Group’s policy on remuneration and overseeing its implementation. It considers and makes recommendations to the Group Board in respect of the remuneration arrangements of the executive directors of the Group. No director is included in decisions regarding his or her own remuneration.

The Group Remuneration Committee is also responsible for approving remuneration and severance arrangements for members of the Group’s Executive and Management Committees, as well as overseeing arrangements for employees who are ‘In-Scope’ under the Asset Protection Scheme (APS) or ‘Code Staff’ under the FSA Remuneration Code. Details of the FSA Remuneration Code can be found at www.fsa.gov.uk and a definition of Code Staff is provided on page 237.

The terms of reference of the Group Remuneration Committee are available on the Group’s website www.rbs.com and these are reviewed annually by the Committee and approved by the Group Board.

Membership of the Group Remuneration Committee
All members of the Committee are independent non-executive directors. The Committee held nine meetings in 2011. The Chair and members of the Committee, together with their attendance at meetings, are shown below:

 
Attended / Scheduled
Penny Hughes (chair)
 
9/9
Sandy Crombie
 
9/9
Alison Davis (1)
 
4/4
John McFarlane (2)
 
9/9

Notes:
(1)
Became a member of the Committee on 1 August 2011.
(2)
Will step down as a member of the Committee on 31 March 2012.

Enhanced governance
The Group Remuneration Committee has taken a number of steps during 2011 to enhance its governance arrangements:

·  
Alison Davis was appointed as an additional member to bring further financial experience and fresh expertise;

·  
private sessions are held at each Committee meeting with only the Group Chairman and non-executive directors present;

·  
a strategy session is carried out to ensure agendas focus on key issues in relation to remuneration;

·  
reporting between the Committee and the Group Board has been improved so that all directors are fully informed and able to discuss the approach being taken; and

·  
greater focus was placed on international regulatory compliance as requirements emerge across the territories in which we operate.

Principal activity of the Group Remuneration Committee during 2011

First quarter
·  
new arrangements for the executive directors. Following extensive shareholder consultation and consideration by the Committee, Share Bank arrangements and new long term incentive plans (LTIP) performance measures were introduced;

·  
remuneration arrangements and year-end performance reports for members of the Executive Committee, Management Committee and annual performance objectives for 2011 and also LTIP performance objectives;

·  
remuneration arrangements and year-end performance reports for APS In-Scope employees and Code Staff;

·  
new process for divisional bonus pools implemented with advice from the Board Risk Committee on risk performance;

·  
progress against unvested LTIP performance measures;

·  
approval of the Group and divisional bonus pools; and

·  
approval of Directors’ remuneration report.

Second quarter
·  
key business and strategic priorities; presentations from Non-Core, RBS Insurance and GBM;

·  
project to enhance risk input into remuneration; and

·  
formal remuneration strategy session - compensation structure and priorities for the forthcoming year were agreed.

 
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Third quarter
·  
half year performance reviews for executive directors, members of the Executive Committee and Management Committee; and

·  
outcome of Group Internal Audit review on how the FSA Remuneration Code has been implemented which showed management is aware of the key risks and are pro-active in identifying issues relating to remuneration.

Fourth quarter
·  
review of risk-adjusted performance across the Group and divisions;

·  
preliminary bonus pools discussions for Group and divisions;

·  
enhanced process for review of risk trigger events for clawback and bonus reduction;

·  
content for shareholder consultations undertaken in December 2011 and January 2012; and

·  
report from the project to enhance risk input into remuneration with recommendations for actions.

In addition, the Committee received regular knowledge updates on global remuneration regulatory developments; pay consultations issued by the FSA, Department for Business, Innovation & Skills, HM Treasury and the High Pay Commission; guidelines from shareholders and investor bodies; and market trends reports.

Advisers to the Group Remuneration Committee
The advisers to the Group Remuneration Committee are appointed independently by the Committee, which reviews its selection of advisers annually. The advisers are instructed by and report directly to the Committee. The Committee Chair oversees the fees for the advisers.

PricewaterhouseCoopers LLP (PwC) were appointed as the Committee’s remuneration advisers on 14 September 2010, and their appointment was reconfirmed by the Committee in June 2011 after an annual review of the quality of the advice received and fees charged. PwC are signatories to the voluntary code of conduct in relation to remuneration consulting in the UK.

PwC also provide professional services in the ordinary course of business including assurance, advisory, tax and legal advice to subsidiaries of the Group. The Committee Chair is notified of other work that is being undertaken by PwC and is satisfied that there are processes in place to ensure that the advice the Committee receives is independent.

As well as receiving advice from PwC during 2011, the Committee took account at meetings of the views of the Group Chairman, Group Chief Executive, Group Finance Director, Group Human Resources Director, Group Head of Reward, Group Secretary and the Chief Risk Officer.

Performance evaluation process
An internal review of the effectiveness of the Group Remuneration Committee was conducted by the Group Secretary during 2011. The evaluation was based on detailed questionnaires and individual meetings with each member and attendee. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, continuing professional development and communication. Generally, the Committee was considered to be effective and meeting its objectives, with members willing to spend the time necessary to discharge their responsibilities.  The evaluation respondents agreed that the Committee was the right size, with an appropriate composition and was headed by a committed Chair.  The respondents were also impressed by the level of work undertaken outside of the meetings, particularly by the Chair.

A number of actions arose from the evaluation relating to the further improvement of the meeting arrangements, including:

·  
improved performance from the Committee’s internal and external resources;

·  
further improvement on length and clarity of materials provided to the Committee; and

·  
monitoring of the new processes for risk input into remuneration and processes for reporting and escalation of trigger events which may lead to clawback or bonus reduction.

The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation was conducted, the conclusions and the recommendations for actions. The outcomes of the evaluation have been reported to the Group Board and the actions are being progressed.


 
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Key inputs to the Group Remuneration Committee to assist its decision-making
The Group Remuneration Committee receives regular updates on regulatory developments and general remuneration issues, as well as market and benchmarking data to support its decisions. It also received information from a number of external and internal sources during 2011.  The diagram below illustrates this:
 


 
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Shareholder consultation and its impact on remuneration policy
In late 2011 and early 2012, an extensive consultation was undertaken with institutional shareholders and other stakeholders on the Group’s remuneration approach.  Investors recognised the difficult challenge faced by the Group Remuneration Committee in balancing the need to pay competitively to support business goals but at the same time being mindful of the wider economic environment and the need to show restraint.

The shareholders gave a clear message that increases to base pay and pension contributions for executive directors were not appropriate.  However, the overall shape of executive remuneration structure received widespread support.  Shareholders recognised the need for retention of the current executive team and the potentially destructive effect that any break up would have on rebuilding the Group.

This consultation included UKFI and as with other shareholders, the Committee received their input.  However, in line with the Group’s mandate to operate commercially, the Committee did not receive formal direction from UK Government.

The consultation process involved one-to-one meetings, a roundtable session hosted by the Association of British Insurers and National Association of Pension Funds and a number of follow-up letters and meetings.
 
Topics discussed with investors included both Group-wide and executive directors’ pay positioning, scale and design of incentive structures, risk alignment of remuneration, deferral, clawback and remuneration disclosures.

The importance of value sharing between investors and employees, retaining capital, and taking this into account in remuneration decisions were key themes from the shareholder consultation. As mentioned in the letter from the Committee Chair, value sharing between investors and employees and retention of capital have been key areas for the Remuneration Committee during 2011. In 2011 variable compensation was 11% of Core Bank operating profit, down from 16% in 2010. This proportion compares favourably with other banks.

There was also concern over falling share prices across the industry. Some shareholders proposed that LTIP award levels to employees should be scaled back given the fall in the share price over 2011. The Committee recognises the impact that the fall in share price has had both on shareholders and employees. The share awards that were made to employees at the beginning of 2011, under bonus deferral or the long term incentive plan, have fallen in value. This is clear alignment with the value reduction that shareholders have experienced. It is also true in the case of prior year unvested and vested but retained awards.

The Committee has considered the LTIP award policy for 2012 in light of the Group’s current share price and has reduced potential awards to executive directors by capping them at 300% of salary.

The population receiving LTIP awards has also been reviewed, and for 2012, there will be a significant reduction as LTIP awards are targeted at the Group’s most senior management. All LTIP awards are subject to both group-wide and division/function specific performance conditions to ensure that the leadership team is focused on both value creation and other key objectives. Group performance targets will be aligned to the executive director LTIP performance targets to ensure a consistent view of performance.

The Group Remuneration Committee and the Group Board have considered carefully their responsibilities and have applied judgement to achieve a balance whereby remuneration policy supports business goals without causing unacceptably high people risks.

The support received by shareholders during the consultation period has been greatly encouraging. Shareholders have played a key role in developing remuneration practices that support the long term goals of the business.

Risk and regulatory environment
FSA Remuneration Code compliance
The Group has been fully compliant throughout 2011, in practice and in spirit, with all aspects of the FSA Remuneration Code.

How risk is reflected in our remuneration process
Focus on risk is achieved through clear risk input into incentive plan design and target setting, as well as thorough risk review of performance, bonus pools and clawback. The Group Remuneration Committee is supported in this by the Board Risk Committee and the Group’s risk management function.

During 2011, a project was undertaken, co-sponsored by the Chairs of the Group Remuneration Committee and Board Risk Committee, to identify and implement further areas of improvement in risk/remuneration alignment. The project focussed on three workstreams:

·  
robust governance (clarify and enhance respective roles of the Group Remuneration Committee and Board Risk Committee and the interaction between them);

·  
pay-for-performance (risk input into objectives and performance reviews and enhanced clawback process); and

·  
control function input and risk adjusted performance measures.

How do we apply this in practice?
The assessment undertaken by the risk function and Board Risk Committee confirmed that, for some divisions, a number of risk-related events needed to be taken account of when determining bonus pools, including regulatory, compliance and credit and market risk issues.

 
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The enhanced process for individual accountability review assessments (which consider material risk management, control and general policy breach failures, accountability for those events and appropriate action against individuals) is operated across divisions and functions. RBS Risk Management has concluded that the accountability review assessments approach is robust and complete from a perspective of all known material events having been considered.

The outcomes from recent accountability reviews for the performance year 2011 have included:

·  
adjustment of current year bonus awards;
·  
dismissal;
·  
clawback of previously awarded deferred and LTIP awards; and
·  
suspended vesting pending further investigation.

External developments
In September 2011, the Department for Business Innovation and Skills (BIS) issued a consultation on plans for investors to have greater clarity on how companies are run and how executive pay is matched to performance. The Group Remuneration Committee played an active role in this consultation process, providing responses and meeting with representatives from BIS on a number of occasions to discuss possible outcomes. This demonstrates a real willingness to engage not just with shareholders but with wider stakeholders in developing a responsible approach to future remuneration practices.

HM Treasury published a consultation on 6 December 2011 with draft regulations on remuneration disclosure. This proposes that all large banks operating in the UK, publish the pay details of their eight highest paid senior executive officers who are not main board directors. The consultation follows the Project Merlin agreement in February 2011 that applied to the five major UK banks including RBS.  Details are set out on page 252.

Pay for performance
The Group Remuneration Committee’s formal process for determining bonus pools is outlined in the diagram below. This process is designed to ensure that financial, risk and non-financial performance measures are all taken in to account in an integrated and structured way with appropriate reference being made to the business plan and capital adequacy.

There is strong central governance and oversight of both bonus pools and individual awards.  Across the Group, bonus awards for the 2011 performance year are significantly lower than those made last year. This is due to a combination of factors including financial performance, particularly in the investment bank division, but also recognising the need for moderation and the external climate. This year we have recorded substantial losses for two issues: PPI and Greek sovereign debt.  Whilst current management inherited these issues, the Committee’s judgement is that reductions to shareholder value of this scale must be reflected in lower variable compensation across the Group and overall bonus pools have been reduced as a result.
 
The process for determining bonus pools is discretionary, to avoid the unintended consequences and incentives of formulaic systems. However, the Group Remuneration Committee's discretion is applied within a structured framework which starts with an assessment of financial performance measured against budget, prior year and long-term strategic plans. This analysis is used to adjust market median bonus funding levels (obtained from rigorous benchmarking against market compensation data) to a performance-adjusted basis.

Risk is taken into account in the performance assessment through a thorough risk analysis carried out by RBS Risk Management to a pre-agreed framework approved by the Group Remuneration and Board Risk Committees. Performance assessments may be adjusted in situations where risk performance is outside risk appetite or strategic plans. Non-financial factors such as turnover, succession issues, customer issues, market environment and franchise development are then taken into account in developing a final bonus proposal. Bonus proposals are reviewed in the context of key compensation framework ratios including: compensation to revenues, compensation to pre-compensation profit and bonus to pre-bonus profit. These ratios help to ensure appropriate sharing of value between employees and shareholders. Finally bonus proposals are reviewed against our capital adequacy framework to ensure that regulatory requirements are met.


 
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Remuneration policy
The remuneration policy supports the Group’s business strategy and is designed to:

·  
attract, retain, motivate and reward high calibre employees to deliver long term business performance within acceptable risk parameters;

·  
provide clear alignment between annual and long-term targets for individuals and Group/divisional strategic plans; and
 
·  
ensure that the Group’s metrics, reward structures and governance processes as a whole provide coverage of the key risks in an appropriate way.

In the Non-Core division and businesses we are exiting, appropriate arrangements are put in place to ensure that employees are motivated to reduce risk effectively, to minimise losses taken on value of businesses/ assets at the point of divestment.

The remuneration policy applies the same principles to all employees including Code Staff (1).  The current key principles underpinning the Group-wide remuneration policy are set out below:
 
Base salary
 
Base salaries are reviewed annually. Base salaries should be competitive in the specific market for the business in which the individual works; reflect the talents, skills and competencies that the individual brings to the Group; and be sufficient so that inappropriate risk-taking is not encouraged.
Annual incentives
 
The annual incentive pool is based on a balanced scorecard of measures including financial performance, risk, people and customer measures.  Capital adequacy and the impact of incentive awards on the balance sheet are also taken into account.
 
Allocation from the pool depends on divisional, functional and individual performance. Individual performance assessment is supported by a structured performance management framework.
 
Guaranteed bonuses are only used in limited circumstances in accordance with the FSA Remuneration Code.
 
Immediate cash bonuses are limited to a maximum of £2,000.
 
Deferred awards support a performance culture where employees recognise the importance of sustainable Group, business and individual performance. Under the Group-wide deferral arrangements a significant proportion of annual incentive awards for our more senior employees are deferred over a three year period. Deferred awards are subject to clawback.
 
In certain circumstances, formulaic short-term incentive arrangements are used to align the objectives of employees with the strategy of the relevant division in which they work.  For such schemes, specific design principles are in place, with strict governance procedures that ensures that all existing and future incentive schemes support our business strategy and risk appetite.
 
All incentive awards are subject to appropriate governance, including independent review by the Risk Management, Finance and HR functions, with oversight from the Group Performance and Reward Committee, which has delegated authority from the Group Remuneration Committee over incentive schemes operating over a period of 12 months or less.
LTIP
To encourage the creation of value over the long term and to further align the rewards of the participants with the returns to shareholders, the Group provides certain employees in senior roles with long-term incentive awards. Awards are structured as performance-vesting shares. Vesting will be based partly on divisional or functional performance and partly on performance across the Group.   All awards are subject to clawback.
Other share plans
Employees in certain countries are eligible to participate in share plans which are not subject to performance conditions.
Benefits
(including pension)
In most jurisdictions, employee benefits or a cash equivalent are provided from a flexible benefits account.
 

(1) The following groups of employees have been identified as meeting the FSA’s criteria for Code Staff:

-  
Members of the Group Board and Group Executive and Management Committees;
-  
Staff performing a Significant Influence Function within RBS Group;
-  
Employees who have approval authorities such that their decision-making could have a material impact on the RBS Group income statement;
-  
Employees who are responsible for a business or businesses whose performance could have a material impact on the RBS Group income statement; and
-  
Key control function roles.
 

 
 
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Executive directors
In determining directors’ remuneration, the Group Remuneration Committee takes into account pay and employment conditions of employees of the company.  It does so by reference to annual market data against an assessment of the competitiveness of the current base salary ranges or benchmarks and actual salaries in payment. Any salary increases awarded to executive directors are also considered in the context of salary increases for the wider employee population. A summary of executive directors’ remuneration for 2011 and 2012 is set out below:

 
Policy
2011 arrangements
2012 arrangements
Base salary
Base salaries are reviewed annually.
Stephen Hester: £1,200,000
Bruce Van Saun: £750,000 (from 1 April 2011)
No increase to executive directors’ base salary.
Annual Incentive
Executive directors have a normal maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).
 
 
For the 2011 performance year, the annual incentive was delivered as an allocation to Share Bank.
 
Stephen Hester:
Provisional maximum allocation of 6.0 million shares to Share Bank. Final allocation based on performance: 3.6 million shares. Stephen Hester has waived this award.
 
Bruce Van Saun:
Provisional maximum allocation of 3.75 million shares to Share Bank. Final allocation based on performance: 3.0 million shares.
 
The shares will vest in two equal tranches on the first and second anniversaries of the date of grant. Prior to vesting, shares will be subject to clawback and shares must be held for a further six months post vesting.
Both Stephen Hester and Bruce Van Saun will have a maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).
 
Incentives will be awarded entirely in shares which will vest in two equal tranches on the first and second anniversaries of the date of grant. Prior to vesting, shares will be subject to clawback and shares must be held for a further six months post vesting.
 
LTIP
Awards to executive directors have a normal maximum limit of 400% of salary.
 
All awards are subject to performance conditions, deferral and clawback.
Both Stephen Hester and Bruce Van Saun received share awards capped at 375% of basic salary.
 
The awards will vest in 2014 in an amount based on the achievement of performance conditions (see description on page 242).  These will each have the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 375% of salary (based on salary and share price at the time the award was made).
 
An additional six month holding period after vesting will apply.
Stephen Hester and Bruce Van Saun will be granted long term share awards which will ultimately vest in a range between zero and a cap of 300% of basic salary depending on performance over the next three years. These share awards have a notional value at grant assessed at £1.62 million and £1.01 million respectively.
 
The awards will vest in 2015 in an amount based on the achievement of performance conditions (see description on page 245).  These will each have the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 300% of salary (based on salary and share price at the time the award was made). The notional value of these awards would be 45% of face value, which is 135% of salary.
 
An additional six month holding period after vesting will apply.
Benefits (including Pension)
Benefits are available from a flexible account on a similar basis to other employees.
 
None of the current executive directors are members of the Group's defined benefit pension plans. Current executive directors receive an allowance in lieu of pension contributions.
Benefits provided in line with Group policy.
 
 
35% (of base salary) pension allowance.
Benefits provided in line with Group policy.
 
 
35% (of base salary) pension allowance.
 

 
 
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Shareholding guidelines
The Group operates shareholding guidelines for executive directors.  The target shareholding level for the Group Chief Executive is 200% of gross annual salary and 100% of gross annual salary for executive directors. A period of five years is allowed in which to build up shareholdings to meet the guideline levels.

The mix of executive directors’ remuneration
The charts below show the composition of remuneration opportunity for on-target annual performance, with the long term incentive awards shown at the expected value. Short term incentive payments earned in relation to 2012 performance will be deferred and will vest, subject to satisfactory performance. The actual value of the long term incentive awards will depend on performance over the period 2012 to 2014 and the share price at the time the awards vest.

Group Chief Executive - Stephen Hester

Group Finance Director - Bruce Van Saun


2009-2011 average compensation outcome for Group Chief Executive
The preceding charts are based on target/expected values of total compensation. Press commentary tends to focus either on these values, or on maximum values assuming all performance conditions are met.  However, in practice over the period 2009 to 2011, the value received will be significantly less than the maximum or even target value incentives, in light of bonus waivers, performance conditions and share price fall over the period. The chart below shows the likely average pay-out to the Group Chief Executive from salary, pension and incentives from awards made over the 2009-2011 period. The average maximum award is shown on the left, but is then adjusted allowing for the impact of LTIP performance conditions, bonus conditions and voluntary waivers and finally the impact of the share price fall on the remaining value of awards.

The data shows that Stephen Hester is likely to receive just 10% of the maximum value of his incentives awarded over the last three years, and around 29% of his maximum total compensation.  This is despite the majority of financial and non-financial targets for RBS having been met when measured over the three year period since 2009. In comparison, levels of pay-out at RBS are expected to be at least one-third lower than recent levels of pay-out in the FTSE-30 and less than half recent pay-outs in the international banking sector.
 


 
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Assessing past performance
Executive directors’ annual incentive 2011
Executive directors have a normal maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).   Share Bank arrangements were put in place for the 2010 and 2011 performance years. The maximum potential allocation into Share Bank for the 2011 performance year was 6.0 million shares for the Group Chief Executive and 3.75 million shares for the Group Finance Director.  This was based on the normal maximum annual incentive levels for executive directors at a share price of 40p per share (calculated as an average share price over December 2010).

The Group Remuneration Committee has reviewed executive directors’ performance against targets set at the beginning of the year as summarised in the table below. Accordingly, the Committee recommended, and the Group Board (excluding executive directors) approved, that the Group Chief Executive should receive an award of 60% and the Group Finance Director an award of 80% of their maximum allocation for the 2011 performance year, which equates to 3.6 million and 3.0 million shares respectively into Share Bank in 2012. The Group Chief Executive has waived his allocation. The shares vest in two equal tranches on the first and second anniversaries of the date of grant and are subject to a holding period of six months after vesting. Clawback provisions will apply prior to the vesting of shares.

Stephen Hester
Stephen Hester’s performance is measured against a number of strategic and business objectives.  In the course of 2011 the Group’s priority has been to strengthen its balance sheet and reduce risk as it works through the restructuring plan, and this is reflected in good progress on the key risk measures set out in 2009.  Targets for capital, short-term wholesale funding, liquidity reserves and leverage have all been met ahead of schedule, while the Group loan:deposit ratio improved further.

Core objectives
Targets for 2011
Progress in 2011
Strategic progress
Delivery of the five year strategic plan.
The Group recovery strategy set out in 2009 has proven its effectiveness and in 2011, most tasks are on or ahead of Plan.  This includes operation of Core/Non-Core structure, rebuilding management and operations and reducing risk. Key Group strategic plan risk measures set in 2009 were all significantly exceeded in 2011. However, the deterioration in external economic and financial conditions impacted profits and further led the Group to prioritise de-risking over driving returns, which affect profitability measures. An extra £1 billion was spent over 2011 in order to accelerate the achievement of RWAs reduction, liquidity and deposit-gathering goals. It was also necessary to make alterations to the strategic plan for the investment banking business in the light of new regulation and market developments.
Business delivery and financial performance
 
ROE, profitability, costs, core tier 1 ratio, funding and risk profile, lending commitments, EU mandated disposals.
 
Retail & Commercial’s ROE improved to 11.3%, or 16.6% excluding Ulster Bank. GBM ROE was 7.7% above median compared to peers, leaving Core overall ROE at 10.5%. Core cost:income ratio was 60%, with Core Tier 1 ratio at 10.6%. The liquidity portfolio was held above target levels at £155 billion, while short-term funding was cut to £102 billion. Gross new lending to business increased by 22%, with lending to SMEs up 4%, exceeding the Group’s Merlin targets. The branch sale to Santander made good progress as did the turnaround of RBS Insurance; facilitating its planned divestment.
Risk and control
 
Funding, leverage ratio, risk measures and Asset protection Scheme (APS) compliance requirements.
 
All risk reduction and control measures were exceeded. This includes Group loan:deposit ratio (LDR) improved to 108%, with Core loan:deposit ratio ahead of target at 94%. Leverage was stable at 16.9x. Performance against agreed APS objectives was satisfactory and significantly improved compared with prior year.
Stakeholder management
 
Relationships with shareholders and other external stakeholders.  Customer satisfaction and Treating Customers Fairly (TCF) measures.
 
Positive feedback from key shareholders and regulators.  Increased engagement with external stakeholders in particular on sustainable lending policies. Good progress to address risks identified by UK/US regulators relating to TCF.
People management
Group’s people strategy including performance, succession and people management.   Improvements in employee engagement.
Stephen Hester is widely acknowledged internally and externally as having provided strong leadership to the Group in extraordinary circumstances. Talent and bench reviews completed in all businesses and actions plans agreed.  Female executive representation increased to 18%. The Group’s ‘Your Feedback 2011’ staff survey results showed a continued upward trend in the vast majority of categories.


 
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Bruce Van Saun
Bruce Van Saun’s performance is measured against a number of Group and divisional targets.  Bruce continues to perform at the level of a world class Chief Financial Officer (CFO), providing strong individual and broader finance contribution to the Group’s priority to strengthen the balance sheet and reduce risk.  Group Treasury has facilitated a significant reduction on the Group’s reliance on short-term funding and Bruce Van Saun has displayed strong leadership on a number of key strategic projects including negotiation of the EU mandated sale of retail branches, the response to the Independent Commission on Banking (ICB) and the preparations for the divestment of RBS Insurance.

 
Core objectives
Targets for 2011
Progress in 2011
Strategic progress
Monitoring/improvement of Group and Divisional Strategic Plans.  Work with Group Chief Executive on Group Strategy/M&A and APS compliance requirements.
Increased effectiveness of strategic planning process resulting in successful Board offsite and strong contribution to GBM strategy revisions and the APA analyses.
 
Strong leadership displayed on key strategic projects including; branch disposal, ICB response, RBS Insurance divestment.  13 M&A transactions delivered, with 70% managed by an in house team led by the CFO.
 
Significant progress made on the Group’s cost-reduction programme, with further progress targeted for 2012.
 
Performance against agreed APS objectives was satisfactory and significantly improved compared with prior year.
 
Business delivery and financial performance
 
Statutory/regulatory/management reporting. Strategic planning, budgeting and forecasting.  Capital and funding planning.
Achievement of ‘best in class’ for external reporting within the UK market. Key contribution to de-risking strategy with significantly reduced reliance on short term funding and raised £20 billion for 2011 term funding in challenging conditions.  Good interest rate positioning achieved. New central bank and lending target reporting requirements implemented.  Improved capital planning capabilities, with detailed capital plans developed at Group and UK solo entity level.
 
Risk and control
 
Regulatory change impacting capital, funding, liquidity, improve quality of risk and financial data.
Strong stewardship over the financial risk and control environment, viewed as a strong risk partner by risk function. Effective management against FSA liquidity metrics. Balance sheet substantiation programme completed. Mobilisation of the FiRST programme, to enhance risk and finance data quality.
 
Stakeholder management
 
External relationships, including investors, rating agencies and regulators.
Strong external feedback received on Investor Relations programme.
Strong engagement with policy makers on the regulatory agenda; stronger relationship achieved with FSA. Major role in working with the FSA through capital and liquidity assessments, as well as the ICB response and RBS N.V. consolidation.
 
People management
Lead upgraded team and build positive culture.
Key strategic hires made for Group Internal Audit and Group Strategy positions, which are a key part of upgrade agenda. External hiring complemented by robust programmes for internal talent implemented across all levels. Number of key executive positions filled internally in 2011. Strong focus on programmes in mentoring, diversity and training & development.
 


 
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Directors’ remuneration report continued

Executive directors long-term incentive plan (LTIP) awards
The following tables provide a current assessment of executive directors' performance against LTIP awards granted in previous years. The Group Remuneration Committee does not believe that these outcomes are reflective of the executive directors' performance over the period 2009 to 2011. As highlighted in the opening letter to this remuneration report, very significant progress has been made across the Group’s strategic plan targets since 2009, resulting in a significantly safer, more resilient and sustainable bank.  However, this is not being reflected in the LTIP outcomes.  In 2009 and 2010, LTIPs were linked entirely to share price and economic profit targets.  In line with the whole sector, and exacerbated by its legacy portfolio, RBS's performance against these metrics has been heavily impacted by the economic and regulatory environment.
 
2011
The table below summarises the assessment of the first year of a three year performance period. Each measure has the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 375% of salary. Awards are due to vest in 2014.  An assessment of performance of each relevant element is provided by the control functions and an external firm assesses relative Total Shareholder Return (TSR) performance. The Group Remuneration Committee determines overall vesting based on these assessments including consideration of the drivers of performance and the context against which it was delivered.  The assessment is analytical and if any discretion is used, it would be explained.  This award is due to be assessed in March 2014 to determine the level of vesting.  The table below represents an early indication only.

Performance measure
Weighting
Rationale
Vesting
Current assessment of performance
Core Bank Economic Profit
25%
Ensures that performance reflects risk adjusted enduring earnings for the Bank.
Threshold: 25% vesting for average return on tangible equity over the performance period at a reasonable margin above the cost of capital.
 
Maximum: 100% vesting for performance ahead of the Group’s Strategic Plan.
Continued difficult economic conditions in a number of our key markets mean that based on performance to date, the threshold targets have not yet been met.
 
Relative TSR
25%
Ensure alignment with shareholders.
Threshold: 20% vesting if the Group’s TSR is at the median of the companies in the comparator group.
 
Maximum: 100% vesting if the Group’s TSR is at the upper quartile of the companies in the comparator group.
 
Pro-rata vesting in between these points.
Based on share price performance to date, the threshold targets have not yet been met.
 
Balance Sheet & Risk
25%
Ensure alignment with the advancement of the strategic position and capability of the organisation and the building of a sustainable business.
Vesting will be qualified by Group Remuneration Committee discretion. Indicative vesting levels are:
 
· Over half of objectives not met: 0%;
 
· Half of objectives met: 25%;
 
· Two-thirds of objectives met: 62.5%; and
 
· Objectives met or exceeded in all material respects: 100%.
Most targets have been met or exceeded. Strong performance on capital, leverage and funding measures, risk appetite embedded.
 
Good progress on brand franchises (e.g., ‘Helpful Banking’ in UK), sustainability and employee engagement measures.  Further work needed on cost:income ratio.
Strategic Scorecard
25%


 
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Directors’ remuneration report continued
 
2010
Awards to executive directors under the LTIP in 2010 are subject to improvements in Economic Profit, Relative TSR and Absolute TSR.  The award is due to be assessed in May 2013 to determine the final level of vesting. The table below is an interim assessment and based on performance to date, the threshold targets have not yet been met.

Performance measure
Weighting
Rationale
Vesting
Current assessment of performance
Economic Profit
50%
Ensures that performance reflects enduring earnings for the Bank.
Maximum vesting of the Economic Profit measure will be triggered by early delivery of Core Business profitability, well ahead of the range implied by the published Strategic Plan targets and also in excess of the cost of capital.
Continued difficult economic conditions in a number of our key markets mean that based on performance to date, the threshold targets have not yet been met.
 
Relative TSR
25%
Ensure alignment with shareholders.
Threshold: 20% vesting if the Group’s TSR is at the median of the companies in the comparator group.
 
Maximum: 100% vesting if the Group’s TSR is at the upper quartile of the companies in the comparator group.
 
Pro-rata vesting in between these points.
 
Based on share price performance to date, the threshold targets have not yet been met.
 
 
Absolute TSR
25%
Ensure alignment with shareholders.
Threshold: 20% vesting if the Group’s share price reaches 57.5p.
 
Maximum: 100% vesting if the Group’s share price reaches 77.5p.
 
Pro-rata vesting in between these points.
Based on share price performance to date, the threshold targets have not yet been met.
 

Note:
For the formulaic performance conditions applying to the executive directors, the percent vesting outcomes were calculated by PwC, based on incremental economic profit figures from Group Finance (Group operating profit less 25% tax less a charge of 10% of tangible equity) and TSR for the period up to and including 3 January 2012.

2009
In 2009, executive directors received long-term incentives under two plans, the Medium Term Performance Plan (MPP) and Executive Share Option Plan (ESOP). These awards are due to be formally assessed in June 2012. It is currently anticipated that, based on performance to date, the threshold targets would not be met and there would be nil vesting under any of the elements of these awards.

Performance measure
Weighting
Rationale
Vesting
Current assessment of performance
Relative TSR
50%
Ensure alignment with shareholders.
Threshold: 25% vesting if the Group’s TSR is at the median of the companies in the comparator group.
 
Maximum: 100% vesting if the Group’s TSR is at the upper quartile of the companies in the comparator group.
 
Pro-rata vesting in between these points.
Based on share price performance to date, the threshold targets would not be met and there would be no vesting under this element of the award.
 
Absolute TSR
50%
Ensure alignment with shareholders.
Threshold: 25% vesting if the Group’s share price reaches 40p.
 
50% vesting if the Group’s share price reaches 55p.
 
Maximum: 100% vesting if the Group’s share price reaches 70p.
Based on share price performance to date, the threshold targets would not be met and there would be no vesting under this element of the award.
 

Note: The TSR calculations were provided by PwC based on TSR calculations up to and including 3 January 2012.

 
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Directors’ remuneration report continued
 
 
Total Shareholder Return performance
The first graph below shows the performance of the company over the past five years in terms of TSR compared with that of the companies comprising the FTSE 100 Index. This index has been selected because it represents a cross-section of leading UK companies. The TSR for FTSE banks for the same period has been added for comparison.

The TSR for the company and the indices have been rebased to 100 for 2006. The second graph shows the same performance of the company during 2011.
 
 
 
Implementation of the Group’s recovery plan started in January 2009 with the publication of the preliminary 2008 losses. The share price reached a low point of just under 10p per share on the news.
 
Since that date to 22 February 2012, the day before the Group’s 2011 results announcement, the Group’s share price has risen 265% which compares to 164% and 145% respectively for the FTSE banks index and the FTSE 100 index as a whole.
 
Total shareholder return - one year
Financial shares outperformed the market for most of the first half of the year. However, focus shifted to the fiscal positions of peripheral Eurozone economies, particularly Greece and Italy, in the summer. This prompted investor concerns about the implications for banks exposed to these countries and caused stresses in European bank funding markets. The RBS share price was impacted broadly in line with other domestic UK banks and European peers, underperforming the market in the second half.  Accompanying this was a reduction in the consensus outlook for bank earnings, driven by a weaker outlook for growth in the global economy.  

In addition, the weight of new regulation on European banks raised concerns about banks' ability to generate attractive returns. Specifically in the UK, the publication of the ICB report in September recommending the ring-fencing of retail banking operations was perceived as detrimental for RBS and its UK domestic peers, although details of the regulations are yet to be finalised.


 
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Directors’ remuneration report continued


Setting performance for 2012
The executive directors’ annual performance objectives are approved by the Group Remuneration Committee. The risk objectives are reviewed by the Board Risk Committee.

Core objectives
Stephen Hester
Bruce Van Saun
Strategic progress
Revise original Strategic Plan to respond to significant changes in the macro environment and outlook for wholesale banking.  Deliver execution of revised strategy.
Monitor and improve the Group and Divisional Strategic Plans.  Drive effective design and implementation of revised plan.  Work with CEO on Group Strategy/M&A/APS.
 
Business delivery and financial performance
 
Lead delivery of overall performance, including measures relating to ROE, cost management, Core Tier 1 capital ratio, funding and risk profile, lending, EU mandated disposals and restructuring of the wholesale business.
Ensure statutory, regulatory and management reporting is compliant with all external and internal standards.  Continue to improve ‘best in class’ external reporting. Provide strong CFO role to the business through strategic planning, budgeting, forecasting and reporting.  Ensure a robust capital and funding planning framework. Drive efficiency.  Successful completion of EU mandated disposals.
 
Risk and control
 
Continue culture change across the Group including delivery of measures relating to wholesale funding reliance and liquidity reserves and leverage ratio. Deliver against agreed APS objectives.
Implementation of effective regulatory changes impacting capital, funding, liquidity. Improve quality of risk and financial data.  Continue development of Internal Audit function.  Deliver against agreed APS objectives.
 
Stakeholder management
 
Achievement of customer franchise measures, maintain strong and effective relationships with external stakeholders and continue progress on TCF actions.
 
Continue to develop effective external relationships, including investors, rating agencies and regulators.
 
People management
Ensure each division/function has high quality leadership teams, build out performance management, talent management and succession planning across the Group. Maintain effective employee engagement.
 
Lead upgraded team and build positive culture. Contribute to overall Group management.


The Group Remuneration Committee will determine the actual value of the award by reference to the extent to which executive directors have met the performance targets. Awards will be paid entirely in shares and will vest in two equal tranches on the first and second anniversaries of the date of grant. Clawback provisions will apply prior to the vesting of the shares.

Long-term incentive plan (LTIP)
2012 Awards have four performance categories, each with equal weighting.

Core bank economic profit (25%)
As the value of the Group will be determined by the Core Bank’s ability to generate enduring returns for shareholders, the Economic Profit measure is focused on the Core Bank to ensure that performance reflects enduring earnings for the bank.  Economic Profit, being a risk-adjusted financial measure, is consistent with the FSA Code and also provides a balance between measuring growth and the cost of capital employed in delivering that growth.

Core bank Economic Profit is defined as return attributable to shareholders less equity multiplied by the cost of equity, where:

Return attributable to shareholders is Core Operating Profit reported in the financial statements, excluding movements in the fair value of own debt and APS, taxed at a standard tax rate.

Equity is defined as tangible equity allocated to the Core businesses, with adjustments to strip out distorting impacts arising from movements in the fair value of own debt, available-for-sale reserves and cash flow hedging reserve.

Current Cost of Equity is 12%, which is subject to review at least annually.

At the end of the performance period for the 2012 awards, the Group Remuneration Committee will assess economic profit performance against plan in light of targets set by it at the start of the performance period. Details of the actual targets, and performance against these, will be disclosed retrospectively once the awards vest.
 
 
 
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Relative Total Shareholder Return (TSR) (25%)
The relative TSR measure provides a direct connection between executive directors’ awards and relative performance delivered to shareholders. The measure compares the Group's performance against a group of comparator banks from the UK and overseas, weighted towards those companies most similar to the Group. Performance is measured over a three year performance period. The Remuneration Committee reviewed the weightings within the TSR peer group, and made a small number of adjustments to reflect emerging regulatory influences, the future geographic and business focus of RBS, and consequent future relevance of peer companies. This has resulted in reducing the weightings of a small number of banks in the peer group for 2012 LTIP awards.

Relative TSR Comparator Group
 
Weighting
1
Barclays
200%
2
Lloyds Banking Group
 
3
HSBC
150%
4
Standard Chartered
 
5
Bank of America
50%
6
BBVA
 
7
BNP Paribas
 
8
Citigroup
 
9
Credit Agricole
 
10
Credit Suisse Group
 
11
Deutsche Bank
 
12
JP Morgan Chase
 
13
National Australia Bank Limited
 
14
Royal Bank of Canada
 
15
Santander
 
16
Societe Generale
 
17
The Toronto-Dominion Bank Group
 
18
UBS
 
19
Unicredito
 
20
Wells Fargo & Company
 

To receive any of the LTIP awards subject to this performance measure the Group’s performance must be at least as good as the median of the comparator companies, with vesting as follows (with a pro-rata proportion of the award vesting in between these points):

·  
20% of the award will vest if the Group’s TSR is at the median of the companies in the comparator group.

·  
100% of the award will vest if the Group’s TSR is at the upper quartile of the companies in the comparator group.

Balance Sheet & Risk (25%)
The Balance Sheet & Risk measures have a particular focus on risk reduction, the resolution of the Non-Core business and the building of a sustainable and responsible franchise for the Group.

Strategic Scorecard (25%)
The balanced Strategic Scorecard rewards management for delivering a robust basis for future growth in terms of the strength of our franchise, efficiency, reputation, and the strength and engagement of employees.

Performance measures
Balance
Sheet and Risk measures
and targets
Non-Core assets
Cumulative Non-Core loss
Core Tier 1 Capital
Wholesale funding
Liquidity reserves
Leverage ratio
Loan:deposit ratio
Earnings volatility
Strategic
Scorecard measures
and targets
Customer franchise
Cost:income ratio in core bank
Lending targets
Sustainability performance
Progress in people issues

Both quantitative and qualitative strategic measures are used, including measures relating to reputation, customer excellence, organisational capability and sustainability, given that these will support the long term goals of the business. Targets for each measure are set at the start of the performance period and where applicable, are aligned with the Group’s strategic plan targets. At the end of the period each measure will be assessed against the target, and vesting will be based on the proportion of targets fully met (see below), qualified by the Group Remuneration Committee’s discretion, taking other relevant factors into account.

Commentary will be provided on an annual basis in relation to progress against the targets, where these are not commercially sensitive.

Vesting point
 
Indicative performance
Does not meet
0%
Over half of objectives not met
Partially meets
25%
Half of objectives met
Significantly meets
62.5%
Two-thirds of objectives met
Fully meets
100%
Objectives met or exceeded in all material respects
Qualified by Group Remuneration Committee discretion taking into account changes in circumstances over the performance period, the relative importance of the measures, the margin by which individual targets have been missed or exceeded, and any other relevant factors.


 
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Risk underpin and clawback
The Group Remuneration Committee will also review financial and operational performance against the Strategic Plan and risk performance prior to agreeing vesting of awards. In assessing this, the Committee will be advised independently by the Board Risk Committee. If the Group Remuneration Committee considers that the vesting outcome calibrated in line with the performance conditions outlined above does not reflect the Group's underlying financial results or if the Committee considers that the financial results have been achieved with excessive risk, then the terms of the awards allow for an underpin to be used to reduce vesting of an award, or to allow the award to lapse in its entirety. All awards are subject to clawback.

Service contracts
The company's policy in relation to the duration of contracts with directors is that executive directors' contracts generally continue until termination by either party, subject to the required notice, or until retirement. The notice period under the service contracts of executive directors will not normally exceed twelve months. In relation to newly recruited executive directors, subject to the prior approval of the Group Remuneration Committee, the notice period may be extended beyond twelve months if there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to twelve months in due course. All new service contracts for executive directors are subject to approval by the Group Remuneration Committee. Those contracts normally include standard clauses covering the performance review process, the company's normal disciplinary procedure, and terms for dismissal in the event of failure to perform or in situations involving actions in breach of the Group's policies and standards. Any compensation payment made in connection with the departure of an executive director will be subject to approval by the Group Remuneration Committee, having regard to the terms of the service contract and the reasons for termination.

Information regarding the executive directors' service contracts is shown below:

 
 
Date of current contract
Notice period -
from the company
Notice period -
from executive
Stephen Hester
4 November 2008
12 months
12 months
Bruce Van Saun
8 September 2009
12 months
12 months

Except as noted below, in the event of severance where any contractual notice period is not worked, the employing company may pay a sum to the executive in lieu of the notice period. In the event of situations involving breach of the employing company's policies resulting in dismissal, reduced or no payments may be made to the executive. Depending on the circumstances of the termination of employment, the executive may be entitled, or the Group Remuneration Committee may allow, outstanding awards under long-term incentive arrangements to vest, subject to the rules of the relevant plan.

Stephen Hester
In the event of his personal underperformance, the company is entitled, after giving reasonable opportunity to remedy any failure, to terminate Stephen Hester’s contract by giving written notice with immediate effect and without making any payment in lieu thereof and Stephen Hester will forfeit any unvested stock awards. In the event that Stephen Hester's employment is terminated by the company (other than by reason of his personal underperformance), he will be entitled to receive a payment in lieu of notice to the value of base salary, bonus and benefits (including pension contributions). If he resigns voluntarily and the company does not require him to work out his notice period, Stephen Hester may receive a payment in lieu of notice based on salary only (i.e. no bonus or benefits). In both cases the treatment of any other unvested stock awards will be determined at the discretion of the Group Remuneration Committee.

Bruce Van Saun
In the event that Bruce Van Saun's employment is terminated by reason of his personal underperformance, the company is entitled, after giving reasonable opportunity to remedy any failure, to terminate by giving written notice with immediate effect and without making any payment in lieu of notice. Any payment in lieu of notice that may be made to Bruce Van Saun would be based on salary only (i.e. no bonus or benefits). The company has agreed that, provided certain conditions are met, on leaving employment, Bruce Van Saun will not forfeit awards under the rules of the Group’s share plans.
 
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Directors’ remuneration report continued
 
 
Chairman and non-executive directors
Information regarding the terms of appointment for the Chairman and non-executive directors is shown below.

Re-election
Under the Articles of Association of the company, directors must stand for re-election by shareholders at least once every three years. However, in accordance with the provisions of the Code, all directors of the company will stand for annual re-election by shareholders at the company’s Annual General Meetings.

Letter of engagement
The non-executive directors do not have service contracts or notice periods although they have letters of engagement reflecting their responsibilities and commitments.

Time commitments
Letters of engagement make clear to non-executive directors the time commitment they are expected to give to their Board duties.  Since 2010, non-executive directors letters of engagement specifically state that their time commitment should be in line with the Walker Review of corporate governance of banks and other financial institutions in respect of their general Board duties. Additional time will be spent as necessary in respect of Committee duties, including in particular any Committees which they chair.

Termination
No compensation would be paid to any non-executive director in the event of termination of appointment.

Arrangements for the Group Chairman
Philip Hampton is entitled to receive a cash payment in lieu of notice if his appointment is terminated as a result of the Group's majority shareholder seeking to effect the termination of his appointment. The applicable notice period is twelve months. In the event that the company terminates Philip Hampton's appointment without good reason, or his re-election is not approved by shareholders in General Meeting resulting in the termination of his appointment, he will be entitled to receive a cash payment in lieu of notice of twelve months' fees.

Fees for non-executive directors
The table below sets out the remuneration structure for non-executive directors for the year ended 31 December 2011. The Senior Independent Director and Chairs of the Board Committees receive a composite fee and therefore do not receive additional fees for membership of any other committees or the Group Board.


Chairman’s fee
£750,000
Senior Independent Director (composite fee)
£150,000
Chairman of Group Audit Committee, Board Risk Committee or Group Remuneration Committee (composite fee)
£150,000
Non-executive director Group Board fee
£72,500
Membership of Group Audit Committee, Board Risk Committee or Group Remuneration Committee fee
£25,000
Membership of Nominations Committee fee
£5,500

No director received any expense allowances chargeable to UK income tax or compensation for loss of office/termination payment. The non-executive directors did not receive any bonus payments or benefits.

 
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Directors’ remuneration report continued

Remuneration in detail
The tables and explanatory notes on pages 249 to 251 detail the remuneration of each director for the year ended 31 December 2011 and have been audited by the company's auditors, Deloitte LLP.

Directors' remuneration
 
Salary/ 
fees 
£000 
Benefits 
£000 
2011 
Total 
£000 
2010
Total
£000
Chairman
       
Philip Hampton
750 
— 
750 
750
         
Executive directors
       
Stephen Hester (1)
1,200 
26 
1,226 
3,267
Bruce Van Saun (1,2)
744 
132 
876 
2,298

Notes:
(1)
Stephen Hester waived his award of 3.6 million shares which was approved by the Group Board and which was due to be awarded in March 2012. Bruce Van Saun will receive an award of 3.0 million shares in respect of 2011 performance, which will be delivered into Share Bank in March 2012 and will vest in March 2013 and 2014. For subsequent reporting years, the 3.0 million shares awarded to Bruce Van Saun will be detailed in the Deferred Awards table (see page 250). Further details of the performance assessment of the executive directors in 2011 is outlined on pages 240 and 241. Amounts disclosed as performance bonus under the remuneration table in the 2010 Report & Accounts represent  the cash value that was subsequently converted to shares at the date of award in March 2011. The awards are shown as deferred awards granted in 2011 as set out on page 250.
(2)
Bruce Van Saun is director of ConvergEx Holdings LLC and retains the fee paid to him in this respect. For 2011, he received a fee of $75,000.

Non-executive directors
The level of remuneration for non-executive directors reflects their responsibility and time commitment and the level of fees paid to non-executive directors of comparable major UK companies. Non-executive directors do not participate in any incentive or performance plan.  Non-executive directors fees are reviewed regularly.
 
Board 
fees 
Board 
Committee 
fees 
2011 
Total 
2010 
Total 
 
£000 
£000 
£000 
£000 
Non-executive directors
       
Sandy Crombie
150 
— 
150 
150 
Alison Davis (1)
30 
13 
43 
— 
Tony Di Iorio (2)
24 
19 
43 
— 
Penny Hughes (3)
150 
— 
150 
130 
Joe MacHale (4)
73 
60 
133 
141 
John McFarlane
73 
30 
103 
103 
Brendan Nelson (5)
150 
— 
150 
111 
Baroness Noakes (6)
30 
13 
43 
— 
Art Ryan
73 
22 
95 
103 
Philip Scott
150 
— 
150 
150 
         
Former non-executive director
       
Colin Buchan (7)
44 
33 
77 
150 

Notes:
(1)
Appointed on 1 August 2011.
(2)
Appointed on 1 September 2011.
(3)
Fee has not increased in 2011.  Lower fee in 2010 reflects appointment as Chair of Group Remuneration Committee with effect from 1 June 2010.
(4)
Board Committee fee includes membership of the Asset Protection Scheme Senior Oversight Committee.
(5)
Fee has not increased in 2011.  Lower fee in 2010 reflects appointment to the Board from 1 April 2010 and as Chairman of the Group Audit Committee from 28 April 2010.
(6)
Appointed on 1 August 2011.
(7)
Retired from the Board with effect from 5 August 2011.


 
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Directors’ remuneration report continued
 
 
Long-Term Incentive Plan (LTIP)
No variation was made to any of the terms of the plan during the year. Awards to executive directors under the LTIP in 2011 are subject to performance conditions detailed on page 242. Performance conditions for awards made in 2010 are detailed on page 243.

 
Awards held 
at 1 January 
2011 
 
Awards 
granted 
in 2011 
Market
price on 
award 
£
Awards 
vested in 
2011 
Market price   
 on vesting   
£   
   Awards held 
 at 31 December 
2011 
End of period 
for qualifying 
conditions to 
be fulfilled 
Stephen Hester
8,578,432 
(1)
— 
0.49
   
8,578,432 
14.05.13 
 
— 
 
10,114,178 
0.44
   
10,114,178 
07.03.14 
 
8,578,432 
 
10,114,178 
     
18,692,610 
 
                 
Bruce Van Saun
5,182,803 
(2)
— 
0.49
   
5,182,803 
14.05.13 
 
— 
 
6,321,362 
0.44
   
6,321,362 
07.03.14 
 
5,182,803 
 
6,321,362 
     
11,504,165 
 

Notes:
(1)
Stephen Hester has agreed to a voluntary holding period of two further years beyond the vesting date for the net post-tax number of vested shares in respect of at least one third of the award.
(2)
Bruce Van Saun has agreed to a voluntary holding period of two further years beyond the vesting date for the net post-tax number of vested shares for the amount over 300% of his salary.

Deferred awards
Below are details of deferred awards granted to executive directors. Awards are structured as conditional rights to receive shares and are subject to clawback. No variation has been made to any of the terms of the plan during the year.

 
Awards held 
at 1 January 
2011 
 
Awards
granted
in 2011
 
Market 
price on 
award 
£ 
Awards
vested in
2011
Market price on vesting
£
Awards held 
 at 31 December
2011 
End of period 
for qualifying 
conditions to 
be fulfilled 
Stephen Hester (1)
— 
 
4,585,094
(2)
0.44
   
4,585,094
07.03.12 - 07.03.13
                   
Bruce Van Saun
957,071 
(3)
   
0.38
   
957,071
18.06.12
 
— 
 
3,030,882
(2)
0.44
   
3,030,882
07.03.12 - 07.03.13
 
957,071
 
3,030,882
       
3,987,953
 

Notes:
(1)
In February 2010, Stephen Hester agreed to waive his deferred award in respect of the 2009 performance year.
(2)
The awards granted on 7 March 2011 relate to an allocation of shares under the Share Bank arrangements for annual incentives in respect of the 2010 performance year.  The allocation was made as a conditional right to acquire ordinary shares under The RBS 2010 Deferral Plan.  The Awards are due to vest in two equal tranches on 7 March 2012 and 7 March 2013 and any vested shares are subject to a further six month retention post-vesting.  Mr Hester has voluntarily agreed to a total retention period of 12 months post-vesting.  Clawback provisions will apply prior to vesting of the shares.
(3)
The Award was granted in March 2010 and relates to an allocation of shares in respect of annual incentives for the 2009 performance year.


Share options
The ESOP was approved by shareholders in April 2007. No further awards will be made under the ESOP as it has been replaced by the LTIP. Performance conditions applying to the outstanding awards are shown on page 243.
 
 
Options held 
at 1 January
2011
 
Number of options
exercised in 2011
Market
price at
date of
exercise
£
Option
price
£
    Options held at 31 December 2011
 
   
Number
Exercise period
Stephen Hester
9,550,000
     
0.37
 
9,550,000
22.06.12 - 21.06.19
Bruce Van Saun
905,306
     
0.57
 
905,306
08.09.12 - 07.09.19
 
No options had their terms and conditions varied during the year ended 31 December 2011. No payment is required on the award of an option. The plan was amended in 2009 to introduce a clawback provision for grants made in 2009. In respect of the grant of options in 2009, the performance conditions for executive directors are based on a combination of relative and absolute TSR measures.

The market price of the company's ordinary shares on 30 December 2011 was 20.18p and the range during the year ended 31 December 2011 was 17.34p to 49.0p.


 
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Directors’ remuneration report continued

Medium-Term Performance Plan (MPP)
The MPP was approved by shareholders in April 2001. No further awards will be made under the MPP as it has been replaced by the LTIP. No variation was made to any of the terms of the plan during the year. In respect of the 2009 awards, the performance conditions for executive directors are based on a combination of relative and absolute TSR measures. Performance conditions applying to the outstanding awards are shown on page 243.

 
Scheme interests 
(share 
 equivalents)
at 1 January 
 2011 
Market price 
on award 
£ 
Awards 
vested in 
2011 
Awards 
exercised 
in 2011 
Scheme interests 
(share 
equivalents)
 at 31 December 
2011 
End of period for 
qualifying conditions 
to be fulfilled 
Stephen Hester (1)
4,800,000 
0.37 
   
4,800,000
22.06.12 
Bruce Van Saun (2)
1,810,611 
0.57 
   
1,810,611
22.06.12 

Notes:
(1)
Stephen Hester has voluntarily agreed to retain any shares that he receives for a further two years past the vesting date.
(2)
End of qualifying period 22 June 2012, however award unavailable for exercise until 8 September 2012, three years from date of award.

Restricted Share Award
No variation was made to any of the terms of the plan during the year and no awards were granted under the Restricted Share plan in 2011.

 
Awards held 
at 1 January  
2011 
 
Awards 
granted in 
2011 
Market price
on award
£
Awards
vested in
2011
Market price
on vesting
£
 
Value of
awards vested
£
 
Awards held at
31 December
2011
End of period for
qualifying conditions
to be fulfilled
Stephen Hester
3,463,298 
(1)
 
0.48
799,292
0.4234
 
338,420
     
       
0.48
2,664,006
0.4259
 
1,134,600
     
 
610,687 
(2)
 
0.48
610,687
0.1983
 
121,099
     
 
4,073,985 
     
4,073,985
   
1,594,119
     
                       
Philip Hampton (3)
5,172,413 
   
0.29
         
5,172,413
27.02.12

Notes:
(1)
Awards to replace bonus and share awards Stephen Hester forfeited on leaving The British Land Company PLC, which reflect the vesting dates of the original awards. Initially Stephen Hester was awarded 10,407,081 restricted shares on joining the Group. The remaining awards granted to Stephen Hester under this plan on joining the Group vested during 2011.
(2)
These awards vested as to one-third on each of the first, second and third anniversary of award, subject to their terms.
(3)
The performance conditions attached to the awards above included measures on effective governance and stewardship of RBS, relationships with key stakeholders and delivery of value and return to shareholders.   Philip Hampton has waived his right to an award of restricted shares which was made in 2009 and due to vest in 2012.


Performance conditions for outstanding share awards made
in prior years
Summaries of the performance targets and current assessment of performance can be found on pages 242 and 243.
 
 2011
The 2011 LTIP measures are similar to those adopted for 2012 awards as set out on page 245, although there are some differences in terms of the individual components within the four headings. Full details of the 2011 LTIP measures are set out on page 192 of the 2010 Form 20-F.

2010
Full details of the 2010 LTIP measures are set out on page 200 of the 2010 Form 20-F.

2009
Full details of the 2009 performance measures are set out on page 191 of the 2009 Form 20-F which can be found on www.rbs.com.

Shareholder dilution
During the ten year period to 31 December 2011, awards were made that could require new issue shares under the company's share plans represented 3.7% of the company's issued ordinary share capital (including the B share capital), leaving an available dilution headroom of 6.3%. The company meets its employee share plan obligations through a combination of new issue shares and market purchase shares.

Directors’ pension arrangements
Executive directors receive a cash allowance in place of pension benefits or have amounts credited to a defined contribution pension arrangement:

 
2011
£000
2010
£000
Cash allowances in place of pension
   
Stephen Hester
420
420
Amounts credited to defined contribution arrangements
   
Bruce Van Saun (1)
403
321

Note:
(1)
This amount includes additional employer pension contribution that Mr Van Saun sacrifices from his salary.

Penny Hughes
Chair of the Group Remuneration Committee
22 February 2012

 
251

 
 
Other remuneration disclosure

HM Treasury published a consultation on 6 December 2011 with draft regulations on remuneration disclosure. The proposals set out that all large banks operating in the UK should publish the pay details of their eight highest paid senior executive officers who are not main board directors.

For consistency, figures shown below are in GBP. Where applicable, currency conversion was based on the 2011 average exchange rate for fixed remuneration and the 31 December 2011 spot rate for bonus figures, in line with the approach taken in this Report. No sign-on or severance awards have been made during 2011 to any of the individuals detailed below.

Remuneration of executive directors and eight highest paid senior executives (attendees at Group Executive Committee)

 
Stephen 
Hester 
Bruce Van 
 Saun 
Executive 1 
Executive 2 
Executive 3 
Executive 4 
Executive 5 
Executive 6 
Executive 7 
Executive 8 
 
£000 
£000 
£000
£000
£000
£000
£000
£000
£000
£000
Fixed remuneration
1,200 
744 
1,730
751
769
688
575
638
769
375
Upfront variable
  remuneration (cash)
— 
— 
2
2
2
2
2
2
2
Upfront variable remuneration
  (shares subject to retention)
— 
— 
390
500
350
166
180
170
98
Deferred variable
  remuneration (bond)
— 
— 
973
1,248
873
413
448
423
161
Deferred variable remuneration
  (shares subject to retention)
— 
840 
585
750
525
249
270
255
65
Long Term Incentive Awards
  vested during 2011
— 
— 
26
15
7
Total variable remuneration
— 
840 
1,950
2,526
1,750
830
915
850
333
Total remuneration
1,200 
1,584 
3,680
3,277
2,519
1,518
1,490
1,488
769
708
                     
Long Term Incentive Awards
  (subject to future performance) (1)
1,620 
1,013 
991
1,125
675
675
675
270

No sign-on or severance awards have been made during 2011 to any of the above individuals.

Note:
(1)
The Long Term Incentive Award (subject to future performance) is made following the end of the relevant financial year. The amounts shown reflects an approximate notional value, verified by external advisors. The actual value of the award which will vest in 2015 will be dependent on actual performance and share price.

2009 GBM LTIP vesting
In 2009 on adoption of the RBS Group recovery plan, John Hourican, the newly appointed Head of GBM, was awarded a conditional LTIP with performance conditions covering the 2009 - 2011 period. The performance period has now completed and 15,904,256 shares (and 5,566,490 share options with zero current intrinsic value), are due to vest on 3 April 2012. The table below summarises the GBM performance tests. The Group Remuneration Committee agreed a 73% vesting level based on performance for the period.

  Vesting potential  
Performance categories
Overall
weighting
%
Weighting per performance year
Final
vesting
%
2009
%
2010
%
2011
%
1. Remake of GBM post 2008 and no material adverse event
20
6
6
8
16
2. Achievement of 15% ROE and outlook
30
9
9
12
18
3. Sustaining key customer/market positions
20
6
6
8
14
4. Management team renewal
10
3
3
4
10
5. Efficiency (Balance Sheet, Risk, Cost:income)
10
3
3
4
6
6. Funding & Capital Structure
5
1.5
1.5
2
5
7. Support of Non-Core
5
1.5
1.5
2
4
8. Total
100
30
30
40
73
 
 
 
252

 
 
Other remuneration disclosure continued
 
The context for this special LTIP award was the important role the restructuring and performance of GBM played in RBS recovery plan amidst the fall out from the financial markets crisis of 2008. GBM underwent a radical restructuring with wholesale management changes, exit of multiple business lines and geographies and a balance sheet reduction from c. £874 billion pre-crisis to £362 billion at year end 2011. During this period the success of this part of the restructuring, the stabilisation of GBM and the restoration of profitability in GBM were vital ingredients in the broader RBS recovery plan.

During the three years covered by the LTIP award, GBM accomplished its restructuring goals and contributed £10.7 billion of operating profit to RBS (a cumulative ROE of 18%, good by industry comparison and good in absolute terms). This performance was ahead of targets and a key ingredient in financing the risk clean up across the whole of RBS accomplished during that time. Without these profits the RBS recapitalisation would have been insufficient.

PwC provided independent analysis and advice to help the Group Remuneration Committee as it made its judgement on the appropriate level of achievement against the performance conditions. The Committee also obtained independent legal advice on the operation of the performance conditions. The Group Remuneration Committee determined that the majority of targets laid down for the period had been met and in important areas exceeded. Some shortcomings were acknowledged relating primarily to lower GBM profitability in 2011 and the closure of cash equities (4% of GBM 2011 income) where targets had not been realised, hence the 27% reduction in vested award value.

While John Hourican, as a member of RBS executive committee, is eligible for annual LTIP awards, the 2009 award was unusual in its size reflecting the special circumstances of the time. Nevertheless, in recognition of the 2009 award payout and the public debate around executive pay, John Hourican has asked the Group Remuneration Committee not to make any LTIP award to him for the 2012 grant year, which would normally vest in 2015.

FSA Remuneration Disclosure
The undernoted disclosures are in accordance with the FSA’s Handbook for banks, building societies and investment firms (BIPRU) 11.5.18 (6) and (7).

1. Aggregate remuneration expenditure
During the year, there were 205 Code Staff classified as Senior Management and 181 other Code Staff.  Aggregate remuneration expenditure was as follows:

Global Banking & Markets 
£m 
Rest of RBS Group
£m
 
186.0
130.6  


2. Amounts and form of fixed and variable remuneration

Fixed Remuneration
Fixed remuneration paid in 2011 consisted of base salaries paid during the year plus fees for non-executive directors. There were no special discretionary pension benefits awarded during the year.

Senior management
£m
Others
£m
 
68.7
55.2  

Variable remuneration for 2011 performance
Variable remuneration payable in respect of 2011 performance consisted of cash bonuses, share or restricted share unit awards, and other awards primarily in the form of deferred bonds payable over three years. Cash bonuses were limited to a maximum of £2,000 per employee.

Form of remuneration
Senior management 
£m 
Others 
£m 
Variable remuneration (cash)
0.3
0.3
Variable remuneration (shares
  subject to retention)
14.4
21.6
Deferred remuneration (bonds)
30.3
48.2
Deferred remuneration (shares)
15.7
25.8

 
2% of total variable remuneration was subject to a guaranteed commitment made on recruitment
 
to secure the employment of key individuals.

Long-term incentives
Long term incentive awards made each year are paid three years after the date of award based on the extent to which performance conditions are met, and can result in zero payment if performance is not at the threshold level.

Senior management
£m
Others
£m
 
23.0
13.2  

3. Outstanding deferred remuneration through 2011
The table below includes deferred remuneration awarded or paid out in 2011, primarily for prior year performance. Deferred remuneration reduced during the year relates to long-term incentives lapsing when performance conditions are not met.

Category of deferred remuneration
Senior management
£m
 
Others
£m
Unvested from prior year
108.6
152.8
Awarded during the financial year
91.7
143.1
Paid out
60.4
119.8
Reduced from prior years
0.2
Unvested at year end
134.2
171.1

4. Sign-on and severance payments
No sign-on or severance payments were made to Code Staff during the year.

Notes on the presentation of remuneration
In the relevant tables above, assumptions have been made for the notional value of LTIP (verified by external advisors), forfeitures through resignation for deferred awards and the share price at 31 December has been used.

 
253

 
Compliance report


 
Statement of compliance
The company is committed to high standards of corporate governance, business integrity and professionalism in all its activities.

Throughout the year ended 31 December 2011, the company has complied with all of the provisions of the UK Corporate Governance Code issued by the Financial Reporting Council in May 2010 (the “Code”) except in relation to the provision (D.2.2) that the Group Remuneration Committee should have delegated responsibility for setting remuneration for the Chairman and executive directors. The company considers that this is a matter which should rightly be reserved for the Board. No director is involved in decisions regarding his or her own remuneration. Information on how the company has applied the main principles of the Code can be found in the Corporate governance report on pages 210 to 253. A copy of the Code can be found at www.frc.org.uk/corporate.

The company has also implemented the recommendations arising from the Walker Review.

The company has also complied in all material respects with the Financial Reporting Council Guidance on Audit Committees issued in December 2010.

Under the US Sarbanes-Oxley Act of 2002, specific standards of corporate governance and business and financial disclosures apply to companies with securities registered in the US. The company complies with all applicable sections of the US Sarbanes-Oxley Act of 2002.

Internal Control
Management of The Royal Bank of Scotland Group (“the Group”) is responsible for the Group’s system of internal control that is designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. In devising internal controls, the Group has regard to the nature and extent of the risk, the likelihood of it crystallising and the cost of controls. A system of internal control is designed to manage, but not eliminate, the risk of failure to achieve business objectives and can only provide reasonable, and not absolute, assurance against the risk of material misstatement, fraud or losses.

Management’s report on internal control over financial reporting
Management of the Group is responsible for establishing and maintaining adequate internal control over financial reporting for the Group.

The Group’s internal control over financial reporting is a component of an overall system of internal control. The Group’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the preparation, reliability and fair presentation of financial statements for external purposes in accordance with International Financial Reporting Standards (“IFRS”) and it includes:

·      Policies and procedures that relate to the maintenance of records that, in reasonable detail, fairly and accurately reflect the transactions and disposition of assets.

·      Controls providing reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with IFRS, and that receipts and expenditures are being made only as authorised by management.

·      Controls providing reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use or disposition of assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or because the degree of compliance with policies or procedures may deteriorate.

Management assessed the effectiveness of the Group’s internal control over financial reporting as of 31 December 2011 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in “Internal Control - Integrated Framework”.

Based on its assessment, management believes that, as of 31 December 2011, the Group’s internal control over financial reporting is effective.

The effectiveness of the Group’s internal control over financial reporting as of 31 December 2011 has been audited by Deloitte LLP, the Group’s independent registered public accounting firm. The report of the independent registered public accounting firm to the directors of The Royal Bank of Scotland Group plc expresses an unqualified opinion on the effectiveness of the Group’s internal control over financial reporting as of 31 December 2011.

Disclosure controls and procedures
As required by US regulations, the effectiveness of the company's disclosure controls and procedures (as defined in the rules under the Exchange Act) have been evaluated. This evaluation has been considered and approved by the Board which has instructed the Group Chief Executive and Group Finance Director to certify that as at 31 December 2011, the company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the company and its consolidated subsidiaries would be made known to them by others within those entities.
 

 
 
254

 
Compliance report continued
 

Report of Independent Registered Public Accounting Firm to the members of The Royal Bank of Scotland Group plc

We have audited the internal control over financial reporting of The Royal Bank of Scotland Group plc and subsidiaries (“the Group”) as at 31 December 2011, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

The Group’s management is responsible for maintaining effective internal control over financial reporting and for assessing its effectiveness as described in Management’s Report on Internal Control over Financial Reporting.  Our responsibility is to express an opinion on the Group's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk of whether a material weakness existed, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances.  We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorisations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Group maintained, in all material respects, effective internal control over financial reporting as at 31 December 2011, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as at and for the year ended 31 December 2011 of the Group and our report dated 22 February 2012 (27 March 2012 as to the consolidating financial information included in Note 43 of the financial statements) expressed an unqualified opinion on those financial statements.



/s/ Deloitte LLP
London, United Kingdom
22 February 2012
 
 


 
255

 
Compliance report continued

 
 
Changes in internal control
There was no change in the company's internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting.

The New York Stock Exchange
As a foreign issuer with American Depositary Shares representing ordinary shares, preference shares and debt securities listed on the New York Stock Exchange (the “NYSE”), the company must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under the NYSE corporate governance listing standards. In addition, the company must comply fully with the provisions of the listing standards that relate to the composition, responsibilities and operation of Audit Committees. These provisions incorporate the relevant rules concerning audit committees of the Exchange Act.

The company has reviewed its corporate governance arrangements and is satisfied that these are consistent with the NYSE’s corporate governance listing practices, with the exception that the Chairman of the Board is also the Chairman of the Group Nominations Committee, which is permitted under the Code (since the Chairman was considered independent on appointment). The company’s Group Audit, Board Risk, Group Remuneration and Group Nominations Committees are otherwise composed solely of non-executive directors deemed by the Group Board to be independent. The NYSE corporate governance listing standards also require that a compensation committee has direct responsibility to review and approve the Group Chief Executive’s remuneration.

As stated at the start of this Compliance report, in the case of the company, the Group Board, rather than the Group Remuneration Committee, reserves the authority to make the final determination of the remuneration of the Group Chief Executive.

The Group Audit Committee complies with the provisions of the NYSE corporate governance listing standards that relate to the composition, responsibilities and operation of audit committees. In April 2011, the company submitted its required annual written affirmation to the NYSE confirming its full compliance with those and other applicable provisions. More detailed information about the Group Audit Committee and its work during 2011 is set out in the Group Audit Committee report on pages 221 to 225.

This Compliance report forms part of the Corporate governance report and the Report of the directors.




 
 

 
256

 


Report of the directors
 
The directors present their report together with the audited accounts for the year ended 31 December 2011.
 
Group structure
The company is a holding company owning the entire issued ordinary share capital of The Royal Bank of Scotland plc, the principal direct operating subsidiary undertaking of the company. The Group comprises the company and all its subsidiary and associated undertakings, including the Royal Bank and NatWest.

Following placing and open offers in December 2008 and in April 2009, HM Treasury (HMT) owned approximately 70.3% of the enlarged ordinary share capital of the company. In December 2009, the company issued a further £25.5 billion of new capital to HMT. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as Core Tier 1 capital.

In 2011, the company issued 770.3 million ordinary shares in connection with employee share schemes. At 31 December 2011, HMT’s holding in the company’s ordinary shares had reduced to 66.9%.

Results and dividends
The loss attributable to the ordinary and B shareholders of the company for the year ended 31 December 2011 amounted to £1,997 million compared with a loss of £1,125 million for the year ended 31 December 2010, as set out in the consolidated income statement on page 266.

The company did not pay a dividend on ordinary shares in 2010 or 2011.

The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (other than companies in the RBS Holdings N.V. group, which are subject to different restrictions, see below) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) for a period of two years from 30 April 2010 (the “Deferral Period”), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.

The Group has agreed that RBS Holdings N.V. will not pay investors any coupons on, or exercise any call rights in relation to, specified hybrid capital instruments for an effective period of two years from 1 April 2011, unless in any such case there is a legal obligation to do so. RBS Holdings N.V. and its group companies are also subject to restrictions on the exercise of call rights in relation to their other hybrid capital instruments.


Business review
Activities
The Group is engaged principally in providing a wide range of banking, insurance and other financial services. Further details of the organisational structure and business overview of the Group, including the products and services provided by each of its divisions and the competitive markets in which they operate, are contained in the Business review on pages 4 to 6.

Risk factors
The Group’s future performance and results could be materially different from expected results depending on the outcome of certain potential risks and uncertainties. Certain risk factors the Group faces are summarised on page 7. Fuller details of these and other risk factors are set out on pages 405 to 418.

The reported results of the Group are also sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. Details of the Group’s critical accounting policies and key sources of accounting judgments are included in Accounting policies on pages 273 to 285.

The Group’s approach to risk management, including its financial risk management objectives and policies and information on the Group’s exposure to price, credit, liquidity and cash flow risk, is discussed in the Risk and balance sheet management section of the Business review on pages 58 to 207.

Financial performance
A review of the Group's performance during the year ended 31 December 2011, including details of each division, and the Group's financial position as at that date is contained in the Business review on pages 8 to 57.

RBS Holdings N.V. (formerly ABN AMRO Holding N.V.)
In 2007, RFS Holdings B.V., which was jointly owned by the Group, the Dutch State (successor to Fortis) and Santander (together, the “Consortium Members”) completed the acquisition of ABN AMRO Holding N.V.

On 6 February 2010, the businesses of ABN AMRO Holding N.V. acquired by the Dutch State were legally demerged to a newly established company, ABN AMRO Bank N.V., which on 1 April 2010 was transferred to ABN AMRO Group N.V., itself owned by the Dutch State.  Following legal separation, RBS Holdings N.V. (formerly ABN AMRO Holding N.V.) has one operating subsidiary, The Royal Bank of Scotland N.V. (“RBS N.V.”), a fully operational bank within the Group. RBS N.V. is independently rated and regulated by the Dutch Central Bank. Certain assets within RBS N.V. continue to be shared by the Consortium Members.


 
257

 
Report of the directors continued


On 19 April 2011, the Group announced the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank. Subject to, among other matters, regulatory and other approvals and procedures, it is expected that the transfers will be implemented on a phased basis over a period ending 31 December 2013. A large part of the transfers is expected to have taken place by the end of 2012.

On 17 October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of the UK Financial Services and Markets Act 2000.

Approximately 98% of the issued share capital of RFS Holdings B.V. is held by the Group.

Business divestments
To comply with EC State Aid requirements the Group agreed a series of restructuring measures to be implemented over a four year period from December 2009. This supplements the measures in the strategic plan previously announced by the Group. These include divesting RBS Insurance, 80.01% of Global Merchant Services (largely completed in 2010) and substantially all of RBS Sempra Commodities JV business (completed in 2010), as well as divesting the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.

Employees
As at 31 December 2011, the Group employed over 146,800 employees (full-time equivalent basis) throughout the world. Details of employee related costs are included in Note 3 on the consolidated accounts.

The Group operates certain employee share plans in which eligible employees are able to participate and which align the interests of employees with those of shareholders.

Employee learning and development
The Group maintains a strong commitment  to providing all its employees with the opportunity to grow through learning and development, which in turn helps to achieve business objectives and drive excellent customer service. Employee Volunteering schemes make it easy for individuals and teams to give something back to their communities and make a real difference.

Employee communication
Employee engagement is encouraged through a range of communication channels, at both divisional and Group level. These channels provide access to news and information in a number of ways, including the intranet, magazines, video, team meetings led by line managers, briefings held by senior managers and regular dialogue with employees and employee representatives.

The Group Chief Executive and other senior Group executives regularly communicate with, and encourage feedback from, employees across a range of channels.

Employee feedback
Every year since 1999, through the Your Feedback survey, employees in all our businesses have shared their thoughts about what it’s like working for RBS. These insights inform what the Group needs to do to improve the way it works, whether it’s a local issue or something that affects everyone. Apart from an opportunity to listen to employees, the survey also enables the Group to monitor levels of employee satisfaction and engagement and how these compare with other companies.

Employee consultation
The Group recognises employee representative organisations such as trade unions and work councils in a number of businesses and countries.

The Group has two European employee fora that provide elected representatives with an opportunity to understand better its European operations.

Diversity and inclusion
During 2011, the Group executive renewed its commitment to make workplace policies, processes and experiences inclusive for staff, customers and stakeholders.

Inclusion is built into the recruitment process, positive action programmes developing talent, flexible working policies and support for ill-health and disability-related absence. The Group continues to support disabled people ensuring they have equal opportunities to recruitment, employment, promotion and training.

The Group supports employee led networks such as Focused Women and Rainbow who support personal and career development through networking and training events.

This commitment to inclusion extends to supporting and participating in positive action programmes outside of the Group aimed at cultivating future leaders including, ‘An Inspirational Journey’, the FTSE-100 cross-company mentoring and Glass Ladder programmes. The Group maintains its involvement with external charitable networks and events such as Manchester Pride.

This approach to inclusion extends to the marketplace with the RBS Women in Business Ambassadors who support and guide more and more women to take the step of starting their own business.

Performance is monitored and reviewed at Group and divisional level and RBS is supportive of the recommendations of Lord Davies' Report. There are currently three female directors on the Board out of a total of 13 directors. The Group expects to meet the aspirational target of 25 per cent female Board representation in 2012. As at 31 December 2011, 18 per cent of executives in the Group and 53 per cent of employees were female.

Further details on the Board diversity policy can be found on page 220.

 
258

 
Report of the directors continued

Safety, health and wellbeing
Ensuring the safety, health and wellbeing of employees and customers is an important responsibility for the Group.

The Group is committed to ensuring legal compliance and managing health and safety risks. During 2011, increased focus on leadership, governance and the effectiveness of controls delivered improvements in health and safety performance.

A wide range of health benefits and services are in place to help employees maintain good physical and psychological health, and support them if they do become unwell. A number of these services have been enhanced and promoted in response to the impact of the economic environment.

Pre-employment screening
The Group has a comprehensive pre-employment screening process to guard against possible infiltration and employee-related fraud for all direct and non-direct staff engaged on Group business.

Code of conduct
The code of conduct applies to everyone who works for RBS. It promotes honest and ethical conduct, including the handling of actual or apparent conflicts of interest between personal and professional relationships. The Group recognises that personal conduct, business integrity and the Group’s security are crucial, and the code of conduct serves to inform those who work for us of the Group’s expectations of their behaviour and practices.

The code of conduct is available on the Group’s website www.rbs.com and will also be provided to any person without charge, upon request, by contacting RBS Secretariat at the telephone number listed on page 451.

Sustainability
Sustainability is central to the way the Group is managed. Sustainability is not just about the many responsibilities and obligations that the Group has in a legal sense, but about specific issues that need to be addressed to ensure that the Group is a healthy and respected business operating on a sustainable basis. There is a clear governance structure for Group Sustainability that oversees and aligns the Group's approach to the range of ethical, social and environmental issues which confront the business on a daily basis.

The Group continues to do significant work and address challenges across five key themes: Fair banking, Supporting enterprise, Employee engagement, Safety and security and Citizenship and environmental sustainability.

Going concern
The Group’s business activities and financial position, the factors likely to affect its future development and performance and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Business review. The risk factors which could materially affect the Group’s future results are set out on pages 405 to 418. The Group’s regulatory capital resources and significant developments in 2011 and anticipated future developments are detailed on pages 68 to 73. The liquidity and funding section on pages 74 to 88, describes the Group’s funding and liquidity profile, including changes in key metrics, the build up of liquidity reserves and the outlook for 2012.

Having reviewed the Group’s forecasts, projections and other relevant evidence, the directors have a reasonable expectation that the Group and the company will continue in operational existence for the foreseeable future. Accordingly, the financial statements of the Group and of the company have been prepared on a going concern basis.

BBA disclosure code
In September 2010, the British Bankers’ Association published its Code for Financial Reporting Disclosure. The code sets out five disclosure principles together with supporting guidance. The principles are that the Group and other major UK banks will provide high quality, meaningful and decision-useful disclosures; review and enhance their financial instrument disclosures for key areas of interest to market participants; assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; seek to enhance the comparability of financial statement disclosures across the UK banking sector; and clearly differentiate in their annual reports between information that is audited and information that is unaudited.  The Group’s 2011 financial statements have been prepared in compliance with the code’s principles.

Corporate governance
The company is committed to high standards of corporate governance. Details are given in the Corporate governance report on pages 210 to 253. The Corporate governance report and compliance report (pages 254 to 256) form part of this Report of the directors.

Share capital
Details of the ordinary and preference share capital at 31 December 2011 and movements during the year are shown in Note 27 on the consolidated accounts.


 
259

 
Report of the directors continued

Additional information
Where not provided elsewhere in the Report of the directors, the following additional information is required to be disclosed by Part 6 of Schedule 7 to the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008.

The rights and obligations attaching to the company’s ordinary shares and preference shares are set out in the company’s Articles of Association, copies of which can be obtained from Companies House in the UK or can be found on the Group’s website www.rbs.com.

On a show of hands at a general meeting of the company every holder of ordinary shares and cumulative preference shares present in person or by proxy and entitled to vote shall have one vote. On a poll, every holder of ordinary shares present in person or by proxy and entitled to vote shall have one vote for every share held. On a poll, holders of cumulative preference shares present in person or by proxy and entitled to vote shall have four votes for every share held. The voting rights of holders of non-cumulative preference shares are set out in Note 27 on the consolidated accounts. The notices of Annual General Meetings and General Meetings specify the deadlines for exercising voting rights and appointing a proxy or proxies to vote in relation to resolutions to be passed at the meeting.

The cumulative preference shares represent less than 0.01% and the non-cumulative preference shares represent less than 0.73% of the total voting rights of the company respectively, the remainder being represented by the ordinary shares.

There are no restrictions on the transfer of ordinary shares in the company other than certain restrictions which may from time to time be imposed by laws and regulations (for example, insider trading laws). Pursuant to the Listing Rules of the FSA, certain employees of the company require the approval of the company to deal in the company’s shares.

The rules governing the powers of directors, including in relation to issuing or buying back shares and their appointment are set out in the company’s Articles of Association. It will be proposed at the 2012 Annual General Meeting that the directors be granted authorities to allot shares under the Companies Act 2006. The company’s Articles of Association may only be amended by a special resolution at a general meeting of shareholders.

A number of the company’s share plans include restrictions on transfers of shares while shares are subject to the plans or the terms under which the shares were awarded.

The rights and obligations of holders of non-cumulative preference shares are set out in Note 27 on the consolidated accounts.

Except in relation to the Dividend Access Share, the company is not aware of any agreements between shareholders that may result in restrictions on the transfer of securities and/or voting rights. There are no persons holding securities carrying special rights with regard to control of the company.

Under the rules of certain employee share plans, eligible employees are entitled to acquire shares in the company, and shares are held in trust for participants by The Royal Bank and Ulster Bank Dublin Trust Company as Trustees. Voting rights are exercised by the Trustees on receipt of participants’ instructions. If a participant does not submit an instruction to the Trustee no vote is registered.

The Royal Bank of Scotland plc 1992 Employee Share Trust, The Royal Bank of Scotland Group plc 2001 Employee Share Trust and The Royal Bank of Scotland Group plc 2007 US Employee Share Trust hold shares on behalf of the Group’s employee share plans. The voting rights are exercisable by the Trustees, however, in accordance with investor protection guidelines, the Trustees abstain from voting. The Trustees would take independent advice before accepting any offer in respect of their shareholdings for the company in a takeover bid situation.

Awards granted under the company’s employee share plans may be met through a combination of newly issued shares and shares acquired in the market by the company’s employee benefit trusts.

A change of control of the company following a takeover bid may cause a number of agreements to which the company is party to take effect, alter or terminate. All of the company’s employee share plans contain provisions relating to a change of control. Outstanding awards and options may vest and become exercisable on change of control, subject where appropriate to the satisfaction of any performance conditions at that time and pro-rating of awards. In the context of the company as a whole, these agreements are not considered to be significant.

Directors
The names and brief biographical details of the directors are shown on pages 211 to 214.

Sandy Crombie, Philip Hampton, Stephen Hester, Penny Hughes, Joe MacHale, John McFarlane, Brendan Nelson, Art Ryan, Philip Scott and Bruce Van Saun all served throughout the year and to the date of signing of the financial statements.

Alison Davis and Baroness Noakes were appointed as non-executive directors on 1 August 2011. Tony Di Iorio was appointed as a non-executive director on 1 September 2011. Colin Buchan retired as a non-executive director on 5 August 2011, having served just over nine years on the Board. John McFarlane will step down from the Board on 31 March 2012.

All directors of the company stand for re-election annually and, with the exception of John McFarlane, all directors will stand for election or re-election by shareholders at the Annual General Meeting in 2012.

 
260

 
Report of the directors continued


Directors’ interests
The interests of the directors in the shares of the company at 31 December 2011 are shown on page 262. None of the directors held an interest in the loan capital of the company or in the shares or loan capital of any of the subsidiary undertakings of the company, during the period from 1 January 2011 to 22 February 2012.

Directors’ indemnities
In terms of section 236 of the Companies Act 2006 (the “Companies Act”), Qualifying Third Party Indemnity Provisions have been issued by the company to directors, members of the Group’s Executive and Management Committees and FSA Approved Persons.

In terms of section 236 of the Companies Act, Qualifying Pension Scheme Indemnity Provisions have been issued to all trustees of the Group’s pension schemes.

Post balance sheet events
There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.

Shareholdings
The table below shows shareholders that have notified the Group that they hold more than 3% of the total voting rights of the company at 31 December 2011.

Solicitor For The Affairs of Her Majesty’s Treasury as Nominee for Her Majesty’s Treasury
 
Number of shares
 
% of share class held
 
 
% of total voting rights held
Ordinary shares
 
39,644,835,194
 
66.9
 
66.4
B shares (non-voting)
 
51,000,000,000
 
100.0
 

The Group has not been notified of any changes to the above interests between 31 December 2011 and 22 February 2012.

Charitable contributions
In 2011, the Group’s overall community contribution was £72.0 million (2010 - £56.1 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2011 was £39.1 million (2010 - £29.6 million).

To ensure it makes its community investments as effective as possible, the Group’s policy is to focus its resources on a small number of substantial strategic programmes. These are issues most relevant to a financial institution and relate broadly to financial education, supporting enterprise and microfinance and the charitable endeavours of employees.

Political donations
At the Annual General Meeting in 2011, shareholders gave authority under Part 14 of the Companies Act, for a period of one year, for the company (and its subsidiaries) to make political donations and incur political expenditure up to a maximum aggregate sum of £500,000. This authorisation was taken as a precaution only, as the company has a longstanding policy of not making political donations or incurring political expenditure within the ordinary meaning of those words. During 2011, the Group made no political donations, nor incurred any political expenditure in the UK or EU and it is not proposed that the Group’s longstanding policy of not making contributions to any political party be changed.  Shareholders will be asked to renew this authorisation at a reduced maximum aggregate sum of £100,000 at the Annual General Meeting in 2012.

Policy and practice on payment of creditors
The Group is committed to maintaining a sound commercial relationship with its suppliers. Consequently, it is the Group’s policy to negotiate and agree terms and conditions with its suppliers, which include the giving of an undertaking to pay suppliers within 30 days of receipt of a correctly prepared invoice submitted in accordance with the terms of the contract or such other payment period as may be agreed.

At 31 December 2011, the Group’s trade creditors represented 27 days (2010 - 29 days) of amounts invoiced by suppliers.

Directors’ disclosure to auditors
Each of the directors at the date of approval of this report confirms that:

(a) so far as the director is aware, there is no relevant audit information of which the company’s auditors are unaware; and

(b) the director has taken all the steps that he/she ought to have taken as a director to make himself/herself aware of any relevant audit information and to establish that the company’s auditors are aware of that information.

This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act.

Auditors
The auditors, Deloitte LLP, have indicated their willingness to continue in office. A resolution to re-appoint Deloitte LLP as the company’s auditors will be proposed at the forthcoming Annual General Meeting.

By order of the Board







Aileen Taylor
Secretary
22 February 2012

The Royal Bank of Scotland Group plc
is registered in Scotland No. SC45551
 
261

 
Directors’ interests in shares


   
31 December 2011
 
Shares beneficially 
 owned at 1 January 2011 
 or date of appointment, if later 
Shares 
beneficially 
owned 
Value (1)
£ 
Chairman
     
Philip Hampton
276,312
276,312
55,760
       
Executive director
     
Stephen Hester
3,463,297
5,411,358
1,092,012
       
Non-executive directors
     
Sandy Crombie
200,000
200,000
40,360
Alison Davis
200,000
40,360
Tony Di lorio (2)
300,000
60,540
Penny Hughes
8,175
8,175
1,650
Joe MacHale
284,317
284,317
57,375
John McFarlane
50,000
50,000
10,090
Brendan Nelson
120,018
120,018
24,220
Baroness Noakes
210,000
42,378
Art Ryan
50,000
50,000
10,090
Philip Scott
500,000
500,000
100,900

Notes:
(1)
Value is based on the share price at 30 December 2011 (the last working day of 2011), which was 20.18p. During the year ended 31 December 2011, the share price ranged from 17.34p to 49.0p.
(2)
Mr Di Iorio holds his interests in the company’s shares in the form of American Depository Receipts (ADRs).  Each ADR represents 20 ordinary shares of £0.25 each in the company. Mr Di Iorio holds 15,000 ADRs representing 300,000 ordinary shares.

No other current director had an interest in the company's ordinary shares during the year or held a non-beneficial interest in the shares of the company at 31 December 2011, at 1 January 2011 or date of appointment if later. The interests shown above include connected persons of the directors.

As at 22 February 2012, there were no changes to the directors' interests in shares shown in the table above.

 
262

 
Statement of directors’ responsibilities

 
The directors are responsible for the preparation of the Annual Report and Accounts.

The directors are required by Article 4 of the IAS Regulation (European Commission Regulation No 1606/2002) to prepare Group accounts, and as permitted by the Companies Act 2006 have elected to prepare company accounts, for each financial year in accordance with International Financial Reporting Standards as adopted by the European Union. They are responsible for preparing accounts that present fairly the financial position, financial performance and cash flows of the Group and the company. In preparing those accounts, the directors are required to:

·  
select suitable accounting policies and then apply them consistently;

·  
make judgements and estimates that are reasonable and prudent; and

·  
state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the accounts.

The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Group and to enable them to ensure that the Annual Report and Accounts complies with the Companies Act 2006. They are also responsible for safeguarding the assets of the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.






By order of the Board



Aileen Taylor
Secretary
22 February 2012


We, the directors listed below, confirm that to the best of our knowledge:
 
·  
the financial statements, prepared in accordance with International Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the company and the undertakings included in the consolidation taken as a whole; and
 
·  
the Business review, which is incorporated into the Directors' report, includes a fair review of the development and performance of the business and the position of the company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.



By order of the Board




Philip Hampton
Stephen Hester
Bruce Van Saun
Chairman
Group Chief Executive
Group Finance Director

22 February 2012


Board of directors

Chairman
Executive directors
Non-executive directors
Philip Hampton
Stephen Hester
Bruce Van Saun
Sandy Crombie
Alison Davis
Tony Di Iorio
Penny Hughes
Joe MacHale
John McFarlane
Brendan Nelson
Baroness Noakes
Arthur ‘Art’ Ryan
Philip Scott

 
263

 
Financial statements

265
Report of Independent Registered Public Accounting Firm
266
Consolidated income statement
267
Consolidated statement of comprehensive income
268
Consolidated balance sheet
269
Consolidated statement of changes in equity
272
Consolidated cash flow statement
273
Accounting policies
286
Notes on the consolidated accounts
 
1
Net interest income
286
 
2
Non-interest income (excluding insurance net premium income)
287
 
3
Operating expenses
288
 
4
Pensions
292
 
5
Auditor’s remuneration
296
 
6
Tax
297
 
7
Profit attributable to preference shareholders and paid-in equity holders
298
 
8
Ordinary dividends
298
 
9
Earnings per ordinary and B share
298
 
10
Financial instruments - classification
299
 
11
Financial instruments - valuation
304
 
12
Financial instruments - maturity analysis
321
 
13
Financial assets - impairments
323
 
14
Derivatives
325
 
15
Debt securities
327
 
16
Equity shares
328
 
17
Intangible assets
329
 
18
Property, plant and equipment
332
 
19
Prepayments, accrued income and other assets
334
 
20
Discontinued operations and assets and liabilities of disposal groups
334
 
21
Short positions
336
 
22
Accruals, deferred income and other liabilities
336
 
23
Deferred tax
337
 
24
Insurance business
338
 
25
Subordinated liabilities
342
 
26
Non-controlling interests
349
 
27
Share capital
350
 
28
Other equity
352
 
29
Leases
353
 
30
Securitisations and asset transfers
355
 
31
Capital resources
357
 
32
Memorandum items
359
 
33
Net cash inflow/(outflow) from operating activities
368
 
34
Analysis of the net investment in business interests and intangible assets
368
 
35
Interest received and paid
369
 
36
Analysis of changes in financing during the year
369
 
37
Analysis of cash and cash equivalents
369
 
38
Segmental analysis
370
 
39
Directors’ and key management remuneration
376
 
40
Transactions with directors and key management
376
 
41
Related parties
377
 
42
Post balance sheet events
378
 
43
Consolidating financial information
379
   
 
 
 
264

 
 
Report of Independent Registered Public Accounting Firm to the members of The Royal Bank of Scotland Group plc

 
We have audited the accompanying consolidated balance sheets of The Royal Bank of Scotland Group plc and its subsidiaries (together "the Group") as at 31 December 2011, 2010 and 2009 and the related consolidated income statements, consolidated statements of comprehensive income, consolidated statements of changes in equity and consolidated cash flow statements for each of the three years in the period ended 31 December 2011, the notes 1 to 43 and the information identified as ‘audited’ in the Risk and balance sheet management section of the Business review.  These financial statements are the responsibility of the Group's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material aspects, the financial position of the Group as at 31 December 2011, 2010 and 2009, and the results of its operations and its cash flows for each of the three years in the period ended 31 December 2011, in conformity with International Financial Reporting Standards ("IFRS") as adopted for use in the European Union and IFRS as issued by the International Accounting Standards Board.

Note 43 to the financial statements was added for the inclusion of consolidating financial information in respect of The Royal Bank of Scotland plc in accordance with Regulation S-X Rule 3-10.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Group's internal control over financial reporting as at 31 December 2011 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organisations of the Treadway Commission and our report dated 22 February 2012 expressed an unqualified opinion on the Group's internal control over financial reporting.
 
 



/s/ Deloitte LLP
London, United Kingdom
22 February 2012 (27 March 2012 for the consolidating financial information in Note 43)


 
265

 
Consolidated income statement for the year ended 31 December 2011


 
Note 
2011 
£m 
2010  
£m 
2009  
£m 
Interest receivable
 
21,410 
22,776 
26,311 
Interest payable
 
(8,731)
(8,567)
(12,923)
Net interest income
1 
12,679 
14,209 
13,388 
Fees and commissions receivable
2 
6,384 
8,193 
8,738 
Fees and commissions payable
2 
(1,460)
(2,211)
(2,790)
Income from trading activities
2 
2,701 
4,517 
3,761 
Gain on redemption of own debt
2 
255 
553 
3,790 
Other operating income (excluding insurance net premium income)
2 
4,122 
1,479 
873 
Insurance net premium income
24 
4,256 
5,128 
5,266 
Non-interest income
 
16,258 
17,659 
19,638 
Total income
 
28,937 
31,868 
33,026 
Staff costs
       
  - excluding curtailment gains
 
(8,678)
(9,671)
(9,993)
  - pension schemes curtailment gains
 
— 
— 
2,148 
Premises and equipment
 
(2,451)
(2,402)
(2,594)
Other administrative expenses
 
(4,931)
(3,995)
(4,449)
Depreciation and amortisation
 
(1,875)
(2,150)
(2,166)
Write-down of goodwill and other intangible assets
 
(91)
(10)
(363)
Operating expenses
3 
(18,026)
(18,228)
(17,417)
Profit before insurance net claims and impairment losses
 
10,911 
13,640 
15,609 
Insurance net claims
24 
(2,968)
(4,783)
(4,357)
Impairment losses
13 
(8,709)
(9,256)
(13,899)
Operating loss before tax
 
(766)
(399)
(2,647)
Tax (charge)/credit
6 
(1,250)
(634)
429 
Loss from continuing operations
 
(2,016)
(1,033)
(2,218)
Profit/(loss) from discontinued operations, net of tax
2
47 
(633)
(105)
Loss for the year
 
(1,969)
(1,666)
(2,323)
         
Loss attributable to:
       
Non-controlling interests
 
28 
(665)
349 
Preference shareholders
7 
— 
105 
878 
Paid-in equity holders
7 
— 
19 
57 
Ordinary and B shareholders
 
(1,997)
(1,125)
(3,607)
   
(1,969)
(1,666)
(2,323)
         
Per ordinary and B share (1)
       
Basic loss from continuing operations
(1.8p)
(0.5p)
(6.3p)
         
Diluted loss from continuing operations
(1.8p)
(0.5p)
(6.3p)
         
Basic loss from discontinued operations
— 
— 
(0.1p)
         
Diluted loss from discontinued operations
— 
— 
(0.1p)

Note:
(1)
B shares rank pari-passu with ordinary shares.


The accompanying notes on pages 286 to 384, the accounting policies on pages 273 to 284 and the audited sections of the Business review: Risk and balance sheet management on pages 58 to 207 form an integral part of these financial statements.

 
266

 
Consolidated statement of comprehensive income for the year ended 31 December 2011

 
Note 
2011 
£m 
2010 
£m 
2009 
£m 
Loss for the year
 
(1,969)
(1,666)
(2,323)
Other comprehensive income/(loss)
       
Available-for-sale financial assets
 
2,258 
(389)
2,016 
Cash flow hedges
 
1,424 
1,454 
684 
Currency translation
 
(440)
81 
(3,300)
Actuarial (losses)/gains on defined benefit plans
(581)
158 
(3,665)
Other comprehensive income/(loss) before tax
 
2,661 
1,304 
(4,265)
Tax (charge)/credit
 
(1,472)
(309)
430 
Other comprehensive income/(loss) after tax
 
1,189 
995 
(3,835)
Total comprehensive loss for the year
 
(780)
(671)
(6,158)
         
Total comprehensive loss is attributable to:
       
Non-controlling interests
 
(24)
(197)
(1,346)
Preference shareholders
 
— 
105 
878 
Paid-in equity holders
 
— 
19 
57 
Ordinary and B shareholders
 
(756)
(598)
(5,747)
   
(780)
(671)
(6,158)


The accompanying notes on pages 286 to 384, the accounting policies on pages 273 to 284 and the audited sections of the Business review: Risk and balance sheet management on pages 58 to 207 form an integral part of these financial statements.

 
267

 
Consolidated balance sheet as at 31 December 2011

 
Note 
2011 
£m 
2010 
£m 
2009 
£m 
Assets
       
Cash and balances at central banks
10 
79,269 
57,014 
52,261 
Loans and advances to banks
1
83,310 
100,518 
91,753 
Loans and advances to customers
1
515,606 
555,260 
728,393 
Debt securities subject to repurchase agreements
3
79,480 
80,104 
66,883 
Other debt securities
 
129,600 
137,376 
200,371 
Debt securities
15 
209,080 
217,480 
267,254 
Equity shares
16 
15,183 
22,198 
19,528 
Settlement balances
 
7,771 
11,605 
12,033 
Derivatives
14 
529,618 
427,077 
441,454 
Intangible assets
17 
14,858 
14,448 
17,847 
Property, plant and equipment
18 
11,868 
16,543 
19,397 
Deferred tax
23 
3,878 
6,373 
7,039 
Prepayments, accrued income and other assets
19 
10,976 
12,576 
20,985 
Assets of disposal groups
2
25,450 
12,484 
18,542 
Total assets
 
1,506,867 
1,453,576 
1,696,486 
         
Liabilities
       
Deposits by banks
1
108,804 
98,790 
142,144 
Customer accounts
1
502,955 
510,693 
614,202 
Debt securities in issue
10 
162,621 
218,372 
267,568 
Settlement balances
 
7,477 
10,991 
10,413 
Short positions
21 
41,039 
43,118 
40,463 
Derivatives
14 
523,983 
423,967 
424,141 
Accruals, deferred income and other liabilities
22 
23,125 
23,089 
30,327 
Retirement benefit liabilities
4 
2,239 
2,288 
2,963 
Deferred tax
23 
1,945 
2,142 
2,811 
Insurance liabilities
24 
6,312 
6,794 
10,281 
Subordinated liabilities
25 
26,319 
27,053 
37,652 
Liabilities of disposal groups
2
23,995 
9,428 
18,890 
Total liabilities
 
1,430,814 
1,376,725 
1,601,855 
Non-controlling interests
26 
1,234 
1,719 
16,895 
Owners’ equity
27,28 
74,819 
75,132 
77,736 
Total equity
 
76,053 
76,851 
94,631 
         
Total liabilities and equity
 
1,506,867 
1,453,576 
1,696,486 

The accompanying notes on pages 286 to 384, the accounting policies on pages 273 to 284 and the audited sections of the Business review: Risk and balance sheet management on pages 58 to 207 form an integral part of these financial statements.

The accounts were approved by the Board of directors on 22 February 2012 and signed on its behalf by:

Philip Hampton
Chairman
 
Stephen Hester
Group Chief Executive
 
Bruce Van Saun
Group Finance Director


The Royal Bank of Scotland Group plc
Registered No. SC45551

 
268

 
Consolidated statement of changes in equity for the year ended 31 December 2011

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Called-up share capital
     
At 1 January
15,125 
14,630 
9,898 
Ordinary shares issued in respect of placing and open offer
— 
— 
4,227 
B shares issued
— 
— 
510 
Ordinary shares issued
193 
523 
 
Preference shares redeemed
— 
(1)
(5)
Cancellation of non-voting deferred shares
— 
(27)
— 
At 31 December
15,318 
15,125 
14,630 
       
Paid-in equity
     
At 1 January
431 
565 
1,073 
Securities redeemed
— 
(132)
(308)
Transfer to retained earnings
— 
(2)
(200)
At 31 December
431 
431 
565 
       
Share premium account
     
At 1 January
23,922 
23,523 
27,471 
Ordinary shares issued in respect of placing and open offer, net of £95 million expenses
— 
— 
1,047 
Ordinary shares issued
79 
281 
 
Redemption of preference shares classified as debt
— 
118 
— 
Preference shares redeemed
— 
— 
(4,995)
At 31 December
24,001 
23,922 
23,523 
       
Merger reserve
     
At 1 January
13,272 
25,522 
10,881 
Issue of B shares, net of £399 million expenses
— 
— 
24,591 
Transfer to retained earnings
(50)
(12,250)
(9,950)
At 31 December
13,222 
13,272 
25,522 
       
Available-for-sale reserve
     
At 1 January
(2,037)
(1,755)
(3,561)
Unrealised gains
1,769 
179 
1,202 
Realised losses/(gains) (1)
486 
(519)
981 
Tax
(1,175)
74 
(377)
Recycled to profit or loss on disposal of businesses (2)
— 
(16)
— 
At 31 December
(957)
(2,037)
(1,755)
       
Cash flow hedging reserve
     
At 1 January
(140)
(252)
(876)
Amount recognised in equity
2,417 
180 
380 
Amount transferred from equity to earnings
(993)
(59)
513 
Tax
(405)
(67)
(269)
Recycled to profit or loss on disposal of businesses (3)
— 
58 
— 
At 31 December
879 
(140)
(252)

 
269

 

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Foreign exchange reserve
     
At 1 January
5,138 
4,528 
6,385 
Retranslation of net assets
(382)
997 
(2,322)
Foreign currency (losses)/gains on hedges of net assets
(10)
(458)
456 
Tax
23 
63 
Recycled to profit or loss on disposal of businesses
— 
At 31 December
4,775 
5,138 
4,528 
       
Capital redemption reserve
     
At 1 January
198 
170 
170 
Preference shares redeemed
— 
— 
Cancellation of non-voting deferred shares
— 
27 
— 
At 31 December
198 
198 
170 
       
Contingent capital reserve
     
At 1 January
(1,208)
(1,208)
— 
Contingent capital agreement - consideration payable
— 
— 
(1,208)
At 31 December
(1,208)
(1,208)
(1,208)
       
Retained earnings
     
At 1 January
21,239 
12,134 
7,542 
(Loss)/profit attributable to ordinary and B shareholders and other equity owners
     
  - continuing operations
(2,002)
(973)
(2,600)
  - discontinued operations
(28)
(72)
Equity preference dividends paid
— 
(105)
(878)
Paid-in equity dividends paid, net of tax
— 
(19)
(57)
Transfer from paid-in equity
     
  - gross
— 
200 
  - tax
— 
(1)
— 
Equity owners gain on withdrawal of non-controlling interest
     
  - gross
— 
40 
629 
  - tax
— 
(11)
(176)
Redemption of equity preference shares
— 
(2,968)
— 
Gain on redemption of equity preference shares
— 
609 
— 
Redemption of preference shares classified as debt
— 
(118)
— 
Transfer from merger reserve
50 
12,250 
9,950 
Actuarial (losses)/gains recognised in retirement benefit schemes
     
  - gross
(581)
158 
(3,756)
  - tax
86 
(71)
1,043 
Purchase of non-controlling interest
— 
(38)
— 
Shares issued under employee share schemes
(58)
(13)
(16)
Share-based payments
     
  - gross
200 
385 
325 
  - tax
(10)
— 
At 31 December
18,929 
21,239 
12,134 
       
Own shares held
     
At 1 January
(808)
(121)
(104)
Disposal/(purchase) of own shares
20 
(700)
(33)
Shares issued under employee share schemes
19 
13 
16 
At 31 December
(769)
(808)
(121)
       
Owners’ equity at 31 December
74,819 
75,132 
77,736 
 
 

 
 
270

 
Consolidated statement of changes in equity continued

 
2011 
£m 
2010 
£m 
2009 
£m 
Non-controlling interests (see Note 26)
     
At 1 January
1,719 
16,895 
21,619 
Currency translation adjustments and other movements
(54)
(466)
(1,434)
Profit/(loss) attributable to non-controlling interests
     
  - continuing operations
(14)
(60)
382 
  - discontinued operations
42 
(605)
(33)
Dividends paid
(40)
(4,200)
(313)
Movements in available-for-sale securities
     
  - unrealised gains/(losses)
(56)
299 
  - realised losses/(gains)
37 
(466)
  - tax
(1)
(36)
  - recycled to profit or loss on disposal of discontinued operations (4)
— 
(7)
— 
Movements in cash flow hedging reserve
     
  - amount recognised in equity
— 
(120)
(209)
  - tax
— 
39 
59 
  - recycled to profit or loss on disposal of discontinued operations (5)
— 
1,036 
— 
Actuarial gains recognised in retirement benefit schemes
     
  - gross
— 
— 
91 
  - tax
— 
— 
Equity raised
— 
559 
Equity withdrawn and disposals
(421)
(11,298)
(2,445)
Transfer to retained earnings
— 
(40)
(629)
At 31 December
1,234 
1,719 
16,895 
       
Total equity at 31 December
76,053 
76,851 
94,631 
       
Total comprehensive loss recognised in the statement of changes in equity is attributable to:
     
Non-controlling interests
(24)
(197)
(1,346)
Preference shareholders
— 
105 
878 
Paid-in equity holders
— 
19 
57 
Ordinary and B shareholders
(756)
(598)
(5,747)
 
(780)
(671)
(6,158)

Notes:
(1)
Includes an impairment loss of £1,099 million in respect of the Group’s holding of Greek government bonds, together with £169 million of related interest rate hedge adjustments, for the year ended 31 December 2011.
(2)
Net of tax (year ended 31 December 2010 - £5 million credit)
(3)
Net of tax (year ended 31 December 2010 - £19 million charge).
(4)
Net of tax (year ended 31 December 2010 - £2 million credit).
(5)
Net of tax (year ended 31 December 2010 - £340 million charge).


The accompanying notes on pages 286 to 384, the accounting policies on pages 273 to 284 and the audited sections of the Business review: Risk and balance sheet management on pages 58 to 207 form an integral part of these financial statements.

 
271

 
Consolidated cash flow statement for the year ended 31 December 2011

 
Note 
2011 
£m 
2010 
£m 
2009 
£m 
Operating activities
       
Operating loss before tax
 
(766)
(399)
(2,647)
Operating profit/(loss) before tax on discontinued operations
 
58 
(541)
(49)
Adjustments for:
       
Depreciation and amortisation
 
1,875 
2,220 
2,809 
Write-down of goodwill and other intangible assets
 
91 
10 
363 
Interest on subordinated liabilities
 
740 
500 
1,490 
Charge for defined benefit pension schemes
 
349 
540 
659 
Pension scheme curtailment gains
 
— 
(78)
(2,148)
Cash contribution to defined benefit pension schemes
 
(1,059)
(832)
(1,153)
Gain on redemption of own debt
 
(255)
(553)
(3,790)
Elimination of foreign exchange differences
 
2,702 
(691)
12,217 
Other non-cash items
 
3,218 
1,455 
7,940 
Net cash flows from trading activities
 
6,953 
1,631 
15,691 
Changes in operating assets and liabilities
 
(3,444)
17,095 
(15,964)
Net cash flows from operating activities before tax
 
3,509 
18,726 
(273)
Income taxes (paid)/received
 
(184)
565 
(719)
Net cash flows from operating activities
33 
3,325 
19,291 
(992)
         
Investing activities
       
Sale and maturity of securities
 
80,093 
47,604 
76,492 
Purchase of securities
 
(77,019)
(43,485)
(73,593)
Sale of property, plant and equipment
 
1,840 
2,011 
1,948 
Purchase of property, plant and equipment
 
(3,472)
(2,113)
(4,898)
Net investment in business interests and intangible assets
34 
(1,428)
3,446 
105 
Transfer out of discontinued operations
 
— 
(4,112)
— 
Net cash flows from investing activities
 
14 
3,351 
54 
         
Financing activities
       
Issue of ordinary shares
 
— 
Placing and open offer
 
— 
— 
5,274 
Issue of B shares
 
— 
— 
25,101 
Issue of subordinated liabilities
 
— 
— 
2,309 
Proceeds of non-controlling interests issued
 
— 
559 
9 
Redemption of paid-in equity
 
— 
(132)
(308)
Redemption of preference shares
 
— 
(2,359)
(5,000)
Redemption of non-controlling interests
 
(382)
(5,282)
(422)
Disposal/(purchase) of own shares
 
20 
(700)
(33)
Repayment of subordinated liabilities
 
(627)
(1,588)
(5,145)
Dividends paid
 
(40)
(4,240)
(1,248)
Interest on subordinated liabilities
 
(714)
(639)
(1,746)
Net cash flows from financing activities
 
(1,741)
(14,380)
18,791 
Effects of exchange rate changes on cash and cash equivalents
 
(1,473)
82 
(8,592)
         
Net increase in cash and cash equivalents
 
125 
8,344 
9,261 
Cash and cash equivalents at 1 January
 
152,530 
144,186 
134,925 
Cash and cash equivalents at 31 December
37 
152,655 
152,530 
144,186 


The accompanying notes on pages 286 to 384, the accounting policies on pages 273 to 284 and the audited sections of the Business review: Risk and balance sheet management on pages 58 to 207 form an integral part of these financial statements.

 
272

 
Accounting policies
 
1. Presentation of accounts
The accounts are prepared on a going concern basis (see page 259 of the Report of the directors) and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (EU) (together IFRS). The EU has not adopted the complete text of IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the standard's hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 39 as issued by the IASB: the Group's financial statements are prepared in accordance with IFRS as issued by the IASB.

The accounts are prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held-for-trading financial assets and financial liabilities, financial assets and financial liabilities that are designated as at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged.  The company’s financial statements and the Group's consolidated financial statements are presented in sterling which is the functional currency of the company.

The company is incorporated in the UK and registered in Scotland and its accounts are presented in accordance with the Companies Act 2006.

There are a number of changes to IFRS that were effective from 1 January 2011. They have had no material effect on the financial statements of the Group or the company:

IFRIC 19 ‘Extinguishing Financial Liabilities with Equity Instruments’ provides guidance on the accounting treatment when financial liabilities are settled with equity instruments.

Amendment to IAS 32 ‘Financial Instruments: Presentation’ - ‘Classification of Rights Issues’ amends IAS 32 so that rights, options or warrants that are fixed for fixed (i.e. a fixed amount of cash for a fixed number of instruments) offered pro rata to all owners of a class of instrument are classified as equity instruments regardless of the currency denomination of the exercise price.

Amendment to IFRIC 14 ‘IAS 19 ‘The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ – ‘Prepayments of a Minimum Funding Requirement’ applies in the limited circumstances where an entity is subject to minimum funding requirements and makes an early payment of contributions to cover those requirements. The amendment permits the benefit of such an early payment to be treated as an asset.

May 2010 ‘Annual Improvements to IFRS’ makes non-urgent but necessary amendments to standards, primarily to remove inconsistencies and to clarify wording.

Revised IAS 24 ‘Related Party Disclosures’ simplifies the disclosure requirements for government-related entities and clarifies the definition of a related party.

2. Basis of consolidation
The consolidated financial statements incorporate the financial statements of the company and entities (including certain special purpose entities) that are controlled by the Group. Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. A subsidiary acquired is included in the consolidated financial statements from the date it is controlled by the Group up until the date the Group ceases to control it through a sale or a significant change in circumstances.  Changes in interest that do not result in a loss of control are accounted for as equity transactions.

All intra-group balances, transactions, income and expenses are eliminated on consolidation. The consolidated accounts are prepared using uniform accounting policies.

3. Revenue recognition
Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those measured at fair value are determined using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.

Financial assets and financial liabilities held for trading or designated as at fair value through profit or loss are recorded at fair value. Changes in fair value are recognised in profit or loss.

Commitment and utilisation fees are determined as a percentage of the outstanding facility. If it is unlikely that a specific lending arrangement will be entered into, such fees are taken to profit or loss over the life of the facility otherwise they are deferred and included in the effective interest rate on the advance.

Fees in respect of services are recognised as the right to consideration accrues through the provision of the service to the customer. The arrangements are generally contractual and the cost of providing the service is incurred as the service is rendered. The price is usually fixed and always determinable. The application of this policy to significant fee types is outlined below.
 
273

 

Payment services - this comprises income received for payment services including cheques cashed, direct debits, Clearing House Automated Payments (the UK electronic settlement system) and BACS payments (the automated clearing house that processes direct debits and direct credits). These are generally charged on a per transaction basis. The income is earned when the payment or transaction occurs. Charges for payment services are usually debited to the customer's account monthly or quarterly in arrears. Income is accrued at period end for services provided but not yet charged.

Card related services - fees from credit card business include:

·  
Commission received from retailers for processing credit and debit card transactions: income is accrued to the income statement as the service is performed.

·  
Interchange received: as issuer, the Group receives a fee (interchange) each time a cardholder purchases goods and services.  The Group also receives interchange fees from other card issuers for providing cash advances through its branch and automated teller machine networks. These fees are accrued once the transaction has taken place.

·  
An annual fee payable by a credit card holder is deferred and taken to profit or loss over the period of the service i.e. 12 months.

Insurance brokerage - this is made up of fees and commissions received from the agency sale of insurance. Commission on the sale of an insurance contract is earned at the inception of the policy, as the insurance has been arranged and placed. However, provision is made where commission is refundable in the event of policy cancellation in line with estimated cancellations.

Investment management fees - fees charged for managing investments are recognised as revenue as the services are provided. Incremental costs that are directly attributable to securing an investment management contract are deferred and charged as expense as the related revenue is recognised.

Insurance premiums - see Accounting policy 12.

4. Assets held for sale and discontinued operations
A non-current asset (or disposal group) is classified as held for sale if the Group will recover its carrying amount principally through a sale transaction rather than through continuing use. A non-current asset (or disposal group) classified as held for sale is measured at the lower of its carrying amount and fair value less costs to sell. If the asset (or disposal group) is acquired as part of a business combination it is initially measured at fair value less costs to sell. Assets and liabilities of disposal groups classified as held for sale and non-current assets classified as held for sale are shown separately on the face of the balance sheet.

The results of discontinued operations - comprising the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognised either on measurement to fair value less costs to sell or on the disposal of the discontinued operation - are shown as a single amount on the face of the income statement. A discontinued operation is a cash-generating unit or a group of cash-generating units that either has been disposed of, or is classified as held for sale, and (a) represents a separate major line of business or geographical area of operations, (b) is part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations or (c) is a subsidiary acquired exclusively with a view to resale.

5. Employee benefits
Short-term employee benefits, such as salaries, paid absences, and other benefits are accounted for on an accruals basis over the period in which the employees provide the related services.  Group employees may receive variable compensation satisfied by cash, by debt instruments issued by the Group or by shares in The Royal Bank of Scotland Group plc.  The treatment of share-based compensation is set out in Accounting policy 25.  Variable compensation that is settled in cash or debt instruments is charged to profit or loss over the period from the start of the year to which the variable compensation relates to the expected settlement date taking account of forfeiture and claw back criteria.

The Group provides post-retirement benefits in the form of pensions and healthcare plans to eligible employees.

For defined benefit schemes, scheme liabilities are measured on an actuarial basis using the projected unit credit method and discounted at a rate determined by reference to market yields at the end of the reporting period on high quality corporate bonds of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. The difference between scheme assets and scheme liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). A net surplus is limited to any unrecognised past service cost plus the present value of any economic benefits available to the Group in the form of refunds from the plan or reduced contributions to it. The current service cost, curtailments and any past service costs together with the expected return on scheme assets less the unwinding of the discount on scheme liabilities are charged to operating expenses. A gain or loss on a curtailment is recognised in profit or loss when the curtailment occurs.  A curtailment occurs when the Group is committed to making a significant reduction in the number of employees covered by a plan or a plan is amended such that future service qualifies for no or reduced benefits. Actuarial gains and losses are recognised in full in the period in which they arise in other comprehensive income.  Contributions to defined contribution pension schemes are recognised in profit or loss when payable.
 
274

 
Accounting policies continued

6. Intangible assets and goodwill
Intangible assets acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss over the assets' estimated economic lives using methods that best reflect the pattern of economic benefits and included in Depreciation and amortisation. The estimated useful economic lives are as follows:

Core deposit intangibles
6 to 10 years
Other acquired intangibles
5 to 10 years
Computer software
3 to 5 years

Expenditure on internally generated goodwill and brands is written-off as incurred. Direct costs relating to the development of internal-use computer software are capitalised once technical feasibility and economic viability have been established. These costs include payroll, the costs of materials and services, and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended.  During and after development, accumulated costs are reviewed for impairment against the benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred as are all training costs and general overheads. The costs of licences to use computer software that are expected to generate economic benefits beyond one year are also capitalised.

Intangible assets include goodwill arising on the acquisition of subsidiaries and joint ventures.  Goodwill on the acquisition of a subsidiary is the excess of the fair value of the consideration transferred, the fair value of any existing interest in the subsidiary and the amount of any non-controlling interest measured either at fair value or at its share of the subsidiary’s net assets over the Group's interest in the net fair value of the subsidiary’s identifiable assets, liabilities and contingent liabilities.  Goodwill arises on the acquisition of a joint venture when the cost of investment exceeds the Group’s share of the net fair value of the joint venture’s identifiable assets and liabilities. Goodwill is measured at initial cost less any subsequent impairment losses. Goodwill arising on the acquisition of associates is included within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.

7. Property, plant and equipment
Items of property, plant and equipment (except investment property - see Accounting policy 9) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.

Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases) over their estimated useful lives.

The depreciable amount is the cost of an asset less its residual value.  Land is not depreciated. Estimated useful lives are as follows:

Freehold and long leasehold buildings
50 years
Short leaseholds
unexpired period of the lease
Property adaptation costs
10 to 15 years
Computer equipment
up to 5 years
Other equipment
4 to 15 years

The residual value and useful life of property, plant and equipment are reviewed at each balance sheet date and updated for any changes to previous estimates.

8. Impairment of intangible assets and property, plant and equipment
At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any.  Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.

If an asset does not generate cash flows that are independent from those of other assets or groups of assets, the recoverable amount is determined for the cash-generating unit to which the asset belongs.  A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.  For the purposes of impairment testing, goodwill acquired in a business combination is allocated to each of the Group’s cash-generating units or groups of cash-generating units expected to benefit from the combination. The recoverable amount of an asset or cash-generating unit is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash-generating unit that have not been taken into account in estimating future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value is not greater than it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.

9. Investment property
Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease in Other operating income. Lease incentives granted are recognised as an integral part of the total rental income.

 
275

 
10. Foreign currencies
The Group's consolidated financial statements are presented in sterling which is the functional currency of the company.

Group entities record transactions in foreign currencies in the currency of the primary economic environment in which they operate (their functional currency) at the foreign exchange rate ruling at the date of the transaction.  Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date.  Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations (see Accounting policy 24).

Non-monetary items denominated in foreign currencies that are stated at fair value are translated into the relevant functional currency at the foreign exchange rates ruling at the dates the values are determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example equity shares, which are recognised in other comprehensive income unless the asset is the hedged item in a fair value hedge.

Assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into sterling at foreign exchange rates ruling at the balance sheet date. Income and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised in other comprehensive income.  The amount accumulated in equity is reclassified from equity to profit or loss on disposal or partial disposal of a foreign operation.

11. Leases
As lessor
Contracts with customers to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer; all other contracts with customers to lease assets are classified as operating leases.

Finance lease receivables are included in the balance sheet, within Loans and advances to banks and Loans and advances to customers, at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment and included in Interest receivable. Unguaranteed residual values are subject to regular review; if there is a reduction in their value, income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.


Rental income from operating leases is recognised in income on a straight-line basis over the lease term unless another systematic basis better represents the time pattern of the asset’s use. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see Accounting policy 7).  Operating lease rentals receivable are included in Other operating income.

As lessee
The Group’s contracts to lease assets are principally operating leases. Operating lease rental expense is included in Premises and equipment costs and recognised as an expense on a straight-line basis over the lease term unless another systematic basis better represents the benefit to the Group.

12. Insurance
General insurance
General insurance comprises short-duration contracts where the Group (the insurer) has accepted significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder. Due to the nature of the products sold - predominantly property and motor - the insurance protection is provided on an even basis throughout the term of the policy.  Consequently, written premiums are recognised over the period of the policy. Insurance premiums exclude insurance premium tax. Unearned premiums represent the proportion of the net premiums that relate to periods of insurance after the balance sheet date and are calculated over the period of exposure under the policy, on a daily or 24th's basis, or allowing for the estimated incidence of exposure under policies which are longer than twelve months. Provision is made where necessary for the estimated amount of claims over and above unearned premiums including that in respect of future written business on discontinued lines under the run-off of delegated underwriting authority arrangements. The provision is designed to meet future claims and related expenses and is calculated across related classes of business on the basis of a separate carry forward of deferred acquisition expenses after making allowance for investment income.

Acquisition expenses relating to new and renewed business for all classes of general insurance business are expensed over the period during which the premiums are earned. The principal acquisition costs so deferred are commissions payable, and costs associated with the telesales and underwriting staff.  Claims and the related reinsurance are recognised in the accounting period in which the loss occurs. The Group cedes insurance risk in the normal course of business.  Reinsurance assets represent balances due from reinsurance companies.  Amounts recoverable from reinsurers are estimated on a basis consistent with the outstanding claims provision or settled claims associated with the reinsurer's policies and are in accordance with the related reinsurance contract.  Reinsurance assets are reviewed for impairment at each reporting date or more frequently when an indication of impairment arises during the reporting year. Provision is made for the cost of settling outstanding claims at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date, and claims handling expenses. Provisions are only discounted where claims, principally motor, either have been or are expected to be settled by periodical payments. Related reinsurance receivables are recognised on the same basis and at the same time.

 
276

 
Accounting policies continued


Life assurance
The Group's long-term assurance contracts include whole-life term assurance, endowment assurance, flexible whole-life, pension and annuity contracts that are expected to remain in force for an extended period of time. Long-term assurance contracts under which the Group does not accept significant insurance risk are classified as financial instruments.

The Group recognises the value of in-force long-term assurance contracts as an asset. Cash flows associated with in-force contracts and related assets, including reinsurance cash flows, are projected, using appropriate assumptions as to future mortality, persistency and levels of expenses and excluding the value of future investment margins, to estimate future surpluses attributable to the Group. These surpluses, discounted at a risk-adjusted rate, are recognised as a separate asset. Changes in the value of this asset are included in profit or loss.

Premiums on long-term insurance contracts are recognised as income when receivable. Claims on long-term insurance contracts reflect the cost of all claims arising during the year, including claims handling costs. Claims are recognised when the Group becomes aware of the claim.

Reinsurance
The Group has reinsurance treaties that transfer significant insurance risk. Liabilities for reinsured contracts are calculated gross of reinsurance and a separate reinsurance asset recorded.

13. Provisions
The Group recognises a provision for a present obligation resulting from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount of the obligation can be estimated reliably.

Provision is made for restructuring costs, including the costs of redundancy, when the Group has a constructive obligation to restructure. An obligation exists when the Group has a detailed formal plan for the restructuring and has raised a valid expectation in those affected by starting to implement the plan or announcing its main features.

If the Group has a contract that is onerous, it recognises the present obligation under the contract as a provision. An onerous contract is one where the unavoidable costs of meeting the Group’s contractual obligations exceed the expected economic benefits. When the Group vacates a leasehold property, a provision is recognised for the costs under the lease less any expected economic benefits (such as rental income).

Contingent liabilities are possible obligations arising from past events, whose existence will be confirmed only by uncertain future events, or present obligations arising from past events that are not recognised because either an outflow of economic benefits is not probable or the amount of the obligation cannot be reliably measured. Contingent liabilities are not recognised but information about them is disclosed unless the possibility of any outflow of economic benefits in settlement is remote.

14. Tax
Income tax expense or income, comprising current tax and deferred tax, is recorded in the income statement except income tax on items recognised outside profit or loss which is credited or charged to other comprehensive income or to equity as appropriate.

Current tax is income tax payable or recoverable in respect of the taxable profit or loss for the year arising in income or in equity.  Provision is made for current tax at rates enacted or substantively enacted at the balance sheet date.

Deferred tax is the tax expected to be payable or recoverable in respect of temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes.  Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that they will be recovered.  Deferred tax is not recognised on temporary differences that arise from initial recognition of an asset or a liability in a transaction (other than a business combination) that at the time of the transaction affects neither accounting nor taxable profit or loss. Deferred tax is calculated using tax rates expected to apply in the periods when the assets will be realised or the liabilities settled, based on tax rates and laws enacted, or substantively enacted, at the balance sheet date.

Deferred tax assets and liabilities are offset where the Group has a legally enforceable right to offset and where they relate to income taxes levied by the same taxation authority either on an individual Group company or on Group companies in the same tax group that intend, in future periods, to settle current tax liabilities and assets on a net basis or on a gross basis simultaneously.

15. Financial assets
On initial recognition, financial assets are classified into held-to-maturity investments; held-for-trading; designated as at fair value through profit or loss; loans and receivables; or available-for-sale financial assets.  Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; all other regular way transactions in financial assets are recognised on trade date.

Held-to-maturity investments - a financial asset may be classified as a held-to-maturity investment only if it has fixed or determinable payments, a fixed maturity and the Group has the positive intention and ability to hold to maturity. Held-to-maturity investments are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see Accounting policy 3) less any impairment losses.

Held-for-trading - a financial asset is classified as held-for-trading if it is acquired principally for sale in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial assets are recognised at fair value with transaction costs being recognised in profit or loss.  Subsequently they are measured at fair value. Gains and losses on held-for-trading financial assets are recognised in profit or loss as they arise.

 
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Designated as at fair value through profit or loss - financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both, that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract. Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial assets that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.

In 2009, financial assets designated as at fair value through profit or loss included policyholders' assets underpinning insurance and investment contracts issued by the Group's life assurance businesses.  Fair value designation significantly reduces the measurement inconsistency that would arise if these assets were classified as available-for-sale.

Loans and receivables - non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables, except those that are classified as available-for-sale or as held-for-trading, or designated as at fair value through profit or loss. Loans and receivables are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see Accounting policy 3) less any impairment losses.

Available-for-sale financial assets - financial assets that are not classified as held-to-maturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see Accounting policy 3) as are gains and losses attributable to the hedged risk on available-for-sale financial assets that are hedged items in fair value hedges (see Accounting policy 24). Other changes in the fair value of available-for-sale financial assets and any related tax are reported in other comprehensive income until disposal, when the cumulative gain or loss is reclassified from equity to profit or loss.
 
Reclassifications - held-for-trading and available-for-sale financial assets that meet the definition of loans and receivables (non-derivative financial assets with fixed or determinable payments that are not quoted in an active market) may be reclassified to loans and receivables if the Group has the intention and ability to hold the financial asset for the foreseeable future or until maturity. The Group typically regards the foreseeable future as twelve months from the date of reclassification. Additionally, held-for-trading financial assets that do not meet the definition of loans and receivables may, in rare circumstances, be transferred to available-for-sale financial assets or to held-to-maturity investments. Reclassifications are made at fair value. This fair value becomes the asset's new cost or amortised cost as appropriate. Gains and losses recognised up to the date of reclassification are not reversed.

Fair value for a net open position in a financial asset that is quoted in an active market is the current bid price times the number of units of the instrument held. Fair values for financial assets not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial assets.

16. Impairment of financial assets
The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets classified as held-to-maturity, available-for-sale or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.

Financial assets carried at amortised cost - if there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivables or as held-to-maturity investments has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition. For collateralised loans and receivables, estimated future cash flows include cash flows that may result from foreclosure less the costs of obtaining and selling the collateral, whether or not foreclosure is probable.

Where, in the course of the orderly realisation of a loan, it is exchanged for equity shares or property, the exchange is accounted for as the sale of the loan and the acquisition of equity securities or investment property. Where the Group’s interest in equity shares following the exchange is such that the Group controls an entity, that entity is consolidated.

 
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Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective assessment of impairment, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of observable data, to reflect current conditions not affecting the period of historical experience. Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If, in a subsequent period, the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment.

Impaired loans and receivables are written off, i.e. the impairment provision is applied in writing down the loan's carrying value partially or in full, when the Group concludes that there is no longer any realistic prospect of recovery of part or all of the loan. For portfolios that are collectively assessed for impairment, the timing of write off principally reflects historic recovery experience for each portfolio. For loans that are individually assessed for impairment, the timing of write off is determined on a case-by-case basis. Such loans are reviewed regularly and write offs will be prompted by bankruptcy, insolvency, restructuring and similar events. Most debt is written off within five years of the recognition of the initial impairment. It is not the Group’s usual practice to write-off all or part of the asset at the time an impairment loss is recognised; it may however, take place in rare circumstances. Amounts recovered after a loan has been written off are credited to the loan impairment charge for the period in which they are received.

Financial assets carried at fair value - when a decline in the fair value of a financial asset classified as available-for-sale has been recognised directly in other comprehensive income and there is objective evidence that it is impaired, the cumulative loss is reclassified from equity to profit or loss. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on available-for-sale equity instruments are not reversed through profit or loss, but those on available-for-sale debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.

17. Financial liabilities
On initial recognition, financial liabilities are classified into held-for-trading; designated as at fair value through profit or loss; or amortised cost.  Issues of financial liabilities measured at amortised cost are recognised on settlement date; all other regular way transactions in financial liabilities are recognised on trade date.
 
Held-for-trading - a financial liability is classified as held-for-trading if it is incurred principally for repurchase in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise.

Designated as at fair value through profit or loss - financial liabilities may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.

Financial liabilities that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial liabilities that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.

Financial liabilities designated as at fair value through profit or loss include structured liabilities issued by the Group: designation significantly reduces the measurement inconsistency between these liabilities and the related derivatives carried at fair value; and in 2009 investment contracts issued by the Group's life assurance businesses: fair value designation significantly reduces the measurement inconsistency that would arise if these liabilities were measured at amortised cost.

Amortised cost - all other financial liabilities are measured at amortised cost using the effective interest method (see Accounting policy 3).

Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities.

18. Financial guarantee contracts
Under a financial guarantee contract, the Group, in return for a fee, undertakes to meet a customer’s obligations under the terms of a debt instrument if the customer fails to do so. A financial guarantee is recognised as a liability; initially at fair value and, if not designated as at fair value through profit or loss, subsequently at the higher of its initial value less cumulative amortisation and any provision under the contract measured in accordance with Accounting policy 13. Amortisation is calculated so as to recognise fees receivable in profit or loss over the period of the guarantee.

 
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19. Loan commitments
Provision is made for loan commitments, other than those classified as held-for-trading, if it is probable that the facility will be drawn and the resulting loan will be recognised at a value less than the cash advanced. Syndicated loan commitments in excess of the level of lending under the commitment approved for retention by the Group are classified as held-for-trading and measured at fair value.

20. Derecognition
A financial asset is derecognised when the contractual right to receive cash flows from the asset has expired or when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either (a) transfers the contractual rights to receive the asset's cash flows; or (b) retains the right to the asset's cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. The asset remains on the balance sheet if substantially all the risks and rewards have been retained. It is derecognised if substantially all the risks and rewards have been transferred. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If it has not retained control, the asset is derecognised. Where the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement.

A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires. On the redemption or settlement of debt securities (including subordinated liabilities) issued by the Group, the Group derecognises the debt instrument and records a gain or loss being the difference between the debt's carrying amount and the cost of redemption or settlement. The same treatment applies where the debt is exchanged for a new debt issue that has terms substantially different from those of the existing debt. The assessment of whether the terms of the new debt instrument are substantially different takes into account qualitative and quantitative characteristics including a comparison of the present value of the cash flows under the new terms with present value of the remaining cash flows of the original debt issue discounted at the effective interest rate of the original debt issue.

21. Sale and repurchase transactions
Securities subject to a sale and repurchase agreement under which substantially all the risks and rewards of ownership are retained by the Group continue to be shown on the balance sheet and the sale proceeds recorded as a financial liability. Securities acquired in a reverse sale and repurchase transaction under which the Group is not exposed to substantially all the risks and rewards of ownership are not recognised on the balance sheet and the consideration paid is recorded as a financial asset.

Securities borrowing and lending transactions are usually secured by cash or securities advanced by the borrower. Borrowed securities are not recognised on the balance sheet or lent securities derecognised. Cash collateral given or received is treated as a loan or deposit; collateral in the form of securities is not recognised. However, where securities borrowed are transferred to third parties, a liability for the obligation to return the securities to the stock lending counterparty is recorded.

22. Netting
Financial assets and financial liabilities are offset and the net amount presented in the balance sheet when, and only when, the Group currently has a legally enforceable right to set off the recognised amounts and it intends either to settle on a net basis or to realise the asset and settle the liability simultaneously. The Group is party to a number of arrangements, including master netting agreements, that give it the right to offset financial assets and financial liabilities but where it does not intend to settle the amounts net or simultaneously and therefore the assets and liabilities concerned are presented gross.

23. Capital instruments
The Group classifies a financial instrument that it issues as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms and as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.

Incremental costs that are directly attributable to an equity transaction are deducted from equity net of any related tax.

The consideration for any ordinary shares of the company purchased by the Group (treasury shares) is deducted from equity.  On the cancellation of treasury shares their nominal value is removed from equity and any excess of consideration over nominal value is treated in accordance with the capital maintenance provisions of the Companies Act.  On the sale or reissue of treasury shares the consideration received is credited to equity, net of any directly attributable incremental costs and related tax.

24. Derivatives and hedging
Derivative financial instruments are initially recognised, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative's components using appropriate pricing or valuation models.

A derivative embedded in a contract is accounted for as a stand-alone derivative if its economic characteristics are not closely related to the economic characteristics of the host contract; unless the entire contract is measured at fair value with changes in fair value recognised in profit or loss.

Gains and losses arising from changes in the fair value of derivatives that are not the hedging instrument in a qualifying hedge are recognised as they arise in profit or loss.   Gains and losses are recorded in Income from trading activities except for gains and losses on those derivatives that are managed together with financial instruments designated at fair value; these gains and losses are included in Other operating income.


 
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Accounting policies continued

The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a highly probable forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.

Hedge relationships are formally designated and documented at inception. The documentation identifies the hedged item and the hedging instrument and details the risk that is being hedged and the way in which effectiveness will be assessed at inception and during the period of the hedge. If the hedge is not highly effective in offsetting changes in fair values or cash flows attributable to the hedged risk, consistent with the documented risk management strategy, hedge accounting is discontinued.  Hedge accounting is also discontinued if the Group revokes the designation of a hedge relationship.

Fair value hedge - in a fair value hedge, the gain or loss on the hedging instrument is recognised in profit or loss. The gain or loss on the hedged item attributable to the hedged risk is recognised in profit or loss and, where the hedged item is measured at amortised cost, adjusts the carrying amount of the hedged item. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; or if the hedging instrument expires or is sold, terminated or exercised; or if hedge designation is revoked. If the hedged item is one for which the effective interest rate method is used, any cumulative adjustment is amortised to profit or loss over the life of the hedged item using a recalculated effective interest rate.

Cash flow hedge - in a cash flow hedge, the effective portion of the gain or loss on the hedging instrument is recognised in other comprehensive income and the ineffective portion in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity to profit or loss in the same periods in which the hedged forecast cash flows affect profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same time as the hedged transaction. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss in equity is recognised in profit or loss when the hedged cash flows occur or, if the forecast transaction results in the recognition of a financial asset or financial liability, when the hedged forecast cash flows affect profit or loss. Where a forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss in equity is recognised in profit or loss immediately.
 
Hedge of net investment in a foreign operation - in the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge is recognised in other comprehensive income. Any ineffective portion is recognised in profit or loss. Non-derivative financial liabilities as well as derivatives may be the hedging instrument in a net investment hedge.  On disposal or partial disposal of a foreign operation, the amount accumulated in equity is reclassified from equity to profit or loss.

25. Share-based compensation
The Group operates a number of share-based compensation schemes under which it awards RBSG shares and share options to its employees.  Such awards are generally subject to vesting conditions: conditions that vary the amount of cash or shares to which an employee is entitled.  Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the employee to complete a specified period of service and specified performance targets to be met).  Other conditions to which an award is subject are non-vesting conditions (such as a requirement to save throughout the vesting period).

The cost of employee services received in exchange for an award of shares or share options granted is measured by reference to the fair value of the shares or share options on the date the award is granted and takes into account non-vesting conditions and market performance conditions (conditions related to the market price of RBSG shares): an award is treated as vesting irrespective of whether any market performance condition or non-vesting condition is met.  The fair value of options granted is estimated using valuation techniques which incorporate exercise price, term, risk-free interest rates, the current share price and its expected volatility.  The cost is expensed on a straight-line basis over the vesting period (the period during which all the specified vesting conditions must be satisfied) with a corresponding increase in equity in an equity-settled award, or a corresponding liability in a cash-settled award.  The cost is adjusted for vesting conditions (other than market performance conditions) so as to reflect the number of shares or share options that actually vest.

If an award is modified, the original cost continues to be recognised as if there had been no modification.  Where modification increases the fair value of the award, this increase is recognised as an expense over the modified vesting period.  A new award of shares or share options is treated as the modification of a cancelled award if, on the date the new award is granted, the Group identifies them as replacing the cancelled award.  The cancellation of an award through failure to meet non-vesting conditions triggers an immediate expense for any unrecognised element of the cost of an award.

 
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26. Cash and cash equivalents
In the cash flow statement, cash and cash equivalents comprises cash and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.

Critical accounting policies and key sources of estimation uncertainty
The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. UK company law and IFRS require the directors, in preparing the Group's financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB's ‘Framework for the Preparation and Presentation of Financial Statements’. The judgements and assumptions involved in the Group's accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.

Loan impairment provisions
The Group's loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost. A loan is impaired when there is objective evidence that events since the loan was granted have affected expected cash flows from the loan. Such objective evidence, indicative that a borrower’s financial condition has deteriorated, can include for loans that are individually assessed: the non-payment of interest or principal; debt restructuring; probable bankruptcy or liquidation; significant reduction in the value of any security; breach of limits or covenants; and deteriorating trading performance and, for collectively assessed portfolios: the borrowers’ payment status and observable data about relevant macroeconomic measures.

The impairment loss is the difference between the carrying value of the loan and the present value of estimated future cash flows at the loan's original effective interest rate.

At 31 December 2011, loans and advances to customers classified as loans and receivables totalled £427,805 million (2010 - £482,710 million; 2009 - £671,037 million) and customer loan impairment provisions amounted to £19,760 million (2010 - £18,055 million; 2009 - £17,126 million).

There are two components to the Group's loan impairment provisions: individual and collective.

Individual component - all impaired loans that exceed specific thresholds are individually assessed for impairment. Individually assessed loans principally comprise the Group's portfolio of commercial loans to medium and large businesses. Impairment losses are recognised as the difference between the carrying value of the loan and the discounted value of management's best estimate of future cash repayments and proceeds from any security held. These estimates take into account the customer's debt capacity and financial flexibility; the level and quality of its earnings; the amount and sources of cash flows; the industry in which the counterparty operates; and the realisable value of any security held. Estimating the quantum and timing of future recoveries involves significant judgement. The size of receipts will depend on the future performance of the borrower and the value of security, both of which will be affected by future economic conditions; additionally, collateral may not be readily marketable. The actual amount of future cash flows and the date they are received may differ from these estimates and consequently actual losses incurred may differ from those recognised in these financial statements.

Collective component - this is made up of two elements: loan impairment provisions for impaired loans that are below individual assessment thresholds (collectively assessed provisions) and for loan losses that have been incurred but have not been separately identified at the balance sheet date (latent loss provisions). Collectively assessed provisions are established on a portfolio basis using a present value methodology taking into account the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends. The most significant factors in establishing these provisions are the expected loss rates and the related average life. These portfolios include credit card receivables and other personal advances including mortgages. The future credit quality of these portfolios is subject to uncertainties that could cause actual credit losses to differ materially from reported loan impairment provisions. These uncertainties include the economic environment, notably interest rates and their effect on customer spending, the unemployment level, payment behaviour and bankruptcy trends. Latent loss provisions are held against estimated impairment losses in the performing portfolio that have yet to be identified as at the balance sheet date. To assess the latent loss within its portfolios, the Group has developed methodologies to estimate the time that an asset can remain impaired within a performing portfolio before it is identified and reported as such.
 
 
 
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Pensions
The Group operates a number of defined benefit pension schemes as described in Note 4 on the accounts. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any recognisable surplus or deficit of scheme assets over liabilities is recorded in the balance sheet as an asset (surplus) or liability (deficit).

In determining the value of scheme liabilities, financial and demographic assumptions are made including price inflation, pension increases, earnings growth and the longevity of scheme members. A range of assumptions could be adopted in valuing the schemes' liabilities. Different assumptions could significantly alter the amount of the surplus or deficit recognised in the balance sheet and the pension cost charged to the income statement. The assumptions adopted for the Group's pension schemes are set out in Note 4 on the accounts, together with sensitivities of the balance sheet and income statement to changes in those assumptions.

A pension asset of £188 million and a liability of £2,239 million were recognised on the balance sheet at 31 December 2011 (2010 - asset  £105 million, liability £2,288 million; 2009 - asset £58 million, liability £2,963 million).

Fair value - financial instruments
Financial instruments classified as held-for-trading or designated as at fair value through profit or loss and financial assets classified as available-for-sale are recognised in the financial statements at fair value. All derivatives are measured at fair value. Gains or losses arising from changes in the fair value of financial instruments classified as held-for-trading or designated as at fair value through profit or loss are included in the income statement. Unrealised gains and losses on available-for-sale financial assets are recognised directly in equity unless an impairment loss is recognised.

Financial instruments measured at fair value include:

Loans and advances (held-for-trading and designated as at fair value though profit or loss) - principally comprise reverse repurchase agreements (reverse repos) and cash collateral.

Debt securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) - debt securities include those issued by governments, municipal bodies, mortgage agencies and financial institutions as well as corporate bonds, debentures and residual interests in securitisations.

Equity securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) - comprise equity shares of companies or corporations both listed and unlisted.

Deposits by banks and customer accounts (held-for-trading and designated as at fair value though profit or loss) - deposits measured at fair value principally include repurchase agreements (repos), cash collateral and investment contracts issued by the Group's life assurance businesses.

Debt securities in issue (held-for-trading and designated as at fair value though profit or loss) - principally comprise medium term notes.

Short positions (held-for-trading) - arise in dealing and market making activities where debt securities and equity shares are sold which the Group does not currently possess.

Derivatives - these include swaps (currency swaps, interest rate swaps, credit default swaps, total return swaps and equity and equity index swaps), forward foreign exchange contracts, forward rate agreements, futures (currency, interest rate and equity) and options (exchange-traded options on currencies, interest rates and equities and equity indices and OTC currency and equity options, interest rate caps and floors and swaptions).

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair values are determined from quoted prices in active markets for identical financial assets or financial liabilities where these are available. Fair value for a net open position in a financial instrument in an active market is the number of units of the instrument held times the current bid price (for financial assets) or offer price (for financial liabilities). In determining the fair value of derivative financial instruments gross long and short positions measured at current mid market prices are adjusted by bid-offer reserves calculated on a portfolio basis. Credit valuation adjustments are made when valuing derivative financial assets to incorporate counterparty credit risk. Adjustments are also made when valuing financial liabilities to reflect the Group’s own credit standing. Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data. More details about the Group’s valuation methodologies and the sensitivity to reasonably possible alternative assumptions of the fair value of financial instruments valued using techniques where at least one significant input is unobservable are given in Note 11 on pages 304 to 320.



 
283

 

General insurance claims
The Group makes provision for the full cost of settling outstanding claims arising from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling expenses. General insurance claims provisions amounted to £6,219 million at 31 December 2011 (2010 - £6,726 million; 2009 - £5,802 million).

Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. Management use the work of internal and external actuaries to assess the level of gross and net outstanding claims provisions required to adopt a measurement basis of reserves which result in a provision in excess of actuarial best estimates.  In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims at the balance sheet date. Also included in the estimation of outstanding claims are other assumptions such as the inflationary factor used for bodily injury claims which is based on historical trends and, therefore, allows for some increase due to changes in common law and statute; and the incidence of periodical payment orders and the rate at which payments under them are discounted. Costs for both direct and indirect claims handling expenses are also included. Outward reinsurance recoveries are accounted for in the same accounting period as the direct claims to which they relate. The outstanding claims provision is based on information available to management and the eventual outcome may vary from the original assessment. Actual claims experience may differ from the historical pattern on which the estimate is based and the cost of settling individual claims may exceed that assumed.

Deferred tax
The Group makes provision for deferred tax on temporary differences where tax recognition occurs at a different time from accounting recognition. Deferred tax assets of £3,878 million were recognised as at 31 December 2011 (2010 - £6,373 million; 2009 - £7,039 million).

The Group has recognised deferred tax assets in respect of losses, principally in the UK, and temporary differences. Deferred tax assets are recognised in respect of unused tax losses to the extent that it is probable that there will be future taxable profits against which the losses can be utilised. Business projections prepared for impairment reviews (see Note 17) indicate that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within six years (2010 - eight years). The Group's cumulative losses are principally attributable to the recent unparalleled market conditions. Deferred tax assets of £3,246 million (2010 - £2,008 million; 2009 - £2,163 million) have not been recognised in respect of tax losses carried forward in jurisdictions where doubt exists over the availability of future taxable profits.

Accounting developments
International Financial Reporting Standards
The IASB issued IFRS 9 ‘Financial Instruments’ in November 2009 simplifying the classification and measurement requirements in IAS 39 in respect of financial assets. The standard reduces the measurement categories for financial assets to two: fair value and amortised cost. A financial asset is classified on the basis of the entity's business model for managing the financial asset and the contractual cash flow characteristics of the financial asset. Only assets with contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on principal and which are held within a business model whose objective is to hold assets in order to collect contractual cash flows are classified as amortised cost. All other financial assets are measured at fair value. Changes in the value of financial assets measured at fair value are generally taken to profit or loss.

In October 2010, IFRS 9 was updated to include requirements in respect of the classification and measurement of liabilities. These do not differ markedly from those in IAS 39 except for the treatment of changes in the fair value of financial liabilities that are designated as at fair value through profit or loss attributable to own credit; these must be presented in other comprehensive income.

In December 2010, the IASB issued amendments to IFRS 9 and to IFRS 7 ‘Financial Instruments: Disclosures’ delaying the effective date of IFRS 9 to annual periods beginning on or after 1 January 2015 and introducing revised transitional arrangements including additional transition disclosures.  If an entity implements IFRS 9 in 2012 the amendments permit it either to restate comparative periods or to provide the additional disclosures.  The additional transition disclosures must be given if implementation takes place after 2012.

IFRS 9 makes major changes to the framework for the classification and measurement of financial instruments and will have a significant effect on the Group's financial statements. The Group is assessing the effect of IFRS 9 which will depend on the outcome of the other phases of the IASB's IAS 39 replacement project and on the outcome the IASB’s tentative decision at its December 2011 meeting to reconsider the following topics:

·  
additional application guidance to clarify how the instrument characteristics test was intended to be applied.

·  
bifurcation of financial assets, after considering any additional guidance for the instrument characteristics test.

·  
expanded use of other comprehensive income or a third business model for some debt instruments.

‘Disclosures - Transfers of Financial Assets (Amendments to IFRS 7)’ was published by the IASB in October 2010.  This replaces IFRS 7’s existing derecognition disclosure requirements with disclosures about (a) transferred assets that are not derecognised in their entirety and (b) transferred assets that are derecognised in their entirety but where an entity has continuing involvement in the transferred asset.  The amendments are effective for annual periods beginning on or after 1 July 2011.
 
284

 
Accounting policies continued


The IASB issued an amendment to IAS 12 ‘Income Taxes’ in December 2010 to clarify that recognition of deferred tax should have regard to the expected manner of recovery or settlement of the asset or liability. The amendment and consequential withdrawal of SIC 21 ‘Deferred Tax: Recovery of Underlying Assets’, effective for annual periods beginning on or after 1 January 2012, is not expected to have a material effect on the Group or the company.

In May 2011, the IASB issued six new or revised standards:

IFRS 10 ‘Consolidated Financial Statements’ which replaces SIC-12 ‘Consolidation - Special Purpose Entities’ and the consolidation elements of the existing IAS 27 ‘Consolidated and Separate Financial Statements’.  The new standard adopts a single definition of control: a reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity to generate returns for the reporting entity.

IAS 27 ‘Separate Financial Statements’ which comprises those parts of the existing IAS 27 that dealt with separate financial statements.

IFRS 11 ‘Joint Arrangements’, which supersedes IAS 31’ Interests in Joint Ventures’, distinguishes between joint operations and joint ventures. Joint operations are accounted for by the investor recognising its assets and liabilities including its share of any assets held and liabilities incurred jointly and its share of revenues and costs. Joint ventures are accounted for in the investor’s consolidated accounts using the equity method.

IAS 28 ‘Investments in Associates and Joint Ventures’ covers joint ventures as well as associates; both must be accounted for using the equity method. The mechanics of the equity method are unchanged.

IFRS 12 ‘Disclosure of Interests in Other Entities’ covers disclosures for entities reporting under IFRS 10 and IFRS 11 replacing those in IAS 28 and IAS 27. Entities are required to disclose information that helps financial statement readers evaluate the nature, risks and financial effects associated with an entity’s interests in subsidiaries, in associates and joint arrangements and in unconsolidated structured entities.
 
IFRS 13 ‘Fair Value Measurement’ which sets out a single IFRS framework for defining and measuring fair value and requiring disclosures about fair value measurements.

The standards are effective for annual periods beginning on or after 1 January 2013. Earlier application is permitted. The Group is reviewing the standards to determine their effect on the Group’s financial reporting.

In June 2011, the IASB issued amendments to two standards:

Amendments to IAS 1 ‘Presentation of Items of Other Comprehensive Income’ require items that will never be recognised in profit or loss to be presented separately in other comprehensive income from those that are subject to subsequent reclassification. The amendments are effective for annual periods beginning on or after 1 July 2012. Earlier application is permitted.

Amendments IAS 19 ‘Employee Benefits’ require the immediate recognition of all actuarial gains and losses eliminating the ‘corridor approach’; interest cost to be calculated on the net pension liability or asset at the appropriate corporate bond rate; and all past service costs to be recognised immediately when a scheme is curtailed or amended.

These amendments are effective for annual periods beginning on or after 1 January 2013. Earlier application is permitted.  The Group is reviewing the amendments to determine their effect on the Group’s financial reporting.

In December 2011, the IASB issued ’Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32)’ and ‘Disclosures-Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7)’. The amendment to IAS 32 adds application guidance on the meaning of ‘a legally enforceable right to set off’ and on simultaneous settlement.   IFRS 7 is amended to require disclosures facilitating comparisons between those entities reporting under IFRS and those reporting under US GAAP.  The amendments are effective for annual periods beginning on or after 1 January 2014 and are required to be applied retrospectively.

 
285

 
Notes on the consolidated accounts

1 Net interest income
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Loans and advances to customers
17,969 
18,889 
21,356 
Loans and advances to banks
697 
591 
830 
Debt securities
2,744 
3,296 
4,125 
Interest receivable
21,410 
22,776 
26,311 
       
Customer accounts: demand deposits
1,147 
1,228 
970 
Customer accounts: savings deposits
1,307 
1,148 
1,245 
Customer accounts: other time deposits
1,075 
1,345 
2,546 
Deposits by banks
982 
1,333 
2,898 
Debt securities in issue
3,371 
3,277 
4,482 
Subordinated liabilities
740 
417 
1,291 
Internal funding of trading businesses
109 
(181)
(509)
Interest payable
8,731 
8,567 
12,923 
       
Net interest income
12,679 
14,209 
13,388 
 
 
 
286

 
Notes on the consolidated accounts continued

 
2 Non-interest income (excluding insurance net premium income)
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Fees and commissions receivable
     
Payment services
1,498 
1,638 
1,776 
Credit and debit card fees
1,093 
2,432 
2,389 
Lending (credit facilities)
1,707 
1,863 
2,433 
Brokerage
631 
652 
450 
Trade finance
410 
423 
370 
Investment management
525 
568 
627 
Other
520 
617 
693 
 
6,384 
8,193 
8,738 
       
Fees and commissions payable
     
Banking
(962)
(1,892)
(2,351)
Insurance related
(498)
(319)
(439)
 
(1,460)
(2,211)
(2,790)
Income from trading activities (1)
     
Foreign exchange
1,327 
1,491 
2,340 
Interest rate
760 
1,862 
3,883 
Credit
(15)
41 
(4,147)
Equities
606 
643 
843 
Commodities
390 
784 
Other
20 
90 
58 
 
2,701 
4,517 
3,761 
       
Gain on redemption of own debt (2)
255 
553 
3,790 
       
Other operating income (excluding insurance net premium income)
     
Operating lease and other rental income
1,307 
1,394 
1,323 
Changes in the fair value of own debt designated as at fair value through profit or loss attributable
  to own credit (3)
     
  - debt securities in issue
1,259 
284 
25 
  - subordinated liabilities
362 
(35)
26 
Changes in the fair value of securities and other financial assets and liabilities
150 
(180)
42 
Changes in the fair value of investment properties
(139)
(405)
(117)
Profit on sale of securities
882 
496 
162 
Profit on sale of property, plant and equipment
22 
50 
40 
Loss on sale of subsidiaries and associates
(28)
(107)
(144)
Life business (losses)/profits
(13)
90 
156 
Dividend income
62 
69 
78 
Share of profits/(losses) of associated entities
26 
70 
(268)
Other income/(loss) (4)
232 
(247)
(450)
 
4,122 
1,479 
873 

Notes:
(1)
The analysis of income from trading activities is based on how the business is organised and the underlying risks managed. Income from trading activities comprises gains and losses on financial instruments held for trading, both realised and unrealised, interest income and dividends and the related funding costs. The types of instruments include:
- Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding.
- Interest rate: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding.
- Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding.
- Equities: equities, equity derivatives and related hedges and funding.
- Commodities: commodities, commodity contracts and related hedges and funding.
Includes £225 million (2010 - (£75) million; 2009 - £(193) million) in relation to changes in fair value in the credit risk premium payable by the Group on debt securities in issue classified as held-for-trading.
(2)
In June 2011, the Group redeemed certain mortgage backed debt securities in exchange for cash, resulting in gains totalling £255 million being credited to profit or loss. In a series of exchange and tender offers in April 2009 and May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. Gains of £553 million and £3,790 million were credited to profit or loss in 2010 and 2009 respectively.  The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability.
(3)
Measured as the change in fair value from movements in the year in the credit risk premium payable by the Group.
(4)
Includes income from activities other than banking and insurance.
 

 
 
287

 
3 Operating expenses
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Wages, salaries and other staff costs
7,367 
7,945 
8,039 
Bonus tax
27 
99 
208 
Social security costs
640 
661 
675 
Share-based compensation
197 
397 
329 
Pension costs
     
  - defined benefit schemes (see Note 4)
349 
519 
638 
  - curtailment gains (see Note 4)
— 
(78)
(2,148)
  - defined contribution schemes
98 
128 
104 
Staff costs
8,678 
9,671 
7,845 
       
Premises and equipment
2,451 
2,402 
2,594 
Other administrative expenses
4,931 
3,995 
4,449 
       
Property, plant and equipment (see Note 18)
1,267 
1,428 
1,427 
Intangible assets (see Note 17)
608 
722 
739 
Depreciation and amortisation
1,875 
2,150 
2,166 
       
Write-down of goodwill and other intangible assets
91 
10 
363 
 
18,026 
18,228 
17,417 




Bank levy
The Finance Act 2011 introduced an annual bank levy in the UK.  The levy is collected through the existing quarterly Corporation Tax collection mechanism starting with payment dates on or after 19 July 2011.

The levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The first chargeable period for the Group was the year ended 31 December 2011. In determining the chargeable equity and liabilities the following amounts are excluded: adjusted Tier 1 capital; certain ‘protected deposits’ (for example those protected under the Financial Services Compensation Scheme); liabilities that arise from certain insurance business within banking groups; liabilities in respect of currency notes in circulation; Financial Services Compensation Scheme liabilities; liabilities representing segregated client money; and deferred tax liabilities, current tax liabilities, liabilities in respect of the levy, revaluation of property liabilities, liabilities representing the revaluation of business premises and defined benefit retirement liabilities. It is also permitted in specified circumstances to reduce certain liabilities: by netting them against certain assets; offsetting assets on the relevant balance sheets that would qualify as high quality liquid assets (in accordance with the FSA definition); and repo liabilities secured against sovereign and supranational debt.

The levy will be set at a rate of 0.088 per cent from 2012. Three different rates applied during 2011, these average to 0.075 per cent. Certain liabilities are subject to only a half rate, namely any deposits not otherwise excluded, (except for those from financial institutions and financial traders) and liabilities with a maturity greater than one year at the balance sheet date. The levy is not charged on the first £20 billion of chargeable liabilities. The cost of the levy to the Group for 2011 is £300 million (included in Other administrative expenses).  As the Group continues to target a reduction in wholesale funding, the cost should decline over time absent further rate increase.


 
288

 
Notes on the consolidated accounts continued

3 Operating expenses continued
Integration costs included in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement programmes connected with acquisitions made by the Group.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
38 
210 
365 
Premises and equipment
78 
Other administrative expenses
51 
143 
398 
Depreciation and amortisation
11 
20 
18 
 
106 
376 
859 

Restructuring costs included in operating expenses comprise:
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
356 
353 
328 
Premises and equipment
156 
117 
48 
Other administrative expenses
276 
104 
51 
 
788 
574 
427 

Divestment costs included in operating expenses comprise:
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Staff costs
95 
51 
— 
Premises and equipment
11 
— 
Other administrative expenses
59 
25 
— 
 
165 
82 
— 

The average number of persons employed, rounded to the nearest hundred, in the continuing operations of the Group during the year, excluding temporary staff, was 144,300 (2010 - 157,000; 2009 - 170,000); on the same basis there were no people employed in discontinued operations (2010 - 12,400; 2009 - 27,600). The average number of temporary employees during 2011 was 12,000 (2010 - 11,400; 2009 - 10,000). The number of persons employed in the continuing operations of the Group at 31 December, excluding temporary staff, was as follows:

 
2011 
2010 
2009
UK Retail
29,500 
30,500 
33,200
UK Corporate
13,300 
13,000 
12,600
Wealth
5,500 
5,300 
4,800
Global Transaction Services
2,400 
2,400 
3,200
Ulster Bank
4,400 
4,400 
4,600
US Retail & Commercial
16,000 
16,500 
16,400
Retail & Commercial
71,100 
72,100 
74,800
Global Banking & Markets
15,100 
15,500 
15,100
RBS Insurance
15,100 
15,000 
14,600
Central items
5,300 
4,300 
3,800
Core
106,600 
106,900 
108,300
Non-Core
4,100 
6,400 
13,700
 
110,700 
113,300 
122,000
Business Services
31,300 
31,900 
36,900
Integration and restructuring
600 
300 
500
RFS Holdings minority interest
— 
— 
300
Total
142,600 
145,500 
159,700
       
UK
90,600 
93,000 
98,400
USA
23,100 
23,900 
25,600
Europe
10,900 
10,800 
12,600
Rest of the World
18,000 
17,800 
23,100
Total
142,600 
145,500 
159,700

There were no people employed in discontinued operations at 31 December 2011 (2010 - nil; 2009 - 24,800).

 
289

 
Share-based payments
As described in the Remuneration report on pages 232 to 253, the Group grants share-based awards to employees principally on the following bases:

Award plan
Eligible employees
Nature of award (1)
Vesting conditions (2)
Issue dates
Sharesave
UK, Republic of Ireland, Channel Islands, Gibraltar and Isle of Man
Option to buy shares under employee savings plan
Continuing employment or leavers in certain circumstances
2012 to 2019
Deferred performance awards
All
Awards of ordinary shares
Continuing employment or leavers in certain circumstances
2012 to 2014
Restricted share awards
Senior employees
Awards of conditional shares
Continuing employment or leavers in certain circumstances and/or achievement of performance conditions
2012 to 2014
Long-term incentives (3)
Senior employees
Awards of conditional shares or share options
Continuing employment or leavers in certain circumstances and/or achievement of performance conditions
2012 to 2019

Notes:
(1)
Awards are equity-settled unless international comparability is better served by cash-settled awards.
(2)
All awards have vesting conditions and therefore some may not vest.
(3)
Long-term incentives include the Executive Share Option Plan, the Long-Term Incentive Plan and the Medium-Term Performance Plan.
(4)
The strike price of options and the fair value on granting awards of fully paid shares is the average market price over the five trading days preceding grant date.

Sharesave
 
2011
 
2010
 
2009
 
Average 
exercise price 
 £ 
Shares 
 under  option 
(million)
 
Average 
exercise price 
£ 
Shares 
under option 
 (million)
 
Average 
exercise price 
£ 
Shares 
under option 
 (million)
At 1 January
0.48 
1,012 
 
0.50 
1,038 
 
2.88 
84 
Granted
0.23 
298 
 
0.43 
147 
 
0.38 
1,176 
Exercised
0.38 
(7)
 
0.38 
(5)
 
— 
— 
Cancelled
0.41 
(664)
 
0.45 
(168)
 
0.77 
(222)
At 31 December
0.34 
639 
 
0.48 
1,012 
 
0.50 
1,038 

Options are exercisable within six months of vesting; 3 million were exercisable at 31 December 2011 (2010 - 23 million; 2009 - 26 million). The weighted average share price at the date of exercise of options was 42p (2010 - 45p; 2009 - not applicable). At 31 December 2011, exercise prices ranged from 23p to 393p and the average contractual life was 3.7 years (2010 - 38p to 393p and 3.3 years; 2009 - 38p to 393p and 3.2 years). The fair value of options granted in 2011 was £43 million (2010 - £48 million; 2009 - £220 million).

Deferred performance awards
 
2011
 
2010
 
Value at 
grant 
£m 
Shares 
awarded 
 (million)
 
Value at 
 grant 
£m 
Shares 
awarded 
 (million)
At 1 January
1,009 
2,665 
 
— 
— 
Granted
258 
578 
 
1,043 
2,755 
Forfeited
(47)
(125)
 
(34)
(90)
Vested
(464)
(1,205)
 
— 
— 
At 31 December
756 
1,913 
 
1,009 
2,665 

The awards granted in 2011 vest evenly over the following three anniversaries.

Restricted share awards
 
2011
 
2010
 
2009
 
Value at 
grant 
£m 
Shares 
awarded 
 (million)
 
Value at 
 grant 
£m 
Shares 
 awarded 
 (million)
 
Value at 
grant 
£m 
Shares 
awarded 
 (million)
At 1 January
110 
335 
 
117 
325 
 
48 
31 
Granted
— 
— 
 
26 
55 
 
94 
309 
Exercised
(6)
(26)
 
(6)
(15)
 
(16)
(5)
Lapsed
(4)
(10)
 
(27)
(30)
 
(9)
(10)
At 31 December
100 
299 
 
110 
335 
 
117
325 
 
 
The market value of awards exercised in 2011 was £11 million (2010 - £6 million; 2009 - £2 million).

 
290

 
Notes on the consolidated accounts continued
 
 
3 Operating expenses continued
Long-term incentives
 
2011
 
2010
 
2009
 
Value 
at grant 
£m 
Shares 
awarded 
 (million)
Options 
 over shares 
 (million)
 
Value at 
grant 
£m 
Shares 
 awarded 
 (million)
Options 
 over shares 
 (million)
 
Value at 
grant 
£m 
Shares 
awarded 
 (million)
Options 
 over shares 
 (million)
At 1 January
219 
250 
377 
 
122 
413 
 
79 
92 
Granted
154 
369 
 
115 
247 
 
70 
353 
Exercised
(6)
(14)
— 
 
— 
— 
(1)
 
— 
— 
— 
Lapsed
(22)
(29)
(15)
 
(18)
(4)
(38)
 
(27)
(2)
(32)
At 31 December
345 
576 
371 
 
219 
250 
377 
 
122 
413 

The market value of awards exercised in 2011 was £5 million (2010 - less than £1 million; 2009 - nil). There are vested options over 48 million shares exercisable up to 2019 (2010 - 33 million shares up to 2020; 2009 - 33 million shares up to 2014).

At 31 December 2011, a provision of £3 million had been made in respect of 4 million share awards and 14 million options over shares that may be cash-settled (2010 - £6 million in respect of 3 million share awards and 16 million options over shares; 2009 - £6 million in respect of 3 million share awards and 16 million options over shares).

The fair value of options granted in 2011 was determined using a pricing model that included: expected volatility of shares determined at the grant date based on historic volatility over a period of up to seven years; expected option lives that equal the vesting period; no dividends on equity shares; and a risk-free interest rate determined from the UK gilt rates with terms matching the expected lives of the options.


Variable compensation awards
The following table analyses the Group and GBM variable compensation awards for 2011, which are 43% and 58% respectively lower than in 2010.

 
Group
 
GBM
 
2011 
£m 
2010 
£m 
Change 
% 
 
2011 
£m 
2010 
£m 
Change 
% 
Non-deferred cash awards (1)
72 
89 
(19)
 
10 
18 
(44)
Non-deferred share awards
35 
54 
(35)
 
23 
43 
(47)
Total non-deferred variable compensation
107 
143 
(25)
 
33 
61 
(46)
Deferred bonds awards
582 
1,029 
(43)
 
286 
701 
(59)
Deferred share awards
96 
203 
(53)
 
71 
175 
(59)
Total deferred variable compensation
678 
1,232 
(45)
 
357 
876 
(59)
               
Total variable compensation
785 
1,375 
(43)
 
390 
937 
(58)
               
Variable compensation as a % of core operating profit (2)
11% 
16% 
   
18% 
22% 
 
Proportion of variable compensation that is deferred
86% 
90% 
   
92% 
93% 
 
               
Total employees
146,800 
148,500 
(1)
 
17,000 
18,700 
(9)
Variable compensation per employee
£5,347 
£9,260 
(42)
 
£22,941 
£50,114 
(54)


Reconciliation of variable compensation awards to income statement charge
2011 
£m 
2010 
£m 
Variable compensation awarded  for 2011
785 
1,375 
Less: deferral of charge for amounts awarded for current year
(302)
(512)
Add: current year charge for amounts deferred  from prior years
502 
383 
Income statement charge for variable compensation
985 
1,246 

 
Actual
 
Expected
Year in which income statement charge is expected to be taken for deferred variable compensation
2010 
£m 
2011 
£m 
 
 
2012 
£m 
2013
and beyond 
£m 
Variable compensation deferred from 2009 and earlier
383 
160 
 
78 
 
Variable compensation deferred from  2010
 
342 
 
105 
65 
Variable compensation for  2011 deferred
 
 
 
225 
77 
 
383 
502 
 
408 
142 

Notes:
(1)
Cash payments to all employees are limited to £2,000.
(2)
Core operating profit pre variable compensation expense and before one-off and other items.
 
 
 
291

 

 
4 Pensions
The Group sponsors a number of pension schemes in the UK and overseas, predominantly defined benefit schemes, whose assets are independent of the Group’s finances. The principal defined benefit scheme is The Royal Bank of Scotland Group Pension Fund (the “Main scheme”) which accounts for 85% (2010 - 84%; 2009 - 61%) of the Group’s retirement benefit obligations.

The Group’s defined benefit schemes generally provide a pension of one-sixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years. Employees do not make contributions for basic pensions but may make voluntary contributions to secure additional benefits on a money-purchase basis. Since October 2006, the Main scheme has been closed to new entrants who have instead been offered membership of The Royal Bank of Scotland Retirement Savings Plan, a defined contribution pension scheme. Since 2009, pensionable salary increases in the Main scheme and certain other UK and Irish schemes have been limited to 2% per annum or CPI inflation if lower.

The Group also provides post-retirement benefits other than pensions, principally through subscriptions to private healthcare schemes in the UK and the US and unfunded post-retirement benefit plans. Provision for the costs of these benefits is charged to the income statement over the average remaining future service lives of eligible employees. The amounts are not material.

Interim valuations of the Group’s schemes under IAS 19 ‘Employee Benefits’ were prepared to 31 December with the support of independent actuaries, using the following assumptions:

 
 
Main scheme
 
All schemes
Principal actuarial assumptions at 31 December (weighted average)
2011 
2010 
2009 
2011 
2010 
2009 
Discount rate
5.0 
5.5 
5.9 
 
5.2 
5.4 
5.7 
Expected return on plan assets
5.7 
6.7 
6.8 
 
5.6 
6.3 
6.1 
Rate of increase in salaries
1.8 
1.8 
1.8 
 
2.0 
2.0 
2.0 
Rate of increase in pensions in payment
3.0 
3.3 
3.5 
 
2.9 
3.0 
3.0 
Inflation assumption
3.0 
3.3 
3.5 
 
3.0 
3.2 
3.0 


 
Main scheme
 
All schemes
Major classes of plan assets as a percentage of total plan assets
2011 
2010 
2009 
 
2011 
2010 
2009 
Quoted equities
20.9 
25.9 
38.9 
 
23.3 
28.2 
36.2 
Private equity
5.8 
5.4 
5.1 
 
4.9 
4.5 
3.1 
Index-linked bonds
26.1 
27.0 
23.7 
 
24.3 
24.1 
15.2 
Government fixed interest bonds
0.9 
— 
— 
 
2.8 
1.9 
18.9 
Corporate and other bonds
23.9 
26.2 
19.7 
 
22.2 
24.8 
14.7 
Hedge funds
2.5 
3.2 
3.6 
 
2.4 
3.5 
3.1 
Property
3.5 
3.4 
3.5 
 
3.6 
3.6 
3.6 
Derivatives
2.4 
0.9 
— 
 
2.1 
1.2 
0.8 
Cash and other assets
13.8 
7.8 
5.3 
 
13.7 
8.1 
4.3 
Equity exposure of equity futures
17.7 
25.6 
10.6 
 
15.7 
21.4 
6.3 
Cash exposure of equity futures
(17.5)
(25.4)
(10.4)
 
(15.0)
(21.3)
(6.2)
 
100.0 
100.0 
100.0 
 
100.0 
100.0 
100.0 


The Main scheme, which represents 84% of plan assets at 31 December 2011 (2010 - 84%; 2009 - 59%), is invested in a diversified portfolio of quoted and private equity, government and corporate fixed-interest and index-linked bonds, and other assets including property and hedge funds.

The Main scheme also employs derivative instruments, where appropriate, to achieve a desired asset class exposure or to match assets more closely to liabilities. The value of assets shown reflects the actual physical assets held by the scheme, with any derivative holdings valued on a mark-to-market basis. The return on assets on the total scheme has been based on the asset exposure created allowing for the net impact of the derivatives on the risk and return profile of the holdings.

 
292

 
Notes on the consolidated accounts continued

4 Pensions continued
The Main scheme’s holdings of derivative instruments are summarised in the table below:

 
2011
 
2010
 
2009
 
Notional 
amounts 
Fair value
 
Notional 
amounts 
Fair value
 
Notional
amounts
Fair value
 
Assets 
Liabilities 
Assets 
Liabilities 
Assets
Liabilities
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m
£m
£m
Inflation rate swaps
2,585 
67 
178 
 
2,132 
69 
 
1,171
75
3
Interest rate swaps
15,149 
2,232 
1,864 
 
10,727 
270 
110 
 
4,893
46
114
Total return swaps
2,085 
169 
— 
 
466 
16 
— 
 
Currency swaps
2,861 
116 
117 
 
(973)
— 
 
Credit default swaps
238 
— 
 
— 
— 
— 
 
Equity and bond futures
3,745 
80 
10 
 
4,851 
49 
14 
 
1,730
37
Currency forwards
2,078 
— 
 
4,883 
35 
91 
 
2,908
58
70
Equity and bond call options
814 
67 
 
— 
— 
— 
 
Equity and bond put options
665 
11 
— 
 
— 
— 
— 
 

 
The investment strategy of other schemes is similar to that of the Main scheme, adjusted to take account of the nature of liabilities, risk appetite of the trustees, size of the scheme and any local regulatory constraints. The use of derivative instruments outside of the Main scheme is not material.

Swaps are part of the management of the inflation and interest rate sensitivity of the Main scheme liabilities. They have been executed at prevailing market rates and within standard market bid/offer spreads. Substantially all swaps are with The Royal Bank of Scotland plc and National Westminster Bank Plc (the “banks”). At 31 December 2011, the gross notional value of the swaps was £22,918 million (2010 - £12,352 million; 2009 - £6,064 million) and had a positive fair value of £431 million (2010 - £236 million positive; 2009 - £4 million positive) to the scheme.

Collateral is required on all swap transactions with those between the banks and the Main scheme on terms that do not allow the banks to re-hypothecate. The banks had delivered £375 million of collateral at 31 December 2011 (2010 - delivered £210 million; 2009 - held £6 million).

Ordinary shares of the company with a fair value of £3 million (2010 - £9 million; 2009 - £4 million) are held by the Group's Main scheme which also holds other financial instruments issued by the Group with a value of £424 million (2010 - £264 million; 2009 - £192 million).
 
The expected return on plan assets at 31 December is based upon the weighted average of the following assumed returns on the major classes of plan assets, allowing for the net impact of derivatives on the risk and return profile:

 
Main scheme
 
All schemes
 
2011 
2010 
2009 
 
2011 
2010 
2009 
Quoted equities
7.7 
7.7 
8.0 
 
7.7 
7.5 
7.8 
Private equity
7.7 
7.7 
8.0 
 
7.7 
7.7 
8.0 
Index-linked bonds
3.1 
4.2 
4.5 
 
3.1 
4.0 
4.5 
Government fixed interest bonds
3.1 
— 
— 
 
2.8 
2.9 
4.0 
Corporate and other bonds
4.7 
5.5 
5.9 
 
4.7 
5.2 
5.8 
Hedge funds
6.0 
6.0 
6.2 
 
6.0 
5.3 
4.3 
Property
6.7 
6.7 
6.2 
 
6.5 
6.4 
6.0 
Cash and other assets
2.6 
4.0 
4.2 
 
2.9 
3.7 
3.8 
Equity exposure of equity futures
7.7 
7.7 
8.0 
 
7.7 
7.7 
8.0 
Cash exposure of equity futures
2.6 
4.0 
4.2 
 
2.6 
4.0 
4.2 
Total fund
5.7 
6.7 
6.8 
 
5.6 
6.3 
6.1 


 
293

 

Post-retirement mortality assumptions (Main scheme)
2011 
2010 
2009
Longevity at age 60 for current pensioners (years)
     
Males
27.3 
27.2 
27.1
Females
29.6 
29.6 
29.5
       
Longevity at age 60 for future pensioners currently aged 40 (years)
     
Males
29.3 
29.3 
29.2
Females
30.9 
30.8 
30.8


 
Main scheme
 
All schemes
Changes in value of net pension deficit
Fair value 
of plan 
assets 
£m 
Present value 
 of defined 
benefit 
obligations
£m 
Net  pension 
deficit 
£m 
 
Fair value 
of plan 
assets 
£m 
Present value 
 of defined 
benefit 
obligations
£m 
Net  pension 
deficit 
£m 
At 1 January 2010
16,603 
18,675 
2,072 
 
27,925 
30,830 
2,905 
Currency translation and other adjustments
— 
— 
— 
 
(206)
(206)
— 
Income statement
             
  Expected return
1,114 
 
(1,114)
 
1,428 
 
(1,428)
  Interest cost
 
1,091 
1,091 
   
1,402 
1,402 
  Current service cost
 
345 
345 
   
499 
499 
  Past service cost
 
76 
76 
   
67 
67 
  Gains on curtailments
 
— 
— 
   
(78)
(78)
 
1,114 
1,512 
398 
 
1,428 
1,890 
462 
Statement of comprehensive income
             
  - Actuarial gains and losses
1,718 
1,674 
(44)
 
1,797 
1,639 
(158)
Disposal of subsidiaries
— 
— 
— 
 
(7,993)
(8,187)
(194)
Contributions by employer - regular
444 
— 
(444)
 
832 
— 
(832)
Contributions by plan participants and other scheme members
— 
— 
— 
 
10 
10 
— 
Benefits paid
(716)
(716)
— 
 
(922)
(922)
— 
Expenses included in service cost
(53)
(53)
— 
 
(55)
(55)
— 
At 1 January 2011
19,110 
21,092 
1,982 
 
22,816 
24,999 
2,183 
Currency translation and other adjustments
— 
— 
— 
 
(30)
(33)
(3)
Income statement
             
  Expected return
1,258 
 
(1,258)
 
1,488 
 
(1,488)
  Interest cost
 
1,150 
1,150 
   
1,354 
1,354 
  Current service cost
 
327 
327 
   
440 
440 
  Past service cost
 
39 
39 
   
43 
43 
 
1,258 
1,516 
258 
 
1,488 
1,837 
349 
Statement of comprehensive income
             
  - Actuarial gains and losses
759 
1,096 
337 
 
636 
1,217 
581 
Contributions by employer
733 
— 
(733)
 
1,059 
— 
(1,059)
Contributions by plan participants and other scheme members
— 
— 
— 
 
10 
10 
— 
Benefits paid
(698)
(698)
— 
 
(840)
(840)
— 
Expenses included in service cost
(51)
(51)
— 
 
(53)
(53)
— 
At 31 December 2011
21,111 
22,955 
1,844 
 
25,086 
27,137 
2,051 



Net pension deficit comprises
2011 
 £m 
2010 
 £m 
2009 
 £m 
Net assets of schemes in surplus (included in Prepayments, accrued income and other assets, Note 19)
(188)
(105)
(58)
Net liabilities of schemes in deficit
2,239 
2,288 
2,963 
 
2,051 
2,183 
2,905 


 
294

 
Notes on the consolidated accounts continued
 
 
4 Pensions continued

The pension charge/(credit) to the income statement comprises:
 
2011 
 £m 
2010 
 £m 
2009 
 £m 
Continuing operations
349 
441 
(1,510)
Discontinued operations
— 
21 
21 
 
349 
462 
(1,489)

Curtailment gains of £78 million were recognised in 2010 arising from changes to pension benefits in a subsidiary’s scheme.

Following the legal separation of ABN AMRO Bank N.V. on 1 April 2010, ABN AMRO’s principal pension scheme in the Netherlands was transferred to the State of the Netherlands. At 31 December 2009, this scheme had fair value of plan assets of £8,118 million and present value of defined benefit obligations of £8,298 million. The principal actuarial assumptions at 31 December 2009 were: discount rate 5.25%; expected return on plan assets (weighted average) 5.25%; rate of increase in salaries 2.5%; rate of increase in pensions in payment 2.0%; and inflation assumption 2.0%.

The Group and the Trustees of the Main scheme agreed the funding valuation as at 31 March 2010 during the year. It showed that the value of liabilities exceed the value of assets by £3.5 billion as at 31 March 2010, a ratio of assets to liabilities of 84%. In order to eliminate this deficit, the Group will pay additional contributions each year over the period 2011 to 2018. These contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. These contributions are in addition to the regular annual contributions of around £300 million for future accrual benefits.

The Group expects to contribute a total of £843 million to its defined benefit pension schemes in 2012. Of the net liabilities of schemes in deficit, £163 million (2010 - £161 million; 2009 - £198 million) relates to unfunded schemes.

Cumulative net actuarial losses of £4,805 million (2010 - £4,224 million; 2009 - £4,382 million) have been recognised in the statement of comprehensive income, of which £3,589 million losses (2010 - £3,252 million losses; 2009 - £3,296 million gains) relate to the Main scheme.


 
Main scheme
 
All schemes
History of defined benefit schemes
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Fair value of plan assets
21,111 
19,110 
16,603 
14,804 
18,575 
 
25,086 
22,816 
27,925 
25,756 
27,662 
Present value of defined benefit
  obligations
22,955 
21,092 
18,675 
15,594 
18,099 
 
27,137 
24,999 
30,830 
27,752 
27,547 
Net deficit/(surplus)
1,844 
1,982 
2,072 
790 
(476)
 
2,051 
2,183 
2,905 
1,996 
(115)
                       
                       
Experience (losses)/gains on plan
  liabilities
(208)
(858)
135 
(55)
(256)
 
(200)
(882)
328 
(65)
(210)
Experience gains/(losses) on plan
  assets
759 
1,718 
993 
(4,784)
163 
 
636 
1,797 
1,344 
(6,051)
19 
Actual return/(loss) on pension
  schemes assets
2,017 
2,832 
2,022 
(3,513)
1,345 
 
2,124 
3,225 
2,897 
(4,186)
1,413 
Actual return/(loss) on pension
  schemes assets - %
10.6% 
17.2% 
13.8% 
(19.0%)
7.8% 
 
9.3% 
15.6% 
11.4% 
(14.5%)
6.9% 


 
295

 

The table below sets out the sensitivities of the pension cost for the year and the present value of defined benefit obligations at 31 December to a change in the principal actuarial assumptions:

 
Main scheme
 
All schemes
 
Increase/(decrease)
 
Increase/(decrease)
 
in pension cost
 for year
 
in obligation
at 31 December
 
in pension cost
 for year
 
in obligation
at 31 December
 
2011 
2010 
2009 
 
2011 
2010 
2009 
 
2011 
2010 
2009 
 
2011 
2010 
2009 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
0.25% increase in the discount rate
(13)
(17)
(21)
 
(1,019)
(925)
(790)
 
(34)
(42)
(41)
 
(1,360)
(1,245)
(1,261)
0.25% increase in inflation
60 
59 
49 
 
911 
799 
654 
 
88 
89 
93 
 
1,244 
1,106 
1,143 
0.25% additional rate of increase in
  pensions in payment
39 
37 
33 
 
618 
527 
442 
 
45 
43 
47 
 
691 
599 
596 
0.25% additional rate of increase in
  deferred pensions
20 
21 
16 
 
285 
265 
214 
 
40 
44 
25 
 
526 
497 
366 
0.25% additional rate of increase in
  salaries
 
56 
56 
66 
 
26 
30 
17 
 
283 
270 
125 
Longevity increase of 1 year
33 
34 
29 
 
566 
519 
416 
 
58 
59 
50 
 
875 
781 
734 


5 Auditor’s remuneration
Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit related and other services are approved by the Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Audit Committee recognise that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.


The analysis of auditors' remuneration is as follows:
 
2011
£m
2010
£m
Fees payable for the audit of the Group’s annual accounts
4.0
4.0
Fees payable to the auditor and its associates for other services to the Group
   
  - the audit of the company’s subsidiaries
24.6
26.0
  - audit-related assurance services (1)
4.7
4.9
Total audit and audit-related assurance services fees
33.3
34.9
     
Taxation compliance services
0.1
0.3
Taxation advisory services
0.2
0.2
Other assurance services (2)
2.2
5.2
Corporate finance services (3)
1.7
0.8
Consulting services (4)
3.6
1.8
Total other services
7.8
8.3
     
Total
41.1
43.2

Notes:
(1)
Includes fees of £0.8 million (2010 - £1.2 million) in relation to reviews of interim financial information, £2.4 million (2010 - £2.0 million) in respect of reports to the Group’s regulators in the UK and overseas, £1.0 million (2010 - £0.9 million) in respect of internal controls assurance and £0.3 million (2010 - £0.7 million) in relation to non-statutory audit opinions.
(2)
Comprises fees of £0.1 million (2010 - £2.9 million) in respect of audit and assurance of financial information in connection with disposals by the Group and £2.1 million (2010 - £2.3 million) in respect of other assurance services.
(3)
Includes fees of £1.0 million (2010 - £0.8 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations, and £0.7 million (2010 - nil) in respect of reporting accountant services in connection with planned divestments by the Group.
(4)
Includes fees of £2.5 million (2010 - £0.3 million) for services provided in respect of US regulatory matters.
 
 
 
296

 
Notes on the consolidated accounts continued
 
6 Tax
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Current tax
     
Charge for the year
(338)
(251)
(494)
Over provision in respect of prior periods
137 
41 
191 
 
(201)
(210)
(303)
Deferred tax
     
(Charge)/credit for the year
(1,108)
(738)
1,041 
Over/(under) provision in respect of prior periods
59 
314 
(309)
Tax (charge)/credit for the year
(1,250)
(634)
429 

The actual tax (charge)/credit differs from the expected tax credit computed by applying the standard rate of UK corporation tax of 26.5% (2010 and 2009 - 28%) as follows:

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Expected tax credit
203 
112 
741 
Sovereign debt impairment where no deferred tax asset recognised
(275)
— 
— 
Other losses in year where no deferred tax asset recognised
(530)
(450)
(780)
Foreign profits taxed at other rates
(417)
(517)
(276)
UK tax rate change - deferred tax impact (1)
(110)
(82)
— 
Unrecognised timing differences
(20)
11 
274 
Non-deductible goodwill impairment
(24)
(3)
(102)
Items not allowed for tax
     
  - losses on strategic disposals and write-downs
(72)
(311)
(152)
  - UK bank levy
(80)
— 
— 
  - employee share schemes
(113)
(32)
(29)
  - other disallowable items
(271)
(296)
(327)
Non-taxable items
     
  - gain on sale of Global Merchant Services
12 
221 
— 
  - gain on redemption of own debt
— 
11 
693 
  - other non-taxable items
245 
341 
410 
Taxable foreign exchange movements
Losses brought forward and utilised
94 
Adjustments in respect of prior years (2)
196 
355 
(118)
Actual tax (charge)/credit
(1,250)
(634)
429 


Notes:
(1)
In the Budget on 22 June 2010, the UK Government proposed, amongst other things, to reduce Corporation Tax rates in four annual decrements of 1% with effect from 1 April 2011. An additional 1% decrement was announced by the UK Government in the Budget on 23 March 2011. The first decrement was enacted on 27 July 2010, the second on 29 March 2011 and the third on 5 July 2011.  Existing temporary differences may therefore unwind in periods subject to these reduced tax rates. Accordingly, the closing deferred tax assets and liabilities have been calculated at the rate of 25%.
(2)
Prior year tax adjustments include releases of tax provisions in respect of structured transactions and investment disposals, and adjustments to reflect submitted tax computations in the UK and overseas.

 
297

 

7 Profit attributable to preference shareholders and paid-in equity holders
 
2011 
£m 
2010 
£m 
2009 
£m 
Preference shareholders
     
Non-cumulative preference shares of US$0.01
— 
105 
342 
Non-cumulative preference shares of €0.01
— 
— 
201 
Non-cumulative preference shares of £1
     
  - issued to UK Financial Investments Limited (1)
— 
— 
274 
  - other
— 
— 
61 
       
Paid-in equity holders
     
Interest on securities classified as equity, net of tax
— 
19 
57 
Total
— 
124 
935 

Note:
(1)
Includes £50 million redemption premium on repayment of preference shares.


8 Ordinary dividends
The company did not pay an ordinary dividend in 2011, 2010 or 2009.


9 Earnings per ordinary and B share
Earnings per ordinary and B share have been calculated based on the following:
 
2011 
£m 
2010 
£m 
2009 
£m 
Earnings
     
Loss attributable to ordinary and B shareholders
(1,997)
(1,125)
(3,607)
(Profit)/loss from discontinued operations attributable to ordinary and B shareholders
(5)
28 
72 
Gain on redemption of preference shares and paid-in equity
— 
610 
200 
Loss from continuing operations attributable to ordinary and B shareholders
(2,002)
(487)
(3,335)
       
Weighted average number of shares (millions)
     
Ordinary shares in issue during the year
57,219 
56,245 
51,494 
B shares in issue during the year
51,000 
51,000 
1,397 
Weighted average number of ordinary and B shares in issue during the year
108,219 
107,245 
52,891 

 
 
 
298

 
Notes on the consolidated accounts continued

10 Financial instruments - classification
The following tables show the Group’s financial assets and liabilities in accordance with the categories of financial instruments in IAS 39 with assets and liabilities outside the scope of IAS 39 shown separately.

 
Held-for-
trading
 
Designated
as at fair value
through profit
or loss
 
Hedging
 derivatives
 
Available-  for-sale
 
Loans and
 receivables
 
Other financial
 instruments
 (amortised
 cost)
 
Finance
 leases
 
Non
financial
 assets/
liabilities
 
Total
 
2011
  £m     £m     £m     £m     £m     £m     £m     £m     £m  
Assets
                                                     
Cash and balances at central banks
                    79,269                       79,269  
Loans and advances to banks
                                                     
  - reverse repos
  34,659                   4,781                       39,440  
  - other (1)
  20,317                   23,553                       43,870  
Loans and advances to customers
                                                     
  - reverse repos
  53,584                   7,910                       61,494  
  - other (2)
  25,322     476               419,895           8,419           454,112  
Debt securities
  95,076     647           107,298     6,059                       209,080  
Equity shares
  12,433     774           1,976                             15,183  
Settlement balances
                    7,771                       7,771  
Derivatives
  521,935           7,683                                   529,618  
Intangible assets
                                            14,858     14,858  
Property, plant and equipment
                                            11,868     11,868  
Deferred tax
                                            3,878     3,878  
Prepayments, accrued income and other assets
                    1,309                 9,667     10,976  
Assets of disposal groups
                                            25,450     25,450  
    763,326     1,897     7,683     109,274     550,547           8,419     65,721     1,506,867  
                                                       
Liabilities
                                                     
Deposits by banks
                                                     
  - repos
  23,342                           16,349                 39,691  
  - other (3)
  34,172                           34,941                 69,113  
Customer accounts
                                                     
  - repos
  65,526                           23,286                 88,812  
  - other (4)
  14,286     5,627                       394,230                 414,143  
Debt securities in issue (5)
  11,492     35,747                       115,382                 162,621  
Settlement balances
                            7,477                 7,477  
Short positions
  41,039                                             41,039  
Derivatives
  518,102           5,881                                   523,983  
Accruals, deferred income and other liabilities
                                1,683     19     21,423     23,125  
Retirement benefit liabilities
                                        2,239     2,239  
Deferred tax
                                            1,945     1,945  
Insurance liabilities
                                            6,312     6,312  
Subordinated liabilities
      903                       25,416                 26,319  
Liabilities of disposal groups
                                            23,995     23,995  
    707,959     42,277     5,881                 618,764     19     55,914     1,430,814  
Equity
                                                  76,053  
                                                    1,506,867  

For the notes relating to this table refer to page 302.

 
299

 
Notes on the consolidated accounts continued
 
 
Held-for- 
trading 
Designated 
as at fair value 
through profit 
or loss 
Hedging 
 derivatives 
Available- 
for-sale  
Loans and 
 receivables 
Other financial 
 instruments 
 (amortised 
 cost)
Finance 
 leases 
Non 
financial 
 assets/ 
liabilities 
Total 
2010
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Assets
                 
Cash and balances at central banks
— 
— 
 
— 
57,014 
     
57,014 
Loans and advances to banks
                 
  - reverse repos
38,215 
— 
 
— 
4,392 
     
42,607 
  - other (1)
26,082 
— 
 
— 
31,829 
     
57,911 
Loans and advances to customers
                 
  - reverse repos
41,110 
— 
 
— 
11,402 
     
52,512 
  - other (2)
19,903 
1,100 
 
— 
471,308 
 
10,437 
 
502,748 
Debt securities
98,869 
402 
 
111,130 
7,079 
     
217,480 
Equity shares
19,186 
1,013 
 
1,999 
— 
     
22,198 
Settlement balances
— 
— 
 
— 
11,605 
     
11,605 
Derivatives
421,648 
 
5,429 
 
— 
     
427,077 
Intangible assets
             
14,448 
14,448 
Property, plant and equipment
             
16,543 
16,543 
Deferred tax
             
6,373 
6,373 
Prepayments, accrued income and other assets
— 
— 
 
— 
1,306 
   
11,270 
12,576 
Assets of disposal groups
             
12,484 
12,484 
 
665,013 
2,515 
5,429 
113,129 
595,935 
 
10,437 
61,118 
1,453,576 
                   
Liabilities
                 
Deposits by banks
                 
  - repos
20,585 
— 
     
12,154 
   
32,739 
  - other (3)
28,216 
— 
     
37,835 
   
66,051 
Customer accounts
                 
  - repos
53,031 
— 
     
29,063 
   
82,094 
  - other (4)
14,357 
4,824 
     
409,418 
   
428,599 
Debt securities in issue (5)
7,730 
43,488 
     
167,154 
   
218,372 
Settlement balances
— 
— 
     
10,991 
   
10,991 
Short positions
43,118 
— 
           
43,118 
Derivatives
419,103 
 
4,864 
         
423,967 
Accruals, deferred income and other liabilities
— 
— 
     
1,793 
458 
20,838 
23,089 
Retirement benefit liabilities
             
2,288 
2,288 
Deferred tax
             
2,142 
2,142 
Insurance liabilities
             
6,794 
6,794 
Subordinated liabilities
— 
1,129 
     
25,924 
   
27,053 
Liabilities of disposal groups
             
9,428 
9,428 
 
586,140 
49,441 
4,864 
   
694,332 
458 
41,490 
1,376,725 
Equity
               
76,851 
                 
1,453,576 

For the notes relating to this table refer to page 302.

 
300

 
Notes on the consolidated accounts continued

10 Financial instruments - classification continued

 
Held-for-
trading
Designated
as at fair value
through profit
or loss
 
Hedging derivatives
Available-
for-sale
 
Loans and receivables
 
Other financial instruments (amortised
cost)
Finance
 leases
Non 
 financial assets/
liabilities
Total
2009
£m
£m
 
£m
£m
 
£m
 
£m
£m
£m
£m
Assets
                       
Cash and balances at central banks
   
 
52,261
       
52,261
Loans and advances to banks
                       
  - reverse repos
26,886
   
 
8,211
       
35,097
  - other (1)
18,563
   
 
38,093
       
56,656
Loans and advances to customers
                       
  - reverse repos
26,313
   
 
14,727
       
41,040
  - other (2)
15,964
1,981
   
 
656,310
   
13,098
 
687,353
Debt securities
111,482
2,603
   
143,298
 
9,871
       
267,254
Equity shares
14,443
2,192
   
2,893
 
       
19,528
Settlement balances
   
 
12,033
       
12,033
Derivatives
436,857
   
4,597
             
441,454
Intangible assets
                   
17,847
17,847
Property, plant and equipment
                   
19,397
19,397
Deferred tax
                   
7,039
7,039
Prepayments, accrued income and other assets
   
 
1,421
     
19,564
20,985
Assets of disposal groups
                   
18,542
18,542
 
650,508
6,776
 
4,597
146,191
 
792,927
   
13,098
82,389
1,696,486
                         
Liabilities
                       
Deposits by banks
                       
  - repos
20,962
           
17,044
   
38,006
  - other (3)
32,647
           
71,491
   
104,138
Customer accounts
                       
  - repos
41,520
           
26,833
   
68,353
  - other (4)
11,348
8,580
           
525,921
   
545,849
Debt securities in issue (5)
3,925
41,537
           
222,106
   
267,568
Settlement balances
           
10,413
   
10,413
Short positions
40,463
                 
40,463
Derivatives
417,634
   
6,507
             
424,141
Accruals, deferred income and other liabilities
           
1,889
467
27,971
30,327
Retirement benefit liabilities
                   
2,963
2,963
Deferred tax
                   
2,811
2,811
Insurance liabilities
                   
10,281
10,281
Subordinated liabilities
1,277
           
36,375
   
37,652
Liabilities of disposal groups
                   
18,890
18,890
 
568,499
51,394
 
6,507
       
912,072
467
62,916
1,601,855
Equity
                     
94,631
                       
1,696,486

For the notes relating to this table refer to page 302.

 
301

 
Notes on the consolidated accounts continued


Amounts included in the consolidated income statement:
 
2011 
£m 
2010 
£m 
2009 
£m 
Gains on financial assets/liabilities designated as at fair value through profit or loss
1,761 
279 
1,441 
Gains/(losses) on disposal or settlement of loans and receivables
59 
267 
(573)

Notes:
(1)
Includes items in the course of collection from other banks of £1,470 million (2010 - £1,958 million; 2009 - £2,533 million).
(2)
The change in fair value of loans and advances to customers designated as at fair value through profit or loss attributable to changes in credit risk was a £31 million charge for the year and cumulatively a credit of £71 million (2010 - £20 million charge, cumulative £82 million credit; 2009 - £157 million credit, cumulative £140 million credit).
(3)
Includes items in the course of transmission to other banks of £506 million (2010 - £577 million; 2009 - £770 million).
(4)
The carrying amount of other customer accounts designated as at fair value through profit or loss is £166 million lower (2010 - £233 million lower; 2009 - £101 million lower) than the principal amount. No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial, measured as the change in fair value from movements in the period in the credit risk premium payable. The amounts include investment contracts with a carrying value of £38 million (2010 - £41 million; 2009 - £5,170 million).
(5)
Comprises bonds and medium term notes of £129,780 million (2010 - £154,282 million; 2009 - £164,900 million) and certificates of deposit and other commercial paper of £32,841 million (2010 - £64,090 million; 2009 - £102,668 million).
(6)
During 2009, the Group reclassified financial assets from the held-for-trading category into the loans and receivables category, and during 2008 from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see below).


Reclassification of financial instruments
The Group has reclassified financial assets from the held-for-trading (HFT) and available-for-sale (AFS) categories into the loans and receivables (LAR) category (as permitted by paragraph 50D of IAS 39 as amended) and from the held-for-trading category into the available-for-sale category (as permitted by paragraph 50B of IAS 39 as amended).


The tables below show the carrying value, fair value and the effect on profit or loss of reclassifications undertaken by the Group in 2008 and 2009. There were no reclassifications in 2010 or 2011.

        Amount recognised in income statement
Amount 
 that would 
have been 
 recognised had 
reclassification 
not occurred 
(Increase)/ 
reduction in 
 profit or loss 
 as result of 
reclassification 
 
Carrying 
 value 
Fair 
value 
Income 
Impairment 
releases/ 
(losses)
2011
£m 
£m 
 
£m 
£m 
£m 
£m 
Reclassified from HFT to LAR
             
Loans
4,128 
3,305 
 
156 
18 
296 
122 
Debt securities
2,645 
1,930 
 
32 
(7)
(284)
(309)
 
6,773 
5,235 
 
188 
11 
12 
(187)
               
Reclassified from HFT to AFS (1)
             
Debt securities
4,176 
4,176 
 
(84)
(61)
(20)
125 
Equity securities
— 
— 
 
— 
— 
1
 
4,176 
4,176 
 
(84)
(61)
(19)
126 
               
Reclassified from AFS to LAR (2)
             
Debt securities
248 
229 
 
(11)
(13)
(24)
— 
 
11,197 
9,640 
 
93 
(63)
(31)
(61)
 
 
 
302

 
Notes on the consolidated accounts continued


 
10 Financial instruments - classification continued
 
 
        Amount recognised in income statement
Amount   that would  have been
recognised had reclassification  not occurred 
  Reduction in   profit or loss   as result of reclassification 
 
Carrying 
 value 
Fair 
value 
Income 
Impairment 
(losses)/ 
releases 
2010
£m 
£m 
 
£m 
£m 
£m 
£m 
Reclassified from HFT to LAR
             
Loans
5,378 
4,428 
 
234 
(146)
491 
403 
Debt securities
3,530 
3,121 
 
48 
(17)
424 
393 
 
8,908 
7,549 
 
282 
(163)
915 
796 
               
Reclassified from HFT to AFS (1)
             
Debt securities
6,446 
6,446 
 
441 
53 
765 
271 
Equity securities
 
29 
— 
38 
 
6,447 
6,447 
 
470 
53 
803 
280 
               
Reclassified from AFS to LAR (2)
             
Debt securities
422 
380 
 
(31)
(50)
(81)
— 
 
15,777 
14,376 
 
721 
(160)
1,637 
1,076 

2009
             
Reclassified from HFT to LAR
             
Loans
7,876 
6,371 
 
208 
(1,263)
161 
1,216 
Debt securities
5,057 
4,273 
 
(179)
(16)
294 
489 
 
12,933 
10,644 
 
29 
(1,279)
455 
1,705 
               
Reclassified from HFT to AFS (1)
             
Debt securities
7,601 
7,601 
 
442 
(428)
1,293 
1,279 
Equity securities
28 
28 
 
(1)
— 
— 
 
7,629 
7,629 
 
441 
(428)
1,293 
1,280 
               
Reclassified from AFS to LAR (2)
             
Debt securities
869 
745 
 
21 
— 
21 
— 
 
21,431 
19,018 
 
491 
(1,707)
1,769 
2,985 

Notes:
(1)
The amount taken to AFS reserves was £152 million (2010 - £326 million; 2009 - £1,067 million).
(2)
The amount that would have been taken to AFS reserves if reclassification had not occurred is £24 million (2010 - £98 million; 2009 - £(73) million).


The following table provides information for reclassifications made in 2009.
       
2009
 
2008 
       
Losses 
up to the 
 date of 
 reclassification 
 
Amount 
 that would 
have been 
 recognised had 
 reclassification 
not occurred 
Reduction in 
 profit or loss 
 as result of 
 reclassification 
 
Losses 
recognised in 
 the income 
 statement 
in prior 
 period 
2009 - on reclassification
31 December 2009
After reclassification
Carrying 
 value 
Effective 
 interest 
rate 
Expected 
 cash flows 
Carrying 
 value 
Fair 
value 
Income
Impairment 
 losses 
 
£m 
%
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
Reclassified from HFT to LAR
                       
Loans
1,740 
5.9 
2,640 
 
887 
924 
(103)
(44)
(251)
(256)
39 
 
(62)
Debt securities
255 
5.5 
349 
 
190 
188 
(33)
— 
— 
(2)
(2)
 
(39)
 
1,995 
 
2,989 
 
1,077 
1,112 
(136)
(44)
(251)
(258)
37 
 
(101)
 
 
 
303

 
Notes on the consolidated accounts continued
 
11 Financial instruments - valuation
Valuation of financial instruments carried at fair value
Control environment
The Group's control environment for the determination of the fair value of financial instruments includes formalised protocols for the review and validation of fair values independent of the businesses entering into the transactions. There are specific controls to ensure consistent pricing policies and procedures, incorporating disciplined price verification. The Group ensures that appropriate attention is given to bespoke transactions, structured products, illiquid products and other instruments which are difficult to price.

A key element of the control environment is the independent price verification (IPV) process. Valuations are first performed by the business which entered into the transaction. Such valuations may be directly from available prices, or may be derived using a model and variable model inputs. These valuations are reviewed, and if necessary amended, by a team independent of those trading the financial instruments, in light of available pricing evidence.

IPV variances are classified as hard, soft or indicative. A variance is hard where the independent information represents tradable or liquid prices and soft where it does not. Variances are classed as indicative where the independent evidence is so subjective or sparse that conclusions cannot be formed with a sufficient degree of confidence. Adjustments are required for all hard variances and for aggressive soft variances, with conservative and indicative variances not requiring automatic adjustment.

IPV is performed at a frequency to match the availability of independent data. For liquid instruments, the standard is to perform IPV daily. The minimum frequency of review in the Group is monthly for exposures in the regulatory trading book and six monthly for exposures in the regulatory banking book. Monthly meetings are held between the business and the support functions to discuss the results of the IPV and reserves process in detail. The IPV control includes formalised reporting and escalation of any valuation differences in breach of established thresholds. The Global Pricing Unit (GPU) determines IPV policy, monitors adherence to that policy and performs additional independent reviews on highly subjective valuation issues for GBM and Non-Core.

During 2011, the Group made a significant and ongoing investment into enhancing its already robust control environment. This included continuing investment into a new global IPV and reserving tool, which partly automates the process of carrying out IPV and consolidation of reserves into a single central portal.

Valuation models are subject to a review process which requires different levels of model documentation, testing and review, depending on the complexity of the model and the size of the Group's exposure. A key element of the control environment for model use is a Modelled Product Review Committee, made up of valuations experts from several functions within the Group. This committee sets the policy for model documentation, testing and review, and prioritises models with significant exposure for review by the Group's Quantitative Research Centre (QuaRC). Potential valuation uncertainty is a key input in determining model review priorities at these meetings. The QuaRC team within Group Risk, which is independent of the trading businesses, assesses the appropriateness of the application of the model to the product, the mathematical robustness of the model, and where appropriate, considers alternative modelling approaches.

Senior management valuation control committees meet formally on a monthly basis to discuss independent pricing, reserving and valuation issues relating to both GBM and Non-Core exposures. All material methodology changes require review and ratification by these committees. The committees include valuation specialists representing several independent review functions which comprise market risk, QuaRC and finance.

The Group Executive Valuation Committee discusses the issues escalated by the Modelled Product Review Committee, GBM and Non-Core senior management Valuations Control Committee and other relevant issues, including the APS credit derivative valuation. This committee covers key material and subjective valuation issues within the trading business and provides a ratification to the appropriateness of areas with high levels of residual valuation uncertainty. Committee members include the Group Finance Director, the Group Chief Accountant, Global Head of Market and Insurance Risk, GBM Chief Financial Officer and Non-Core Chief Financial Officer, and representation from front office trading and finance.

Valuation issues, adjustments and reserves are reported to GBM, Non-Core and Group Audit Committees. Key judgmental issues are described in reports submitted to these Audit Committees.

New products
The Group has formal review procedures owned by Group Operational Risk to ensure that new products, asset classes and risk types are appropriately reviewed to ensure, amongst other things, that valuation is appropriate. The scope of this process includes new business, markets, models, risks and structures.

Valuation hierarchy
There is a process to review and control the classification of financial instruments into the three level hierarchy established by IFRS 7. Some instruments may not easily fall into a level of the fair value hierarchy per IFRS 7 (see page 309) and judgment may be required as to which level the instrument is classified.

Initial classification of a financial instrument is carried out by the Business Unit Control team following the principles in IFRS. The Business Unit Control team base their judgment on information gathered during the IPV process for instruments which include the sourcing of independent prices and model inputs. The quality and completeness of the information gathered in the IPV process gives an indication as to the liquidity and valuation uncertainty of an instrument.

These initial classifications are challenged by GPU and are subject to senior management review. Particular attention is paid during the review processes upon instruments crossing from one level to another, new instrument classes or products, instruments that are generating significant profit and loss and instruments where valuation uncertainty is high.
 
304

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
Valuation techniques
The Group derives fair value of its instruments differently depending on whether the instrument is a non-modelled or a modelled product.

Non-modelled products
Non-modelled products are valued directly from a price input and are typically valued on a position by position basis and include cash, equities and most debt securities.

Modelled products
Modelled products are those that are valued using a pricing model, ranging in complexity from comparatively vanilla products such as interest rate swaps and options (e.g. interest rate caps and floors) through to more complex derivatives. The valuation of modelled products requires an appropriate model and inputs into this model. Sometimes models are also used to derive inputs (e.g. to construct volatility surfaces). The Group uses a number of modelling methodologies.

Inputs to valuation models
Values between and beyond available data points are obtained by interpolation and extrapolation. When utilising valuation techniques, the fair value can be significantly affected by the choice of valuation model and by underlying assumptions concerning factors such as the amounts and timing of cash flows, discount rates and credit risk. The principal inputs to these valuation techniques are as follows:

·  
Bond prices - quoted prices are generally available for government bonds, certain corporate securities and some mortgage-related products.

·  
Credit spreads - where available, these are derived from prices of credit default swaps or other credit based instruments, such as debt securities. For others, credit spreads are obtained from pricing services.

·  
Interest rates - these are principally benchmark interest rates such as the London Interbank Offered Rate (LIBOR) and quoted interest rates in the swap, bond and futures markets.

·  
Foreign currency exchange rates - there are observable markets both for spot and forward contracts and futures in the world's major currencies.

·  
Equity and equity index prices - quoted prices are generally readily available for equity shares listed on the world's major stock exchanges and for major indices on such shares.

·  
Commodity prices - many commodities are actively traded in spot and forward contracts and futures on exchanges in London, New York and other commercial centres.

·  
Price volatilities and correlations - volatility is a measure of the tendency of a price to change with time. Correlation measures the degree which two or more prices or other variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation. Volatility is a key input in valuing options and the valuation of certain products such as derivatives with more than one underlying variable that are correlation-dependent. Volatility and correlation values are obtained from broker quotations, pricing services or derived from option prices.

·  
Prepayment rates - the fair value of a financial instrument that can be prepaid by the issuer or borrower differs from that of an instrument that cannot be prepaid. In valuing prepayable instruments that are not quoted in active markets, the Group considers the value of the prepayment option.

·  
Counterparty credit spreads - adjustments are made to market prices (or parameters) when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price (or parameters).

·  
Recovery rates/loss given default - these are used as an input to valuation models and reserves for asset-backed securities and other credit products as an indicator of severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.

The Group may use consensus prices for the source of independent pricing for some assets. The consensus service encompasses the equity, interest rate, currency, commodity, credit, property, fund and bond markets, providing comprehensive matrices of vanilla prices and a wide selection of exotic products. GBM and Non-Core contribute to consensus pricing services where there is a significant interest either from a positional point of view or to test models for future business use. Data sourced from consensus pricing services is used for a combination of control processes including direct price testing, evidence of observability and model testing. In practice this means that the Group submits prices for all material positions for which a service is available.

In order to determine a reliable fair value, where appropriate, management applies valuation adjustments to the pricing information gathered from the above sources. These adjustments reflect the Group's assessment of factors that market participants would consider in setting a price. Furthermore, on an ongoing basis, the Group assesses the appropriateness of any model used. To the extent that the price provided by internal models does not represent the fair value of the instrument, for instance in highly stressed market conditions, the Group makes adjustments to the model valuation to calibrate to other available pricing sources. Where unobservable inputs are used, the Group may determine a range of possible valuations derived from differing stress scenarios to determine the sensitivity associated with the valuation. When establishing the fair value of a financial instrument using a valuation technique, the Group considers certain adjustments to the modelled price which market participants would make when pricing that instrument. Such adjustments include the credit quality of the counterparty and adjustments to compensate for any known model limitations.

 
305

 
Notes on the consolidated accounts continued
 
Valuation reserves
When valuing financial instruments in the trading book, adjustments are made to mid-market valuations to cover bid-offer spread, liquidity and credit risk. The following table shows the valuation reserves and adjustments.

 
2011 
£m 
2010 
£m 
2009 
£m 
Credit valuation adjustments
     
Monoline insurers
1,198 
2,443 
3,796 
Credit derivative product companies
1,034 
490 
499 
Other counterparties
2,254 
1,714 
1,588 
 
4,486 
4,647 
5,883 
Bid-offer, liquidity and other reserves
2,704 
2,797 
2,814 
 
7,190 
7,444 
8,697 

Key points
·  
The exposure to monolines reduced primarily due to the restructuring of some  exposures, partially offset by lower prices of underlying reference instruments. The credit valuation adjustments decreased due to the reduction in exposure partially offset by wider credit spreads.
 
·  
The exposure to credit derivative product companies has increased, primarily driven by wider credit spreads of the underlying reference loans and bonds. The credit valuation adjustments increased in line with the increase in exposure.

Credit valuation adjustments (CVA)
Credit valuation adjustments represent an estimate of the adjustment to fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures.

Monoline insurers
The Group has purchased protection from monoline insurers (“monolines”), mainly against specific Asset-backed securities. Monolines specialise in providing credit protection against the principal and interest cash flows due to the holders of debt instruments in the event of default by the debt instrument counterparty. This protection is typically held in the form of derivatives such as credit default swaps (CDSs) referencing underlying exposures held directly or synthetically by the Group.

The gross mark-to-market of the monoline protection depends on the value of the instruments against which protection has been bought. A positive fair value, or a valuation gain, in the protection is recognised if the fair value of the instrument it references decreases. For the majority of trades the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument However, for the remainder of the trades the gross mark-to-market is determined using industry standard models.

The methodology employed to calculate the monoline CVA uses market implied probability of defaults and internally assessed recovery levels to determine the level of expected loss on monoline exposures of different maturities. The probability of default is calculated with reference to market observable credit spreads and recovery levels. CVA is calculated at a trade level by applying the expected loss corresponding to each trade’s expected maturity, to the gross mark-to-market of the monoline protection. The expected maturity of each trade reflects the scheduled notional amortisation of the underlying reference instruments and whether payments due from the monoline are received at the point of default or over the life of the underlying reference instruments.

Credit derivative product companies (CDPC)
A CDPC is a company that sells protection on credit derivatives. CDPCs are similar to monoline insurers however, they are not regulated as insurers.

The Group has purchased credit protection from CDPCs through tranched and single name credit derivatives. The Group's exposure to CDPCs is predominantly due to tranched credit derivatives (“tranches”). A tranche references a portfolio of loans and bonds and provides protection against total portfolio default losses exceeding a certain percentage of the portfolio notional (the attachment point) up to another percentage (the detachment point).

The Group has predominantly traded senior tranches with CDPCs, the average attachment and detachment points are 13% and 47% respectively (2010 - 13% and 49%; 2009 - 15% and 51%), and the majority of the loans and bonds in the reference portfolios are investment grade.

The gross mark-to-market of the CDPC protection is determined using industry standard models. The methodology employed to calculate the CDPC CVA is different to that outlined above for monolines, as there are no market observable credit spreads and recovery levels for these entities. The level of expected loss on CDPC exposures is estimated with reference to recent market events impacting CDPCs (including communication activity); risk mitigation strategies (including analysing the underlying trades and the cost of hedging expected default losses in excess of the available capital); and the total notional of trades transacted by each CDPC together with the level of resources available to settle default payments.

.
 
306

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
Other counterparties
The CVA for all other counterparties is calculated on a portfolio basis reflecting an estimate of the amount a third party would charge to assume the credit risk.

Expected losses are applied to estimated potential future exposures which are modelled to reflect the volatility of the market factors which drive the exposures and the correlation between those factors. Potential future exposures arising from vanilla products (including interest rate and foreign exchange derivatives) are modelled jointly using the Group's core counterparty risk systems. The majority of the Group's CVA held in relation to other counterparties arises on these vanilla products. The exposures arising from all other product types are modelled and assessed individually. The potential future exposure to each counterparty is the aggregate of the exposures arising on the underlying product types.

The correlation between exposure and counterparty risk is also incorporated within the CVA calculation where this risk is considered significant. The risk primarily arises on trades with emerging market counterparties where the gross mark-to-market value of the trade, and therefore the counterparty exposure, increases as the strength of the local currency declines.

Collateral held under a credit support agreement is factored into the CVA calculation. In such cases where the Group holds collateral against counterparty exposures, CVA is held to the extent that residual risk remains.

CVA is held against exposures to all counterparties with the exception of the CDS protection that the Group has purchased from HM Treasury, as part of its participation in the Asset Protection Scheme, due to the unique features of this derivative.

Bid-offer, liquidity and other reserves
Fair value positions are adjusted to bid or offer levels, by marking individual cash based positions directly to bid or offer or by taking bid-offer reserves calculated on a portfolio basis for derivatives exposures. The bid-offer approach is based on current market spreads and standard market bucketing of risk.

Risk data are used as the primary sources of information within bid-offer calculations and are aggregated when they are more granular than market standard buckets. Bid-offer adjustments for each risk factor (including delta (the degree to which the price of an instrument changes in response to a change in the price of the underlying), vega (the degree to which the price of an instrument changes in response to the volatility in the price of the underlying), correlation (the degree to which prices of different instruments move together) and others) are determined by aggregating similar risk exposures arising on different products. Additional basis bid-offer reserves are taken where these are charged in the market. Risk associated with non-identical underlying exposures is not netted down unless there is evidence that the cost of closing the combined risk exposure is less than the cost of closing on an individual basis.

Bid-offer spreads vary by maturity and risk type to reflect different spreads in the market. For positions where there is no observable quote, the bid-offer spreads are widened in comparison to proxies to reflect reduced liquidity or observability. Bid-offer methodologies also incorporate liquidity triggers whereby wider spreads are applied to risks above pre-defined thresholds.

Netting is applied on a portfolio basis to reflect the level at which the Group believes it could exit the portfolio, rather than the sum of exit costs for each of the portfolio’s individual trades.  For example, netting is applied where long and short risk in two different maturity buckets can be closed out in a single market transaction at less cost than by way of two separate transactions (calendar netting).  This reflects the fact that to close down the portfolio, the net risk can be settled rather than each long and short trade individually.

Vanilla risk on exotic products is typically reserved as part of the overall portfolio based calculation e.g. delta and vega risk on exotic products are included within the delta and vega bid-offer calculations. Aggregation of risk arising from different models is in line with the Group's risk management practices; the model review control process considers the appropriateness of model selection in this respect.

Product related risks such as correlation risk, attract specific bid-offer reserves. Additional reserves are provided for exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects (taking into account how moves in one risk factor may affect other inputs rather than treating all risk factors independently) that are unlikely to be adequately reflected in a static hedge based on vanilla instruments.  Where there is limited bid-offer information for a product, the pricing approach and risk management strategy are taken into account when assessing the reserve.

Amounts deferred on initial recognition
On initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data becomes observable; or when the transaction matures or is closed out as appropriate. At 31 December 2011, net gains of £161 million (2010 - £167 million; 2009 - £204 million) were carried forward. During the year, net gains of £89 million (2010 - £62 million; 2009 - £127 million) were deferred and £95 million (2010 - £99 million; 2009 - £25 million) recognised in the income statement.

 
307

 
Notes on the consolidated accounts continued

Own credit
The Group takes into account the effect of its own credit standing when valuing financial liabilities recorded at fair value in accordance with IFRS. Own credit spread adjustments are made to issued debt held at fair value, including issued structured notes, and derivatives. An own credit adjustment is applied to positions where it is believed that counterparties would consider the Group's creditworthiness when pricing trades.

For issued debt and structured notes this adjustment is based on debt issuance spreads above average inter-bank rates (at a range of tenors). At the beginning of the year the spreads were based on levels which the market would demand when purchasing new senior or sub-debt issuances from the Group. During the year, primary debt issuance activity in the market reduced whilst liquidity remained in the secondary trading of Group senior debt. These secondary senior debt issuance spreads were considered to provide a more accurate reflection of fair value and these levels are therefore now used in the calculation of the own credit adjustment applied to senior debt. Where necessary, these quotes are interpolated using a curve shape derived from credit default swap prices.

The fair value of the Group's derivative financial liabilities has also been adjusted to reflect the Group's own credit risk. The adjustment takes into account collateral posted by it and the effects of master netting agreements.

The own credit adjustment for fair value does not alter cash flows, is not used for performance management, is disregarded for regulatory capital reporting processes and will reverse over time as the liabilities mature.

The reserve movement between periods will not equate to the reported profit or loss for own credit. The balance sheet reserves are stated by conversion of underlying currency balances at spot rates for each period whereas the income statement includes intra-period foreign exchange sell-offs.

The effect of change in credit spreads could be reversed in future periods, provided the liability is not repaid at a premium or a discount.

The following table shows own credit adjustments on own liabilities.

 
Debt securities in issue (1)
Subordinated 
liabilities 
DFV (2)
£m 
Total 
£m 
Derivatives 
£m 
Total 
£m 
Cumulative own credit adjustment
 
HFT 
£m 
 
DFV (2)
£m 
Total 
£m 
2011
882 
2,647 
3,529 
679 
4,208 
602 
4,810 
2010
517 
1,574 
2,091 
325 
2,416 
534 
2,950 
2009
548 
1,309 
1,857 
474 
2,331 
467 
2,798 
               
               
Carrying values of underlying liabilities
£bn 
£bn 
£bn 
£bn 
£bn 
   
2011
11.5 
35.7 
47.2 
0.9 
48.1 
   
2010
7.7 
43.5 
51.2 
1.1 
52.3 
   
2009
4.0 
41.5 
45.5 
1.3 
46.8 
   

Notes:
(1)
Consists of wholesale and retail note issuances.
(2)
Designated as at fair value through profit and loss.


 
308

 
Notes on the consolidated accounts continued

11 Financial instruments - valuation continued
Valuation hierarchy
The following tables show financial instruments carried at fair value on the Group’s balance sheet by valuation hierarchy - level 1, level 2 and level 3.

 
2011
 
2010
 
2009
 
Level 1 
£bn 
Level 2 
£bn 
Level 3 
£bn 
Total 
£bn 
 
Level 1 
£bn 
Level 2 
£bn 
Level 3 
£bn 
Total 
£bn 
 
Level 1 
£bn 
Level 2 
£bn 
Level 3 
£bn 
Total 
£bn 
Assets
                           
Loans and advances to banks
                           
 Reverse repos
— 
34.7 
— 
34.7 
 
— 
38.2 
— 
38.2 
 
— 
26.9 
— 
26.9 
 Collateral
— 
19.7 
— 
19.7 
 
— 
25.1 
— 
25.1 
 
— 
18.4 
— 
18.4 
 Other
— 
0.2 
0.4 
0.6 
 
— 
0.6 
0.4 
1.0 
 
— 
0.1 
— 
0.1 
 
— 
54.6 
0.4 
55.0 
 
— 
63.9 
0.4 
64.3 
 
— 
45.4 
— 
45.4 
Loans and advances to customers
                           
 Reverse repos
— 
53.6 
— 
53.6 
 
— 
41.1 
— 
41.1 
 
— 
26.3 
— 
26.3 
 Collateral
— 
22.0 
— 
22.0 
 
— 
14.4 
— 
14.4 
 
— 
9.6 
— 
9.6 
 Other
— 
3.4 
0.4 
3.8 
 
— 
6.2 
0.4 
6.6 
 
— 
7.3 
1.1 
8.4 
 
— 
79.
0.
79.4 
 
— 
61.7 
0.4 
62.1 
 
— 
43.2 
1.1 
44.3 
Debt securities
                           
 UK government
22.4 
— 
— 
22.4 
 
13.5 
— 
— 
13.5 
 
27.3 
— 
— 
27.3 
 US government
35.5 
5.0 
— 
40.5 
 
31.0 
7.0 
— 
38.0 
 
19.2 
9.2 
— 
28.4 
 Other government
53.9 
8.7 
— 
62.6 
 
62.3 
13.6 
— 
75.9 
 
79.6 
16.3 
— 
95.9 
 Corporate
— 
5.0 
0.5 
5.5 
 
— 
6.5 
1.2 
7.7 
 
— 
9.2 
1.2 
10.4 
 Financial institutions
3.0 
61.6 
7.4 
72.
 
3.5 
64.8 
7.0 
75.3 
 
4.2 
88.3 
2.9 
95.4 
 
114.8 
80.3 
7.9 
203.0 
 
110.3 
91.9 
8.2 
210.4 
 
130.3 
123.0 
4.1 
257.4 
Equity shares
12.4 
1.8 
1.0 
15.2 
 
18.4 
2.8 
1.0 
22.2 
 
15.4 
2.6 
1.5 
19.5 
Derivatives
                           
 Foreign exchange
— 
72.9 
1.6 
74.5 
 
— 
83.2 
0.1 
83.3 
 
— 
69.2 
0.2 
69.4 
 Interest rate
0.2 
420.8 
1.1 
422.1 
 
1.7 
308.3 
1.7 
311.7 
 
0.3 
321.8 
1.5 
323.6 
 Equities and commodities
— 
5.9 
0.2 
6.1 
 
0.1 
4.9 
0.2 
5.2 
 
0.4 
6.1 
0.3 
6.8 
 Credit - APS
— 
— 
— 
— 
 
— 
— 
0.6 
0.6 
 
— 
— 
1.4 
1.4 
 Credit - other
— 
23.1 
3.8 
26.9 
 
— 
23.2 
3.1 
26.3 
 
0.1 
37.2 
3.0 
40.3 
 
0.2 
522.7 
6.7 
529.6 
 
1.8 
419.6 
5.7 
427.1 
 
0.8 
434.3 
6.4 
441.5 
 
127.4 
738.4 
16.4 
882.2 
 
130.5 
639.9 
15.7 
786.1 
 
146.5 
648.5 
13.1 
808.1 
                             
Of which
                           
Core
126.9 
724.5 
7.2 
858.6 
 
129.4 
617.6 
7.2 
754.2 
         
Non-Core
0.5 
13.9 
9.2 
23.6 
 
1.1 
22.3 
8.5 
31.9 
         
 
127.4 
738.4 
16.4 
882.2 
 
130.5 
639.9 
15.7 
786.1 
 
 
     
                             
Proportion
14.4% 
83.7% 
1.9% 
100.0% 
 
16.6% 
81.4% 
2.0% 
100.0% 
 
18.1% 
80.3% 
1.6% 
100.0% 
                             
Of which AFS debt securities
                           
 UK government
13.4 
— 
— 
13.4 
 
8.4 
— 
— 
8.4 
 
19.1 
— 
— 
19.1 
 US government
18.1 
2.7 
— 
20.8 
 
17.8 
4.4 
— 
22.2 
 
12.6 
6.4 
— 
19.0 
 Other government
21.6 
4.0 
— 
25.6 
 
26.5 
6.4 
— 
32.9 
 
38.4 
7.1 
— 
45.5 
 Corporate
— 
2.3 
0.2 
2.5 
 
— 
1.4 
0.1 
1.5 
 
— 
3.3 
0.2 
3.5 
 Financial institutions
0.2 
39.3 
5.5 
45.0 
 
0.4 
41.4 
4.3 
46.1 
 
0.2 
54.9 
1.1 
56.2 
 
53.3 
48.3 
5.7 
107.3 
 
53.1 
53.6 
4.4 
111.1 
 
70.3 
71.7 
1.3 
143.3 
Equity shares
0.3 
1.3 
0.4 
2.0 
 
0.3 
1.4 
0.3 
2.0 
 
0.5 
1.7 
0.7 
2.9 
Total AFS assets
53.6 
49.6 
6.1 
109.3 
 
53.4 
55.0 
4.7 
113.1 
 
70.8 
73.4 
2.0 
146.2 
                             
Of which
                           
Core
53.6 
46.9 
0.6 
101.1 
 
52.8 
49.2 
1.0 
103.0 
         
Non-Core
— 
2.7 
5.5 
8.2 
 
0.6 
5.8 
3.7 
10.1 
         
 
53.6 
49.6 
6.1 
109.3 
 
53.4 
55.0 
4.7 
113.1 
         

For notes relating to this table refer to page 310.

 
309

 
Notes on the consolidated accounts continued
 
 
2011
 
2010
 
2009
 
Level 1 
Level 2 
Level 3 
Total 
 
Level 1 
Level 2 
Level 3 
Total 
 
Level 1  
Level 2 
Level 3 
Total\
 
£bn 
£bn 
£bn 
£bn 
 
£bn 
£bn 
£bn 
£bn 
 
£bn  
£bn 
£bn 
£bn 
Liabilities
                           
Deposits by banks
                           
 Repos
— 
23.3 
— 
23.3 
 
— 
20.6 
— 
20.6 
 
— 
21.0 
— 
21.0 
 Collateral
— 
31.8 
— 
31.8 
 
— 
26.6 
— 
26.6 
 
— 
28.2 
— 
28.2 
 Other
— 
2.4 
— 
2.4 
 
— 
1.6 
— 
1.6 
 
— 
4.4 
— 
4.4 
 
— 
57.5 
— 
57.5 
 
48.8 
— 
48.8 
 
— 
53.6 
— 
53.6 
Customer accounts
                           
 Repos
— 
65.5 
— 
65.5 
 
— 
53.0 
— 
53.0 
 
— 
41.5 
— 
41.5 
 Collateral
— 
9.2 
— 
9.2 
 
— 
10.4 
— 
10.4 
 
— 
8.0 
— 
8.0 
 Other
— 
10.8 
— 
10.8 
 
— 
8.7 
0.1 
8.8 
 
— 
11.8 
0.1 
11.9 
 
— 
85.5 
— 
85.5 
 
72.1 
0.1 
72.2 
 
— 
61.3 
0.1 
61.4 
Debt securities in issue
— 
45.0 
2.2 
47.2 
 
— 
49.0 
2.2 
51.2 
 
— 
43.2 
2.3 
45.5 
Short positions
34.4 
6.3 
0.3 
41.0 
 
35.0 
7.3 
0.8 
43.1 
 
27.1 
13.2 
0.2 
40.5 
Derivatives
                           
 Foreign exchange
— 
80.6 
0.4 
81.0 
 
0.1 
89.3 
— 
89.4 
 
— 
63.9 
— 
63.9 
 Interest rate
0.4 
405.2 
1.1 
406.7 
 
0.2 
298.0 
1.0 
299.2 
 
0.1 
310.5 
0.8 
311.4 
 Equities and commodities
— 
9.1 
0.5 
9.6 
 
0.1 
9.6 
0.4 
10.1 
 
1.0 
8.5 
0.2 
9.7 
 Credit - APS
— 
— 
0.2 
0.2 
 
— 
— 
— 
— 
 
— 
— 
— 
— 
 Credit - other
— 
24.9 
1.6 
26.5 
 
— 
25.0 
0.3 
25.3 
 
— 
38.1 
1.0 
39.1 
 
0.4 
519.8 
3.8 
524.0 
 
0.4 
421.9 
1.7 
424.0 
 
1.1 
421.0 
2.0 
424.1 
Subordinated liabilities
— 
0.9 
— 
0.9 
 
— 
1.1 
— 
1.1 
 
— 
1.3 
— 
1.3 
 
34.8 
715.0 
6.3 
756.1 
 
35.4 
600.2 
4.8 
640.4 
 
28.2 
593.6 
4.6 
626.4 
                             
Of which
                           
Core
34.8 
708.9 
5.7 
749.4 
 
35.4 
586.9 
3.8 
626.1 
         
Non-Core
— 
6.1 
0.6 
6.7 
 
— 
13.3 
1.0 
14.3 
         
 
34.8 
715.0 
6.3 
756.1 
 
35.4 
600.2 
4.8 
640.4 
         
                             
Proportion
4.6% 
94.6% 
0.8% 
100.0% 
 
5.5% 
93.7% 
0.8% 
100.0% 
 
4.5% 
94.8% 
0.7% 
100.0% 

Note:
(1)
Level 1: valued using unadjusted quoted prices in active markets, for identical financial instruments. Examples include G10 government securities, listed equity shares, certain exchange-traded derivatives and certain US agency securities.

 
Level 2: valued using techniques based significantly on observable market data. Instruments in this category are valued using:
 
(a)
quoted prices for similar instruments or identical instruments in markets which are not considered to be active; or
 
(b)
valuation techniques where all the inputs that have a significant effect on the valuations are directly or indirectly based on observable market data.
 
The type of instruments that trade in markets that are not considered to be active, but are based on quoted market prices, banker dealer quotations, or alternative pricing sources with reasonable levels of price transparency and those instruments valued using techniques include non-G10 government securities, most government agency securities, investment-grade corporate bonds, certain mortgage products, including CLOs, most bank loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most notes issued, investment contracts issued by the Group's life assurance business (2009) and certain money market securities and loan commitments and most OTC derivatives.

Level 3: instruments in this category have been valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation, is not based on observable market data. Where inputs can be observed from market data without undue cost and effort, the observed input is used. Otherwise, the Group determines a reasonable level for the input. Financial instruments primarily include cash instruments which trade infrequently, certain syndicated and commercial mortgage loans, unlisted equity shares, certain residual interests in securitisations, majority of CDOs, other mortgage-backed products and less liquid debt securities, certain structured debt securities in issue, and OTC derivatives where valuation depends upon unobservable inputs such as certain credit and exotic derivatives. No gain or loss is recognised on the initial recognition of a financial instrument valued using a technique incorporating significant unobservable data.




 
310

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
The following table analyses level 3 balances and related valuation sensitivities.

 
2011
 
2010
 
2009
   
   
Sensitivity (1)
   
Sensitivity (1)
   
Sensitivity (1)
   
 
Balance 
Favourable 
Unfavourable 
 
Balance 
Favourable 
Unfavourable 
 
Balance 
Favourable 
Unfavourable 
   
 
£bn 
£m 
£m 
 
£bn 
£m 
£m 
 
£bn 
£m 
£m 
 
Assumptions
Assets
                         
Loans and advances
0.8 
120 
(70)
 
0.8 
70 
(60)
 
1.1 
80 
(40)
 
c, k
Debt securities
                         
Corporate
0.5 
30 
(30)
 
1.2 
210 
(170)
 
1.2 
180 
(60)
 
c
Financial institutions
7.4 
560 
(180)
 
7.0 
540 
(180)
 
2.9 
290 
(170)
 
a, c, d, i, j, m, n, o, p
 
7.9 
590 
(210)
 
8.2 
750 
(350)
 
4.1 
470 
(230)
   
Equity shares
1.0 
140 
(130)
 
1.0 
160 
(160)
 
1.5 
280 
(220)
 
h
Derivatives
                         
Foreign exchange
1.6 
100 
(100)
 
0.1 
— 
— 
 
0.2 
10 
— 
 
a, q
Interest rate
1.1 
80 
(80)
 
1.7 
150 
(140)
 
1.5 
80 
(100)
 
a, q
Equities and commodities
0.2 
— 
— 
 
0.2 
— 
— 
 
0.3 
20 
(20)
 
a, f
Credit - APS
— 
— 
— 
 
0.6 
860 
(940)
 
1.4 
1,370 
(1,540)
 
a, c, e, g, l
Credit - other
3.8 
680 
(400)
 
3.1 
320 
(170)
 
3.0 
420 
(360)
 
a, b, q
 
6.7 
860 
(580)
 
5.7 
1,330 
(1,250)
 
6.4 
1,900 
(2,020)
   
 
16.4 
1,710 
(990)
 
15.7 
2,310 
(1,820)
 
13.1 
2,730 
(2,510)
   
                           
                           
Of which AFS debt securities
                         
Corporate
0.2 
10 
(10)
 
0.1 
20 
(20)
 
0.2 
10 
(10)
   
Financial institutions
5.5 
310 
(50)
 
4.3 
280 
(40)
 
1.1 
80 
(40)
   
 
5.7 
320 
(60)
 
4.4 
300 
(60)
 
1.3 
90 
(50)
   
Equity shares
0.4 
70 
(70)
 
0.3 
60 
(60)
 
0.7 
100 
(90)
   
Total AFS assets
6.1 
390 
(130)
 
4.7 
360 
(120)
 
2.0 
190 
(140)
   
                           
                           
Liabilities
                         
Customer accounts
— 
20 
(20)
 
0.1 
60 
(60)
 
0.1 
— 
(10)
 
a, c
Debt securities in issue
2.2 
80 
(60)
 
2.2 
90 
(110)
 
2.3 
50 
(10)
 
a, q
Short positions
0.3 
10 
(100)
 
0.8 
20 
(50)
 
0.2 
10 
(20)
 
a, c
Derivatives
                         
Foreign exchange
0.4 
30 
(20)
 
— 
— 
(10)
 
— 
— 
— 
 
a, q
Interest rate
1.1 
80 
(90)
 
1.0 
70 
(90)
 
0.8 
40 
(60)
 
a, q
Equity and commodities
0.5 
10 
(10)
 
0.4 
10 
— 
 
0.2 
20 
(70)
 
a, f
Credit - APS
0.2 
300 
(40)
 
— 
— 
— 
 
— 
— 
— 
 
a, c, e, g, l
Credit - other
1.6 
80 
(130)
 
0.3 
40 
(40)
 
1.0 
80 
(100)
 
a, b, q
 
3.8 
500 
(290)
 
1.7 
120 
(140)
 
2.0 
140 
(230)
   
 
6.3 
610 
(470)
 
4.8 
290 
(360)
 
4.6 
200 
(270)
   


Key to assumptions:
(a) Correlation; (b) counterparty credit risk; (c) credit spreads; (d) default rates; (e) discount rate recoveries; (f) dividends; (g) expected losses; (h) fund valuation; (i) housing prices; (j) implied collateral valuation; (k) indices; (l) loss credits; (m) prepayment rates; (n) probability of default; (o) loss severity and yield; (p) recovery rates; (q) volatility.

Note:
(1)
Sensitivity represents the favourable and unfavourable effect on the income statement or the statement of comprehensive income due to reasonably possible changes to valuations using reasonably possible alternative inputs to the Group's valuation techniques or models. Totals for sensitivities are not indicative of the total potential effect on the income statement or the statement of comprehensive income.
 
 
 
311

 
Notes on the consolidated accounts continued
 
Key points
·  
Total assets carried at fair value increased by £96.1 billion in the year to £882.2 billion at 31 December 2011, principally reflecting increases in derivative assets (£102.5 billion), reverse repos (£9.0 billion) and derivative collateral (£2.2 billion), partially offset by decreases in debt securities (£7.4 billion) and equity shares (£7.0 billion).

·  
Total liabilities carried at fair value increased by £115.7 billion, with increases in derivative liabilities (£100.0 billion), repos (£15.2 billion) and collateral (£4.0 billion), partially offset by decreases in debt securities in issue (£4.0 billion) and short positions (£2.1 billion).

·  
Level 3 assets of £16.4 billion represented 1.9% (2010 - £15.7 billion and 2.0%) of assets at fair value, an increase of £0.7 billion.  This reflected transfers from level 2 to level 3 of £5.7 billion based on a review in the latter part of 2011 in light of liquidity in the market, maturity and sale of instruments.  These transfers related to ABS in Non-Core Markets and certain foreign exchange options and credit derivatives in GBM.  £1.9 billion was transferred from level 3 to level 2, based on the re-assessment of the impact and nature of unobservable inputs used in valuation models.

·  
Level 3 liabilities increased to £6.3 billion in the year from £4.8 billion, mainly in credit derivatives due to market liquidity and resultant transfers from level 2 to level 3.

·  
The favourable and unfavourable effects of reasonably possible alternative assumptions on level 3 instruments carried at fair value excluding APS credit derivatives were £2.0 billion favourable (2010 - £1.7 billion favourable) and £1.4 billion unfavourable (2010 - £1.2 billion unfavourable) respectively. Favourable and unfavourable sensitivities for APS credit derivatives were £0.3 billion (2010 - £0.9 billion favourable) and £0.1 billion unfavourable (2010 - £0.9 billion unfavourable). The change in APS sensitivities reflected the decrease in overall value of the Scheme.

·  
There were no significant transfers between level 1 and level 2.

The level 3 sensitivities above are calculated at a trade or low level portfolio basis. They are not calculated on an overall portfolio basis and therefore do not reflect the likely overall potential uncertainty on the whole portfolio. The figures are aggregated and do not reflect the correlated nature of some of the sensitivities. In particular, for some of the portfolios the sensitivities may be negatively correlated where a downwards movement in one asset would produce an upwards movement in another, but due to the additive presentation of the above figures this correlation cannot be observed. For example, with assets in the APS, the downwards sensitivity on the underlying asset would be partially offset by the consequent upward movement of the APS derivative, so whilst the net sensitivity of the two positions may be lower, it would be shown with the gross upside and downside sensitivity of the two assets inflating the overall sensitivity figures in the above table. The actual potential downside sensitivity of the total portfolio may be less than the non-correlated sum of the additive figures as shown in the above table.

Judgmental issues
The diverse range of products traded by the Group results in a wide range of instruments that are classified into the three level hierarchy. Whilst the majority of these instruments naturally fall into a particular level, for some products an element of judgment is required. The majority of the Group’s financial instruments carried at fair value are classified as level 2: inputs are observable either directly (i.e. as a price) or indirectly (i.e. derived from prices).

Active and inactive markets
A key input in the decision making process for the allocation of assets to a particular level is liquidity. In general, the degree of valuation uncertainty depends on the degree of liquidity of an input. For example, a derivative can be placed into level 2 or level 3 dependent upon its liquidity.

Where markets are liquid or very liquid, little judgment is required. However, when the information regarding the liquidity in a particular market is not clear, a judgment may need to be made. This can be made more difficult as assessing the liquidity of a market may not always be straightforward. For an equity traded on an exchange, daily volumes of trading can be seen, but for an-over-the counter (OTC) derivative assessing the liquidity of the market with no central exchange can be more difficult.

A key related issue is where a market moves from liquid to illiquid or vice versa. Where this change is considered to be temporary, the classification is not changed. For example, if there is little market trading in a product on a reporting date but at the previous reporting date and during the intervening period the market has been considered to be liquid, the instrument will continue to be classified in the same level in the hierarchy. This is to provide consistency so that transfers between levels are driven by genuine changes in market liquidity and do not reflect short term or seasonal effects.

Interaction with the IPV process
The determination of an instrument’s level cannot be made at a global product level as a single product type can be in more than one level. For example, a single name corporate credit default swap could be in level 2 or level 3 depending on whether the reference counterparty is liquid or illiquid.

As part of the Group’s IPV process, data is gathered at a trade level from market trading activity, trading systems, pricing services, consensus pricing providers, brokers and research material amongst other sources.

The breadth and detail of this data allows a good assessment to be made of liquidity and pricing uncertainty, which assists with the process of allocation to an appropriate level. Where suitable independent pricing information is not readily available the instrument will be considered to be level 3.

 
312

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
Modelled products
For modelled products the market convention is to quote these trades through the model inputs or parameters as opposed to a cash price equivalent. A mark-to-market is derived from the use of the independent market inputs calculated using the Group’s model.

The decision to classify a modelled asset as level 2 or 3 will be dependent upon the product/model combination, the currency, the maturity, the observability of input parameters and other factors. All these need to be assessed to classify the asset.

An assessment is made of each input into a model. There may be multiple inputs into a model and each is assessed in turn for observability and quality. If an input fails the observability or quality tests then the instrument is considered to be in level 3 unless the input can be shown to have an insignificant effect on the overall valuation of the product.

The majority of derivative instruments are classified as level 2 as they are vanilla products valued using observable inputs. The valuation uncertainty on these is considered to be low and both input and output testing may be available. Examples of these products would be vanilla interest rate swaps, foreign exchange swaps and liquid single name credit derivatives.

Non-modelled products
Non-modelled products are generally quoted on a price basis and can therefore be considered for each of the 3 levels. This is determined by the liquidity and valuation uncertainty of the instruments which is in turn measured from the availability of independent data used by the IPV process.

The availability and quality of independent pricing information is considered during the classification process. An assessment is made regarding the quality of the independent information. For example where consensus prices are used for non-modelled products, a key assessment of the quality of a price is the depth of the number of prices used to provide the consensus price. If the depth of contributors falls below a set hurdle rate, the instrument is considered to be level 3. This hurdle rate is consistent with the rate used in the IPV process to determine whether or not the data is of sufficient quality to adjust the instrument’s valuations. However, where an instrument is generally considered to be illiquid, but regular quotes from market participants exist, these instruments may be classified as level 2 depending on frequency of quotes, other available pricing and whether the quotes are used as part of the IPV process or not.
 
For some instruments with a wide number of available price sources, there may be differing quality of available information and there may be a wide range of prices from different sources. In these situations an assessment is made as to which source is the highest quality and this will be used to determine the classification of the asset. For example, a tradable quote would be considered a better source than a consensus price.

Instruments that cross levels
Some instruments will predominantly be in one level or the other, but others may cross between levels. For example, a cross currency swap may be between very liquid currency pairs where pricing is readily observed in the market and will therefore be classified as level 2. The cross currency swap may also be between two illiquid currency pairs in which case the swap would be placed into level 3. Defining the difference between liquid and illiquid may be based upon the number of consensus providers the consensus price is made up from and whether the consensus price can be supplemented by other sources.

Level 3 portfolios and sensitivity methodologies
For each of the portfolio categories shown in the tables above, there follows a description of the types of products that comprise the portfolio and the valuation techniques that are applied in determining fair value, including a description of valuation techniques used for levels 2 and 3 and inputs to those models and techniques. Where reasonably possible alternative assumptions of unobservable inputs used in models would change the fair value of the portfolio significantly, the alternative inputs are indicated. Where there have been significant changes to valuation techniques during the year a discussion of the reasons for this are also included.

Loans and advances to customers
Loans in level 3 primarily comprise loans to emerging market counterparties, structured loans and legacy commercial mortgages.

Commercial mortgages
These senior and mezzanine commercial mortgages are loans secured on commercial land and buildings that were originated or acquired by the Group for securitisation. Senior commercial mortgages carry a variable interest rate and mezzanine or more junior commercial mortgages may carry a fixed or variable interest rate. Factors affecting the value of these loans may include, but are not limited to, loan type, underlying property type and geographic location, loan interest rate, loan to value ratios, debt service coverage ratios, prepayment rates, cumulative loan loss information, yields, investor demand, market volatility since the last securitisation and credit enhancement. Where observable market prices for a particular loan are not available, the fair value will typically be determined with reference to observable market transactions in other loans or credit related products including debt securities and credit derivatives. Assumptions are made about the relationship between the loan and the available benchmark data.

 
313

 
Notes on the consolidated accounts continued


Debt securities
Level 3 debt securities principally comprise asset-backed securities.

Residential mortgage-backed securities (RMBS)
RMBS where the underlying assets are US agency-backed mortgages and there is regular trading are generally classified as level 2 in the fair value hierarchy. RMBS are also classified as level 2 when regular trading is not prevalent in the market, but similar executed trades or third-party data including indices, broker quotes and pricing services can be used to substantiate the fair value. RMBS are classified as level 3 when trading activity is not available and a model with significant unobservable data is utilised.

In determining whether an instrument is similar to that being valued, the Group considers a range of factors, principally: the lending standards of the brokers and underwriters that originated the mortgages, the lead manager of the security, the issue date of the respective securities, the underlying asset composition (including origination date, loan to value ratios, historic loss information and geographic location of the mortgages), the credit rating of the instrument, and any credit protection that the instrument may benefit from, such as insurance wraps or subordinated tranches. Where there are instances of market observable data for several similar RMBS tranches, the Group considers the extent of similar characteristics shared with the instrument being valued, together with the frequency, tenor and nature of the trades that have been observed. This method is most frequently used for US and UK RMBS. RMBS of Dutch and Spanish originated mortgages guaranteed by those governments are valued using the credit spreads of the respective government debt and certain assumptions made by the Group, or based on observable prices from Bloomberg or consensus pricing services.

The Group primarily uses an industry standard model to project the expected future cash flows to be received from the underlying mortgages and to forecast how these cash flows will be distributed to the various holders of the RMBS. This model utilises data provided by the servicer of the underlying mortgage portfolio, layering on assumptions for mortgage prepayments, probability of default, expected losses and yield. The Group uses data from third-party sources to calibrate its assumptions, including pricing information from third party pricing services, independent research, broker quotes, and other independent sources. An assessment is made of third party data source to determine its applicability and reliability. The Group adjusts the model price with a liquidity premium to reflect the price that the instrument could be traded in the market and may also make adjustments for model deficiencies.

The fair value of securities within each class of asset changes on a broadly consistent basis in response to changes in given market factors. However, the extent of the change, and therefore the range of reasonably possible alternative assumptions, may be either more or less pronounced, depending on the particular terms and circumstances of the individual security. The Group believes that probability of default was the least transparent input into Alt-A and prime RMBS modelled valuations (and most sensitive to variations).

Commercial mortgage-backed securities (CMBS)
CMBS are valued using an industry standard model and the inputs, where possible, are corroborated using observable market data.

Collateralised debt obligations (CDO)
CDOs purchased from third-parties are valued using independent, third-party quotes or independent lead manager indicative prices. For super senior CDOs which have been originated by the Group no specific third-party information is available. The valuation of these super senior CDOs therefore takes into consideration outputs from a proprietary model, market data and appropriate valuation adjustments.

A collateral net asset value methodology using dealer buy side marks is used to determine an upper bound for super senior CDO valuations. An ABS index implied collateral valuation is also used to provide a market calibrated valuation data point. Both the ABS index implied valuation and the collateral net asset value methodology apply an assumed immediate liquidation approach.

Collateralised loan obligations (CLO)
To determine the fair value of CLOs purchased from third parties, the Group uses third party broker or lead manager quotes as the primary pricing source. These quotes are benchmarked to consensus pricing sources where they are available.

For CLOs originated and still held by the Group, the fair value is determined using a correlation model based on a Monte Carlo simulation framework. The main model inputs are credit spreads and recovery rates of the underlying assets and their correlation. A credit curve is assigned to each underlying asset based on prices from third party dealer quotes and cash flow profiles, sourced from an industry standard model. Losses are calculated taking into account the attachment and detachment point of the exposure. Where the correlation inputs to this model are not observable, CLOs are classified as level 3.

Other asset-backed and corporate debt securities
Where observable market prices for a particular debt security are not available, the fair value will typically be determined with reference to observable market transactions in other related products, such as similar debt securities or credit derivatives. Assumptions are made about the relationship between the individual debt security and the available benchmark data. Where significant management judgment has been applied in identifying the most relevant related product, or in determining the relationship between the related product and the instrument itself, the instrument is classified as level 3.

Equity shares
Private equity investments include unit holdings and limited partnership interests primarily in corporate private equity funds, debt funds and fund of hedge funds. Externally managed funds are valued using recent prices where available. Where not available, the fair value of investments in externally managed funds is generally determined using statements or other information provided by the fund managers.

The Group considers that valuations may rely significantly on the judgments and estimates made by the fund managers, particularly in assessing private equity components. Given the decline in liquidity in world markets, and the level of subjectivity, these are included in level 3.

 
314

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
Derivatives
Derivatives are priced using quoted prices for the same or similar instruments where these are available. However, the majority of derivatives are valued using pricing models. Inputs for these models are usually observed directly in the market, or derived from observed prices. However, it is not always possible to observe or corroborate all model inputs. Unobservable inputs used are based on estimates taking into account a range of available information including historic analysis, historic traded levels, market practice, comparison to other relevant benchmark observable data and consensus pricing data.

Credit derivatives - APS
The Group purchased credit protection over a portfolio of specified assets and exposures (covered assets) from HM Treasury. The Group has a right to terminate the APS at any time provided that the Financial Services Authority has confirmed in writing to HM Treasury that it has no objection to the proposed termination. On termination the Group must pay HM Treasury the higher of the regulatory capital relief received and £2.5 billion less premiums paid plus the aggregate of amounts received from the UK Government under the APS. The Group has paid APS premiums totalling £2,225 million (£125 million in 2011, £700 million in 2010 and £1,400 million in 2009). From 31 December 2011, premiums of £125 million are payable quarterly until the earlier of 2099 and the date the Group leaves the Scheme.

The APS is a single contract providing credit protection in respect of the covered assets. Under IFRS, credit protection is treated either as a financial guarantee contract or as a derivative financial instrument depending on the terms of the agreement and the nature of the protected assets and exposures. The Group has concluded, principally because the covered portfolio includes significant exposure in the form of derivatives, that the APS does not meet the criteria to be treated as a financial guarantee contract. The contract has therefore been accounted for as a derivative financial instrument. It was recognised initially and measured subsequently at fair value with changes in fair value recognised in profit or loss within income from trading activities. There is no change in the recognition and measurement of the covered assets as a result of the APS.

For the purpose of the APS, a loss is deemed to have arisen on a covered asset when that asset has experienced a trigger event which comprises of failure to pay subject to grace periods, bankruptcy and restructuring.

Where protection is provided on a particular seniority of exposure, as is the case with the APS, which requires initial losses to be taken by the Group, it is termed ‘tranched’ protection. The model being used to value the APS - a Gaussian Copula model with stochastic recoveries - is used by the Group to value tranches traded by the exotic credit desk and is a model that is currently used within the wider market.

The option to exit the APS is not usually present in such tranched trades and consequently, there is no standard market practice for reflecting this part of the trade within the standard model framework. The approach that has been adopted assumes that the Group will not exit the trade before the minimum level of fees have been paid and at this point it will be clear whether it should exit the trade or not. The APS derivative is valued as the payment of the minimum level of fees in return for protection receipts which are in excess of both the first loss and the total future premiums.

The model primarily uses the following inputs in relation to each individual non-triggered asset: notional, maturity, probability of default and expected recovery rate given default. Other key inputs include: the correlation between the underlying assets; the range of possible recovery rates on the underlying assets (“alpha”); the size of the first loss. The size of the first loss is adjusted to reflect both realised and expected losses on triggered assets as well as the level of expected losses on covered assets that have been sold, that can be treated as losses for the purpose of the APS (“loss credits”).

During 2011, refinements were made to the treatment of expected losses on certain triggered assets following a modification to the trigger events that apply to some portfolios. The valuation refinement was made to accurately reflect the impact of the changes. The expected losses arising on assets that trigger under the modified rules now reflect a range of possible recovery rates.

The APS protects a wide range of asset types, and hence, the correlation between the underlying assets cannot be observed from market data. In the absence of this, the Group determines a reasonable level for this input. The expected recovery rate given default is based on internally assessed levels. The probability of default is calculated with reference to data observable in the market. Where possible, data is obtained for each asset within the APS, but for most of the assets, such observable data does not exist. In these cases, this important input is determined from information available for similar entities by geography and rating. The approach for doing this was refined during the year in order to accurately reflect both changes in market conditions and the profile of the portfolio of covered assets.

As the inputs into the valuation model are not all observable the APS derivative is a level 3 instrument. The fair value of the credit protection at 31 December 2011 was £(0.2) billion (2010 - £0.6 billion; 2009 - £1.4 billion).


 
315

 
Notes on the consolidated accounts continued


The Group has used the following reasonably possible alternative assumptions in relation to those inputs that could have a significant effect on the valuation of the APS:

Correlation: +/- 10%
The correlation uncertainty relates to both the nature of the underlying portfolio and the seniority of protection. The +/-10% correlation range looks reasonable in light of market observable correlations of similar levels of protection seniority, for portfolios of investment grade and high yield assets.

Range of possible recovery rates on underlying assets (alpha): +/- 10%
The level of alpha used in the valuation of the APS is in line with that used to value tranches traded by the exotic credit desk and assumes that the underlying assets have a wide range of potential recovery rates. As the APS protects a wider range of asset classes than is generally referenced by exotic credit trades, there is uncertainty in relation to this approach. A comparison of actual recoveries to expected recoveries supports the approach adopted and, in light of this, only changes of +/-10% in the assumed width of this range are considered reasonable.

Credit spreads: +/- 10%
The credit spread uncertainty relates to determining the probability of default for assets where there is no such observable data in the market. An analysis of the impact on credit spreads of small changes in the ratings assumptions in key geographic regions indicated that overall credit spread movements in the +/- 10% range look reasonable.

Discount curve: +/- 1%
Due to the long-dated contractual maturity of the APS, and the requirement to pay fixed levels of premiums each year, the valuation is sensitive to long-term interest rates. Valuation uncertainty arises due to the illiquidity of such interest rates. An interest rate range of +/- 1% is considered reasonable.

Loss credits: +/- 10%
The level of expected losses on covered assets that have been sold that can be treated as losses for the purpose of the APS are assessed by the Asset Protection Agency. For disposals made by the Group where this assessment has not been completed, the Group makes an estimate of the likely assessment for the purpose of valuing of the APS. A range of +/- 10% in the level of assessment is considered reasonable.

Using the above reasonably possible alternative assumptions, the fair value of the APS derivative could be higher by approximately £295 million or lower by approximately £44 million as detailed in the table below.


Sensitivity
Favourable 
£m 
Unfavourable 
£m 
Correlation +/- 10%
35 
(23)
Recover alpha +/- 10%
64 
(44)
Spreads +/-10%
(5)
Discount curve +/- 1%
48 
(34)
Loss credit +/- 10%
(2)
Cumulative offset
141 
64 
Total
295 
(44)

Individual sensitivities above have been aggregated and do not reflect the correlated effect of some of the assumptions as related sensitivities.

Credit derivatives - other
The Group's other credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades.

Valuation of single name credit derivatives is carried out using industry standard models. Where single name derivatives have been traded and there is a lack of independent data or the quality of the data is weak, these instruments are classified into level 3. These assets will be priced using the Group’s standard credit derivative model using a proxy curve based upon a suitable alternative single name curve, a cash based product or a sector based curve. Where the sector based curve is used, the proxy will be chosen taking maturity, rating, seniority, geography and internal credit review on recoveries into account. Sensitivities for these instruments will be based upon the selection of reasonable alternative assumptions which may include adjustments to the credit curve and recovery rate assumptions.

The bespoke portfolio tranches are synthetic tranches referenced to a bespoke portfolio of corporate names on which the Group purchases credit protection. Bespoke portfolio tranches are valued using Gaussian Copula, a standard method which uses observable market inputs (credit spreads, index tranche prices and recovery rates) to generate an output price for the tranche by way of a mapping methodology. In essence this method takes the expected loss of the tranche expressed as a fraction of the expected loss of the whole underlying portfolio and calculates which detachment point on the liquid index, and hence which correlation level, coincides with this expected loss fraction. Where the inputs to this valuation technique are observable in the market, bespoke tranches are considered to be level 2 assets. Where inputs are not observable, bespoke tranches are considered to be level 3 assets. However, all transactions executed with a CDPC counterparty are considered level 3 as the counterparty credit risk assessment is a significant component of these valuations.


 
316

 
Notes on the consolidated accounts continued


11 Financial instruments - valuation continued
Gap risk products are leveraged trades, with the counterparty's potential loss capped at the amount of the initial principal invested. Gap risk is the probability that the market will move discontinuously too quickly to exit a portfolio and return the principal to the counterparty without incurring losses, should an unwind event be triggered. This optionality is embedded within these portfolio structures and is very rarely traded outright in the market. Gap risk is not observable in the markets and, as such, these structures are deemed to be level 3 instruments.

Other unique trades are valued using a specialised model for each instrument and the same market data inputs as all other trades where applicable. By their nature, the valuation is also driven by a variety of other model inputs, many of which are unobservable in the market. Where these instruments have embedded optionality they are valued using a variation of the Black-Scholes option pricing formula, and where they have correlation exposure they are valued using a variant of the Gaussian Copula model. The volatility or unique correlation inputs required to value these products are generally unobservable and the instruments are therefore deemed to be level 3 instruments.

Equity derivatives
Equity derivative products are split into equity exotic derivatives and equity hybrids. Equity exotic derivatives have payouts based on the performance of one or more stocks, equity funds or indices. Most payouts are based on the performance of a single asset and are valued using observable market option data. Unobservable equity derivative trades are typically complex basket options on stocks. Such basket option payouts depend on the performance of more than one equity asset and require correlations for their valuation. Valuation is then performed using industry standard valuation models, with unobservable correlation inputs calculated by reference to correlations observed between similar underlyings.

Equity hybrids have payouts based on the performance of a basket of underlyings where underlyings are from different asset classes. Correlations between these different underlyings are typically unobservable with no market information on closely related assets available. Where no market for the correlation input exists, these inputs are based on historical time series.

Interest rate and commodity derivatives
Interest rate and commodity options provide a payout (or series of payouts) linked to the performance of one or more underlying, including interest rates, foreign exchange rates and commodities.

Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided firstly, into modelling approaches and secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades.

Exotic valuation inputs include the correlation between interest rates, foreign exchange rates and commodity prices. Correlations for more liquid rate pairs are valued using independently sourced consensus pricing levels. Where a consensus pricing benchmark is unavailable, these instruments are classified as level 3.

The carrying value of debt securities in issue is represented partly by underlying cash and partly through a derivative component. The classification of the amount in level 3 is driven by the derivative component and not by the cash element.

Other financial instruments
In addition to the portfolios discussed above, there are other financial instruments which are held at fair value determined from data which are not market observable, or incorporating material adjustments to market observed data.

 
317

 
Notes on the consolidated accounts continued


Level 3 movement table

 
At 
1 January 
Amounts
recorded in the
 
Level 3 transfers
Issuances 
Purchases 
Settlements 
Sales 
Foreign 
 exchange 
At 31 
 December 
 
Amounts recorded in 
the income statement 
relating to instruments 
held at year end 
Income 
statement (3)
SOCI (1)
In 
Out 
2011
£m 
£m 
£m 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
Assets
                           
FVTPL (2)
                           
Loans and advances
843 
(15)
 
145 
— 
701 
(856)
(64)
760 
 
(11)
Debt securities
3,784 
(177)
 
164 
(380)
1,014 
(149)
(2,026)
13 
2,243 
 
(61)
Equity shares
716 
(46)
 
143 
(33)
56 
(96)
(162)
(5)
573 
 
(43)
Derivatives
5,737 
(511)
 
3,042 
(1,441)
681 
(688)
(146)
55 
6,732 
 
(522)
FVTPL assets
11,080 
(749)
 
3,494 
(1,854)
2,452 
(1,789)
(2,398)
69 
10,308 
 
(637)
                             
AFS
                           
Debt securities
4,379 
 
2,097 
(21)
98 
(817)
(47)
5,697 
 
Equity shares
279 
59 
 
82 
— 
(1)
(29)
(4)
395 
 
(4)
AFS assets
4,658 
62 
 
2,179 
(21)
105 
(818)
(76)
(1)
6,092 
 
(2)
 
15,738 
(745)
62 
 
5,673 
(1,875)
2,557 
(2,607)
(2,474)
68 
16,400 
 
(639)
                             
Liabilities
                           
Deposits
84 
(35)
 
— 
(24)
— 
— 
(4)
— 
22 
 
(25)
Debt securities in issue
2,203 
(201)
 
948 
(520)
688 
— 
(886)
— 
(33)
2,199 
 
(50)
Short positions
776 
(71)
 
58 
(3)
20 
14 
(2)
(504)
291 
 
(207)
Derivatives
1,740 
279 
 
1,822 
(240)
534 
(197)
(169)
38 
3,811 
 
325 
Other financial liabilities
— 
 
— 
(1)
— 
— 
— 
— 
— 
 
— 
 
4,804 
(28)
 
2,828 
(788)
712 
548 
(1,089)
(673)
6,323 
 
43 
                             
Net (losses)/gains
 
(717)
62 
                   
(682)

For notes to this table refer to page 319.

 
318

 
Notes on the consolidated accounts continued

11 Financial instruments - valuation continued

 
At 
1 January 
Amounts
recorded in the
Transfers 
 in/(out) of 
 level 3 
Issuances 
Purchases 
Settlements 
Sales 
Foreign 
 exchange 
At 31 
 December 
 
Amounts recorded in the 
income statement 
relating to instruments 
held at year end 
Income 
statement (3)
SOCI (1)
2010
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
Assets
                       
FVTPL (2)
                       
Loans and advances
1,059 
169 
— 
10 
— 
169 
(451)
(165)
52 
843 
 
38 
Debt securities
2,782 
294 
— 
1,770 
— 
1,973 
(386)
(2,682)
33 
3,784 
 
154 
Equity shares
711 
414 
— 
(26)
— 
654 
— 
(1,027)
(10)
716 
 
54 
Derivatives
6,429 
(1,561)
— 
1,728 
— 
948 
(299)
(1,534)
26 
5,737 
 
(1,556)
 
10,981 
(684)
— 
3,482 
— 
3,744 
(1,136)
(5,408)
101 
11,080 
 
(1,310)
                         
AFS
                       
Debt securities
1,325 
26 
511 
2,909 
— 
306 
(458)
(274)
34 
4,379 
 
10 
Equity shares
749 
(4)
(39)
(118)
— 
22 
(2)
(343)
14 
279 
 
(4)
 
2,074 
22 
472 
2,791 
— 
328 
(460)
(617)
48 
4,658 
 
 
13,055 
(662)
472 
6,273 
— 
4,072 
(1,596)
(6,025)
149 
15,738 
 
(1,304)
                         
Liabilities
                       
Deposits
103 
— 
— 
11 
— 
— 
(32)
— 
84 
 
— 
Debt securities in issue
2,345 
336 
— 
(212)
413 
— 
(695)
— 
16 
2,203 
 
309 
Short positions
184 
(187)
— 
792 
— 
(2)
(16)
(1)
776 
 
(179)
Derivatives
1,987 
(258)
— 
(152)
— 
318 
(175)
(27)
47 
1,740 
 
(187)
Other financial liabilities
— 
— 
— 
— 
— 
— 
— 
— 
 
— 
 
4,620 
(109)
— 
439 
419 
318 
(904)
(43)
64 
4,804 
 
(57)
                         
Net (losses)/gains
 
(553)
472 
               
(1,247)

 
At 
1 January 
Amounts
recorded  in the
Transfers 
 in/(out) of 
level 3 
Reclassification 
Purchases and 
 issuances 
Sales and 
 settlements 
Foreign 
 exchange 
At  31 
December 
 
Amounts recorded in 
the income statement 
relating to instruments 
held at year end 
Income 
statement (3)
SOCI (1)
2009
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
 
£m 
Assets
                     
FVTPL (2)
                     
Loans and advances
3,148 
130 
— 
330 
(1,537)
22 
(898)
(136)
1,059 
 
11 
Debt securities
3,846 
(49)
— 
104 
(157)
378 
(1,207)
(133)
2,782 
 
(165)
Equity shares
793 
(49)
— 
133 
— 
22 
(151)
(37)
711 
 
(48)
Derivatives
10,265 
(3,672)
— 
(211)
— 
1,811 
(1,301)
(463)
6,429 
 
(1,079)
 
18,052 
(3,640)
— 
356 
(1,694)
2,233 
(3,557)
(769)
10,981 
 
(1,281)
                       
AFS
                     
Debt securities
3,102 
(329)
(47)
(929)
— 
128 
(491)
(109)
1,325 
 
(9)
Equity shares
325 
(128)
(13)
632 
— 
53 
(75)
(45)
749 
 
(51)
 
3,427 
(457)
(60)
(297)
— 
181 
(566)
(154)
2,074 
 
(60)
 
21,479 
(4,097)
(60)
59 
(1,694)
2,414 
(4,123)
(923)
13,055 
 
(1,341)
                       
Liabilities
                     
Deposits
290 
43 
— 
(217)
— 
15 
(23)
(5)
103 
 
— 
Debt securities in issue
4,362 
57 
— 
(1,682)
— 
493 
(638)
(247)
2,345 
 
(41)
Short positions
41 
(45)
— 
188 
— 
(4)
— 
184 
 
12 
Derivatives
4,035 
(215)
— 
(978)
— 
76 
(744)
(187)
1,987 
 
(244)
Other financial liabilities
257 
— 
— 
— 
— 
— 
(242)
(14)
 
— 
 
8,985 
(160)
— 
(2,689)
— 
588 
(1,651)
(453)
4,620 
 
(273)
                       
Net losses
 
(3,937)
(60)
             
(1,068)

Notes:
(1)
Consolidated statement of comprehensive income.
(2)
Fair value through profit or loss.
(3)
Net losses on HFT instruments of £860 million (2010 - £694 million; 2009 - £3,372 million) and net gains of £143 million (2010 - £141 million gains; 2009 - £565 million losses) were recorded in other operating income, interest income and impairment losses as appropriate on other instruments.
 
 
 
319

 
Notes on the consolidated accounts continued

 
Fair value of financial instruments not carried at fair value
The following table shows the carrying value and fair value of financial instruments carried at amortised cost on the balance sheet.

 
2011 
 Carrying value 
2011 
Fair value 
2010 
 Carrying value 
2010 
 Fair value 
2009 
 Carrying value 
2009 
Fair value 
 
£bn 
£bn 
£bn 
£bn 
£bn 
£bn 
Financial assets
           
Cash and balances at central banks
79.3 
79.3 
57.0 
57.0 
52.3 
52.3 
Loans and advances to banks
28.3 
28.2 
36.2 
36.1 
46.3 
46.0 
Loans and advances to customers
436.2 
406.3 
493.1 
468.8 
684.1 
650.9 
Debt securities
6.1 
5.5 
7.1 
6.4 
9.9 
9.0 
Settlement balances
7.8 
7.8 
11.6 
11.6 
12.0 
12.0 
             
Financial liabilities
           
Deposits by banks
51.3 
50.7 
50.0 
50.4 
88.5 
88.3 
Customer accounts
417.5 
417.6 
438.5 
438.6 
552.8 
552.1 
Debt securities in issue
115.4 
112.7 
167.2 
163.8 
222.1 
218.5 
Settlement balances
7.5 
7.5 
11.0 
11.0 
10.4 
10.4 
Subordinated liabilities
25.4 
19.2 
25.9 
21.9 
36.4 
31.6 


The fair value is the amount an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm's length transaction. Quoted market values are used where available; otherwise, fair values have been estimated based on discounted expected future cash flows and other valuation techniques. These techniques involve uncertainties and require assumptions and judgments covering prepayments, credit risk and discount rates. Changes in these assumptions would significantly affect estimated fair values. The fair values reported would not necessarily be realised in an immediate sale or settlement. As a wide range of valuation techniques is available, it may be inappropriate to compare the Group's fair value information to independent markets or other financial institutions.

The fair values of intangible assets, such as core deposits, credit card and other customer relationships are not included in the calculation of these fair values as they are not financial instruments.

The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are as follows:

The fair value of financial instruments which are of short maturity (three months or less) approximates their carrying value. This mainly applies to cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks and demand deposits.

Loans and advances to banks and customers
In estimating the fair value of loans and advances to banks and customers measured at amortised cost, the Group’s loans are segregated into appropriate portfolios reflecting the characteristics of the constituent loans.  Two principal methods are used to estimate fair value:

(a)
contractual cash flows are discounted using a market discount rate that incorporates the current spread for the borrower or where this is not observable, the spread for borrowers of a similar credit standing.  This method is used for the majority of GBM’s lending portfolios where most counterparties have external ratings.

(b)
expected cash flows (unadjusted for credit losses) are discounted at the current offer rate for the same or similar products.  This approach is adopted for lending portfolios in UK Retail, UK Corporate and Ulster Bank reflecting the more homogeneous nature of these portfolios.

For certain portfolios where there are very few or no recent transactions, for example Ulster Bank’s corporate property lending portfolio, a bespoke approach is used based on available market data.

The discount to amortised cost reflects current stressed markets for Non-Core loans, real estate lending in Ireland and other commercial real estate loans, and in GBM, corporate downgrades.

Debt securities
Fair values are determined using quoted prices where available or by reference to quoted prices of similar instruments.

Deposits by banks and customer accounts
Fair values of deposits are estimated using discounted cash flow valuation techniques.

Debt securities in issue and subordinated liabilities
Fair values are determined using quoted prices where available or by reference to valuation techniques, adjusting for own credit spreads where appropriate.

 
320

 
Notes on the consolidated accounts continued


12 Financial instruments - maturity analysis
Remaining maturity
The following table shows the residual maturity of financial instruments, based on contractual date of maturity.

 
2011
 
2010
 
2009
 
Less than 
12 months 
More than 
12 months 
Total 
 
Less than 
12 months 
More than 
12 months 
Total 
 
Less than 
12 months 
More than 
12 months 
Total 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
Assets
                     
Cash and balances at central banks
79,269 
— 
79,269 
 
56,997 
17 
57,014 
 
52,229 
32 
52,261 
Loans and advances to banks
80,905 
2,405 
83,310 
 
98,789 
1,729 
100,518 
 
89,622 
2,131 
91,753 
Loans and advances to customers
197,338 
318,268 
515,606 
 
199,626 
355,634 
555,260 
 
227,745 
500,648 
728,393 
Debt securities
45,311 
163,769 
209,080 
 
42,678 
174,802 
217,480 
 
69,197 
198,057 
267,254 
Equity shares
— 
15,183 
15,183 
 
— 
22,198 
22,198 
 
— 
19,528 
19,528 
Settlement balances
7,767 
7,771 
 
11,605 
— 
11,605 
 
12,022 
11 
12,033 
Derivatives
60,250 
469,368 
529,618 
 
65,639 
361,438 
427,077 
 
70,537 
370,917 
441,454 
                       
Liabilities
                     
Deposits by banks
100,499 
8,305 
108,804 
 
95,241 
3,549 
98,790 
 
135,641 
6,503 
142,144 
Customer accounts
487,428 
15,527 
502,955 
 
492,609 
18,084 
510,693 
 
586,628 
27,574 
614,202 
Debt securities in issue
68,889 
93,732 
162,621 
 
94,048 
124,324 
218,372 
 
140,826 
126,742 
267,568 
Settlement balances and short
  positions
15,248 
33,268 
48,516 
 
16,981 
37,128 
54,109 
 
17,952 
32,924 
50,876 
Derivatives
61,734 
462,249 
523,983 
 
71,306 
352,661 
423,967 
 
71,625 
352,516 
424,141 
Subordinated liabilities
624 
25,695 
26,319 
 
964 
26,089 
27,053 
 
2,144 
35,508 
37,652 
                       
 
 
 
321

 
Notes on the consolidated accounts continued

 
On balance sheet liabilities
The following tables show by contractual maturity, the undiscounted cash flows payable up to a period of 20 years from the balance sheet date, including future payments of interest.

 
0-3 months 
3-12 months 
1-3 years 
3-5 years 
5-10 years 
10-20 years 
2011
£m 
£m 
£m 
£m 
£m 
£m 
Deposits by banks
39,139 
5,104 
5,513 
461 
1,121 
364 
Customer accounts
379,692 
23,068 
12,643 
5,389 
1,483 
779 
Debt securities in issue
66,253 
15,756 
25,099 
17,627 
18,833 
4,190 
Derivatives held for hedging
525 
788 
1,981 
1,186 
1,101 
821 
Subordinated liabilities
133 
1,116 
4,392 
7,872 
8,654 
3,488 
Settlement balances and other liabilities
9,015 
37 
36 
62 
16 
15 
 
494,757 
45,869 
49,664 
32,597 
31,208 
9,657 
             
Guarantees and commitments - notional amount
           
Guarantees (1)
24,886 
— 
— 
— 
— 
— 
Commitments (2)
239,963 
— 
— 
— 
— 
— 
 
264,849 
— 
— 
— 
— 
— 
             
2010
           
Deposits by banks
43,396 
4,417 
1,243 
304 
651 
374 
Customer accounts
402,457 
18,580 
8,360 
4,651 
4,393 
2,384 
Debt securities in issue
89,583 
43,032 
31,862 
22,569 
24,209 
6,697 
Derivatives held for hedging
608 
936 
2,103 
969 
681 
253 
Subordinated liabilities
2,485 
2,611 
6,570 
8,691 
8,672 
4,607 
Settlement balances and other liabilities
12,423 
59 
136 
177 
385 
25 
 
550,952 
69,635 
50,274 
37,361 
38,991 
14,340 
             
Guarantees and commitments - notional amount
           
Guarantees (1)
31,026 
— 
— 
— 
— 
— 
Commitments (2)
266,822 
— 
— 
— 
— 
— 
 
297,848 
— 
— 
— 
— 
— 
             
2009
           
Deposits by banks
65,966 
15,541 
3,934 
2,301 
632 
12 
Customer accounts
521,400 
15,619 
5,944 
4,221 
8,490 
4,392 
Debt securities in issue
100,220 
49,300 
56,869 
25,915 
27,326 
3,819 
Derivatives held for hedging
660 
1,566 
3,232 
1,264 
1,674 
1,508 
Subordinated liabilities
1,929 
1,892 
3,654 
4,963 
20,157 
6,105 
Settlement balances and other liabilities
12,048 
100 
139 
104 
239 
83 
 
702,223 
84,018 
73,772 
38,768 
58,518 
15,919 
             
Guarantees and commitments - notional amount
           
Guarantees (1)
39,952 
— 
— 
— 
— 
— 
Commitments (2)
291,634 
— 
— 
— 
— 
— 
 
331,586 
— 
— 
— 
— 
— 


Notes:
(1)
The Group is only called upon to satisfy a guarantee when the guaranteed party fails to meet its obligations. The Group expects most guarantees it provides to expire unused.
(2)
The Group has given commitments to provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.
 
 

 
 
322

 
Notes on the consolidated accounts continued

12 Financial instruments - maturity analysis continued
The tables above show the timing of cash outflows to settle financial liabilities, prepared on the following basis:

Financial liabilities are included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If repayment is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note automatically prepays when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period whatever the level of the index at the year end. The settlement date of debt securities issued by certain securitisation vehicles consolidated by the Group depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date.

Liabilities with a contractual maturity of greater than 20 years - the principal amounts of financial liabilities that are repayable after 20 years or where the counterparty has no right to repayment of the principal, are excluded from the table along with interest payments after 20 years.

Held-for-trading assets and liabilities - held-for-trading assets and liabilities amounting to £763.3 billion (assets) and £708.0 billion (liabilities) (2010 - £665.0 billion assets and £586.1 billion liabilities; 2009 - £650.5 billion assets and £568.5 billion liabilities) have been excluded from the table in view of their short-term nature.



13 Financial assets - impairments
The following table shows the movement in the provision for impairment losses on loans and advances.

 
Individually 
assessed 
Collectively 
assessed 
Latent 
 
2011 
2010 
2009 
 
£m 
£m 
£m 
£m 
£m 
£m 
At 1 January
10,236 
5,296 
2,650 
18,182 
17,283 
11,016 
Transfers to disposal groups
(158)
(536)
(79)
(773)
(72)
(324)
Currency translation and other adjustments
(244)
(40)
(283)
43 
(530)
Disposal of subsidiaries
— 
— 
(2,172)
(65)
Amounts written-off
(2,205)
(2,322)
— 
(4,527)
(6,042)
(6,939)
Recoveries of amounts previously written-off
275 
252 
— 
527 
411 
399 
Charged to income statement
           
  - continuing operations
5,195 
2,591 
(545)
7,241 
9,144 
13,090 
  - discontinued operations
(8)
— 
— 
(8)
42 
1,044 
Unwind of discount (recognised in interest income)
(342)
(142)
— 
(484)
(455)
(408)
At 31 December (1)
12,757 
5,140 
1,986 
19,883 
18,182 
17,283 

Note:
(1)
Includes £123 million relating to loans and advances to banks (2010 - £127 million; 2009 - £157 million).


Impairment losses charged to the income statement
2011 
£m 
2010 
£m 
2009 
£m 
Loans and advances to customers
7,241 
9,157 
13,056 
Loans and advances to banks
— 
(13)
34 
 
7,241 
9,144 
13,090 
Debt securities
1,433 
81 
601 
Equity shares
35 
31 
208 
 
1,468 
112 
809 
 
8,709 
9,256 
13,899 


 
323

 
Notes on the consolidated accounts continued

The following tables analyse impaired financial assets.

 
2011
 
2010
 
2009
     
Carrying 
     
Carrying 
     
Carrying 
 
Cost 
Provision 
value 
 
Cost 
Provision 
value 
 
Cost 
Provision 
value 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
Loans and receivables
                     
Loans and advances to banks (1)
137 
123 
14 
 
145 
127 
18 
 
206 
157 
49 
Loans and advances to customers (2)
38,610 
17,774 
20,836 
 
35,556 
15,405 
20,151 
 
34,801 
14,050 
20,751 
 
38,747 
17,897 
20,850 
 
35,701 
15,532 
20,169 
 
35,007 
14,207 
20,800 

Notes:
(1)
Impairment provisions individually assessed.
(2)
Impairment provisions individually assessed on balances of £29,196 million (2010 - £25,492 million; 2009 - £24,540 million).

 
Carrying 
Carrying 
Carrying 
 
value 
value 
value 
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Available-for-sale securities
     
Debt securities
873 
580 
758 
Equity shares
57 
43 
180 
       
Loans and receivables
     
Debt securities
234 
230 
— 
 
1,164 
853 
938 

The following table shows financial and non-financial assets, recognised on the Group's balance sheet, obtained during the year by taking possession of collateral or calling on other credit enhancements.

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Residential property
60 
47 
52 
Other property
73 
139 
110 
Cash
56 
127 
283 
Other assets
28 
42 
 
191 
341 
487 

In general, the Group seeks to dispose of property and other assets not readily convertible into cash, obtained by taking possession of collateral, as rapidly as the market for the individual asset permits.


 
324

 
Notes on the consolidated accounts continued

14 Derivatives
Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.

The Group enters into fair value hedges, cash flow hedges and hedges of net investments in foreign operations. The majority of the Group's interest rate hedges relate to the management of the Group's non-trading interest rate risk. The Group manages this risk within approved limits. Residual risk positions are hedged with derivatives principally interest rate swaps. Suitable larger ticket financial instruments are fair value hedged; the remaining exposure, where possible, is hedged by derivatives documented as cash flow hedges and qualifying for hedge accounting. The majority of the Group's fair value hedges involve interest rate swaps hedging the interest rate risk in recognised financial assets and financial liabilities. Cash flow hedges relate to exposures to the variability in future interest payments and receipts on forecast transactions and on recognised financial assets and financial liabilities. The Group hedges its net investments in foreign operations with currency borrowings and forward foreign exchange contracts.

For cash flow hedge relationships of interest rate risk, the hedged items are actual and forecast variable interest rate cash flows arising from financial assets and financial liabilities with interest rates linked to LIBOR, EURIBOR or the Bank of England Official Bank Rate. The financial assets are customer loans and the financial liabilities are customer deposits and LIBOR linked medium-term notes and other issued securities. At 31 December 2011, variable rate financial assets of £49.5 billion and variable rate financial liabilities of £12.9 billion were hedged in such cash flow hedge relationships.

For cash flow hedging relationships, the initial and ongoing prospective effectiveness is assessed by comparing movements in the fair value of the expected highly probable forecast interest cash flows with movements in the fair value of the expected changes in cash flows from the hedging interest rate swap or by comparing the respective changes in the price value of a basis point. Prospective effectiveness is measured on a cumulative basis i.e. over the entire life of the hedge relationship. The method of calculating hedge ineffectiveness is the hypothetical derivative method. Retrospective effectiveness is assessed by comparing the actual movements in the fair value of the cash flows and actual movements in the fair value of the hedged cash flows from the interest rate swap over the life to date of the hedging relationship.

For fair value hedge relationships of interest rate risk, the hedged items are typically government bonds, large corporate fixed-rate loans, fixed rate finance leases, fixed rate medium-term notes or preference shares classified as debt. At 31 December 2011, fixed rate financial assets of £33.1 billion and fixed rate financial liabilities of £41.4 billion were hedged by interest rate swaps in fair value hedge relationships.

The initial and ongoing prospective effectiveness of fair value hedge relationships is assessed on a cumulative basis by comparing movements in the fair value of the hedged item attributable to the hedged risk with changes in the fair value of the hedging interest rate swap or by comparing the respective changes in the price value of a basis point. Retrospective effectiveness is assessed by comparing the actual movements in the fair value of the hedged items attributable to the hedged risk with actual movements in the fair value of the hedging derivative over the life to date of the hedging relationship.

The following table shows the notional amounts and fair values of the Group's derivatives.


 
2011
 
2010
 
2009
 
Notional 
     
Notional 
     
Notional
   
 
amount 
Assets 
Liabilities 
 
amount 
Assets 
Liabilities 
 
amount
Assets
Liabilities 
 
£bn 
£m 
£m 
 
£bn 
£m 
£m 
 
£bn
£m
£m 
Exchange rate contracts
                     
Spot, forwards and futures
2,127 
30,249 
28,868 
 
2,807 
39,859 
41,424 
 
2,004
26,744
24,898
Currency swaps
1,071 
25,212 
33,541 
 
1,000 
28,696 
34,328 
 
922
25,883
23,466
Options purchased
640 
19,031 
— 
 
503 
14,698 
— 
 
440
16,656
Options written
641 
— 
18,571 
 
544 
— 
13,623 
 
476
15,555
                       
Interest rate contracts
                     
Interest rate swaps
29,976 
346,682 
333,968 
 
29,792 
251,312 
243,807 
 
30,956
265,528
253,793
Options purchased
2,398 
74,600 
— 
 
2,619 
57,359 
— 
 
3,180
55,976
Options written
2,592 
— 
71,998 
 
2,731 
— 
54,141 
 
2,539
55,589
Futures and forwards
3,756 
874 
743 
 
4,618 
3,060 
1,261 
 
6,555
2,088
2,033
                       
Credit derivatives
1,054 
26,836 
26,743 
 
1,357 
26,872 
25,344 
 
1,621
41,748
39,127
                       
Equity and commodity contracts
123 
6,134 
9,551 
 
179 
5,221 
10,039 
 
188
6,831
9,680
   
529,618 
523,983 
   
427,077 
423,967 
   
441,454
424,141

Certain derivative asset and liability balances with the London Clearing House, which meet the offset criteria in IAS 32 ‘Financial Instruments: Presentation’, are shown net.

 
325

 
Notes on the consolidated accounts continued

Included in the table above are derivatives held for hedging purposes as follows:

 
2011
 
2010
 
2009
 
Assets 
Liabilities 
 
Assets
Liabilities 
 
Assets 
Liabilities 
 
£m 
£m 
 
£m
£m 
 
£m 
£m 
Fair value hedging
               
Exchange rate contracts
— 
— 
 
— 
 
160 
38 
Interest rate contracts
3,550 
4,288 
 
2,496
3,767 
 
2,672 
3,292 
                 
Cash flow hedging
               
Exchange rate contracts
— 
— 
 
— 
 
2
7
Interest rate contracts
3,985 
1,445 
 
2,903
995 
 
1,753 
3,080 
                 
Net investment hedging
               
Exchange rate contracts
148 
148 
 
30
102 
 
10 
90 

Hedge ineffectiveness recognised in other operating income comprised:

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Fair value hedging
     
Gains on the hedged items attributable to the hedged risk
557 
343 
512 
Losses on the hedging instruments
(541)
(405)
(455)
Fair value hedging ineffectiveness
16 
(62)
57 
Cash flow hedging ineffectiveness
20 
(37)
14 
 
36 
(99)
71 

The following tables show, when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges.

 
0-1 years 
£m 
1-2 years 
£m 
2-3 years 
£m 
3-4 years 
£m 
4-5 years 
£m 
5-10 years 
£m 
10-20 years 
£m 
Over 20 years 
£m 
Total 
£m 
2011
Hedged forecast cash flows expected to occur
                 
Forecast receivable cash flows
407 
415 
360 
306 
200 
280 
— 
— 
1,968 
Forecast payable cash flows
(120)
(106)
(73)
(70)
(71)
(344)
(568)
(160)
(1,512)
                   
Hedged forecast cash flows affect on profit or loss
                 
Forecast receivable cash flows
422 
402 
355 
291 
188 
265 
— 
— 
1,923 
Forecast payable cash flows
(122)
(102)
(72)
(70)
(70)
(346)
(568)
(159)
(1,509)
                   
2010
                 
Hedged forecast cash flows expected to occur
                 
Forecast receivable cash flows
280 
254 
219 
161 
120 
169 
30 
— 
1,233 
Forecast payable cash flows
(47)
(41)
(33)
(30)
(30)
(137)
(176)
(54)
(548)
                   
Hedged forecast cash flows affect on profit or loss
                 
Forecast receivable cash flows
281 
250 
214 
157 
112 
161 
28 
— 
1,203 
Forecast payable cash flows
(46)
(41)
(33)
(30)
(29)
(137)
(175)
(54)
(545)

2009
                 
Hedged forecast cash flows expected to occur
                 
Forecast receivable cash flows
504 
466 
423 
267 
163 
379 
141 
— 
2,343 
Forecast payable cash flows
(554)
(521)
(416)
(350)
(299)
(990)
(819)
(167)
(4,116)
                   
Hedged forecast cash flows affect on profit or loss
                 
Forecast receivable cash flows
503 
467 
422 
255 
163 
371 
141 
— 
2,322 
Forecast payable cash flows
(554)
(518)
(409)
(346)
(296)
(978)
(818)
(167)
(4,086)


 
326

 
Notes on the consolidated accounts continued

15 Debt securities
 
 
Central and local government
Banks 
Other 
financial 
institutions 
Corporate 
Total 
Of which 
ABS (1) 
 
UK 
US 
Other 
2011
£m 
£m 
£m  
£m 
£m 
£m 
£m 
£m 
Held-for-trading
9,004 
19,636 
36,928 
3,400 
23,160 
2,948 
95,076 
20,816 
Designated as at fair value through profit or loss
— 
127 
53 
457 
647 
558 
Available-for-sale
13,436 
20,848 
25,552 
13,175 
31,752 
2,535 
107,298 
40,735 
Loans and receivables
10 
— 
312 
5,259 
477 
6,059 
5,200 
 
22,451 
40,484 
62,608 
16,940 
60,628 
5,969 
209,080 
67,309 
                 
Available-for-sale
               
Gross unrealised gains
1,428 
1,311 
1,180 
52 
913 
94 
4,978 
1,001 
Gross unrealised losses
— 
— 
(171)
(838)
(2,386)
(13)
(3,408)
(3,158)
                 
                 
2010
               
Held-for-trading
5,097 
15,648 
42,828 
5,486 
23,711 
6,099 
98,869 
21,988 
Designated as at fair value through profit or loss
117 
262 
10 
402 
119 
Available-for-sale
8,377 
22,244 
32,865 
16,982 
29,148 
1,514 
111,130 
42,515 
Loans and receivables
11 
— 
— 
6,686 
381 
7,079 
6,203 
 
13,486 
38,009 
75,955 
22,473 
59,553 
8,004 
217,480 
70,825 
                 
Available-for-sale
               
Gross unrealised gains
349 
525 
700 
143 
827 
51 
2,595 
1,057 
Gross unrealised losses
(10)
(2)
(618)
(786)
(2,626)
(55)
(4,097)
(3,396)
                 
                 
2009
               
Held-for-trading (2)
8,128 
9,175 
49,967 
5,856 
31,708 
6,648 
111,482 
28,820 
Designated as at fair value through profit or loss
122 
208 
402 
415 
1,211 
245 
2,603 
394 
Available-for-sale
19,071 
19,010 
45,530 
19,569 
36,635 
3,483 
143,298 
51,044 
Loans and receivables (2)
— 
— 
— 
6,899 
2,971 
9,871 
7,924 
 
27,322 
28,393 
95,899 
25,840 
76,453 
13,347 
267,254 
88,182 
                 
Available-for-sale
               
Gross unrealised gains
109 
399 
1,062 
149 
621 
72 
2,412 
783 
Gross unrealised losses
(60)
(98)
(266)
(289)
(2,984)
(213)
(3,910)
(3,314)
 

Notes:
(1)
Includes asset-backed securities issued by US federal agencies and government sponsored entities, and covered bonds.
(2)
During 2009, the Group reclassified debt securities from the held-for-trading category into the loans and receivables category and in 2008 from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see pages 302 and 303).

 
Gross gains of £751 million (2010 - £635 million; 2009 - £1,155 million) and gross losses of £19 million (2010 - £159 million; 2009 - £1,255 million) were realised on the sale of available-for-sale securities.

 
327

 
Notes on the consolidated accounts continued


The following table analyses the Group's available-for-sale debt securities and the related yield (based on weighted averages) by remaining maturity and issuer.

 
Within 1 year
 
After 1 but within 5 years
 
After 5 but within 10 years
 
After 10 years
 
Total
 
Amount 
Yield 
 
Amount 
Yield 
 
Amount 
Yield 
 
Amount 
Yield 
 
Amount 
Yield 
2011
£m 
 
£m 
 
£m 
 
£m 
 
£m 
Central and local governments
                           
  - UK
65 
0.1 
 
3,489 
2.8 
 
7,067 
3.3 
 
2,815 
3.2 
 
13,436 
3.1 
  - US
1,471 
1.2 
 
8,026 
2.1 
 
9,865 
2.8 
 
1,486 
3.2 
 
20,848 
2.5 
  - other
6,219 
1.0 
 
9,511 
3.1 
 
7,366 
3.9 
 
2,456 
4.2 
 
25,552 
2.9 
Banks
3,632 
3.1 
 
6,324 
3.3 
 
2,066 
3.2 
 
1,153 
2.7 
 
13,175 
3.2 
Other financial institutions
1,091 
2.8 
 
6,459 
2.7 
 
6,906 
2.9 
 
17,296 
2.2 
 
31,752 
2.5 
Corporate
145 
4.5 
 
1,425 
4.6 
 
776 
4.4 
 
189 
3.6 
 
2,535 
4.5 
 
12,623 
1.9 
 
35,234 
2.9 
 
34,046 
3.2 
 
25,395 
2.6 
 
107,298 
2.8 
                             
Of which ABS (1)
2,442 
2.1 
 
9,021 
2.9 
 
9,409 
2.8 
 
19,863 
2.1 
 
40,735 
2.5 

Note:
(1)
Includes asset-backed securities issued by US federal agencies and government sponsored entities, and covered bonds.


16 Equity shares
 
2011
 
2010
 
2009
 
Listed 
Unlisted 
Total 
 
Listed 
Unlisted 
Total 
 
Listed 
Unlisted 
Total 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
 
£m 
£m 
£m 
Held-for-trading
12,366 
67 
12,433 
 
19,110 
76 
19,186 
 
14,394 
49 
14,443 
Designated as at fair value
  through profit or loss
373 
401 
774 
 
282 
731 
1,013 
 
1,548 
644 
 
2,192 
Available-for-sale
609 
1,367 
1,976 
 
650 
1,349 
1,999 
 
937 
1,956 
2,893 
 
13,348 
1,835 
15,183 
 
20,042 
2,156 
22,198 
 
16,879 
2,649 
19,528 
                       
Available-for-sale
                     
Gross unrealised gains
69 
317 
386 
 
67 
232 
299 
 
293 
312 
605 
Gross unrealised losses
(19)
(114)
(133)
 
(17)
(145)
(162)
 
(14)
(68)
(82)

Gross gains of £152 million (2010 - £83 million; 2009 - £385 million) and gross losses of £2 million (2010 - £63 million; 2009 - £123 million) were realised on the sale of available-for-sale equity shares.

Dividend income from available-for-sale equity shares was £62 million (2010 - £69 million; 2009 - £78 million).

Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include capital stock (redeemable at cost) in the Federal Home Loan Bank and the Federal Reserve Bank of £0.7 billion (2010 - £0.8 billion; 2009 - £0.8 billion) that the Group's banking subsidiaries in the US are required to hold; and a number of individually small shareholdings in unlisted companies. Disposals in the year generated a gain of £2 million (2010 - £2 million loss; 2009 - £21 million loss).

 
328

 
Notes on the consolidated accounts continued

 
17 Intangible assets
 
Goodwill 
Core 
deposit 
 intangibles 
Other 
 purchased 
 intangibles 
Internally 
 generated 
 software 
Total 
2011
£m 
£m 
£m 
£m 
£m 
Cost
         
At 1 January
27,139 
612 
2,458 
4,575 
34,784 
Transfers to disposal groups
(95)
— 
— 
— 
(95)
Currency translation and other adjustments
(219)
(60)
59 
(212)
Acquisition of subsidiaries
18 
— 
— 
— 
18 
Additions
— 
— 
34 
1,050 
1,084 
Disposals and write-off of fully amortised assets
— 
— 
— 
(236)
(236)
At 31 December
26,843 
620 
2,432 
5,448 
35,343 
           
Accumulated amortisation and impairment
         
At 1 January
14,611 
462 
1,822 
3,441 
20,336 
Transfers to disposal groups
(80)
— 
— 
— 
(80)
Currency translation and other adjustments
(203)
(5)
(55)
13 
(250)
Disposals and write-off of fully amortised assets
— 
— 
— 
(220)
(220)
Charge for the year - continuing operations
— 
38 
184 
386 
608 
Write down of goodwill and other intangible assets
91 
— 
— 
— 
91 
At 31 December
14,419 
495 
1,951 
3,620 
20,485 
           
Net book value at 31 December
12,424 
125 
481 
1,828 
14,858 
           
2010
         
Cost
         
At 1 January
42,643 
2,553 
4,139 
4,815 
54,150 
Currency translation and other adjustments
(374)
(59)
(63)
(21)
(517)
Additions
— 
— 
46 
742 
788 
Disposal of subsidiaries
(15,130)
(1,882)
(1,664)
(544)
(19,220)
Disposals and write-off of fully amortised assets
— 
— 
— 
(417)
(417)
At 31 December
27,139 
612 
2,458 
4,575 
34,784 
           
Accumulated amortisation and impairment
         
At 1 January
28,379 
1,562 
2,577 
3,785 
36,303 
Currency translation and other adjustments
(510)
(29)
(31)
(24)
(594)
Disposal of subsidiaries
(13,268)
(1,139)
(1,027)
(304)
(15,738)
Disposals and write-off of fully amortised assets
— 
— 
— 
(391)
(391)
Charge for the year - continuing operations
— 
68 
301 
353 
722 
  - discontinued operations
— 
— 
22 
24 
Write down of goodwill and other intangible assets
10 
— 
— 
— 
10 
At 31 December
14,611 
462 
1,822 
3,441 
20,336 
           
Net book value at 31 December
12,528 
150 
636 
1,134 
14,448 


 
329

 
Notes on the consolidated accounts continued



 
Goodwill 
Core 
deposit 
 intangibles 
Other 
 purchased 
 intangibles 
Internally 
 generated 
 software 
Total 
2009
£m 
£m 
£m 
£m 
£m 
Cost
         
At 1 January
45,624 
2,780 
4,367 
4,524 
57,295 
Transfers to disposal groups
(238)
— 
— 
— 
(238)
Currency translation and other adjustments
(2,743)
(225)
(281)
(65)
(3,314)
Additions
— 
— 
53 
559 
612 
Disposal of subsidiaries
— 
— 
— 
(16)
(16)
Disposals and write-off of fully amortised assets
— 
(2)
— 
(187)
(189)
At 31 December
42,643 
2,553 
4,139 
4,815 
54,150 
           
Accumulated amortisation and impairment
         
At 1 January
30,062 
1,407 
2,369 
3,408 
37,246 
Currency translation and other adjustments
(2,046)
(106)
(137)
(58)
(2,347)
Disposals of subsidiaries
— 
— 
— 
(13)
(13)
Disposals and write-off of fully amortised assets
— 
(1)
— 
(138)
(139)
Charge for the year - continuing operations
— 
89 
183 
467 
739 
 - discontinued operations
— 
173 
162 
119 
454 
Write down of goodwill and other intangible assets
363 
— 
— 
— 
363 
At 31 December
28,379 
1,562 
2,577 
3,785 
36,303 
           
Net book value at 31 December
14,264 
991 
1,562 
1,030 
17,847 

Goodwill is analysed by operating segment in Note 38.


Impairment review
The Group's goodwill acquired in business combinations is reviewed annually at 30 September for impairment by comparing the recoverable amount of each cash generating unit (CGU) to which goodwill has been allocated with its carrying value.

The CGUs of the Group, excluding RFS Holdings minority interest, where the goodwill is significant, principally arose on the acquisitions of NatWest, ABN AMRO, Charter One and Churchill and are as follows:


Goodwill at 30 September
Recoverable
 amount
based on
 
 2011 
£m 
2010 
 £m 
 
2009 
£m 
UK Retail
Value in use
2,697 
2,697 
2,697 
UK Corporate
Value in use
2,693 
2,693 
2,693 
Wealth
Value in use
611 
611 
611 
Global Transaction Services
Value in use
2,370 
2,376 
2,749 
US Retail & Commercial
Value in use
2,826 
2,811 
2,761 
RBS Insurance
Value in use
935 
935 
935 
 
 
 
330

 
 

Notes on the consolidated accounts continued

 
17 Intangible assets continued
Impairment testing involves the comparison of the carrying value of a CGU or group of CGUs with its recoverable amount. The recoverable amount is the higher of the unit's fair value and its value in use. Value in use is the present value of expected future cash flows from the CGU or group of CGUs. Fair value is the amount obtainable from the sale of the CGU in an arm's length transaction between knowledgeable, willing parties.

Impairment testing inherently involves a number of judgmental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of CGUs; and the valuation of the separable assets of each business whose goodwill is being reviewed. Sensitivity to the more significant variables in each assessment are presented below.

The recoverable amounts for all CGUs at 30 September 2011 were based on the value in use test, using management's latest five-year forecasts. The long-term growth rates have been based on respective country GDP rates adjusted for inflation. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.

The recoverable amount of UK Retail, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and a 14.0% (2010 - 15.7%; 2009 - 14.6%) pre tax discount rate, exceeded the carrying amount by £5.5 billion (2010 - £6.9 billion; 2009 - £0.7 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.5 billion; 2009 - £0.9 billion) and £0.6 billion (2010 - £0.9 billion; 2009 - £0.5 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.8 billion (2010 - £0.9 billion; 2009 - £0.4 billion).
 
The recoverable amount of UK Corporate, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and a 14.1% (2010 - 15.6%; 2009 - 15.1%) pre tax discount rate, exceeded its carrying value by £2.1 billion (2010 - £5.3 billion; 2009 - £6.1 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion; 2009 - £1.4 billion) and £0.5 billion (2010 and 2009 - £0.9 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.8 billion (2010 - £1.0 billion; 2009 - £0.8 billion).

The recoverable amount of Wealth, based on a 3% (2010 - 3%; 2009 - 4%) terminal growth rate and an 11.0% (2010 - 12.0%; 2009 - 15.3%) pre tax discount rate, exceeded its carrying value by more than 100% and was insensitive to a reasonably possible change in key assumptions.

The recoverable amount of Global Transaction Services, based on a 3% (2010 and 2009 - 3%) terminal growth rate and an 11.4% (2010 - 12.8%; 2009 - 16.7%) pre tax discount rate, exceeded its carrying value by more than 100% (2010 and 2009 - 100%) and was insensitive to a reasonably possible change in key assumptions.

The recoverable amount of US Retail & Commercial, based on a 5% (2010 and 2009 - 5%) terminal growth rate and a 14.4% (2010 - 14.9%; 2009 - 14.8%) pre tax discount rate, exceeded its carrying value by £0.2 billion (2010 - £1.6 billion; 2009 - £2.1 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £1.1 billion (2010 - £1.6 billion; 2009 - £1.0 billion) and £0.5 billion (2010 and 2009 - £0.8 billion) respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.6 billion (2010 and 2009 - £0.7 billion).

The recoverable amount of RBS Insurance, based on a 3% (2010 and 2009 - 3%) terminal growth rate and a 12.3% (2010 - 13.1%; 2009 - 13.9%) pre tax discount rate, exceeded the carrying amount by £0.8 billion (2010 - £2.4 billion; 2009 - £3.0 billion). A 1% change in the discount rate or terminal growth rate would change the recoverable amount by approximately £0.5 billion and £0.2 billion respectively. In addition, a 5% change in forecast pre tax earnings would change the recoverable amount by approximately £0.3 billion.


 
331

 
Notes on the consolidated accounts continued



18 Property, plant and equipment
 
Investment 
properties 
Freehold 
 premises 
Long 
 leasehold 
 premises 
Short 
 leasehold 
 premises 
Computers 
and other 
 equipment 
Operating 
lease 
 assets 
Total 
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Cost or valuation
             
At 1 January
4,170 
2,938 
291 
1,832 
4,239 
9,235 
22,705 
Transfers to disposal groups
— 
(107)
(12)
(93)
(49)
(5,355)
(5,616)
Currency translation and other adjustments
(103)
(4)
(6)
(77)
(185)
Reclassifications
57 
(38)
(35)
— 
— 
Additions
1,262 
68 
46 
174 
532 
1,384 
3,466 
Expenditure on investment properties
14 
— 
— 
— 
— 
— 
14 
Change in fair value of investment properties
(139)
— 
— 
— 
— 
— 
(139)
Disposals and write-off of fully depreciated assets
(793)
(54)
(10)
(49)
(174)
(1,375)
(2,455)
At 31 December
4,468 
2,855 
273 
1,823 
4,479 
3,892 
17,790 
               
Accumulated impairment, depreciation and amortisation
             
At 1 January
— 
702 
118 
793 
2,700 
1,849 
6,162 
Transfers to disposal groups
— 
(43)
(6)
(66)
(26)
(730)
(871)
Currency translation and other adjustments
— 
(1)
(28)
15 
(4)
Reclassifications
— 
(9)
— 
(1)
— 
Write down of property, plant and equipment
— 
— 
— 
Disposals and write-off of fully depreciated assets
— 
(29)
— 
(32)
(110)
(466)
(637)
Charge for the year - continuing operations
— 
97 
148 
498 
520 
1,267 
At 31 December
— 
736 
114 
850 
3,035 
1,187 
5,922 
               
Net book value at 31 December
4,468 
2,119 
159 
973 
1,444 
2,705 
11,868 
               
2010
             
Cost or valuation
             
At 1 January
4,883 
4,098 
214 
1,803 
4,282 
9,558 
24,838 
Currency translation and other adjustments
— 
31 
81 
227 
231 
572 
Disposal of subsidiaries
— 
(1,118)
— 
(104)
(372)
(369)
(1,963)
Reclassifications
— 
(104)
76 
15 
13 
— 
— 
Additions
511 
103 
137 
411 
1,178 
2,345 
Expenditure on investment properties
— 
— 
— 
— 
— 
Change in fair value of investment properties
(405)
— 
— 
— 
— 
— 
(405)
Disposals and write-off of fully depreciated assets
(821)
(72)
(6)
(100)
(322)
(1,363)
(2,684)
At 31 December
4,170 
2,938 
291 
1,832 
4,239 
9,235 
22,705 
               
Accumulated impairment, depreciation and amortisation
             
At 1 January
— 
553 
87 
641 
2,396 
1,764 
5,441 
Currency translation and other adjustments
— 
62 
75 
199 
17 
354 
Disposal of subsidiaries
— 
(24)
— 
(30)
(197)
(141)
(392)
Reclassifications
— 
(17)
17 
— 
— 
— 
— 
Write down of property, plant and equipment
— 
32 
— 
41 
Disposals and write-off of fully depreciated assets
— 
(10)
(2)
(48)
(261)
(435)
(756)
Charge for the year - continuing operations
— 
106 
11 
148 
536 
627 
1,428 
Charge for the year - discontinued operations
— 
— 
— 
23 
17 
46 
At 31 December
— 
702 
118 
793 
2,700 
1,849 
6,162 
               
Net book value at 31 December
4,170 
2,236 
173 
1,039 
1,539 
7,386 
16,543 
 
 
 
332

 
 
Notes on the consolidated accounts continued


 
18 Property, plant and equipment continued

 
Investment 
 properties 
Freehold 
 premises 
Long 
 leasehold 
 premises 
Short 
 leasehold 
 premises 
Computers 
 and other 
 equipment 
Operating 
 lease 
assets 
Total 
2009
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Cost or valuation
             
At 1 January
3,868 
4,032 
224 
1,867 
4,168 
9,334 
23,493 
Transfers to disposal groups
— 
(32)
— 
(62)
(80)
— 
(174)
Currency translation and other adjustments
(85)
(134)
— 
(65)
(131)
(561)
(976)
Disposal of subsidiaries
— 
(15)
— 
— 
(19)
— 
(34)
Reclassifications
1 
18 
1 
(34)
14 
— 
— 
Additions
1,634 
304 
8 
153 
750 
2,241 
5,090 
Expenditure on investment properties
8 
— 
— 
— 
— 
— 
8 
Change in fair value of investment properties
(117)
— 
— 
— 
— 
— 
(117)
Disposals and write-off of fully depreciated assets
(426)
(75)
(19)
(56)
(420)
(1,456)
(2,452)
At 31 December
4,883 
4,098 
214 
1,803 
4,282 
9,558 
24,838 
               
Accumulated impairment, depreciation and amortisation
             
At 1 January
— 
422 
79 
492 
1,916 
1,635 
4,544 
Transfers to disposal groups
— 
— 
— 
(7)
(31)
— 
(38)
Currency translation and other adjustments
— 
(1)
— 
(11)
(48)
(69)
(129)
Disposal of subsidiaries
— 
(1)
— 
— 
(14)
— 
(15)
Write down of property, plant and equipment
— 
5 
— 
5 
— 
— 
10 
Disposals and write-off of fully depreciated assets
— 
— 
— 
(2)
(126)
(419)
(547)
Charge for the year - continuing operations
— 
92 
8 
142 
621 
564 
1,427 
Charge for the year - discontinued operations
— 
36 
— 
22 
78 
53 
189 
At 31 December
— 
553 
87 
641 
2,396
1,764 
5,441 
               
Net book value at 31 December
4,883 
3,545 
127 
1,162 
1,886 
7,794 
19,397 

 
Investment properties are valued to reflect fair value, that is, the market value of the Group's interest at the reporting date excluding any special terms or circumstances relating to the use or financing of the property and transaction costs that would be incurred in making a sale. Observed market data such as rental yield, replacement cost and useful life, reflect relatively few transactions involving property that is not necessarily identical to property owned by the Group.

Valuations are carried out by qualified surveyors who are members of the Royal Institution of Chartered Surveyors, or an equivalent overseas body. The valuation as at 31 December 2011 for a significant majority of the Group's investment properties was undertaken with the support of external valuers.

The fair value of investment properties includes £146 million of depreciation since purchase (2010 - £248 million depreciation; 2009 - £84 million appreciation).

Rental income from investment properties was £270 million (2010 - £279 million; 2009 - £233 million). Direct operating expenses of investment properties were £67 million (2010 - £42 million; 2009 - £16 million).

Property, plant and equipment, excluding investment properties, include £186 million (2010 - £298 million; 2009 - £213 million) assets in the course of construction.

There were no sales of freehold and long leasehold properties subject to operating leases during 2011 (2010 - net book value of £2 million; 2009 - net book value of £5 million).

 
333

 
Notes on the consolidated accounts continued




19 Prepayments, accrued income and other assets
 
2011 
2010 
2009
 
£m 
£m 
£m
Prepayments
1,123 
1,529 
1,872
Accrued income
672 
1,186 
897
Deferred expenses
502 
568 
596
Pension schemes in net surplus (see Note 4)
188 
105 
58
Other assets
8,491 
9,188 
17,562
 
10,976 
12,576 
20,985


20 Discontinued operations and assets and liabilities of disposal groups

(a) Profit/(loss) from discontinued operations, net of tax
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Discontinued operations
     
Total income
42 
1,433 
5,664 
Operating expenses
(5)
(803)
(4,061)
Insurance net claims
— 
(161)
(500)
Impairment losses
(42)
(1,051)
Profit before tax
45 
427 
52 
Gain on disposal before recycling of reserves
— 
113 
— 
Recycled reserves
— 
(1,076)
— 
Operating profit/(loss) before tax
45 
(536)
52 
Tax
(11)
(92)
(58)
Profit/(loss) after tax
34 
(628)
(6)
       
Businesses acquired exclusively with a view to disposal
     
Profit/(loss) after tax
13 
(5)
(99)
Profit/(loss) from discontinued operations, net of tax
47 
(633)
(105)


Discontinued operations reflect the results of RFS Holdings attributable to the State of the Netherlands and Santander following the legal separation of ABN AMRO Bank N.V. on 1 April 2010.


(b) Cash flows attributable to discontinued operations
Included within the Group's cash flows are the following amounts attributable to discontinued operations:

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Net cash flows from operating activities
— 
2,528 
(542)
Net cash flows from investing activities
— 
400 
(264)
Net cash flows from financing activities
— 
129 
1,020 
Net increase/(decrease) in cash and cash equivalents
— 
3,062 
(402)


The effect of net cash flows from discontinued operations on the consolidated assets and liabilities of the Group for 2011 was nil, due to the net cash flows being internally funded.
 
 
 
334

 

Notes on the consolidated accounts continued

 
20 Discontinued operations and assets and liabilities of disposal groups continued
(c) Assets and liabilities of disposal groups
 
2011
   
 
UK branch 
based 
businesses 
Other 
Total 
2010 
2009 
 
£m 
£m 
£m 
£m 
£m 
Assets of disposal groups
         
Cash and balances at central banks
100 
27 
127 
184 
129 
Loans and advances to banks
 
87 
87 
651 
388 
Loans and advances to customers
18,676 
729 
19,405 
5,013 
3,216 
Debt securities and equity shares
 
20 
904 
Derivatives
431 
439 
5,148 
6,361 
Intangible assets
 
15 
15 
— 
238 
Settlement balances
 
14 
14 
555 
1,579 
Property, plant and equipment
112 
4,637 
4,749 
18 
136 
Other assets
 
456 
456 
704 
5,417 
Discontinued operations and other disposal groups
19,319 
5,978 
25,297 
12,293 
18,368 
Assets acquired exclusively with a view to disposal
 
153 
153 
191 
174 
 
19,319 
6,131 
25,450 
12,484 
18,542
           
Liabilities of disposal groups
         
Deposits by banks
 
266 
618 
Customer accounts
21,784 
826 
22,610 
2,267 
8,907 
Derivatives
117 
126 
5,042 
6,683 
Settlement balances
 
907 
950 
Subordinated liabilities
 
 
— 
— 
6 
Other liabilities
 
1,233 
1,233 
925 
1,675 
Discontinued operations and other disposal groups
21,901 
2,077 
23,978 
9,407 
18,839 
Liabilities acquired exclusively with a view to disposal
 
17 
17 
21 
51 
 
21,901 
2,094 
23,995 
9,428 
18,890 


The assets and liabilities of disposal groups at 31 December 2011 primarily comprise the RBS England and Wales and NatWest Scotland branch-based businesses (“UK branch-based businesses”) and the RBS Aviation Capital business both of which are expected to be sold in the second half of 2012. On being classified as held-for-sale, disposal groups are required to be measured at the lower of carrying amount and fair value less costs to sell. Accordingly, £80 million of allocated goodwill has been written off against other income in respect of the UK branch-based businesses. No adjustment has been made in respect of the RBS Aviation Capital business.

The disposal of the RBS Sempra Commodities JV was substantially completed in 2010. Certain contracts of the RBS Sempra Commodities JV were sold in risk transfer transactions prior to being novated to the purchaser, the majority of which completed during 2011.


 
335

 
Notes on the consolidated accounts continued


21 Short positions
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Debt securities
     
  - Government
32,895 
34,056 
26,647 
  - Other issuers
6,164 
6,961 
10,871 
Equity shares
1,980 
2,101 
2,945 
 
41,039 
43,118 
40,463 

Note:
(1)
All short positions are classified as held-for-trading.


22 Accruals, deferred income and other liabilities
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Notes in circulation
1,683 
1,793 
1,889 
Current tax
700 
723 
429 
Accruals
4,941 
6,773 
7,429 
Deferred income
3,481 
4,766 
5,818 
Other liabilities (1)
12,320 
9,034 
14,762 
 
23,125 
23,089 
30,327 

Note:
(1)
Other liabilities include £15 million (2010 - £18 million; 2009 - £10 million) in respect of share-based compensation.


Included in other liabilities are provisions for liabilities and charges as follows:
 
Payment 
Protection 
Insurance (1)
£m 
Other (2)
£m 
Total 
£m 
At 1 January 2011
— 
624 
624 
Transfer from accruals and other liabilities
215 
— 
215 
Currency translation and other movements
— 
22 
22 
Charge to income statement - continuing operations
850 
166 
1,016 
Releases to income statement - continuing operations
— 
(53)
(53)
Provisions utilised
(320)
(193)
(513)
At 31 December 2011
745 
566 
1,311 

Notes:
(1)
The FSA published its final policy statement on Payment Protection Insurance (PPI) complaint handling and redress in August 2010. The new rules impose significant changes with respect to the handling of mis-selling PPI complaints. In October 2010, the British Bankers’ Association (BBA) filed an application for judicial review of the FSA’s policy statement and of related guidance issued by the Financial Ombudsman Service (FOS). In April 2011, the High Court issued judgment in favour of the FSA and the FOS and in May 2011, the BBA announced that it would not appeal that judgment.  During 2011, the Group reached agreement with the FSA on a process for implementation of its policy statement and for the future handling of PPI complaints following which it recorded a provision of £850 million in respect of PPI.
 
The principal assumptions underlying the PPI provision are: an assessment of the total number of complaints that the Group will receive; the proportion of these complaints that will result in redress; and the average cost of such redress. To determine the number of complaints that it expects to receive the Group has analysed the population of PPI policies sold by vintage and by product.  Estimates of the percentage of policyholders that will lodge complaints (the take up rate) and of the number of these that will be upheld have been established based on historical experience, guidance set out in the FSA policy statements and on anticipated customer contact. A one percent rise in the take up rate across the entire population of PPI policies would increase the provision by £95 million; a one percent fall would reduce the provision by the same amount. Interest that will be payable on successful complaints has been included in the provision as has the estimated cost to the Group of administering the redress process. The Group expects the majority of the cash outflows associated with this provision to have occurred by the end of 2013. There are uncertainties as to the eventual cost of redress which will depend on actual complaint volumes, uphold rates and average redress costs; and in particular, the results of the past book review to be conducted in 2012 and any additional reviews that may be required.
 
(2)
Includes property provisions and other provisions arising in the normal course of business.


 
336

 
 
Notes on the consolidated accounts continued


23 Deferred tax
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Deferred tax liability
1,945 
2,142 
2,811 
Deferred tax asset
(3,878)
(6,373)
(7,039)
Net deferred tax asset
(1,933)
(4,231)
(4,228)

Net deferred tax asset comprised:

 
Pension 
Accelerated 
capital 
allowances 
Provisions 
Deferred 
gains 
IFRS 
transition 
Fair 
value of 
financial 
instruments 
Available- 
for-sale 
financial 
 assets 
Intangibles 
Cash 
 flow 
 hedging 
Share 
schemes 
Tax 
losses 
carried 
forward 
Other 
Total 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
At 1 January
  2010
(724)
2,815 
(1,480)
136 
(373)
(184)
(391)
1,108 
(60)
(8)
(5,134)
67 
(4,228)
Transfers to
  disposal groups
— 
(120)
(149)
— 
— 
— 
— 
— 
— 
— 
— 
(268)
(Disposal)/
  acquisition of
  subsidiaries
(32)
— 
148 
— 
— 
— 
120 
(631)
— 
— 
65 
(324)
Charge/(credit)
  to income
  statement
46 
(91)
(24) 
(21)
77 
(20)
(160)
(12)
273 
(12)
470 
(102)
424 
Charge/(credit)
  to other
  comprehensive
  income
73 
— 
— 
(2)
— 
— 
(434)
— 
133 
(6)
397 
167 
Currency
  translation
  and other
  adjustments
(1)
52 
(96)
(25)
— 
112 
23 
(36)
(61)
(5)
(7)
42 
(2)
At 1 January
  2011
(638)
2,656 
(1,601)
88 
(296)
(92)
(841)
429 
291 
(31)
(4,274)
78 
(4,231)
Transfers to
  disposal groups
— 
(308)
(52)
— 
— 
16 
— 
— 
— 
— 
159 
52 
(133)
Acquisition/
  (disposal) of
  subsidiaries
(76)
39 
— 
— 
— 
(1)
(1)
— 
— 
— 
(28)
Charge/(credit)
  to income
  statement
223 
27 
344 
262 
77 
46 
(13)
(178)
22 
(3)
394 
(152)
1,049 
(Credit)/charge
  to other
  comprehensive
  income
(86)
— 
— 
— 
— 
780 
— 
238 
14 
415 
— 
1,362 
Currency
  translation
  and other
  adjustments
(4)
— 
(3)
22 
— 
12 
(4)
(48)
At 31 December
  2011
(493)
2,306 
(1,274)
359 
(219)
(33)
(52)
252 
550 
(17)
(3,294)
(18)
(1,933)

Notes:
(1)
Deferred tax assets are recognised depending on the availability of future taxable profits in excess of profits arising from the reversal of other temporary differences. Business projections prepared for impairment reviews (see Note 17) indicate it is probable that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within six years. UK losses do not expire and Netherlands losses expire after nine years. In jurisdictions where doubt exists over the availability of future taxable profits, deferred tax assets of £3,246 million (2010 - £2,008 million; 2009 - £2,163 million) have not been recognised in respect of tax losses carried forward of £16,691 million
(2010 - £9,869 million; 2009 - £7,759 million). Of these losses, none will expire within one year, £392 million within five years and £9,505 million thereafter. The balance of tax losses carried forward has no time limit.
(2)
Deferred tax liabilities of £249 million (2010 and 2009 - £279 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further tax. No tax is expected to arise in the foreseeable future in respect of held-over gains. Changes to UK tax legislation largely exempts overseas dividends received on or after 1 July 2009 from UK tax.
 
 
 
337

 
Notes on the consolidated accounts continued

 
24 Insurance business

 
2011 
2010 
2009 
 
£m 
£m 
£m 
Insurance premium income
4,526 
5,379 
5,529 
Reinsurers' share
(270)
(251)
(263)
Net premium income
4,256 
5,128 
5,266 
       
Insurance claims
3,084 
4,932 
4,492 
Reinsurers' share
(116)
(149)
(135)
Net claims
2,968 
4,783 
4,357 
       
Insurance liabilities
     
General insurance business
6,219 
6,726 
5,802 
Life assurance business
     
  - disposed
— 
— 
4,397 
  - retained
93 
68 
82 
 
6,312 
6,794 
10,281 


General insurance business
(i) Claims and loss adjustment expenses.
 
Gross 
Reinsurance 
Net 
 
£m 
£m 
£m 
Notified claims
4,101 
(276)
3,825 
Incurred but not reported
1,701 
(10)
1,691 
At 1 January 2010
5,802 
(286)
5,516 
Cash paid for claims settled in the year
(3,843)
55 
(3,788)
Increase/(decrease) in liabilities
     
  - arising from current year claims
4,459 
(24)
4,435 
  - arising from prior year claims
322 
(56)
266 
Net exchange differences
(14)
(13)
At 31 December 2010
6,726 
(310)
6,416 
       
       
Notified claims
4,375 
(305)
4,070 
Incurred but not reported
2,351 
(5)
2,346 
At 1 January 2011
6,726 
(310)
6,416 
Cash paid for claims settled in the year
(3,555)
80 
(3,475)
Increase/(decrease) in liabilities
     
  - arising from current year claims
3,318 
(100)
3,218 
  - arising from prior year claims
(257)
— 
(257)
Net exchange differences
(13)
(12)
At 31 December 2011
6,219 
(329)
5,890 
       
Notified claims
4,269 
(318)
3,951 
Incurred but not reported
1,950 
(11)
1,939 
At 31 December 2011
6,219 
(329)
5,890 

 
 
 
338

 

Notes on the consolidated accounts continued

 
24 Insurance business continued
Outstanding claims provisions are not discounted for the time value of money except for claims, principally motor, settled by periodical payments under the Courts Act 2003. Total reserves for claims outstanding in respect of periodical payments are £1,167 million (2010 - £1,180 million; 2009 - £92 million) gross and £835 million (2010 - £827 million; 2009 - £26 million) net of reinsurance. The corresponding undiscounted amounts are £3,857 million (2010 - £4,321 million; 2009 - £276 million) gross and £2,405 million (2010 - £2,660 million; 2009 - £62 million) net of reinsurance. The amounts for 2011 and 2010 include a provision for estimated periodical payment orders incurred but not reported which is excluded from 2009. The rate of interest used for the calculation of present values is 4.5% (2010 - 4.5%; 2009 - 4.1%). The average interval between the date of the last future cash flow being discounted and the end of the financial year is 50.3 years on open and settled cases.

(ii) Provisions for unearned premiums and unexpired short-term insurance risks.
 
Gross 
£m 
Reinsurance 
£m 
Net 
£m 
 
At 1 January 2010
2,490 
(67)
2,423 
Increase in the year
2,191 
(76)
2,115 
Release in the year
(2,393)
71 
(2,322)
At 1 January 2011
2,288 
(72)
2,216 
Increase in the year
1,906 
(66)
1,840 
Release in the year
(2,257)
78 
(2,179)
Foreign exchange and other adjustments
(5)
— 
(5)
At 31 December 2011
1,932 
(60)
1,872 

The unearned premium provision is included within Accruals, deferred income and other liabilities (see Note 22).

 
Retained life 
business 
2011 
£m 
Retained life 
business 
2010 
£m 
Disposed 
business 
2010 
£m 
Movement in provision for life business liabilities
At 1 January
68 
82 
9,526 
Premiums received
46 
49 
234 
Fees and expenses
(8)
(14)
(15)
Investment return
323 
Actuarial adjustments
(36)
(138)
Account balances paid on surrender and other terminations in the year
(23)
(18)
(575)
Disposal of subsidiaries
— 
— 
(9,147)
Foreign exchange and other adjustments
— 
— 
(208)
At 31 December
93 
68 
— 


Insurance risk
Insurance risk is the risk of fluctuations in the timing, frequency or severity of insured events, relative to the expectations of the Group at the time of underwriting.

Underwriting and pricing risk
The Group manages underwriting and pricing risk through the use of underwriting guidelines which detail the class, nature and type of business that may be accepted; pricing policies by product line and by brand; and centralised control of policy wordings and any subsequent changes.

Claims management risk
The risk that claims are handled or paid inappropriately is managed using a range of IT system controls and manual processes conducted by experienced staff. These, together with a range of detailed policies and procedures ensure that all claims are handled in a timely, appropriate and accurate manner.
 
Reinsurance risk
Reinsurance is used to protect against the impact of major catastrophic events or unforeseen volumes of, or adverse trends in, large individual claims and to transfer risk that is outside the Group's current risk appetite.

Reinsurance of risks above the Group's risk appetite is only effective if the reinsurance premium is economic and the counterparty is financially secure. Acceptable reinsurers are rated A- or better unless specifically authorised.

Reserving risk
Reserving risk relates to both premiums and claims. It is the risk that reserves are assessed incorrectly such that insufficient funds have been retained to pay or handle claims as the amounts fall due. Claims development data provides information on the historical pattern of reserving risk.

 
 
339

 
Notes on the consolidated accounts continued


 
Insurance claims - gross
Accident year
 
2002 
£m 
2003 
£m 
2004 
£m 
2005 
£m 
2006 
£m 
2007 
£m 
2008 
£m 
2009 
£m 
2010 
£m 
2011 
£m 
Total 
£m 
Estimate of ultimate claims costs:
                     
At end of accident year
3,013 
3,658 
3,710 
4,265 
4,269 
4,621 
4,080 
4,383 
4,459 
3,318 
39,776 
One year later
91 
(140)
(186)
(92)
(275)
(71)
29 
120 
(66)
 
(590)
Two years later
(106)
(88)
(147)
(77)
(5)
(39)
   
(452)
Three years later
(12)
(55)
(85)
(60)
(16)
14 
31 
     
(183)
Four years later
(17)
(47)
(31)
(55)
23 
       
(125)
Five years later
(19)
(21)
— 
(23)
         
(54)
Six years later
(11)
(32)
45 
(3)
           
(1)
Seven years later
(14)
28 
(14)
             
— 
Eight years later
14 
(9)
               
Nine years later
(29)
                 
(29)
Current estimate of cumulative claims
3,017 
3,276 
3,351 
3,917 
3,880 
4,582 
4,149 
4,464 
4,393 
3,318 
38,347 
Cumulative payments to date
(2,992)
(3,162)
(3,168)
(3,729)
(3,582)
(4,092)
(3,494)
(3,458)
(3,096)
(1,600)
(32,373)
 
25 
114 
183 
188 
298 
490 
655 
1,006 
1,297 
1,718 
5,974 
Liability in respect of earlier years
                 
88 
Claims handling costs
                   
157 
Gross general insurance claims liability
                 
6,219 


Insurance claims - net of reinsurance
Accident year
 
2002 
2003 
2004 
2005 
2006 
2007 
2008 
2009 
2010 
2011 
Total 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Estimate of ultimate claims costs:
                     
At end of accident year
2,584 
3,215 
3,514 
4,168 
4,215 
4,572 
4,034 
4,360 
4,435 
3,218 
38,315 
One year later
59 
(106)
(168)
(67)
(261)
(90)
24 
99 
(67)
 
(577)
Two years later
(12)
(103)
(90)
(161)
(87)
(17)
(37)
   
(498)
Three years later
(3)
(53)
(81)
(64)
(23)
16 
27 
     
(181)
Four years later
(21)
(44)
(46)
(60)
10 
(3)
       
(164)
Five years later
(24)
(23)
(19)
(42)
         
(104)
Six years later
(5)
(34)
45 
— 
           
Seven years later
(11)
20 
             
14 
Eight years later
10 
               
16 
Nine years later
(35)
                 
(35)
Current estimate of cumulative claims
2,542 
2,878 
3,160 
3,820 
3,812 
4,478 
4,094 
4,422 
4,368 
3,218 
36,792 
Cumulative payments to date
(2,536)
(2,805)
(3,008)
(3,647)
(3,530)
(4,030)
(3,466)
(3,428)
(3,078)
(1,572)
(31,100)
 
73 
152 
173 
282 
448 
628 
994 
1,290 
1,646 
5,692 
Liability in respect of earlier years
                   
41 
Claims handling costs
                   
157 
Net general insurance claims liability
                 
5,890 


Claims reserves
It is the Group’s policy to hold claims reserves (including reserves to cover claims which have been incurred but not reported (IBNR reserves)) for all classes at a sufficient level to meet all liabilities as they fall due.

The Group’s focus is on high volume and relatively straightforward products, for example home and motor. This facilitates the generation of comprehensive underwriting and claims data, which are used to price and monitor the risks accepted.
 
 
 
340

 

Notes on the consolidated accounts continued

 
24 Insurance business continued
Loss ratios
The following table shows loss ratios for each major class of business, gross and net of reinsurance.

   
2011
 
2010
 
2009
   
Earned 
premiums 
Claims 
 incurred 
Loss 
 ratio 
 
Earned 
 premiums 
Loss 
 ratio 
 
Earned premiums
Loss
ratio
   
£m 
£m 
 
£m 
 
£m
%
Residential property
Gross
1,053 
597 
57 
 
1,168 
55 
 
1,129
53
 
Net
992 
599 
60 
 
1,107 
58 
 
1,065
56
Personal motor
Gross
2,385 
1,977 
83 
 
2,829 
125 
 
2,984
103
 
Net
2,230 
1,880 
84 
 
2,760 
125 
 
2,901
103
Commercial property
Gross
215 
79 
37 
 
187 
57 
 
182
41
 
Net
192 
78 
41 
 
169 
63 
 
166
45
Commercial motor
Gross
122 
130 
107 
 
120 
107 
 
136
100
 
Net
121 
133 
110 
 
119 
104 
 
135
98
Other
Gross
705 
278 
39 
 
837 
45 
 
848
51
 
Net
701 
273 
39 
 
834 
44 
 
845
51
Total
Gross
4,480 
3,061 
68 
 
5,141 
93 
 
5,279
82
 
Net
4,236 
2,963 
70 
 
4,989 
94 
 
5,112
83


Frequency and severity of specific risks and sources of uncertainty
Most general insurance contracts are written on an annual basis, which means that the Group’s liability extends for a 12 month period, after which the Group is entitled to decline or renew or can impose renewal terms by amending the premium, terms and conditions, or both.

The frequency and severity of claims and the sources of uncertainty for the key classes that the Group is exposed to are as follows:

Motor insurance contracts (personal and commercial)
Claims experience is quite variable, due to a wide range of factors, but the principal ones are age, sex and driving experience of the driver, type and nature of vehicle, use of vehicle and area.

There are many sources of uncertainty that will affect the Group’s experience under motor insurance, including operational risk, reserving risk, premium rates not matching claims inflation rates, weather, the social, economic and legislative environment and reinsurance failure risk.

Property insurance contracts (residential and commercial)
The major causes of claims for property insurance are theft, flood, escape of water, fire, storm, subsidence and various types of accidental damage.

The major source of uncertainty in the Group’s property contracts is the volatility of weather. Over a longer period, the strength of the economy is also a factor.

Other commercial insurance contracts
Other commercial claims come mainly from business interruption and loss arising from the negligence of the insured (liability insurance). Business interruption losses come from the loss of income, revenue and/or profit as a result of property damage claims. Liability insurance includes employers’ liability and public/products’ liability. Liability insurance is written on an occurrence basis, and is subject to claims that are identified over a substantial period of time, but where the loss event occurred during the life of the policy.

Fluctuations in the social and economic climate are a source of uncertainty in the Group’s business interruption and general liability accounts. Other sources of uncertainty are changes in the law, or its interpretation, and reserving risk. Other uncertainties are significant events (for example terrorist attacks) and any emerging new heads of damage or types of claim that are not envisaged when the policy is written.

The following table shows the expected maturity of undiscounted insurance liabilities up to 20 years, excluding those linked directly to the financial assets backing these contracts (2011 and 2010 - nil; 2009 - £4,175 million).
 
 
0-3 months 
3-12 months 
1-3 years 
3-5 years 
5-10 years 
10-20 years 
 
£m 
£m 
£m 
£m 
£m 
£m 
2011
546 
1,110 
1,592 
792 
849 
502 
2010
724 
1,503 
1,821 
898 
734 
442 
2009
561 
1,685 
1,898 
949 
665 
73 

 
 
341

 
Notes on the consolidated accounts continued

 
25 Subordinated liabilities
 
2011 
2010 
2009
 
£m 
£m 
£m
Dated loan capital
19,654 
20,658 
24,597
Undated loan capital
2,558 
2,552 
8,164
Preference shares
1,116 
1,112 
2,000
Trust preferred securities
2,991 
2,731 
2,891
 
26,319 
27,053 
37,652


In a series of exchange and tender offers in April 2009 and May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability.

The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions, see below) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter (“the Deferral Period”), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.

The Group has agreed that RBS Holdings N.V. will not pay investors any coupons on, or exercise any call rights in relation to, specified hybrid capital instruments for an effective period of two years from 1 April 2011, unless in any such case there is a legal obligation to do so. RBS Holdings N.V. and its group companies are also subject to restrictions on the exercise of call rights in relation to their other hybrid capital instruments.

Certain preference shares issued by the company are classified as liabilities; these securities remain subject to the capital maintenance rules of the Companies Act 2006.
 
 
 
342

 

Notes on the consolidated accounts continued

 
25 Subordinated liabilities continued
The following tables analyse the remaining contractual maturity of subordinated liabilities by (1) the final redemption date; and (2) the next call date.

   
2012
£m
2013
£m
2014-2016
£m
2017-2021
£m
Thereafter
£m
Perpetual
£m
Total
£m
2011 - final redemption
 
Sterling
 
73
158
648
453
823
2,155
US dollar
 
302
555
3,903
1,793
190
4,619
11,362
Euro
 
220
1,299
2,389
4,296
513
832
9,549
Other
 
29
1,618
1,261
345
3,253
   
624
2,012
8,558
7,803
703
6,619
26,319

 
Currently
£m
2012
£m
2013
£m
2014-2016
£m
2017-2021
£m
Thereafter
£m
Perpetual
£m
Total
£m
2011 - call date
Sterling
15
127
218
855
593
176
171
2,155
US dollar
3,230
3,974
765
1,196
824
1,059
314
11,362
Euro
159
2,714
1,299
1,954
2,863
513
47
9,549
Other
9
1,407
489
1,306
42
3,253
 
3,413
8,222
2,771
5,311
4,322
1,748
532
26,319

   
2011
£m
2012
£m
2013-2015
£m
2016-2020
£m
Thereafter
£m
Perpetual
£m
Total
£m
2010 - final redemption
 
Sterling
 
79
817
63
361
806
2,126
US dollar
 
195
262
3,171
3,054
261
4,398
11,341
Euro
 
663
3,368
3,849
1,611
866
10,357
Other
 
27
1,612
1,252
338
3,229
   
964
262
8,968
8,218
2,233
6,408
27,053

 
Currently
£m
2011
£m
2012
£m
2013-2015
£m
2016-2020
£m
Thereafter
£m
Perpetual
£m
Total
£m
2010 - call date
Sterling
172
96
55
1,027
217
530
29
2,126
US dollar
3,099
2,889
1,228
1,960
800
1,052
313
11,341
Euro
613
1,940
849
2,387
3,855
664
49
10,357
Other
672
11
728
1,438
380
3,229
 
4,556
4,936
2,860
6,812
5,252
2,246
391
27,053


   
2010
£m
2011
£m
2012-2014
£m
2015-2019
£m
Thereafter
£m
Perpetual
£m
Total
£m
2009 - final redemption
 
Sterling
 
122
8
164
1,778
2,603
4,675
US dollar
 
407
196
1,457
5,314
323
5,294
12,991
Euro
 
1,589
443
1,414
7,360
1,664
4,410
16,880
Other
 
26
554
1,905
621
3,106
   
2,144
647
3,589
16,357
1,987
12,928
37,652

 
Currently
£m
2010
£m
2011
£m
2012-2014
£m
2015-2019
£m
Thereafter
£m
Perpetual
£m
Total
£m
2009 - call date
Sterling
174
408
202
496
1,720
1,504
171
4,675
US dollar
1,811
1,814
1,429
3,171
1,139
1,891
1,736
12,991
Euro
564
2,849
1,755
3,142
5,501
709
2,360
16,880
Other
419
576
1,025
914
172
3,106
 
2,968
5,647
3,386
7,834
9,274
4,276
4,267
37,652

 
 
343

 
Notes on the consolidated accounts continued

Dated loan capital
 
2011
2010
2009
 
£m
£m
£m
The Royal Bank of Scotland Group plc
     
US$300 million 6.375% subordinated notes 2011 (redeemed February 2011) (1)
199
201
US$750 million 5% subordinated notes 2013 (1)
522
532
503
US$750 million 5% subordinated notes 2014 (1)
558
559
521
US$250 million 5% subordinated notes 2014 (1)
163
162
153
US$675 million 5.05% subordinated notes 2015 (1)
494
492
468
US$350 million 4.7% subordinated notes 2018 (1)
271
252
231
       
The Royal Bank of Scotland plc
     
€1,000 million 6% subordinated notes 2013
921
989
1,014
US$50 million floating rate subordinated notes 2013
37
38
36
€500 million 6% subordinated notes 2013
426
439
452
£150 million 10.5% subordinated bonds 2013 (2)
171
177
177
AUD590 million 6% subordinated notes 2014 (callable July 2012)
392
391
330
AUD410 million floating rate subordinated notes 2014 (callable July 2012)
272
272
229
CAD700 million 4.25% subordinated notes 2015 (callable March 2015)
444
452
419
£250 million 9.625% subordinated bonds 2015
297
303
301
US$750 million floating rate subordinated notes 2015 (callable June 2012)
485
483
462
€750 million floating rate subordinated notes 2015
709
725
741
CHF400 million 2.375% subordinated notes 2015
295
287
244
CHF100 million 2.375% subordinated notes 2015
88
83
69
CHF200 million 2.375% subordinated notes 2015
136
136
117
US$500 million floating rate subordinated notes 2016 (callable January 2012)
324
322
308
US$1,500 million floating rate subordinated notes 2016 (callable January 2012)
971
967
926
€500 million 4.5% subordinated notes 2016 (callable January 2012)
420
450
476
CHF200 million 2.75% subordinated notes 2017 (callable December 2012)
138
138
120
€100 million floating rate subordinated notes 2017
84
86
89
€500 million floating rate subordinated notes 2017 (callable June 2012)
419
432
445
€750 million 4.35% subordinated notes 2017 (callable January 2017)
723
721
728
AUD450 million 6.5% subordinated notes 2017 (callable February 2012)
303
302
255
AUD450 million floating rate subordinated notes 2017 (callable February 2012)
298
295
250
US$1,500 million floating rate subordinated callable step-up notes 2017 (callable August 2012)
971
966
925
€2,000 million 6.93% subordinated notes 2018
2,023
1,999
2,017
US$125.6 million floating rate subordinated notes 2020
81
81
78
€1,000 million 4.625% subordinated notes 2021 (callable September 2016)
948
949
962
€300 million CMS linked floating rate subordinated notes 2022 (callable June 2022)
271
280
292
€144.4 million floating rate subordinated notes 2023
157
153
143
       
National Westminster Bank Plc
     
€600 million 6% subordinated notes 2010
564
€500 million 5.125% subordinated notes 2011 (redeemed June 2011)
442
455
£300 million 7.875% subordinated notes 2015
371
370
365
£300 million 6.5% subordinated notes 2021
400
367
351
       
Charter One Financial, Inc.
     
US$400 million 6.375% subordinated notes 2012
261
265
255
       
RBS Holdings USA Inc.
     
US$500 million subordinated loan capital floating rate notes 2010
— 
311

 
 
344

 
 
Notes on the consolidated accounts continued

25 Subordinated liabilities continued

 
2011
2010
2009
 
£m
£m
£m
First Active plc
     
£60 million 6.375% subordinated bonds 2018 (callable April 2013)
64
66
66
       
RBS NV and subsidiaries
     
€250 million 4.70% CMS linked subordinated notes 2019
136
181
189
€800 million 6.25% fixed rate subordinated notes 2010
733
€100 million 5.13% flip flop Bermudan callable subordinated notes 2017 (callable December 2012)
78
69
84
€500 million floating rate Bermudan callable subordinated lower tier 2 notes 2018  (3)
426
€1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2016 (3)
862
€13 million zero coupon subordinated notes 2029
14
9
4
€82 million floating rate subordinated notes 2017 (3)
68
€103 million floating rate subordinated lower tier 2 notes 2020 (3)
83
€170 million floating rate sinkable subordinated notes 2041
81
240
190
€15 million CMS linked floating rate subordinated lower tier 2 notes 2020
7
10
10
€1,500 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable March 2012)
1,246
1,283
1,326
€5 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable January 2012)
4
4
4
€65 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (3)
58
US$165 million 6.14% subordinated notes 2019
76
104
132
US$72 million 5.98% subordinated notes 2019
47
42
34
US$500 million 4.65% subordinated notes 2018
354
326
293
US$1,500 million floating rate Bermudan callable subordinated notes 2015 (callable March 2012)
930
927
887
US$100 million floating rate Bermudan callable subordinated lower tier 2 notes 2015  (3)
62
US$36 million floating rate Bermudan callable subordinated lower tier 2 notes 2015  (3)
22
US$1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2017 (3)
598
AUD575 million 6.50% Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013)
378
371
318
AUD175 million floating rate Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013)
111
111
93
€26 million 7.42% subordinated notes 2016
25
26
27
€7 million 7.38% subordinated notes 2016
7
7
7
£42 million amortising MTN subordinated lower tier 2 notes 2010
7
£25 million amortising MTN subordinated lower tier 2 notes 2011 (redeemed January 2011)
3
8
£750 million 5% fixed rate Bermudan callable subordinated upper tier 2 notes 2016 (3)
727
US$136 million (2010 and 2009 - US$250 million) 7.75% fixed rate subordinated notes 2023
90
163
155
US$150 million 7.13% fixed rate subordinated notes 2093
100
98
93
MYR200 million 4.15% subordinated notes 2017
42
42
36
       
Non-controlling interests subordinated issues
20
20
12
 
19,654
20,658
24,597

Notes:
(1)
On-lent to The Royal Bank of Scotland plc on a subordinated basis.
(2)
Unconditionally guaranteed by the company.
(3)
Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V. in 2010.
(4)
In the event of certain changes in tax laws, dated loan capital issues may be redeemed in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior regulatory approval.
(5)
Except as stated above, claims in respect of the Group's dated loan capital are subordinated to the claims of other creditors. None of the Group's dated loan capital is secured.
(6)
Interest on all floating rate subordinated notes is calculated by reference to market rates.

 
 
345

 
Notes on the consolidated accounts continued

Undated loan capital
 
2011 
2010
2009
 
£m 
£m
£m
The Royal Bank of Scotland Group plc
     
US$106 million (2010 - US$106 million; 2009 - US$163 million) undated floating rate
  primary capital notes (callable on any interest payment date) (1,2)
69
69
101
US$762 million 7.648% perpetual regulatory tier one securities (callable September 2031) (1,3,4)
497
494
473
       
The Royal Bank of Scotland plc
     
£31 million (2010 - £31 million; 2009 - £96 million) 7.375% undated subordinated notes
  (callable December 2019) (1,2)
31
31
101
£51 million (2010 - £51 million; 2009 - £117 million) 6.25% undated subordinated notes
  (callable December 2012) (1,2)
53
55
126
£56 million (2010 - £56 million; 2009 - £138 million) 6% undated subordinated notes
  (callable September 2014) (1,2)
62
61
143
€176 million (2010 - €176 million; 2009 - €197 million) 5.125% undated subordinated notes
  (callable July 2014) (1,2)
161
166
194
€170 million (2010 - €170 million; 2009 - €243 million) floating rate undated subordinated
  notes (callable July 2014) (1,2)
141
145
214
£54 million (2010 - £54 million; 2009 - £178 million) 5.125% undated subordinated notes
  (callable March 2016) (1,2)
61
58
189
£200 million 5.125% subordinated upper tier 2 notes
210
£35 million (2010 - £35 million; 2009 - £260 million) 5.5% undated subordinated notes
  (callable December 2019) (1,2)
37
35
272
£21 million (2010 - £21 million; 2009 - £174 million) 6.2% undated subordinated notes
  (callable March 2022) (1,2)
45
43
206
£103 million (2010 - £103 million; 2009 - £145 million) 9.5% undated subordinated bonds
  (callable August 2018) (1,2,5)
137
130
176
£22 million (2010 - £22 million; 2009 - £83 million) 5.625% undated subordinated notes
  (callable September 2026) (1,2)
23
21
90
£19 million (2010 - £19 million; 2009 - £201 million) 5.625% undated subordinated notes
  (callable June 2032) (1,2)
13
20
199
£1 million (2010 - £1 million; 2009 - £190 million) 5% undated subordinated notes
  (callable September 2012) (1,2)
1
2
197
JPY25 billion 2.605% undated subordinated notes
173
CAD474 million (2010 - CAD474 million; 2009 - CAD700 million) 5.37% fixed rate undated
  subordinated notes (callable May 2016) (2)
347
340
452
       
National Westminster Bank Plc
     
US$193 million (2010 - US$193 million; 2009 - US$332 million) primary capital floating rate
  notes, Series A (callable on any interest payment date) (1,2)
124
124
205
US$229 million (2010 - US$229 million; 2009 - US$293 million) primary capital floating rate
  notes, Series B (callable on any interest payment date) (1,2)
148
148
182
US$285 million (2010 - US$285 million; 2009 - US$312 million) primary capital floating rate
  notes, Series C (callable on any interest payment date) (1,2)
184
184
192
€178 million (2010 - €178 million; 2009 - €400 million) 6.625% fixed/floating rate undated
  subordinated notes (callable on any interest payment date) (2)
150
154
358
€10 million (2010 - €10 million; 2009 - €100 million) floating rate undated step-up notes
  (callable on any interest payment date) (2)
9
9
90
£87 million (2010 - £87 million; 2009 - £162 million) floating undated subordinated step-up
  notes (callable January 2015) (1,2)
91
89
174
£53 million (2010 - £53 million; 2009 - £127 million) 7.125% undated subordinated step-up
  notes (callable October 2022) (1,2)
56
54
127
£35 million (2010 - £35 million; 2009 - £55 million) 11.5% undated subordinated notes
  (callable December 2022) (1,2,6)
42
42
79

 
 
346

 
 
Notes on the consolidated accounts continued

25 Subordinated liabilities continued

 
2011 
2010 
2009
 
£m 
£m 
£m
First Active plc
     
£20 million 11.75% perpetual tier two capital
26 
26 
26
€38 million 11.375% perpetual tier two capital
48 
50 
51
£1.3 million floating rate perpetual tier two capital
2 
2
       
RBS NV and subsidiaries
     
€1,000 million 4.31% perpetual Bermudan callable subordinated tier 1 notes (callable March 2016) (7)
— 
— 
834
€800 million 10% fixed perpetual mandatory convertible tier 1 notes 2099 (7)
— 
— 
716
€967 million 10% fixed perpetual mandatory convertible tier 1 notes 2072 (7)
— 
— 
866
€833 million 10% fixed perpetual mandatory convertible tier 1 notes 2073 (7)
— 
— 
746
 
2,558 
2,552 
8,164

Notes:
(1)
Partially repurchased following completion of the exchange and tender offers in April 2009.
(2)
Partially repurchased following completion of the exchange and tender offers in May 2010.
(3)
On-lent to The Royal Bank of Scotland plc on a subordinated basis.
(4)
The company can satisfy interest payment obligations by issuing sufficient ordinary shares to appointed Trustees to enable them, on selling these shares, to settle the interest payment.
(5)
Guaranteed by the company.
(6)
Exchangeable at the option of the issuer into 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time.
(7)
Transferred to the Dutch State on legal separation of ABN AMRO Holding N.V. in 2010.
(8)
Except as stated above, claims in respect of the Group's undated loan capital are subordinated to the claims of other creditors. None of the Group's undated loan capital is secured.
(9)
In the event of certain changes in tax laws, undated loan capital issues may be redeemed in whole, but not in part, at the option of the Group, at the principal amount thereof plus accrued interest, subject to prior regulatory approval.
(10)
Interest on all floating rate subordinated notes is calculated by reference to market rates.

Preference shares
 
2011
2010
2009
 
£m
£m
£m
The Royal Bank of Scotland Group plc (1)
     
Non-cumulative preference shares of US$0.01
     
  Series F US$156 million (2010 - US$156 million; 2009 - US$200 million) 7.65%
  (redeemable at option of issuer) (2)
101
101
123
  Series H US$242 million (2010 - US$242 million; 2009 - US$300 million) 7.25%
  (redeemable at option of issuer) (2)
157
156
185
  Series L US$751 million (2010 - US$751 million; 2009 - US$850 million) 5.75%
  (redeemable at option of issuer) (2)
485
484
524
       
Non-cumulative convertible preference shares of US$0.01
     
  Series 1 US$65 million (2010 - US$65 million; 2009 - US$1,000 million) 9.118%
  (redeemable at option of issuer) (3)
43
43
630
       
Non-cumulative convertible preference shares of £0.01
     
  Series 1 £15 million (2010 - £15 million; 2009 - £200 million) 7.387% (redeemable at option of issuer) (3)
15
15
199
       
Cumulative preference shares of £1
     
  £0.5 million 11% and £0.4 million 5.5% (non-redeemable)
1
1
1
       
National Westminster Bank Plc
     
Non-cumulative preference shares of £1
     
  Series A £140 million 9% (non-redeemable)
145
144
145
       
Non-cumulative preference shares of US$25
     
  Series C US$246 million (2010 - US$246 million; 2009 - US$300 million) 7.7628% (2,4)
169
168
193
 
1,116
1,112
2,000
 
Notes:
(1)
Further details of the contractual terms of the preference shares are given in Note 27.
(2)
Partially repurchased following completion of the exchange and tender offers in May 2010.
(3)
Partially converted into ordinary shares in the company in 2010.
(4)
Series C preference shares each carry a gross dividend of 8.625% inclusive of associated tax credit. Redeemable at the option of the issuer at par.

 
 
347

 
Notes on the consolidated accounts continued

Trust preferred securities
 
2011
2010
2009
 
£m
£m
£m
€391 million 6.467% (redeemable June 2012) (1,2)
340
339
362
US$486 million (2010 and 2009 - US$486 million) 6.8%
  (perpetual callable September 2009) (1,2)
309
289
300
US$318 million (2010 - US$318 million; 2009 - US$322 million) 4.709%
  (redeemable July 2013) (1,2,3)
210
190
196
US$394 million 6.425% (redeemable January 2034) (1,2)
382
291
280
       
RBS NV and subsidiaries (4)
     
US$1,285 million 5.90% Trust Preferred V
684
633
696
US$200 million 6.25% Trust Preferred VI
108
100
107
US$1,800 million 6.08% Trust Preferred VII
958
889
950
 
2,991
2,731
2,891

Notes:
(1)
The trust preferred securities issued by subsidiaries have no maturity date and are not redeemable at the option of the holders at any time. These securities may, with the consent of the UK Financial Services Authority, be redeemed by the issuer on the dates specified above or on any interest payment date thereafter. They may also be redeemed in whole, but not in part, upon the occurrence of certain tax and regulatory events. Dividends are non-cumulative and may, subject to the restrictions described in (5) below, be paid provided distributable profits are sufficient unless payment would breach the capital adequacy requirements of the UK Financial Services Authority.  Distributions are not made if dividends are not paid on any series of the company’s non-cumulative preference shares. The company classifies its obligations to these subsidiaries as dated loan capital.
(2)
Partially repurchased following completion of the exchange and tender offers in April 2009.
(3)
Partially repurchased following completion of the exchange and tender offers in May 2010.
(4)
Dividends are non-cumulative. They cannot be declared if RBS Holdings N.V. has not paid dividends on any parity securities. Distributions must be made, subject to the restrictions described in (5) below, if RBS Holdings N.V. pays a dividend on its ordinary shares or on its parity securities or redeems or repurchases such securities.
(5)
The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see page 352).


 
348

 
 
Notes on the consolidated accounts continued


26 Non-controlling interests
 
ABN 
AMRO 
Other 
 interests 
Total 
 
£m 
£m 
£m 
At 1 January 2010
14,668 
2,227 
16,895 
Currency translation and other adjustments
(529)
63 
(466)
(Loss)/profit attributable to non-controlling interests
     
  - continuing operations
(121)
61 
(60)
  - discontinued operations
(605)
— 
(605)
Dividends paid
(4,028)
(172)
(4,200)
Losses on available-for-sale financial assets, net of tax
(21)
— 
(21)
Movements in cash flow hedging reserves, net of tax
955 
— 
955 
Equity raised
501 
58 
559 
Equity withdrawn and disposals
(10,525)
(773)
(11,298)
Transfer to retained earnings
— 
(40)
(40)
At 1 January 2011
295 
1,424 
1,719 
Currency translation and other adjustments
(20)
(34)
(54)
Profit/(loss) attributable to non-controlling interests
     
  - continuing operations
(7)
(7)
(14)
  - discontinued operations
42 
— 
42 
Dividends paid
— 
(40)
(40)
Losses on available-for-sale financial assets, net of tax
— 
Equity withdrawn and disposals
(29)
(392)
(421)
At 31 December 2011
283 
951 
1,234 


ABN AMRO represents the other Consortium Members' interests in RFS Holdings B.V. The capital and income rights of shares issued by RFS Holdings B.V. are linked to the net assets and income of the ABN AMRO business units which the individual Consortium Members agreed to acquire. The distribution to other Consortium Members of their respective interests occurred in 2010. Equity withdrawn in respect of ABN AMRO in 2010 relates to distributions to Consortium Members.

Other non-controlling interests include the following trust preferred securities:
 
2011 
2010 
2009 
 
£m 
£m 
£m 
US$357 million 5.512% (redeemable September 2014) (1)
198 
198 
198 
US$276 million (2010 - US$276 million; 2009 - US$470 million) 3 month US$ LIBOR plus 0.80%
  (redeemable September 2014) (1,2)
153 
153 
261 
€166 million 4.243% (redeemable January 2016) (1)
112 
112 
112 
£93 million 5.6457% (redeemable June 2017) (1)
93 
93 
93 
 
556 
556 
664 

Notes:
(1)
Partially repurchased following completion of the exchange and tender offers in April 2009.
(2)
Partially repurchased following completion of the exchange and tender offers in May 2010.
(3)
The trust preferred securities issued by subsidiaries have no maturity date and are not redeemable at the option of the holders at any time. These securities may, with the consent of the UK Financial Services Authority, be redeemed, in whole or in part, by the issuer on the dates specified above or on any interest payment date thereafter. They may also be redeemed in whole, but not in part, upon the occurrence of certain tax and regulatory events. Dividends are non-cumulative and discretionary. Distributions are not made if dividends are not paid on any series of the company’s non-cumulative preference shares. The company classifies its obligations to these subsidiaries as dated loan capital.
(4)
The trust preferred securities are subject to restrictions on dividend payments agreed with the European Commission (see page 352).


 
349

 
Notes on the consolidated accounts continued


 
 
27 Share capital
 
Allotted, called up and fully paid
 
1 January 
2011 
Issued 
during 
the year 
31 December 
 2011 
 
£m 
£m 
£m 
Ordinary shares of 25p
14,614 
193 
14,807 
B shares of £0.01
510 
— 
510 
Dividend access share of £0.01
— 
— 
— 
Non-cumulative preference shares of US$0.01
— 
Non-cumulative convertible preference shares of US$0.01
— 
— 
— 
Non-cumulative preference shares of €0.01
— 
— 
— 
Non-cumulative convertible preference shares of £0.01
— 
— 
— 
Non-cumulative preference shares of £1
— 
— 
— 
Cumulative preference shares of £1
— 


 
Allotted, called up and fully paid
Number of shares - thousands
2011 
2010 
2009 
Ordinary shares of 25p
59,228,412 
58,458,131 
56,365,721 
B shares of £0.01
51,000,000 
51,000,000 
51,000,000 
Dividend access share of £0.01 (1)
— 
— 
Non-voting deferred shares of £0.01
— 
— 
2,660,556 
Non-cumulative preference shares of US$0.01
209,609 
209,609 
308,015 
Non-cumulative convertible preference shares of US$0.01
65 
65 
1,000 
Non-cumulative preference shares of €0.01
2,044 
2,044 
2,526 
Non-cumulative convertible preference shares of £0.01
15 
15 
200 
Non-cumulative preference shares of £1
54 
54 
750 
Cumulative preference shares of £1
900 
900 
900 

Note:
(1)
One dividend access share in issue.


Movement in ordinary shares in issue - thousands
Ordinary shares 
 of 25p 
At 1 January 2010
56,365,721 
Shares issued
2,092,410 
At 1 January 2011
58,458,131 
Shares issued
770,281 
At 31 December 2011
59,228,412 


Ordinary shares
During the year, the issued ordinary share capital was increased by 770 million ordinary shares in connection with employee share schemes.

B shares and dividend access share
In December 2009, the company entered into an acquisition and contingent capital agreement with HM Treasury. HM Treasury agreed to acquire at 50p per share 51 billion B shares with a nominal value of 1p each and a dividend access share with a nominal value of 1p; these shares were issued to HM Treasury on 22 December 2009. Net proceeds were £25.1 billion.

The B shares do not generally carry voting rights at general meetings of ordinary shareholders. Each B share is entitled to the same cash dividend as an ordinary share (subject to anti-dilution adjustments). The B shares may be converted into ordinary shares at a fixed ratio of issue price (50p) divided by the conversion price (50p subject to anti-dilution adjustments) at the option of the holder at any time after issue. HM Treasury has agreed not to convert its B shares into ordinary shares to the extent that its holding of ordinary shares following the conversion would represent more than 75% of the company's issued ordinary share capital.



 
350

 
 
Notes on the consolidated accounts continued

 
27 Share capital continued
The dividend access share entitles the holder to dividends equal to the greater of 7% of the aggregate issue price of B shares issued to HM Treasury and 250% of the ordinary dividend rate multiplied by the number of B shares issued, less any dividends paid on the B shares and on ordinary shares issued on conversion. Dividends on the dividend access share are discretionary unless a dividend has been paid on the ordinary shares, in which case dividends became mandatory. The dividend access share does not generally carry voting rights at general meetings of ordinary shareholders and is not convertible into ordinary shares.

The contingent capital commitment agreement can be terminated in whole or in part by the company, with the FSA's consent, at any time. It expires at the end of five years or, if earlier, on its termination in full.

Preference shares
Under IFRS certain of the Group's preference shares are classified as debt and are included in subordinated liabilities on the balance sheet.

Other securities
Certain of the Group's subordinated securities in the legal form of debt are classified as equity under IFRS.

These securities entitle the holders to interest which may be deferred at the sole discretion of the company. Repayment of the securities is at the sole discretion of the company on giving between 30 and 60 days notice.

Non-cumulative preference shares
Non-cumulative preference shares entitle the holders thereof (subject to the terms of issue) to receive periodic non-cumulative cash dividends at specified fixed rates for each Series payable out of distributable profits of the company.

The non-cumulative preference shares are redeemable at the option of the company, in whole or in part from time to time at the rates detailed below plus dividends otherwise payable for the then current dividend period accrued to the date of redemption.


Class of preference share
Number of shares in issue
Interest
 rate
Redemption
date on or after
Redemption
price per share
Debt/equity (1)
Non-cumulative preference shares of US$0.01
         
  Series F
6.3 million
7.65%
31 March 2007
US$25
Debt
  Series H
9.7 million
7.25%
31 March 2004
US$25
Debt
  Series L
30.0 million
5.75%
30 September 2009
US$25
Debt
  Series M
23.1 million
6.4%
30 September 2009
US$25
Equity
  Series N
22.1 million
6.35%
30 June 2010
US$25
Equity
  Series P
9.9 million
6.25%
31 December 2010
US$25
Equity
  Series Q
20.6 million
6.75%
30 June 2011
US$25
Equity
  Series R
10.2 million
6.125%
30 December 2011
US$25
Equity
  Series S
26.4 million
6.6%
30 June 2012
US$25
Equity
  Series T
51.2 million
7.25%
31 December 2012
US$25
Equity
  Series U
10,130
7.64%
29 September 2017
US$100,000
Equity
             
Non-cumulative convertible preference shares of US$0.01
         
  Series 1
64,772
9.118%
31 March 2010
US$1,000
Debt
             
Non-cumulative preference shares of €0.01
           
  Series 1
1.25 million
5.5%
31 December 2009
€1,000
Equity
  Series 2
784,989
5.25%
30 June 2010
€1,000
Equity
  Series 3
9,429
7.0916%
29 September 2017
€50,000
Equity
             
Non-cumulative convertible preference shares of £0.01
           
  Series 1
14,866
7.387%
31 December 2010
£1,000
Debt
             
Non-cumulative preference shares of £1
           
  Series 1
54,442
8.162%
5 October 2012
£1,000
Equity

Note:
(1)
Those preference shares where the Group has an obligation to pay dividends are classified as debt; those where distributions are discretionary are classified as equity. The conversion rights attaching to the convertible preference shares may result in the Group delivering a variable number of equity shares to preference shareholders; these convertible preference shares are treated as debt.

In the event that the non-cumulative convertible preference shares are not redeemed on or before the redemption date, the holder may convert them into ordinary shares in the company at the prevailing market price.

Under existing arrangements, no redemption or purchase of any non-cumulative preference shares may be made by the company without the prior consent of the UK Financial Services Authority.


 
351

 
 
Notes on the consolidated accounts continued

 
On a winding-up or liquidation of the company, the holders of the non-cumulative preference shares will be entitled to receive, out of any surplus assets available for distribution to the company's shareholders (after payment of arrears of dividends on the cumulative preference shares up to the date of repayment) pari passu with the cumulative preference shares and all other shares of the company ranking pari passu with the non-cumulative preference shares as regards participation in the surplus assets of the company, a liquidation distribution per share equal to the applicable redemption price detailed in the table above, together with an amount equal to dividends for the then current dividend period accrued to the date of payment, before any distribution or payment may be made to holders of the ordinary shares as regards participation in the surplus assets of the company.

Except as described above, the holders of the non-cumulative preference shares have no right to participate in the surplus assets of the company.

Holders of the non-cumulative preference shares are not entitled to receive notice of or attend general meetings of the company except if any resolution is proposed for adoption by the shareholders of the company to vary or abrogate any of the rights attaching to the non-cumulative preference shares or proposing the winding-up or liquidation of the company. In any such case, they are entitled to receive notice of and to attend the general meeting of shareholders at which such resolution is to be proposed and are entitled to speak and vote on such resolution (but not on any other resolution). In addition, in the event that, prior to any general meeting of shareholders, the company has failed to pay in full the three most recent quarterly dividend payments due on the non-cumulative dollar preference shares (other than Series U), the two most recent semi-annual dividend payments due on the non-cumulative convertible dollar preference shares and the most recent dividend payments due on the non-cumulative euro preference shares, the non-cumulative sterling preference shares, the Series U non-cumulative dollar preference shares and the non-cumulative convertible sterling preference shares, the holders shall be entitled to receive notice of, attend, speak and vote at such meeting on all matters together with the holders of the ordinary shares. In these circumstances only, the rights of the holders of the non-cumulative preference shares so to vote shall continue until the company shall have resumed the payment in full of the dividends in arrears.

The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (excluding companies in the RBS Holdings N.V. Group, which are subject to different restrictions) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter ("the Deferral Period"), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the Deferral Period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.


28 Other equity
Paid-in equity - notes issued under the company's euro medium term note programme with an initial par value of US$1,600 million and CAD600 million are classified as equity under IFRS. The notes attract coupons of 6.99% and 6.666% respectively until October 2017 when they change to 2.67% above the London interbank offered rate for 3-month US dollar deposits and 2.76% above the Canadian dollar offered rate respectively. Paid-in equity of US$1,036 million was repurchased in April 2009 and CAD279 million was repurchased in May 2010 as part of the liability management exercises.

Merger reserve - on 1 January 2009, the merger reserve comprised the premium on shares issued to acquire NatWest less goodwill amortisation charged under previous GAAP. No share premium was recorded in the company financial statements through the operation of the merger relief provisions of the Companies Act 1985.

Under the arrangements for accession to APS in December 2009, the company issued B shares in exchange for shares in Aonach Mor Limited. No share premium was recorded in the company financial statements through the operation of the merger relief provisions of the Companies Act 2006. The subsequent redemption of these shares gave rise to distributable profits of £50 million in 2011, £12,250 million in 2010 and £9,950 million in 2009, which were transferred from merger reserve to retained earnings.

Capital redemption reserve - under UK companies legislation, when shares are redeemed or purchased wholly or partly out of the company's profits, the amount by which the company's issued share capital is diminished must be transferred to the capital redemption reserve.  The capital maintenance provisions of UK companies legislation apply to the capital redemption reserve as if it were part of the company’s paid up share capital.

Contingent capital reserve - in December 2009, HM Treasury agreed to subscribe for up to 16 billion B shares of 1p each at 50p per share subject to certain conditions including the Group's Core Tier 1 capital ratio falling below 5%. The fair value of the consideration payable by the company on entering into this agreement amounted to £1,458 million; of this £1,208 million was debited to the contingent capital reserve.

Own shares held - at 31 December 2011, 1.6 billion (2010 - 1.7 billion; 2009 - 139 million) ordinary shares of 25p each of the company were held by Employee Share Trusts in respect of share awards and options granted to employees. Employee share trusts awarded 84.2 million ordinary shares in satisfaction of the exercise of awards under employee share plans during the year.

The Group optimises capital efficiency by maintaining reserves in subsidiaries, including regulated entities. Certain preference shares and subordinated debt are also included within regulatory capital. The remittance of reserves to the company or the redemption of shares or subordinated capital by regulated entities may be subject to maintaining the capital resources required by the relevant regulator.

UK law prescribes that only the reserves of the company are taken into account for the purpose of making distributions and in determining the permissible applications of the share premium account.


 
352

 
 
Notes on the consolidated accounts continued

29 Leases
Year in which receipt will occur
Finance lease contracts and hire purchase agreements
 
Operating lease
 assets:
future minimum
lease rentals
£m 
Gross 
amounts 
£m 
Present value 
 adjustments 
£m 
Other 
 movements 
£m 
Present 
value 
£m 
2011
           
Within 1 year
3,996 
(340)
(29)
3,627 
 
406 
After 1 year but within 5 years
6,806 
(763)
(193)
5,850 
 
605 
After 5 years
5,822 
(2,710)
(270)
2,842 
 
359 
Total
16,624 
(3,813)
(492)
12,319 
 
1,370 
             
2010
         
Within 1 year
3,559 
(309)
(20)
3,230 
 
997 
After 1 year but within 5 years
7,833 
(795)
(245)
6,793 
 
2,388 
After 5 years
7,843 
(2,763)
(263)
4,817 
 
998 
Total
19,235 
(3,867)
(528)
14,840 
 
4,383 
             
2009
         
Within 1 year
3,617 
(534)
(30)
3,053 
 
781 
After 1 year but within 5 years
8,582 
(1,890)
(212)
6,480 
 
2,514 
After 5 years
11,251 
(2,461)
(334)
8,456 
 
1,018 
Total
23,450 
(4,885)
(576)
17,989 
 
4,313 


 
2011 
2010 
2009 
 
£m 
£m 
£m 
Nature of operating lease assets on the balance sheet
     
Transportation
1,549 
6,162 
6,039 
Cars and light commercial vehicles
995 
1,016 
1,352 
Other
161 
208 
403 
 
2,705 
7,386 
7,794 
       
Amounts recognised as income and expense
     
Finance leases - contingent rental income
(133)
(160)
(139)
Operating leases - minimum rentals payable
490 
519 
556 
       
Finance lease contracts and hire purchase agreements
     
Accumulated allowance for uncollectable minimum receivables
347 
401 
313 

 
 
353

 
 
Notes on the consolidated accounts continued


 
Residual value exposures
The table below gives details of the unguaranteed residual values included in the carrying value of finance lease receivables (see pages 299 to 302) and operating lease assets (see pages 332 and 333).

 
Year in which residual value will be recovered
 
Within 1 
 year 
After 1 year 
 but within 
 2 years 
After 2 years 
 but within 
 5 years 
After 5 
 years 
Total 
2011
£m 
£m 
£m 
£m 
£m 
Operating leases
         
  - transportation
244 
314 
187 
390 
1,135 
  - cars and light commercial vehicles
458 
75 
105 
640 
  - other
23 
21 
33 
85 
Finance lease contracts
26 
48 
147 
270 
491 
Hire purchase agreements
— 
— 
— 
 
751 
458 
473 
670 
2,352 
           
2010
         
Operating leases
         
  - transportation
357 
457 
1,834 
2,097 
4,745 
  - cars and light commercial vehicles
503 
109 
100 
721 
  - other
30 
20 
39 
13 
102 
Finance lease contracts
20 
41 
131 
263 
455 
Hire purchase agreements
— 
70 
— 
73 
 
910 
630 
2,174 
2,382 
6,096 
           
2009
         
Operating leases
         
  - transportation
164 
327 
1,607 
2,255 
4,353 
  - cars and light commercial vehicles
624 
134 
113 
878 
  - other
31 
32 
40 
110 
Finance lease contracts
23 
35 
96 
313 
467 
Hire purchase agreements
20 
61 
21 
109 
 
849 
548 
1,917 
2,603 
5,917 


The Group provides asset finance to its customers through acting as a lessor. It purchases plant, equipment and intellectual property, renting them to customers under lease arrangements that, depending on their terms, qualify as either operating or finance leases.


 
354

 

Notes on the consolidated accounts continued

30 Securitisations and asset transfers
Secured funding
The Group has access to secured funding markets through own-asset securitisation and covered bond funding programmes to complement existing wholesale funding programmes and access to the repo markets. The Group monitors and manages encumbrance levels related to these secured funding programmes. This includes 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 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 and 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.


 
2011
 
2010
 
2009
     
Debt securities in issue
     
Debt securities in issue
     
Debt securities in issue
Asset type (1)
Assets 
£m 
 
Held by third 
parties (2)
£m 
Held by the 
Group (3)
£m 
Total 
£m 
 
Assets 
£m 
 
Held by third 
parties (2)
£m 
Held by the 
Group (3)
£m 
Total 
£m 
 
Assets 
£m 
 
Held by third 
parties (2)
£m 
Held by the 
Group (3)
£m 
Total 
£m 
Mortgages
                                 
  - UK (RMBS)
49,549 
 
10,988 
47,324 
58,312 
 
53,132 
 
13,047 
50,028 
63,075 
 
55,387 
 
10,138 
53,356 
63,494 
  - UK (covered bonds)
15,441 
 
9,107 
— 
9,107 
 
8,046 
 
4,100 
— 
4,100 
 
— 
 
— 
— 
— 
  - Irish
12,660 
 
3,472 
8,670 
12,142 
 
15,034 
 
5,101 
11,152 
16,253 
 
14,540 
 
5,799 
6,905 
12,704 
UK credit cards
4,037 
 
500 
110 
610 
 
3,993 
 
34 
1,500 
1,534 
 
2,975 
 
1,592 
1,500 
3,092 
UK personal loans
5,168 
 
— 
4,706 
4,706 
 
5,795 
 
— 
5,383 
5,383 
 
8,411 
 
— 
8,160 
8,160 
Other loans (4)
19,778 
 
20,577 
20,581 
 
25,193 
 
974 
23,186 
24,160 
 
28,037 
 
1,010 
25,290 
26,300 
 
106,633 
 
24,071 
81,387 
105,458 
 
111,193 
 
23,256 
91,249 
114,505 
 
109,350 
 
18,539 
95,211 
113,750 
Cash deposits (5)
11,998 
         
13,068 
         
12,016 
       
 
118,631 
         
124,261 
         
121,366 
       

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)
Comprises corporate, social housing and student loans.
(5)
At 31 December 2011, cash deposits comprised £11.2 billion from mortgage repayments and £0.8 billion from other loan repayments held in the SPEs, to repay debt securities issued by the own-asset securitisation vehicles (2010 - £12.3 billion and £0.8 billion; 2009 - £11.1 billion and £0.9 billion respectively).


 
355

 
Notes on the consolidated accounts continued

 
Continuing involvement
In certain securitisations of US residential mortgages, substantially all the risks and rewards have been neither transferred nor retained, but the Group has retained control, as defined by IFRS, of the assets and continues to recognise the assets to the extent of its continuing involvement which takes the form of retaining certain subordinated bonds issued by the securitisation SPEs. These bonds have differing rights and, depending on their terms, they may expose the Group to interest rate risk where they carry a fixed coupon or to credit risk depending on the extent of their subordination. Certain bonds entitle the Group to additional interest if the portfolio performs better than expected and others give the Group the right to prepayment penalties received on the securitised mortgages.  At 31 December 2011, securitised assets were £0.6 billion (2010 - £2.3 billion; 2009 - £3.1 billion); retained interest £72 million (2010 - £286 million; 2009 - £102 million); subordinated assets £3 million (2010 - £4 million; 2009 - £91 million); and related liabilities £3 million (2010 - £4 million; 2009 - £33 million).

The Group retained interests in securitised financial assets take the form of senior or subordinated securities.  These interests predominantly relate to mortgage-backed securities which were re-securitised.  Retained interests are generally not held to maturity and are typically sold after settlement of the securitisation.  Retained interests may be subordinated to other investors' interests.  Third party investors and securitisation trusts have no recourse to the Group's other assets for failure of debtors to perform on the securitised loans or securities, effectively transferring the risk of future credit losses to the purchasers of the securities issued by the trust.  The value of retained interest varies and is subject to credit, interest rate, prepayment, and other risks of the transferred assets.  In the ordinary course of business, the Group does not provide any other financial support to the securitisation trusts other than holding these retained interests.

Securities repurchase agreements and lending transactions
The Group enters into securities repurchase agreements and securities lending transactions 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 (and carrying value) of securities transferred under such repurchase transactions included within debt securities on the balance sheet, are set out below. All of these securities could be sold or repledged by the holder.
 
Assets pledged in securities repurchase agreements and lending transactions
2011 
£m 
2010 
£m 
2009 
£m 
Debt securities
79,480 
80,104 
66,883 
Equity shares
6,534 
5,148 
3,409 

Other collateral given
This primarily relates to cash collateral relating to derivative contracts as well as assets pledged for bank and other borrowings.

Assets pledged against liabilities
2011 
£m 
2010 
£m 
2009 
£m 
Loans and advances to banks
19,691 
27,271 
25,712 
Loans and advances to customers
52,225 
46,352 
38,924 
Debt securities
3,713 
7,200 
8,723 
 
75,629 
80,823 
73,359 

Liabilities secured by assets
     
Deposits by banks
6,369 
10,565 
12,724 
Customer accounts
2,663 
3,599 
3,319 
Debt securities in issue
— 
— 
1,237 
Derivatives
82,356 
93,570 
65,225 
 
91,388 
107,734 
82,505 


 
356

 

Notes on the consolidated accounts continued

 
31 Capital resources
The Group's regulatory capital resources in accordance with Financial Services Authority (FSA) definitions were as follows:

Shareholders’ equity (excluding non-controlling interests)
2011 
£m 
2010 
£m 
2009 
£m 
Shareholders’ equity per balance sheet
74,819 
75,132 
77,736 
Preference shares - equity
(4,313)
(4,313)
(7,281)
Other equity instruments
(431)
(431)
(565)
 
70,075 
70,388 
69,890 
       
Non-controlling interests
     
Non-controlling interests per balance sheet
1,234 
1,719 
16,895 
Non-controlling preference shares
(548)
(548)
(656)
Other adjustments to non-controlling interests for regulatory purposes
(259)
(259)
(497)
 
427 
912 
15,742 
       
Regulatory adjustments and deductions
     
Own credit
(2,634)
(1,182)
(1,057)
Unrealised losses on AFS debt securities
1,065 
2,061 
1,888 
Unrealised gains on AFS equity shares
(108)
(25)
(134)
Cash flow hedging reserve
(879)
140 
252 
Other adjustments for regulatory purposes
571 
204 
(193)
Goodwill and other intangible assets
(14,858)
(14,448)
(17,847)
50% excess of expected losses over impairment provisions (net of tax)
(2,536)
(1,900)
(2,558)
50% of securitisation positions
(2,019)
(2,321)
(1,353)
50% of APS first loss
(2,763)
(4,225)
(5,106)
 
(24,161)
(21,696)
(26,108)
       
Core Tier 1 capital
46,341 
49,604 
59,524 
       
Other Tier 1 capital
     
Preference shares - equity
4,313 
4,313 
7,281 
Preference shares - debt
1,094 
1,097 
3,984 
Innovative/hybrid Tier 1 securities
4,667 
4,662 
5,213 
 
10,074 
10,072 
16,478 
       
Tier 1 deductions
     
50% of material holdings
(340)
(310)
(601)
Tax on excess of expected losses over impairment provisions
915 
758 
1,020 
 
575 
448 
419 
       
Total Tier 1 capital
56,990 
60,124 
76,421 


 
357

 
Notes on the consolidated accounts continued


Qualifying Tier 2 capital
2011 
£m 
2010 
£m 
2009 
£m 
Undated subordinated debt
1,838 
1,852 
4,950 
Dated subordinated debt - net of amortisation
14,527 
16,745 
20,063 
Reserves arising on revaluation of property
— 
— 
73 
Unrealised gains on AFS equity shares
108 
25 
134 
Collectively assessed impairment provisions
635 
778 
796 
Non-controlling Tier 2 capital
11 
11 
11 
 
17,119 
19,411 
26,027 
       
Tier 2 deductions
     
50% of securitisation positions
(2,019)
(2,321)
(1,353)
50% excess of expected losses over impairment provisions
(3,451)
(2,658)
(3,578)
50% of material holdings
(340)
(310)
(601)
50% of APS first loss
(2,763)
(4,225)
(5,106)
 
(8,573)
(9,514)
(10,638)
       
Total Tier 2 capital
8,546 
9,897 
15,389 
       
Supervisory deductions
     
Unconsolidated investments
     
  - RBS Insurance
(4,354)
(3,962)
(4,068)
  - Other investments
(239)
(318)
(404)
Other deductions
(235)
(452)
(93)
 
(4,828)
(4,732)
(4,565)
       
Total regulatory capital (1)
60,708 
65,289 
87,245 

Note:
(1)
Total capital includes certain instruments issued by RBS N.V. Group that are treated consistent with the local implementation of the Capital Requirements Directive (including the transitional provisions of that Directive). The FSA formally confirmed this treatment in 2012.


It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the FSA. The FSA uses risk asset ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. The Group has complied with the FSA’s capital requirements throughout the year.

A number of subsidiaries and sub-groups within the Group, principally banking and insurance entities, are subject to various individual regulatory capital requirements in the UK and overseas.


 
358

 
 
Notes on the consolidated accounts continued

32 Memorandum items
Contingent liabilities and commitments
The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December 2011. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group's expectation of future losses.

 
Less than 
1 year 
More than 
1 year but 
less than 
3 years 
More than 
3 years but 
less than 
5 years 
Over 
5 years 
2011 
2010 
2009
 
£m 
£m 
£m 
£m 
£m 
£m 
£m
Contingent liabilities
             
Guarantees and assets pledged as collateral security
13,512 
3,514 
2,082 
5,924 
25,032 
31,101 
40,008
Other contingent liabilities
4,631 
1,958 
2,373 
1,950 
10,912 
12,254 
14,012
 
18,143 
5,472 
4,455 
7,874 
35,944 
43,355 
54,020
               
Commitments (1)
             
Undrawn formal standby facilities, credit lines and other
  commitments to lend
             
  - less than one year
100,092 
— 
— 
— 
100,092 
117,581 
127,423
  - one year and over
17,626 
38,175 
65,441 
18,629 
139,871 
149,241 
164,211
Other commitments
721 
132 
2,059 
— 
2,912 
4,154 
6,007
 
118,439 
38,307 
67,500 
18,629 
242,875 
270,976 
297,641

Note:
(1)
Includes liquidity facilities provided to Group sponsored conduits as detailed on page 83.


Banking commitments and contingent obligations, which have been entered into on behalf of customers and for which there are corresponding obligations from customers, are not included in assets and liabilities. The Group's maximum exposure to credit loss, in the event of non-performance by the other party and where all counterclaims, collateral or security proves valueless, is represented by the contractual nominal amount of these instruments included in the table above. These commitments and contingent obligations are subject to the Group's normal credit approval processes.

Contingent liabilities
Guarantees - the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer's obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.

Other contingent liabilities - these include standby letters of credit, supporting customer debt issues and contingent liabilities relating to customer trading activities such as those arising from performance and customs bonds, warranties and indemnities.

Commitments
Commitments to lend - under a loan commitment the Group agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.

Other commitments - these include documentary credits, which are commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents, forward asset purchases, forward deposits placed and undrawn note issuance and revolving underwriting facilities, and other short-term trade related transactions.

 
 
359

 
Notes on the consolidated accounts continued
 
 
Contractual obligations for future expenditure not provided for in the accounts
The following table shows contractual obligations for future expenditure not provided for in the accounts at the year end.

 
2011 
£m 
2010 
£m 
2009 
£m 
Operating leases
     
Minimum rentals payable under non-cancellable leases (1)
     
  - within 1 year
468 
497 
479 
  - after 1 year but within 5 years
1,453 
1,515 
1,691 
  - after 5 years
2,714 
2,892 
3,055 
 
4,635 
4,904 
5,225 
Property, plant and equipment
     
Contracts to buy, enhance or maintain investment properties
— 
— 
Contracts to buy assets to be leased under operating leases (2,3)
2,607 
2,585 
2,724 
Other capital expenditure
35 
150 
89 
 
2,642 
2,737 
2,813 
       
Contracts to purchase goods or services (4)
1,130 
950 
1,025 
 
8,407 
8,591 
9,063 

Notes:
(1)
Predominantly property leases.
(2)
Of which due within 1 year: £486 million (2010 - £263 million; 2009 - £370 million).
(3)
At 31 December 2011, £2,607 million related to the RBS Aviation Capital business which is included in disposal groups.
(4)
Of which due within 1 year: £483 million (2010 - £440 million; 2009 - £579 million).


Trustee and other fiduciary activities
In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group's financial statements. The Group earned fee income of £502 million (2010 - £629 million; 2009 - £1,355 million) from these activities.

The Financial Services Compensation Scheme
The Financial Services Compensation Scheme (FSCS), the UK's statutory fund of last resort for customers of authorised financial services firms, pays compensation if a firm is unable to meet its obligations. The FSCS funds compensation for customers by raising management expenses levies and compensation levies on the industry. In relation to protected deposits, each deposit-taking institution contributes towards these levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year (which runs from 1 April to 31 March), subject to annual maxima set by the Financial Services Authority. In addition, the FSCS has the power to raise levies on a firm that has ceased to participate in the scheme and is in the process of ceasing to be authorised for the costs that it would have been liable to pay had the FSCS made a levy in the financial year it ceased to be a participant in the scheme.
 
The FSCS has borrowed from HM Treasury to fund the compensation costs associated with Bradford & Bingley, Heritable Bank, Kaupthing Singer & Friedlander, Landsbanki ‘Icesave’ and London Scottish Bank plc. These borrowings are on an interest-only basis until 31 March 2012. The annual limit on the FSCS interest and management expenses levy for the period September 2008 to March 2012 in relation to these institutions has been capped at £1 billion per annum.

The FSCS will receive funds from asset sales, surplus cash flow, or other recoveries in relation to these institutions which will be used to reduce the principal amount of the FSCS's borrowings. After the interest only period a schedule for repayment of any outstanding borrowings will be agreed between the FSCS and HM Treasury in the light of market conditions at that time and the FSCS will begin to raise compensation levies (principal repayments).

The Group has accrued £157 million for its share of FSCS levies for the 2011/12 and 2012/13 scheme years.


 
360

 

Notes on the consolidated accounts continued


32 Memorandum items continued
Litigation and Investigations
RBSG and certain Group members are party to legal proceedings, investigations and regulatory matters in the United Kingdom, the United States and other jurisdictions, arising out of their normal business operations. All such matters are periodically reassessed with the assistance of external professional advisers, where appropriate, to determine the likelihood of the Group incurring a liability. The Group recognises a provision for a liability in relation to these matters when it is probable that an outflow of economic benefits will be required to settle an obligation which has arisen as a result of past events, and for which a reliable estimate can be made of the amount of the obligation.

In many proceedings, it is not possible to determine whether any loss is probable or to estimate the amount of any loss.  Numerous legal and factual issues may need to be resolved, including through potentially lengthy discovery and determination of important factual matters, and by addressing novel or unsettled legal questions relevant to the proceedings in question, before a liability can be reasonably estimated for any claim.  The Group cannot predict if, how, or when such claims will be resolved or what the eventual settlement, fine, penalty or other relief, if any, may be, particularly for claims that are at an early stage in their development or where claimants seek substantial or indeterminate damages.

While the outcome of the legal proceedings, investigations and regulatory matters in which the Group is involved is inherently uncertain, management believes that, based on the information available to it, appropriate provisions have been made in respect of legal proceedings, investigations and regulatory matters as at 31 December 2011.

Other than as set out in these sections entitled ‘Litigation’ and ‘Investigations, reviews and proceedings’, no member of the Group is or has been involved in any governmental, legal or arbitration proceedings (including any such proceedings which are pending or threatened of which RBSG is aware) during the 12 months prior to the date of this document which may have, or have had in the recent past, significant effects on the financial position or profitability of RBSG and/or the Group taken as a whole.

In each of the material legal proceedings and investigations, reviews and proceedings described below, unless specifically noted otherwise, it is not possible to reliably estimate with any certainty the liability, if any, or the effect these proceedings investigations and reviews, and any related developments, may have on the Group.  However, in the event that any such matters were resolved against the Group, these matters could, individually or in the aggregate, have a material adverse effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Litigation
Set out below are descriptions of the material legal proceedings involving the Group.

Shareholder litigation
RBSG and certain of its subsidiaries, together with certain current and former individual officers and directors have been named as defendants in purported class actions filed in the United States District Court for the Southern District of New York involving holders of RBSG preferred shares (the “Preferred Shares litigation”) and holders of American Depositary Receipts (the “ADR claims”).

In the Preferred Shares litigation, the consolidated amended complaint alleges certain false and misleading statements and omissions in public filings and other communications during the period 1 March 2007 to 19 January 2009, and variously asserts claims under Sections 11, 12 and 15 of the US Securities Act of 1933, as amended (the ”Securities Act”). The putative class is composed of all persons who purchased or otherwise acquired Group Series Q, R, S, T and/or U non-cumulative dollar preference shares issued pursuant or traceable to the 8 April 2005 US Securities and Exchange Commission (the SEC) registration statement. Plaintiffs seek unquantified damages on behalf of the putative class. The defendants have moved to dismiss the complaint and briefing on the motions was completed in September 2011.

With respect to the ADR claims, a complaint was filed in January 2011 and a further complaint was filed in February 2011 asserting claims under Sections 10 and 20 of the US Securities Exchange Act of 1934, as amended (the “Exchange Act”) on behalf of all persons who purchased or otherwise acquired the Group’s American Depositary Receipts (ADRs) between 1 March 2007 and 19 January 2009. On 18 August 2011, these two ADR cases were consolidated and lead plaintiff and lead counsel were appointed. On 1 November 2011, the lead plaintiff filed a consolidated amended complaint asserting ADR-related claims under Sections 10 and 20 of the Exchange Act and Sections 11, 12 and 15 of the Securities Act. The defendants moved to dismiss the complaint in January 2012 and briefing is ongoing.

The Group has also received notification of similar prospective claims in the United Kingdom and elsewhere but no court proceedings have been commenced in relation to these claims.

The Group considers that it has substantial and credible legal and factual defences to the remaining and prospective claims and will defend itself vigorously.

Other securitisation and securities related litigation in the United States
Recently, the level of litigation activity in the financial services industry focused on residential mortgage and credit crisis related matters has increased.  As a result, the Group has become and expects that it may further be the subject of additional claims for damages and other relief regarding residential mortgages and related securities in the future.


 
361

 
Notes on the consolidated accounts continued
 

 
To date, Group companies have been named as defendants in their various roles as issuer, depositor and/or underwriter in a number of claims in the United States that relate to the securitisation and securities underwriting businesses. These cases include actions by individual purchasers of securities and purported class action suits. Together, the individual and class action cases involve the issuance of more than US$83 billion of mortgage-backed securities (MBS) issued primarily from 2005 to 2007. Although the allegations vary by claim, in general, plaintiffs in these actions claim that certain disclosures made in connection with the relevant offerings contained materially false or misleading statements and/or omissions regarding the underwriting standards pursuant to which the mortgage loans underlying the securities were issued.  Group companies have been named as defendants in more than 30 lawsuits brought by purchasers of MBS, including five purported class actions.  Among the lawsuits are six cases filed on 2 September 2011 by the US Federal Housing Finance Agency (FHFA) as conservator for the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac").  The primary FHFA lawsuit pending in the federal court in Connecticut relates to approximately US$32 billion of AAA rated MBS for which Group entities acted as sponsor/depositor and/or lead underwriter or co-lead underwriter.

FHFA has also filed five separate lawsuits (against Ally Financial Group, Countrywide Financial Corporation, JP Morgan, Morgan Stanley and Nomura respectively) in which RBS Securities Inc. is named as a defendant by virtue of the fact that it was an underwriter of some of the securities at issue.

Other lawsuits against Group companies include two cases filed by the National Credit Union Administration Board (on behalf of US Central Federal Credit Union and Western Corporate Federal Credit Union) and eight cases filed by the Federal Home Loan Banks of Boston, Chicago, Indianapolis, Seattle and San Francisco.

The purported MBS class actions in which Group companies are defendants include New Jersey Carpenters Vacation Fund et al. v. The Royal Bank of Scotland plc et al.;  New Jersey Carpenters Health Fund v. Novastar Mortgage Inc. et al.;  In re IndyMac Mortgage-Backed Securities Litigation;  Genesee County Employees’ Retirement System et al.  v. Thornburg Mortgage Securities Trust 2006-3, et al.; and Luther v. Countrywide Financial Corp. et al. and related cases.

Certain other institutional investors have threatened to bring claims against the Group in connection with various mortgage-related offerings. The Group cannot predict with any certainty whether any of these individual investors will pursue these threatened claims (or their outcome), but expects that several may. If such claims are asserted and were successful, the amounts involved may be material.

In many of these actions, the Group has or will have contractual claims to indemnification from the issuers of the securities (where a Group company is underwriter) and/or the underlying mortgage originator (where a Group company is issuer). The amount and extent of any recovery on an indemnification claim, however, is uncertain and subject to a number of factors, including the ongoing creditworthiness of the indemnifying party.

With respect to the current claims described above, the Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously.

Madoff
In December 2010, Irving Picard, as trustee for the bankruptcy estates of Bernard L. Madoff and Bernard L. Madoff Investment Securities LLC filed a claim against RBS N.V. for approximately US$271 million. This is a clawback action similar to claims filed against six other institutions in December 2010. RBS N.V. (or its subsidiaries) invested in Madoff funds through feeder funds. The Trustee alleges that RBS N.V. received US$71 million in redemptions from the feeder funds and US$200 million from its swap counterparties while RBS N.V. ‘knew or should have known of Madoff’s possible fraud’. The Trustee alleges that those transfers were preferences or fraudulent conveyances under the US bankruptcy code and New York law and he asserts the purported right to claw them back for the benefit of Madoff’s estate. A further claim, for US$21.8 million, was filed in October 2011.  The Group considers that it has substantial and credible legal and factual defences to these claims and intends to defend itself vigorously.

Unarranged overdraft charges
In the US, Citizens Financial Group, Inc (“Citizens”) in common with other US banks, has been named as a defendant in a class action asserting that Citizens charges excessive overdraft fees. The plaintiffs claim that overdraft fees resulting from point of sale and automated teller machine (ATM) transactions violate the duty of good faith implied in Citizens’ customer account agreement and constitute an unfair trade practice. The Group considers that it has substantial and credible legal and factual defences to these claims and will defend them vigorously.

London Interbank Offered Rate (LIBOR)
Certain members of the Group have been named as defendants in a number of class actions and individual claims filed in the US with respect to the setting of LIBOR. The complaints are substantially similar and allege that certain members of the Group and other panel banks individually and collectively violated US commodities and antitrust laws and state common law by manipulating LIBOR and prices of LIBOR-based derivatives in various markets through various means. The Group considers that it has substantial and credible legal and factual defences to these and prospective claims.


 
362

 
 
Notes on the consolidated accounts continued


32 Memorandum items continued
Litigation and Investigations continued
Summary of other disputes, legal proceedings and litigation
In addition to the matters described above, members of the Group are engaged in other legal proceedings in the United Kingdom and a number of overseas jurisdictions, including the United States, involving claims by and against them arising in the ordinary course of business. The Group has reviewed these other actual, threatened and known potential claims and proceedings and, after consulting with its legal advisers, does not expect that the outcome of any of these other claims and proceedings will have a significant effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Investigations, reviews and proceedings
The Group’s businesses and financial condition can be affected by the fiscal or other policies and actions of various governmental and regulatory authorities in the United Kingdom, the European Union, the United States and elsewhere. The Group has engaged, and will continue to engage, in discussions with relevant regulators, including in the United Kingdom and the United States, on an ongoing and regular basis regarding operational, systems and control evaluations and issues including those related to compliance with applicable anti-bribery, anti-money laundering and sanctions regimes. It is possible that any matters discussed or identified may result in investigatory or other action being taken by the regulators, increased costs being incurred by the Group, remediation of systems and controls, public or private censure, restriction of the Group’s business activities or fines. Any of these events or circumstances could have a significant effect on the Group, its business, authorisations and licences, reputation, results of operations or the price of securities issued by it.

Political and regulatory scrutiny of the operation of retail banking and consumer credit industries in the United Kingdom, United States and elsewhere continues. The nature and impact of future changes in policies and regulatory action are not predictable and are beyond the Group’s control but could have a significant effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

The Group is cooperating fully with the investigations and proceedings described below.

Retail banking
In the European Union, regulatory actions included an inquiry into retail banking initiated on 13 June 2005 in all of the then 25 member states by the European Commission’s Directorate General for Competition. The inquiry examined retail banking in Europe generally. On 31 January 2007, the European Commission (EC) announced that barriers to competition in certain areas of retail banking, payment cards and payment systems in the European Union had been identified. The EC indicated that it will consider using its powers to address these barriers and will encourage national competition authorities to enforce European and national competition laws where appropriate. In addition, in late 2010, the EC launched an initiative pressing for increased transparency in respect of bank fees. The EC is currently proposing to legislate for the increased harmonisation of terminology across Member States, with proposals expected in 2012. The Group cannot predict the outcome of these actions at this stage and is unable reliably to estimate the effect, if any, that these may have on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Multilateral interchange fees
In 2007, the EC issued a decision that while interchange is not illegal per se, MasterCard’s current multilateral interchange fee (MIF) arrangements for cross border payment card transactions with MasterCard and Maestro branded consumer credit and debit cards in the European Union are in breach of competition law. MasterCard was required by the decision to withdraw the relevant cross-border MIF (i.e. set these fees to zero) by 21 June 2008.

MasterCard appealed against the decision to the European Court of First Instance (subsequently re-named the General Court) on 1 March 2008, and the Group has intervened in the appeal proceedings. In addition, in summer 2008, MasterCard announced various changes to its scheme arrangements. The EC was concerned that these changes might be used as a means of circumventing the requirements of the infringement decision. In April 2009, MasterCard agreed an interim settlement on the level of cross-border MIF with the EC pending the outcome of the appeal process and, as a result, the EC has advised it will no longer investigate the non-compliance issue (although MasterCard is continuing with its appeal). The appeal was heard on 8 July 2011 by the General Court and judgment is awaited. This could be delivered in spring or summer 2012, although it may take longer.

Visa’s cross-border MIFs were exempted in 2002 by the EC for a period of five years up to 31 December 2007 subject to certain conditions. On 26 March 2008, the EC opened a formal inquiry into Visa’s current MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit cards in the European Union and on 6 April 2009 the EC announced that it had issued Visa with a formal Statement of Objections. At the same time Visa announced changes to its interchange levels and introduced some changes to enhance transparency. There is no deadline for the closure of the inquiry. However, on 26 April 2010 Visa announced it had reached an agreement with the EC as regards immediate cross border debit card MIF rates only and in December 2010 the commitments were finalised for a four year period commencing December 2010 under Article 9 of Regulation 1/2003. The EC is continuing its investigations into Visa’s cross border MIF arrangements for deferred debit and credit transactions.

In the UK, the Office of Fair Trading (OFT) has carried out investigations into Visa and MasterCard domestic credit card interchange rates. The decision by the OFT in the MasterCard interchange case was set aside by the Competition Appeal Tribunal (CAT) in June 2006. The OFT’s investigations in the Visa interchange case and a second MasterCard interchange case are ongoing. On 9 February 2007, the OFT announced that it was expanding its investigation into domestic interchange rates to include debit cards. In January 2010 the OFT advised that it did not anticipate issuing a Statement of Objections prior to the General Court’s judgment, although it has reserved the right to do so if it considers it appropriate.

The outcome of these investigations is not known, but they may have a significant effect on the consumer credit industry in general and, therefore, on the Group’s business in this sector.

 
 
363

 
Notes on the consolidated accounts continued
 
Payment Protection Insurance
Having conducted a market study relating to Payment Protection Insurance (PPI), in February 2007 the OFT referred the PPI market to the Competition Commission (CC) for an in-depth inquiry. The CC published its final report in January 2009 and announced its intention to order a range of remedies, including a prohibition on actively selling PPI at point of sale of the credit product (and for 7 days thereafter), a ban on single premium policies and other measures to increase transparency (in order to improve customers’ ability to search and improve price competition). Barclays Bank PLC subsequently appealed certain CC findings to the CAT. In October 2009, the CAT handed down a judgment remitting the matter back to the CC for review. Following further review, in October 2010, the CC published its final decision on remedies following the remittal which confirmed the point of sale prohibition. In March 2011, the CC made a final order setting out its remedies with a commencement date of 6 April 2011. The key remedies come into force in two parts. A number came into force in October 2011, and the remainder come into force in April 2012.

The FSA conducted a broad industry thematic review of PPI sales practices and in September 2008, the FSA announced that it intended to escalate its level of regulatory intervention. Substantial numbers of customer complaints alleging the mis-selling of PPI policies have been made to banks and to the Financial Ombudsman Service (“FOS”) and many of these are being upheld by the FOS against the banks.

Following unsuccessful negotiations with the industry, the FSA issued consultation papers on PPI complaint handling and redress in September 2009 and in March 2010. The FSA published its final policy statement in August 2010.  The new rules imposed significant changes with respect to the handling of mis-selling PPI complaints. In October 2010, the British Bankers’ Association (BBA) filed an application for judicial review of the FSA’s policy statement and of related guidance issued by the FOS.   In April 2011 the High Court issued judgment in favour of the FSA and the FOS and in May 2011 the BBA announced that it would not appeal that judgment. The Group then recorded an additional provision of £850 million in respect of PPI.  During 2011, the Group reached agreement with the FSA on a process for implementation of its policy statement and for the future handling of PPI complaints.

Personal current accounts
On 16 July 2008, the OFT published the results of its market study into Personal Current Accounts (PCAs) in the United Kingdom. The OFT found evidence of competition and several positive features in the personal current account market but believed that the market as a whole was not working well for consumers and that the ability of the market to function well had become distorted.

On 7 October 2009, the OFT published a follow-up report summarising the initiatives agreed between the OFT and personal current account providers to address the OFT’s concerns about transparency and switching, following its market study. Personal current account providers will take a number of steps to improve transparency, including providing customers with an annual summary of the cost of their account and making charges prominent on monthly statements. To improve the switching process, a number of steps are being introduced following work with Bacs, the payment processor, including measures to reduce the impact on consumers of any problems with transferring direct debits.

On 22 December 2009, the OFT published a further report in which it stated that it continued to have significant concerns about the operation of the PCA market in the United Kingdom, in particular in relation to unarranged overdrafts, and that it believed that fundamental changes are required for the market to work in the best interests of bank customers. The OFT stated that it would discuss these issues intensively with banks, consumer groups and other organisations, with the aim of reporting on progress by the end of March 2010. On 16 March 2010, the OFT announced that it had secured agreement from the banks on four industry-wide initiatives, namely minimum standards on the operation of opt-outs from unarranged overdrafts, new working groups on information sharing with customers, best practice for PCA customers in financial difficulties and incurring charges, and PCA providers to publish their policies on dealing with PCA customers in financial difficulties. The OFT also announced its plan to conduct six-monthly ongoing reviews, fully to review the market again in 2012 and to undertake a brief analysis on barriers to entry.

The first six-monthly ongoing review was completed in September 2010. The OFT noted progress in the areas of switching, transparency and unarranged overdrafts for the period March to September 2010, as well as highlighting further changes the OFT expected to see in the market. On 29 March 2011, the OFT published its update report in relation to PCA. This noted further progress in improving consumer control over the use of unarranged overdrafts. In particular, the Lending Standards Board had led on producing standards and guidance to be included in a revised Lending Code. The OFT stated it would continue to monitor the market and would consider the need for, and appropriate timing of, further update reports in light of other developments, in particular the work of the UK Government’s Independent Commission on Banking (ICB). The OFT has indicated its intention to conduct a more comprehensive review of the market in 2012.

On 26 May 2010, the OFT announced its review of barriers to entry. The review concerned retail banking for individuals and small and medium size enterprises (up to £25 million turnover) and looked at products which require a banking licence to sell mortgages, loan products and, where appropriate, other products such as insurance or credit cards where cross-selling may facilitate entry or expansion. The OFT published its report in November 2010. It advised that it expected its review to be relevant to the ICB, the FSA, HM Treasury and the Department for Business, Innovation and Skills and to the devolved governments in the United Kingdom. The OFT did not indicate whether it would undertake any further work. The report maintained that barriers to entry remain, in particular regarding switching, branch networks and brands. At this stage, it is not possible to estimate the effect of the OFT’s report and recommendations regarding barriers to entry upon the Group.



 
364

 

Notes on the consolidated accounts continued



32 Memorandum items continued
Private motor insurance
On 14 December 2011, the OFT launched a market study into private motor insurance, with a focus on the provision of third party vehicle repairs and credit hire replacement vehicles to claimants. The OFT aims to complete its market study by spring 2012. At this stage, it is not possible to estimate with any certainty the effect the market study and any related developments may have on the Group.

Independent Commission on Banking
Following an interim report published on 11 April 2011, the ICB published its final report to the Cabinet Committee on Banking Reform on 12 September 2011 (the “Final Report”). The Final Report makes a number of recommendations, including in relation to (i) the implementation of a ring-fence of retail banking operations, (ii) loss-absorbency (including bail-in) and (iii) competition.

On 19 December 2011 the UK Government published a response to the Final Report (the “Response”), reaffirming its intention to accept the majority of the ICB’s recommendations. The Government agreed that “vital banking services - in particular the taking of retail deposits – should only be provided by ‘ring-fenced banks’, and that these banks should be prohibited from undertaking certain investment banking activities.” It also broadly accepted the ICB’s recommendations on loss absorbency and on competition.

The UK Government has now embarked on an extensive consultation on how exactly the general principles outlined by the ICB should be implemented, and intends to bring forward a White Paper in the spring of 2012. Its intention is to complete primary and secondary legislation before the end of the current Parliamentary term in May 2015 and to implement the ring-fencing measures as soon as practicable thereafter and the loss absorbency measures by 2019. The Government also stated its determination that changes to the account switching process should be completed by September 2013, as already scheduled.

With regard to the competition aspects, the Government recommended a number of initiatives aimed at improving transparency and switching in the market and ensuring a level playing field for new entrants. In addition, the Government has recommended that HM Treasury should consult on regulating the UK Payments Council and has confirmed that the Financial Conduct Authority's remit will include competition.

Until the UK Government consultation is concluded and significantly more detail is known on how the precise legislative and regulatory framework is to be implemented it is impossible to estimate the potential impact of these measures with any level of precision.

The Group will continue to participate in the debate and to consult with the UK Government on the implementation of the recommendations set out in the Final Report and the Response, the effects of which could have a negative impact on the Group’s consolidated net assets, operating results or cash flows in any particular period.

US dollar clearing activities
In May 2010, following a criminal investigation by the United States Department of Justice (DoJ) into its dollar clearing activities, Office of Foreign Assets Control compliance procedures and other Bank Secrecy Act compliance matters, RBS N.V. formally entered into a Deferred Prosecution Agreement (DPA) with the DoJ resolving the investigation. Pursuant to the DPA, RBS N.V. paid a penalty of US$500 million in 2010 and agreed to comply with the terms of the DPA and to co-operate fully with any further investigations. Payment of the penalty was made from a provision established in April 2007 when an agreement in principle to settle was first announced.  On 20 December 2011, the DoJ filed a motion with the US District Court to dismiss the criminal information underlying the DPA, stating that RBS N.V. had met the terms and obligations of the DPA.  The US District Court granted the DoJ’s motion on the same day, and this matter is now fully resolved.

Securitisation and collateralised debt obligation business
In the United States, the Group is also involved in other reviews, investigations and proceedings (both formal and informal) by federal and state governmental law enforcement and other agencies and self-regulatory organisations relating to, among other things, mortgage-backed securities, collateralised debt obligations (CDOs), and synthetic products.  In connection with these inquiries, Group companies have received requests for information and subpoenas seeking information about, among other things, the structuring of CDOs, financing to loan originators, purchase of whole loans, sponsorship and underwriting of securitisations, due diligence, representations and warranties, communications with ratings agencies, disclosure to investors, document deficiencies, and repurchase requests.

By way of example, in September and October 2010, the SEC requested voluntary production of information concerning residential mortgage-backed securities underwritten by subsidiaries of RBSG during the period from September 2006 to July 2007 inclusive. In November 2010, the SEC commenced a formal investigation and requested testimony from a former Group employee. The investigation is in its preliminary stages and it is difficult to predict any potential exposure that may result.


 
365

 
Notes on the consolidated accounts continued


Also in October 2010, the SEC commenced an inquiry into document deficiencies and repurchase requests with respect to certain securitisations, and in January 2011, this was converted to a formal investigation. Among other matters, the investigation seeks information related to document deficiencies and remedial measures taken with respect to such deficiencies. The investigation also seeks information related to early payment defaults and loan repurchase requests.

In June 2009, in connection with an investigation into the role of investment banks in the origination and securitisation of sub-prime loans in Massachusetts, the Massachusetts Attorney General issued subpoenas to various banks, including an RBSG subsidiary, seeking information related to residential mortgage lending practices and sales and securitisation of residential mortgage loans.  On 28 November 2011, an Assurance of Discontinuance between RBS Financial Products Inc. and the Massachusetts Attorney General was filed in Massachusetts State Court which resolves the Massachusetts Attorney General's investigation as to RBSG. The Assurance of Discontinuance required RBS Financial Products Inc. to make payments totalling approximately US$52 million.

In 2007, the New York State Attorney General issued subpoenas to a wide array of participants in the securitisation and securities industry, focusing on the information underwriters obtained from the independent firms hired to perform due diligence on mortgages. The Group completed its production of documents requested by the New York State Attorney General in 2008, principally producing documents related to loans that were pooled into one securitisation transaction. In May 2011, at the New York State Attorney General's request, representatives of the Group attended an informal meeting to provide additional information about the Group's mortgage securitisation business. The investigation is ongoing and the Group continues to provide requested information.

In September 2010, RBSG subsidiaries received a request from the Nevada State Attorney General requesting information related to securitisations of mortgages issued by three specific originators. The investigation by the Nevada State Attorney General is in the early stages and therefore it is difficult to predict the potential exposure from any such investigation.

US mortgages - Loan Repurchase Matters
The Group’s Global Banking & Markets N.A. (GBM N.A.), has been a purchaser of non-agency US residential mortgages in the secondary market, and an issuer and underwriter of non-agency residential mortgage-backed securities (RMBS). GBM N.A. did not originate or service any US residential mortgages and it was not a significant seller of mortgage loans to government sponsored enterprises (“GSEs”) (e.g., the Federal National Mortgage Association and the Federal Home Loan Mortgage Association).

In issuing RMBS, GBM N.A. generally assigned certain representations and warranties regarding the characteristics of the underlying loans made by the originator of the residential mortgages; however, in some circumstances, GBM N.A. made such representations and warranties itself. Where GBM N.A. has given those or other representations and warranties (whether relating to underlying loans or otherwise), GBM N.A. may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of such representations and warranties. In certain instances where it is required to repurchase loans or related securities, GBM N.A. may be able to assert claims against third parties who provided representations or warranties to GBM N.A. when selling loans to it; although the ability to recover against such parties is uncertain. Since January 2009, GBM N.A. has received approximately US$75 million in repurchase demands in respect of loans made primarily from 2005 to 2008 and related securities sold where obligations in respect of contractual representations or warranties were undertaken by GBM N.A.. However, repurchase demands presented to GBM N.A. are subject to challenge and, to date, GBM N.A. has rebutted a significant percentage of these claims.

Citizens has not been an issuer or underwriter of non-agency RMBS. However, Citizens is an originator and servicer of residential mortgages, and it routinely sells such mortgage loans in the secondary market and to GSEs. In the context of such sales, Citizens makes certain representations and warranties regarding the characteristics of the underlying loans and, as a result, may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of the representations and warranties concerning the underlying loans. Since January 2009, Citizens has received approximately US$41.2 million in repurchase demands in respect of loans originated primarily since 2003. However, repurchase demands presented to Citizens are subject to challenge and, to date, Citizens has rebutted a significant percentage of these claims.

Although there has been disruption in the ability of certain financial institutions operating in the United States to complete foreclosure proceedings in respect of US mortgage loans in a timely manner (or at all) over the last year (including as a result of interventions by certain states and local governments), to date, Citizens has not been materially impacted by such disruptions and the Group has not ceased making foreclosures.

The Group cannot estimate what the future level of repurchase demands or ultimate exposure of GBM N.A. or Citizens may be, and cannot give any assurance that the historical experience will continue in the future. It is possible that the volume of repurchase demands will increase in the future.  Furthermore, the Group is unable to estimate the extent to which the matters described above will impact it and future developments may have an adverse impact on the Group’s consolidated net assets, operating results or cash flows in any particular period.


 
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Notes on the consolidated accounts continued



32 Memorandum items continued
Litigation and Investigations continued
LIBOR
The Group continues to receive requests from various regulators investigating the setting of LIBOR and other interest rates, including the US Commodity Futures Trading Commission, the US Department of Justice, the European Commission, the FSA and the Japanese Financial Services Agency. The authorities are seeking documents and communications related to the process and procedures for setting LIBOR and other interest rates, together with related trading information. In addition to co-operating with the investigations as described above, the Group is also keeping relevant regulators informed. It is not possible to estimate with any certainty what effect these investigations and any related developments may have on the Group.

Other investigations
The Federal Reserve and state banking supervisors have been reviewing the Group's US operations and RBSG and its subsidiaries have been required to make improvements with respect to various matters, including enterprise-wide governance, US Bank Secrecy Act and anti-money laundering compliance, risk management and asset quality. The Group is in the process of implementing measures for matters identified to date.

On 27 July 2011, the Group consented to the issuance of a Cease and Desist Order (“the Order”) setting forth measures required to address deficiencies related to governance, risk management and compliance systems and controls identified by the Federal Reserve and state banking supervisors during examinations of the RBS plc and RBS N.V. branches in 2010. The Order requires the Group to strengthen its US corporate governance structure, to develop an enterprise-wide risk management programme, and to develop and enhance its programmes to ensure compliance with US law, particularly the US Bank Secrecy Act and anti-money laundering laws, rules and regulations. The Group has established a strategic and remedial programme of change to address the identified concerns and is committed to working closely with the US bank regulators to implement the remedial measures required by the Order.

The Group’s operations include businesses outside the United States that are responsible for processing US dollar payments. The Group is conducting a review of its policies, procedures and practices in respect of such payments and has initiated discussions with UK and US authorities to discuss its historical compliance with applicable laws and regulations, including US economic sanctions regulations. Although the Group cannot currently determine when the review of its operations will be completed or what the outcome of its discussions with UK and US authorities will be, the investigation costs, remediation required or liability incurred could have a material adverse effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

The Group may become subject to formal and informal supervisory actions and may be required by its US banking supervisors to take further actions and implement additional remedial measures with respect to these and additional matters. Any limitations or conditions placed on the Group's activities in the United States, as well as the terms of any supervisory action applicable to RBSG and its subsidiaries, could have a material adverse effect on the Group's consolidated net assets, operating results or cash flows in any particular period.

In April 2009, the FSA notified the Group that it was commencing a supervisory review of the acquisition of ABN AMRO Holding N.V. in 2007 and the 2008 capital raisings and an investigation into conduct, systems and controls within the Global Banking & Markets division of the Group. RBSG and its subsidiaries co-operated fully with this review and investigation. On 2 December 2010, the FSA confirmed that it had completed its investigation and had concluded that no enforcement action, either against the Group or against individuals, was warranted. On 12 December 2011, the FSA published its report ‘The Failure of the Royal Bank of Scotland’, on which the Group engaged constructively with the FSA.

In July 2010, the FSA notified the Group that it was commencing an investigation into the sale by Coutts & Co of the ALICO (American Life Insurance Company) Premier Access Bond Enhanced Variable Rate Fund (“EVRF”) to customers between 2001 and 2008 as well as its subsequent review of those sales. Subsequently on 11 January 2011 the FSA revised the investigation start date to December 2003.

On 8 November 2011, the FSA published its Final Notice having reached a settlement with Coutts & Co, under which Coutts & Co agreed to pay a fine of £6.3 million.  The FSA did not make any findings on the suitability of advice given in individual cases.  Nonetheless, Coutts & Co has agreed to undertake a past business review of its sales of the product.  This review will be overseen by an independent third party and will consider the advice given to customers invested in the EVRF as at the date of its suspension, 15 September 2008. For any sales which are found to be unsuitable, redress will be paid to the customers to ensure that they have not suffered financially.

On 18 January 2012, the FSA published its Final Notice having reached a settlement with UK Insurance Limited for breaches of Principle 2 by Direct Line and Churchill (the "Firms"), under which UK Insurance Limited agreed to pay a fine of £2.17 million.  The Firms were found to have acted without due skill, care and diligence in the way that they responded to the FSA's request to provide it with a sample of their closed complaint files. The Firms' breaches of Principle 2 did not result in any customer detriment.

During March 2008, the Group was advised by the SEC that it had commenced a non-public, formal investigation relating to the Group’s United States sub-prime securities exposures and United States residential mortgage exposures. In December 2010, the SEC contacted the Group and indicated that it would also examine valuations of various RBS N.V. structured products, including CDOs.

 
 
367

 
Notes on the consolidated accounts continued
 
 
33 Net cash inflow/(outflow) from operating activities
 
2011 
2010 
2009 
 
£m 
£m 
£m 
Operating loss before tax - continuing operations
(766)
(399)
(2,647)
Operating profit/(loss) before tax - discontinued operations
58 
(541)
(49)
Decrease/(increase) in prepayments and accrued income
976 
(67)
433 
Interest on subordinated liabilities
740 
500 
1,490 
Decrease in accruals and deferred income
(2,897)
(1,915)
(1,538)
Provisions for impairment losses
8,709 
9,298 
14,950 
Loans and advances written-off net of recoveries
(4,000)
(5,631)
(6,540)
Unwind of discount on impairment losses
(484)
(455)
(408)
Profit on sale of property, plant and equipment
(22)
(50)
(43)
Loss on sale of subsidiaries and associates
28 
107 
135 
Profit on sale of securities
(882)
(496)
(294)
Charge for defined benefit pension schemes
349 
540 
659 
Pension schemes curtailment gains
— 
(78)
(2,148)
Cash contribution to defined benefit pension schemes
(1,059)
(832)
(1,153)
Other provisions utilised
(513)
(211)
(159)
Depreciation and amortisation
1,875 
2,220 
2,809 
Gain on redemption of own debt
(255)
(553)
(3,790)
Write-down of goodwill and other intangible assets
91 
10 
363 
Elimination of foreign exchange differences
2,702 
(691)
12,217 
Other non-cash items
2,303 
875 
1,404 
Net cash inflow from trading activities
6,953 
1,631 
15,691 
Decrease in loans and advances to banks and customers
15,800 
42,766 
151,568 
Decrease/(increase) in securities
10,418 
8,723 
(5,902)
Decrease/(increase) in other assets
4,991 
445 
(1,839)
(Increase)/decrease in derivative assets
(102,972)
10,741 
544,744 
Changes in operating assets
(71,763)
62,675 
688,571 
Increase/(decrease) in deposits by banks and customers
24,096 
(24,794)
(131,685)
(Decrease)/increase in insurance liabilities
(482)
494 
429 
Decrease in debt securities in issue
(55,496)
(28,493)
(34,528)
Increase in other liabilities
1,827 
1,108 
20 
Increase/(decrease) in derivative liabilities
100,133 
2,454 
(540,540)
(Decrease)/increase in settlement balances and short positions
(1,759)
3,651 
1,769 
Changes in operating liabilities
68,319 
(45,580)
(704,535)
Income taxes (paid)/received
(184)
565 
(719)
Net cash inflow/(outflow) from operating activities
3,325 
19,291 
(992)


34 Analysis of the net investment in business interests and intangible assets
Acquisitions and disposals
 
2011 
£m 
2010 
£m 
2009 
£m 
Fair value given for businesses acquired
(44)
(210)
(115)
Other assets sold
(299)
4,539 
896 
Loss on disposal
(28)
(107)
(135)
Net (outflow)/inflow of cash in respect of disposals
(327)
4,432 
761 
Dividends received from joint ventures
11 
21 
Cash expenditure on intangible assets
(1,068)
(783)
(562)
Net (outflow)/inflow
(1,428)
3,446 
105 


The Group's reported results from continuing operations for 2011, 2010 and 2009 would not have been materially affected had all acquisitions occurred on 1 January 2009.


 
368

 
 
Notes on the consolidated accounts continued

 
35 Interest received and paid
 
2011 
£m 
2010 
£m 
2009 
£m 
Interest received
21,777 
23,571 
36,396 
Interest paid
(8,629)
(9,823)
(21,224)
 
13,148 
13,748 
15,172 


36 Analysis of changes in financing during the year

 
Share capital,
 share premium, paid-in equity
 and merger reserve
 
Subordinated liabilities
 
2011 
£m 
2010 
£m 
2009 
£m 
 
2011 
£m 
2010 
£m 
2009 
£m 
At 1 January
52,750 
64,240 
49,323 
 
27,053 
37,652 
49,154 
Issue of ordinary shares
 
— 
— 
Redemption of preference shares
— 
117 
(5,000)
 
— 
— 
Placing and open offer
— 
— 
5,274 
 
— 
— 
Issue of B shares
— 
— 
25,101 
 
— 
— 
Redemption of paid-in equity
— 
(132)
(308)
 
— 
— 
Cancellation of non-voting deferred shares
— 
(27)
— 
 
— 
— 
— 
Issue of subordinated liabilities
— 
— 
 
— 
— 
2,309 
Repayment of subordinated liabilities
— 
— 
 
(627)
(1,588)
(5,145)
Net cash inflow/(outflow) from financing
(41) 
25,067 
 
(627)
(1,588)
(2,836)
Transfer to retained earnings
(50)
(12,252)
(10,150)
 
— 
— 
Other adjustments including foreign exchange (1)
270 
803 
 
(107)
(9,011)
(8,666)
At 31 December
52,972 
52,750 
64,240 
 
26,319 
27,053 
37,652 

Note:
(1)
The subordinated liabilities adjustment in 2010 includes £6.1 billion relating to the disposal of RFS Holdings minority interest.


37 Analysis of cash and cash equivalents
 
2011 
£m 
2010 
£m 
2009 
£m 
At 1 January
     
  - cash
102,573 
95,330 
72,425 
  - cash equivalents
49,957 
48,856 
62,500 
 
152,530 
144,186 
134,925 
Disposal of subsidiaries
— 
(4,112)
— 
Net cash inflow
125 
12,456 
9,261 
At 31 December
152,655 
152,530 
144,186 
       
Comprising:
     
Cash and balances at central banks
79,269 
56,590 
51,811 
Treasury bills and debt securities
3,172 
5,672 
15,818 
Loans and advances to banks
70,214 
90,268 
76,557 
Cash and cash equivalents
152,655 
152,530 
144,186 


Certain subsidiary undertakings are required to maintain balances with the Bank of England which, at 31 December 2011, amounted to £415 million (2010 - £424 million; 2009 - £450 million). Certain subsidiary undertakings are required by law to maintain reserve balances with the Federal Reserve Bank in the US. Such reserve balances were $1.2 billion at 31 December 2011 (2010 and 2009 - $1.0 billion). RBS NV had mandatory reserve deposits of €1 billion at 31 December 2011 (2010 - €1 billion; 2009 - €6 billion).

 
 
369

 
Notes on the consolidated accounts continued
 
 
38 Segmental analysis
(a) Divisions
The directors manage the Group primarily by class of business and present the segmental analysis on that basis. This includes the review of net interest income for each class of business - interest receivable and payable for all reportable segments is therefore presented net. Segments charge market prices for services rendered to other parts of the Group; funding charges between segments are determined by Group Treasury, having regard to commercial demands. The segment measure is operating profit/(loss) before tax.

The Group's reportable segments are on a divisional basis as follows:

UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through a number of channels including: the RBS and NatWest network of branches and ATMs in the United Kingdom, telephony, online and mobile.

UK Corporate is a leading provider of banking, finance, and risk management services to the corporate and SME sector in the United Kingdom. It offers a full range of banking products and related financial services through a nationwide network of relationship managers, and also through telephone and internet channels. The product range includes asset finance through the Lombard brand.

Wealth provides private banking and investment services in the UK through Coutts & Co and Adam & Company, offshore banking through RBS International, NatWest Offshore and Isle of Man Bank, and international private banking through Coutts & Co Ltd.

Global Transaction Services (GTS) ranks among the top tier of global transaction banks, offering payments, cash and liquidity management, trade finance and commercial card products and services. Through the network and extensive partner bank agreements, GTS are able to support and connect customers across 128 countries.

Ulster Bank is the leading retail and business bank in Northern Ireland and the third largest banking group on the island of Ireland. It provides a comprehensive range of financial services. The Retail Markets division which has a network of 236 branches, operates in the personal and financial planning sectors. The Corporate Markets division provides services to SME business customers, corporates and institutional markets.

US Retail & Commercial provides financial services primarily through the Citizens and Charter One brands. US Retail & Commercial is engaged in retail and corporate banking activities through its branch network in 12 states in the United States and through non-branch offices in other states.

Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is organised along six principal business lines: money markets; rates flow trading; currencies; equities; credit and mortgage markets and portfolio management and origination.

RBS Insurance provides a wide range of general insurance products to consumers through a number of well known brands including; Direct Line, Churchill and Privilege. It also provides insurance services for third party brands through its UKI Partnerships business. In the commercial sector, its NIG and Direct Line for Business operations provide insurance products for businesses via brokers or direct respectively. Through its international division, RBS Insurance sells general insurance, mainly motor, in Germany and Italy. In addition to insurance services, RBS Insurance continues to provide support and reassurance to millions of UK motorists through its Green Flag breakdown recovery service and Tracker stolen vehicle recovery and telematics business.

To comply with EC State Aid requirements, the Group has agreed to dispose of RBS Insurance.  It continues to be reported as a separate operating segment rather than within the Non-Core division as its operating results are regularly reviewed by the Group’s Chief Executive Officer and its business is distinct from the activities of the Non-Core division.

Central items comprises Group and corporate functions, such as treasury, funding and finance, risk management, legal, communications and human resources. The Centre manages the Group's capital resources and Group-wide regulatory projects and provides services to the operating divisions.

Non-Core Division manages separately assets that the Group intends to run off or dispose of. The division contains a range of businesses and asset portfolios primarily from the GBM division, linked to proprietary trading, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses, including regional markets businesses, that the Group has concluded are no longer strategic.


 
370

 

Notes on the consolidated accounts continued

38 Segmental analysis continued
 
Net 
interest 
 income 
Non-interest 
 income 
Total 
 income 
Operating 
 expenses and 
 insurance 
 claims 
Depreciation 
and 
 amortisation 
Impairment 
 losses 
Operating 
 profit/(loss)
2011
£m 
£m 
£m 
£m 
£m 
£m 
£m 
UK Retail
4,272 
1,206 
5,478 
(2,699)
— 
(788)
1,991 
UK Corporate
2,585 
1,275 
3,860 
(1,489)
(172)
(785)
1,414 
Wealth
718 
459 
1,177 
(820)
(11)
(25)
321 
Global Transaction Services
1,076 
1,175 
2,251 
(1,335)
(7)
(166)
743 
Ulster Bank
696 
211 
907 
(546)
(1)
(1,384)
(1,024)
US Retail & Commercial
1,896 
1,004 
2,900 
(1,979)
(117)
(325)
479 
Global Banking & Markets
665 
5,276 
5,941 
(4,170)
(161)
(49)
1,561 
RBS Insurance
343 
3,729 
4,072 
(3,583)
(35)
— 
454 
Central items
(228)
213 
(15)
950 
(781)
156 
Core
12,023 
14,548 
26,571 
(15,671)
(1,285)
(3,520)
6,095 
Non-Core
666 
540 
1,206 
(1,133)
(357)
(3,919)
(4,203)
Managed basis
12,689 
15,088 
27,777 
(16,804)
(1,642)
(7,439)
1,892 
               
Reconciling items
             
Fair value of own debt
— 
1,846 
1,846 
— 
— 
— 
1,846 
Asset Protection Scheme
— 
(906)
(906)
— 
— 
— 
(906)
Payment Protection Insurance costs
— 
— 
— 
(850)
— 
— 
(850)
Sovereign debt impairment
— 
— 
— 
— 
— 
(1,099)
(1,099)
Amortisation of purchased intangible assets
— 
— 
— 
— 
(222)
— 
(222)
Integration and restructuring costs
(2)
(3)
(5)
(1,048)
(11)
— 
(1,064)
Gain on redemption of own debt
— 
255 
255 
— 
— 
— 
255 
Strategic disposals
— 
(24)
(24)
(80)
— 
— 
(104)
Bank levy
— 
— 
— 
(300)
— 
— 
(300)
Bonus tax
— 
— 
— 
(27)
— 
— 
(27)
Interest rate hedge adjustments on impaired available-for-sale
  Greek government bonds
— 
— 
— 
— 
— 
(169)
(169)
Write-down of goodwill and other intangible assets
— 
— 
— 
(11)
— 
— 
(11)
RFS Holdings minority interest
(8)
(6)
— 
(2)
(7)
Statutory basis
12,679 
16,258 
28,937 
(19,119)
(1,875)
(8,709)
(766)
               
2010
             
UK Retail
4,078 
1,422 
5,500 
(2,967)
(1)
(1,160)
1,372 
UK Corporate
2,572 
1,323 
3,895 
(1,498)
(173)
(761)
1,463 
Wealth
609 
447 
1,056 
(723)
(11)
(18)
304 
Global Transaction Services
974 
1,587 
2,561 
(1,459)
(5)
(9)
1,088 
Ulster Bank
761 
214 
975 
(573)
(2)
(1,161)
(761)
US Retail & Commercial
1,917 
1,029 
2,946 
(2,024)
(99)
(517)
306 
Global Banking & Markets
1,215 
6,697 
7,912 
(4,281)
(116)
(151)
3,364 
RBS Insurance
381 
4,135 
4,516 
(4,788)
(23)
— 
(295)
Central items
10 
327 
337 
1,095 
(852)
(3)
577 
Core
12,517 
17,181 
29,698 
(17,218)
(1,282)
(3,780)
7,418 
Non-Core
1,683 
1,281 
2,964 
(2,513)
(480)
(5,476)
(5,505)
Managed basis
14,200 
18,462 
32,662 
(19,731)
(1,762)
(9,256)
1,913 
               
Reconciling items
             
Fair value of own debt
— 
174 
174 
— 
— 
— 
174 
Asset Protection Scheme
— 
 (1,550)
 (1,550)
— 
— 
— 
(1,550)
Amortisation of purchased intangible assets
— 
— 
— 
— 
 (369)
— 
(369)
Integration and restructuring costs
— 
— 
— 
 (1,012)
 (20)
— 
 (1,032)
Gain on redemption of own debt
— 
553 
553 
— 
— 
— 
553 
Strategic disposals
— 
171 
171 
— 
— 
— 
171 
Bonus tax
— 
— 
— 
 (99)
— 
— 
 (99)
Write-down of goodwill and other intangible assets
— 
— 
— 
(10)
— 
— 
(10)
RFS Holdings minority interest
 (151)
(142) 
 (9)
— 
(150)
Statutory basis
14,209 
17,659 
31,868 
(20,861)
(2,150)
(9,256)
(399)

 
 
371

 
Notes on the consolidated accounts continued
 
 

 
2009
Net 
 interest 
 income 
£m 
Non-interest 
 income 
£m 
Total 
income 
£m 
Operating 
 expenses and 
 insurance 
 claims 
£m 
Depreciation 
 and 
amortisation 
 £m 
Impairment 
 losses 
£m 
Operating 
profit/(loss)
 £m 
UK Retail
3,452 
1,635 
5,087 
(3,176)
(3)
(1,679)
229 
UK Corporate
2,292 
1,290 
3,582 
(1,376)
(154)
(927)
1,125 
Wealth
663 
446 
1,109 
(645)
(11)
(33)
420 
Global Transaction Services
912 
1,575 
2,487 
(1,462)
(13)
(39)
973 
Ulster Bank
780 
254 
1,034 
(748)
(5)
(649)
(368)
US Retail & Commercial
1,775 
949 
2,724 
(2,063)
(72)
(702)
(113)
Global Banking & Markets
2,375 
8,683 
11,058 
(4,518)
(142)
(640)
5,758 
RBS Insurance
383 
4,231 
4,614 
(4,517)
(31)
(8)
58 
Central items
(315)
557 
242 
1,144 
(1,000)
(1)
385 
Core
12,317 
19,620 
31,937 
(17,361)
(1,431)
(4,678)
8,467 
Non-Core
1,250 
(3,620)
(2,370)
(2,524)
(442)
(9,221)
(14,557)
Managed basis
13,567 
16,000 
29,567 
(19,885)
(1,873)
(13,899)
(6,090)
               
Reconciling items
             
Fair value of own debt
— 
(142)
 (142)
— 
— 
— 
 (142)
Amortisation of purchased intangible assets
— 
— 
— 
— 
 (272)
— 
 (272)
Integration and restructuring costs
— 
— 
— 
 (1,268)
 (18)
— 
 (1,286)
Gain on redemption of own debt
— 
3,790 
3,790 
— 
— 
— 
3,790 
Strategic disposals
— 
132 
132 
— 
— 
— 
132 
Bonus tax
— 
— 
— 
(208)
— 
— 
 (208)
Gains on pensions curtailment
— 
— 
— 
2,148 
— 
— 
2,148 
Write-down of goodwill and other intangible assets
— 
— 
— 
 (363)
— 
— 
(363)
RFS Holdings minority interest
 (179)
 (142)
 (321)
 (32)
 (3)
— 
 (356)
Statutory basis
13,388 
19,638 
33,026 
(19,608)
(2,166)
(13,899)
(2,647)


 
2011
 
2010
 
2009
Total income
External 
 £m 
Inter 
segment 
 £m 
Total 
 £m 
 
External 
 £m 
Inter 
segment 
 £m 
Total 
 £m 
 
External 
 £m 
Inter 
segment 
 £m 
Total 
 £m 
UK Retail
5,520 
(42)
5,478 
 
5,523 
(23)
5,500 
 
5,163 
(76)
5,087 
UK Corporate
4,368 
(508)
3,860 
 
4,345 
(450)
3,895 
 
4,422 
(840)
3,582 
Wealth
565 
612 
1,177 
 
562 
494 
1,056 
 
409 
700 
1,109 
Global Transaction Services
2,041 
210 
2,251 
 
2,428 
133 
2,561 
 
2,438 
49 
2,487 
Ulster Bank
928 
(21)
907 
 
865 
110 
975 
 
1,003 
31 
1,034 
US Retail & Commercial
2,710 
190 
2,900 
 
2,672 
274 
2,946 
 
2,380 
344 
2,724 
Global Banking & Markets
5,970 
(29)
5,941 
 
7,817 
95 
7,912 
 
10,174 
884 
11,058 
RBS Insurance
4,133 
(61)
4,072 
 
4,565 
(49)
4,516 
 
4,629 
(15)
4,614 
Central items
(935)
920 
(15)
 
(489)
826 
337 
 
(1,668)
1,910 
242 
Core
25,300 
1,271 
26,571 
 
28,288
1,410 
29,698 
 
28,950 
2,987 
31,937 
Non-Core
2,477 
(1,271)
1,206 
 
4,382 
(1,418)
2,964 
 
547 
(2,917)
(2,370)
Managed basis
27,777 
— 
27,777 
 
32,670 
(8)
32,662 
 
29,497 
70 
29,567 
                       
Reconciling items
                     
Fair value of own debt
1,846 
— 
1,846 
 
174 
— 
174 
 
(142)
— 
(142)
Asset Protection Scheme
(906)
— 
(906)
 
 (1,550)
 (1,550)
 
Integration and restructuring costs
(5)
— 
(5)
 
 
Gain on redemption of own debt
255 
— 
255 
 
553 
553 
 
3,790 
3,790 
Strategic disposals
(24)
— 
(24)
 
171 
171 
 
132 
132 
RFS Holdings minority interest
(6)
— 
(6)
 
 (150)
8
 (142)
 
 (251)
 (70)
 (321)
Statutory basis
28,937 
— 
28,937 
 
31,868
— 
31,868 
 
33,026 
33,026 
 
 
 
372

 
 
Notes on the consolidated accounts continued

38 Segmental analysis continued

 
2011
 
2010
 
2009
Total revenue
External 
 £m 
Inter 
segment 
£m 
Total 
 £m 
 
External 
 £m 
Inter 
segment 
£m 
Total 
 £m 
 
External 
 £m 
Inter 
segment 
£m 
Total 
 £m 
UK Retail
6,804 
441 
7,245 
 
7,008 
401 
7,409 
 
7,162 
599 
7,761 
UK Corporate
4,447 
112 
4,559 
 
4,347 
132 
4,479 
 
4,563 
118 
4,681 
Wealth
1,026 
731 
1,757 
 
957 
617 
1,574 
 
813 
820 
 1,633 
Global Transaction Services
1,646 
81 
1,727 
 
2,850 
85 
2,935 
 
2,923 
60 
2,983 
Ulster Bank
1,298 
104 
1,402 
 
1,386 
134 
1,520 
 
1,604 
104 
1,708 
US Retail & Commercial
3,341 
199 
3,540 
 
3,660 
286 
3,946 
 
4,080 
378 
4,458 
Global Banking & Markets
8,058 
7,352 
15,410 
 
9,999 
7,195 
17,194 
 
13,805 
9,142 
22,947 
RBS Insurance
4,724 
4,733 
 
5,072 
10 
5,082 
 
5,183 
21 
5,204 
Central items
2,932 
13,129 
16,061 
 
2,856 
9,900 
12,756 
 
1,955 
10,823 
12,778 
Core
34,276 
22,158 
56,434 
 
38,135 
18,760 
56,895 
 
42,088 
22,065 
64,153 
Non-Core
3,959 
378 
4,337 
 
5,555 
1,049 
6,604 
 
3,289 
1,292 
4,581 
Managed basis 
38,235 
22,536 
60,771 
 
43,690 
19,809 
63,499 
 
45,377 
23,357 
68,734 
                       
Reconciling items
                     
Fair value of own debt
1,846 
— 
1,846 
 
174 
— 
174 
 
 (142)
— 
 (142)
Asset Protection Scheme
(906)
— 
(906)
 
 (1,550)
— 
 (1,550)
 
— 
— 
— 
Integration and restructuring costs
(5)
— 
(5)
 
— 
— 
— 
 
— 
— 
— 
Gain on redemption of own debt
255 
— 
255 
 
553 
— 
553 
 
3,790 
— 
3,790 
Strategic disposals
(24)
— 
(24)
 
171 
— 
171 
 
132 
— 
132 
RFS Holdings minority interest
(3)
— 
(3)
 
 (141)
— 
 (141)
 
 (155)
— 
 (155)
Eliminations
— 
(22,536)
(22,536)
 
— 
(19,809)
(19,809)
 
— 
 (23,357)
 (23,357)
Statutory basis
39,398 
— 
39,398 
 
42,897 
— 
42,897 
 
49,002 
— 
49,002 


 
2011
 
2010
 
2009
Total assets
Assets 
£m 
Liabilities 
 £m 
Cost to 
acquire fixed 
 assets and 
 intangible 
assets 
£m 
 
Assets 
 £m 
Liabilities 
£m 
Cost to 
 acquire fixed 
 assets and 
 intangible 
 assets 
£m 
 
Assets 
£m 
Liabilities 
£m 
Cost to 
 acquire fixed 
 assets and 
 intangible 
 assets 
 £m 
UK Retail
114,469 
103,748 
— 
 
111,793 
97,164 
— 
 
110,987 
91,760 
— 
UK Corporate
111,835 
103,554 
712 
 
114,550 
101,738 
381 
 
114,854 
89,306 
598 
Wealth
21,718 
39,061 
65 
 
21,073 
37,054 
63 
 
17,952 
36,273 
11 
Global Transaction Services
25,937 
83,415 
18 
 
25,221 
78,032 
22 
 
18,380 
64,684 
17 
Ulster Bank
34,810 
27,782 
45 
 
40,081 
34,481 
101 
 
44,021 
40,597 
— 
US Retail & Commercial
74,502 
65,511 
271 
 
71,173 
66,088 
197 
 
75,369 
72,407 
179 
Global Banking & Markets
874,848 
847,877 
1,553 
 
802,578 
774,753 
852 
 
826,054 
822,830 
513 
RBS Insurance
12,912 
8,077 
99 
 
12,555 
8,195 
50 
 
11,973 
7,775 
33 
Central items
130,306 
133,048 
960 
 
99,728 
140,070 
632 
 
82,041 
150,734 
804 
Core
1,401,337 
1,412,073 
3,723 
 
1,298,752 
1,337,575 
2,298 
 
1,301,631 
1,376,366 
2,155 
Non-Core
104,726 
18,220 
841 
 
153,882 
38,503 
761 
 
220,850 
66,152 
3,259 
 
1,506,063 
1,430,293 
4,564 
 
1,452,634 
1,376,078 
3,059 
 
1,522,481 
1,442,518 
5,414 
Reconciling item
                     
RFS Holdings minority
  interest
804 
521 
— 
 
942 
647 
76 
 
174,005 
159,337 
296 
 
1,506,867 
1,430,814 
4,564 
 
1,453,576 
1,376,725 
3,135 
 
1,696,486 
1,601,855 
5,710 



 
373

 
Notes on the consolidated accounts continued
 
 
Assets and liabilities held for sale included in the divisional segments above:
 
2011
 
2010
 
2009
 
Assets 
£m
Liabilities 
£m
 
Assets 
£m
Liabilities 
£m
 
Assets 
£m
Liabilities 
£m
UK Retail
7,048 
8,808 
 
— 
— 
 
— 
— 
UK Corporate
11,661 
12,977 
 
— 
— 
 
— 
— 
Global Transaction Services
66 
— 
 
251 
549 
 
— 
— 
Global Banking & Markets
431 
117 
 
19 
— 
 
— 
Centre
136 
 
— 
— 
 
— 
— 
Non-Core
5,670 
1,779 
 
11,639 
8,404 
 
18,532 
18,886 
RFS Holdings minority interest
438 
312 
 
575 
475 
 
 
25,450 
23,995 
 
12,484 
9,428 
 
18,542 
18,890 

Segmental analysis of goodwill is as follows:
 
UK 
 Retail 
 
UK 
 Corporate 
Wealth 
Global 
Transaction 
Services 
US Retail & 
Commercial 
Global 
Banking & 
 Markets 
RBS 
Insurance 
Non-Core 
RFS 
Holdings 
minority 
interest 
Total 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
At 1 January 2009
2,803 
2,695 
800 
3,067 
3,023 
38 
1,029 
597 
1,510 
15,562 
Transfers to disposal groups
— 
— 
— 
— 
— 
— 
— 
(238)
— 
(238)
Currency translation and
  other adjustments
— 
— 
(12)
(233)
(302)
(1)
(8)
(34)
(107)
(697)
Write-down of goodwill
— 
— 
— 
— 
— 
— 
(66)
(297)
— 
(363)
At 1 January 2010
2,803 
2,695 
788 
2,834 
2,721 
37 
955 
28 
1,403 
14,264 
Currency translation and
  other adjustments
25 
24 
122 
— 
(40)
136 
Disposals
(4)
(481)
(14)
(1,363)
(1,862)
Write-down of goodwill
(1)
— 
— 
— 
(9)
— 
— 
(10)
At 1 January 2011
2,799 
2,695 
812 
2,377 
2,843 
41 
946 
15 
— 
12,528 
Transfers to disposal groups
— 
— 
— 
— 
— 
— 
— 
(15)
— 
(15)
Currency translation and
  other adjustments
— 
— 
— 
(24)
— 
(1)
— 
— 
(16)
Acquisitions
— 
— 
— 
— 
— 
18 
— 
— 
— 
18 
Write-down of goodwill
(20)
(60)
— 
— 
— 
— 
(11)
— 
— 
(91)
At 31 December 2011
2,779 
2,635 
812 
2,353 
2,852 
59 
934 
— 
— 
12,424 

(b) Geographical segments
The geographical analysis in the tables below has been compiled on the basis of location of office where the transactions are recorded.

2011
UK 
£m 
USA 
 £m 
Europe 
 £m 
Rest of the 
 World 
£m 
Total 
 £m 
Total revenue
22,749 
7,271 
5,582 
3,796 
39,398 
           
Net interest income
8,711 
2,430 
994 
544 
12,679 
Net fees and commissions
2,925 
1,365 
215 
419 
4,924 
Income from trading activities
661 
1,318 
508 
214 
2,701 
Other operating income/(loss)
3,097 
219 
1,079 
(18)
4,377 
Insurance premium income (net of reinsurers' share)
3,894 
— 
362 
— 
4,256 
Total income
19,288 
5,332 
3,158 
1,159 
28,937 
           
Operating profit/(loss) before tax
1,292 
1,794 
(3,414)
(438)
(766)
Total assets
1,007,096 
359,592 
66,239 
73,940 
1,506,867 
Of which total assets held for sale
19,343 
53 
6,011 
43 
25,450 
Total liabilities
936,477 
341,631 
82,059 
70,647 
1,430,814 
Of which total liabilities held for sale
21,903 
104 
1,988 
— 
23,995 
Net assets attributable to equity owners and non-controlling interests
70,619 
17,961 
(15,820)
3,293 
76,053 
Contingent liabilities and commitments
118,702 
95,703 
51,465 
12,949 
278,819 
Cost to acquire property, plant and equipment and intangible assets
2,522 
500 
1,484 
58 
4,564 

 
 
374

 
 
Notes on the consolidated accounts continued

38 Segmental analysis continued

2010
UK 
£m 
USA 
 £m 
Europe 
 £m 
Rest of the 
 World 
£m 
Total 
 £m 
Total revenue
25,468 
8,332 
6,196 
2,901 
42,897 
           
Net interest income
8,932 
3,128 
1,384 
765 
14,209 
Net fees and commissions
3,272 
1,557 
591 
562 
5,982 
Income from trading activities
2,106 
1,963 
197 
251 
4,517 
Other operating income/(loss)
1,376 
232 
836 
(412)
2,032 
Insurance premium income (net of reinsurers' share)
4,809 
— 
319 
— 
5,128 
Total income
20,495 
6,880 
3,327 
1,166 
31,868 
           
Operating profit/(loss) before tax
862 
2,091 
(2,450)
(902)
(399)
Total assets
932,917 
341,770 
102,756 
76,133 
1,453,576 
Of which total assets held for sale
2,855 
6,686 
2,943 
— 
12,484 
Total liabilities
860,932 
323,529 
119,946 
72,318 
1,376,725 
Of which total liabilities held for sale
570 
6,938 
1,920 
— 
9,428 
Net assets attributable to equity owners and non-controlling interests
71,985 
18,241 
(17,190)
3,815 
76,851 
Contingent liabilities and commitments
134,983 
98,429 
71,025 
9,894 
314,331 
Cost to acquire property, plant and equipment and intangible assets
1,283 
355 
1,388 
109 
3,135 

2009
         
Total revenue
28,421 
10,517 
6,442 
3,622 
49,002 
           
Net interest income
7,759 
2,674 
1,741 
1,214 
13,388 
Net fees and commissions
3,640 
1,586 
316 
406 
5,948 
Income from trading activities
131 
2,396 
584 
650 
3,761 
Other operating income/(loss)
6,015 
(37)
(977)
(338)
4,663 
Insurance premium income (net of reinsurers' share)
4,879 
— 
387 
— 
5,266 
Total income
22,424 
6,619 
2,051 
1,932 
33,026 
           
Operating profit/(loss) before tax
1,776 
(457)
(2,877)
(1,089)
(2,647)
Total assets
949,765 
338,649 
320,008 
88,064 
1,696,486 
Of which total assets held for sale
— 
14,203 
4,339 
— 
18,542 
Total liabilities
873,716 
322,698 
321,133 
84,308 
1,601,855 
Of which total liabilities held for sale
— 
10,993 
7,897 
— 
18,890 
Net assets attributable to equity owners and non-controlling interests
76,049 
15,951 
(1,125)
3,756 
94,631 
Contingent liabilities and commitments
175,392 
93,694 
65,026 
17,549 
351,661 
Cost to acquire property, plant and equipment and intangible assets
1,974 
390 
3,252 
94 
5,710 


 
375

 
Notes on the consolidated accounts continued


39 Directors' and key management remuneration

Directors' remuneration
2011 
£000 
2010 
£000 
Non-executive directors - emoluments
1,137 
1,093 
Chairman and executive directors
   
  - emoluments
4,671 
5,243 
  - contributions and allowances in respect of defined contribution pension schemes
403 
321 
 
6,211 
6,657 
  - amounts receivable under long-term incentive plans
1,594 
1,097 
 
7,805 
7,754 

No directors are accruing benefits under defined benefit schemes (2010 - nil). One director is accruing benefits under a defined contribution arrangement (2010 - one).

The executive directors may participate in the company's long term incentive plans, executive share option and sharesave schemes and details of their interests in the company's shares arising from their participation are given in the Directors' remuneration report. Details of the remuneration received by each director during the year and each director's pension arrangements are also given in the Directors' remuneration report.

Compensation of key management
The aggregate remuneration of directors and other members of key management during the year was as follows:

 
2011 
£000 
2010 
£000 
Short-term benefits
36,371 
35,654 
Post-employment benefits
3,547 
(503)
Share-based payments
21,062 
21,551 
 
60,980 
56,702 


40 Transactions with directors and key management
(a) At 31 December 2011, amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined in UK legislation, were £3,550,864 in respect of loans to eight persons who were directors of the company at any time during the financial period.
 
(b) For the purposes of IAS 24 ‘Related Party Disclosures’, key management comprise directors of the company and members of the Group Management Committee. The captions in the Group's primary financial statements include the following amounts attributable, in aggregate, to key management:
 
 
2011 
£000 
2010 
£000 
Loans and advances to customers
19,366 
10,970 
Customer accounts
33,149 
10,641 

Key management have banking relationships with Group entities which are entered into in the normal course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with other persons of a similar standing or, where applicable, with other employees. These transactions did not involve more than the normal risk of repayment or present other unfavourable features.


 
376

 
 
Notes on the consolidated accounts continued


41 Related parties

UK Government
On 1 December 2008, the UK Government through HM Treasury became the ultimate controlling party of The Royal Bank of Scotland Group plc. The UK Government's shareholding is managed by UK Financial Investments Limited, a company wholly owned by the UK Government. As a result, the UK Government and UK Government controlled bodies became related parties of the Group.

The Group enters into transactions with many of these bodies on an arm’s length basis. The principal transactions during 2011, 2010 and 2009 were: the Asset Protection Scheme, Bank of England facilities and the issue of debt guaranteed by the UK Government discussed below. In addition, the redemption of non-cumulative sterling preference shares and the placing and open offer in April 2009 was underwritten by HM Treasury and, in December 2009, B shares were issued to HM Treasury and a contingent capital agreement concluded with HM Treasury (see Note 27). Other transactions include the payment of: taxes principally UK corporation tax (page 297) and value added tax; national insurance contributions; local authority rates; and regulatory fees and levies (including the bank levy (page 288) and FSCS levies (page 360)); together with banking transactions such as loans and deposits undertaken in the normal course of banker-customer relationships.

Asset Protection Scheme
On 22 December 2009, the Group entered into an agreement (the Asset Protection Scheme (APS), with HM Treasury, acting on behalf of the UK Government, under which the Group purchased credit protection over a portfolio of specified assets and exposures (covered assets) from HM Treasury. The portfolio of covered assets has a par value of approximately £282 billion. The protection is subject to a first loss of £60 billion and covers 90% of subsequent losses net of recoveries. Once the first loss has been exhausted, losses and recoveries in respect of assets for which a trigger event - failure to pay, bankruptcy or restructuring - has occurred are included in the balance receivable under the APS. Receipts from HM Treasury will, over time, amount to 90% of cumulative losses (net of 90% of cumulative recoveries) on the portfolio of covered assets less the first loss amount.

The Group has a right to terminate the APS at any time provided that the Financial Services Authority has confirmed in writing to HM Treasury that it has no objection. On termination the Group must pay HM Treasury the higher of the regulatory capital relief received and £2.5 billion less premiums paid plus the aggregate of amounts received from the UK Government under the APS.

HM Treasury has the right to appoint step-in managers to carry out any oversight, management or additional functions on behalf of HM Treasury to ensure that the covered assets are managed and administered in compliance with the agreed terms and conditions. This right is exercisable if certain step-in triggers occur. These include:

·  
losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds;

·  
a breach of specified obligations in the APS rules or the accession agreement;

·  
the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight and such failure is persistent and material or it is evidence of a systematic problem; and

·  
material or systematic data deficiencies in the information provided to HM Treasury in accordance with the terms of APS.

HM Treasury may at any time elect to cease to exercise its step-in rights in whole or part when it is satisfied that the step-in triggers have been remedied.

The Group has paid APS premiums totalling £2,225 million (2011 - £125 million; 2010 - £700 million; 2009 - £1,400 million). From 31 December 2011, premiums of £125 million are payable quarterly until the earlier of 2099 and the date the Group leaves the Scheme.

The APS is a single contract providing credit protection in respect of a portfolio of financial assets. Under IFRS, credit protection is treated either as a financial guarantee contract or as a derivative financial instrument depending on the terms of the agreement and the nature of the protected assets and exposures. The Group has concluded, principally because the covered portfolio includes significant exposure in the form of derivatives, that the APS does not meet the criteria to be treated as a financial guarantee contract. The contract has been accounted for as a derivative financial instrument and is recognised as a fair value liability £231 million (2010 - asset £550 million; 2009 - asset £1,400 million) and included within the Derivative liability balance sheet caption. Changes in fair value of £906 million (2010 - £1,550 million; 2009 - nil) were recognised in profit or loss within Income from trading activities. Details of the valuation methodology for the APS are set out in Note 11 Financial instruments on pages 315 and 317.

There is no change in the recognition and measurement of the covered assets as a result of the APS. Impairment provisions on covered assets measured at amortised cost are assessed and charged in accordance with the Group’s accounting policy; held-for-trading assets, assets designated at fair value and available-for-sale assets within the APS portfolio continue to be measured at fair value with no adjustments to reflect the protection provided by the APS. There is no change in how gains and losses on the covered assets are recognised in the income statement or in other comprehensive income.


 
377

 

Notes on the consolidated accounts continued


Bank of England facilities
The Group also participates in a number of schemes operated by the Bank of England available to eligible banks and building societies.

·  
Open market operations - these provide market participants with funding at market rates on a tender basis in the form of short and long-term repos on a wide range of collateral and outright purchases of high-quality bonds to enable them to meet the reserves that they must hold at the Bank of England.

·  
The special liquidity scheme - this was launched in April 2008 to allow financial institutions to swap temporarily illiquid assets for treasury bills, with fees charged based on the spread between 3-month LIBOR and the 3-month gilt repo rate. The scheme officially closed on 30 January 2012.

At 31 December 2011, the Group had no amounts outstanding under these facilities (2010 - £16.1 billion; 2009 - £21.4 billion).

Government credit and asset-backed securities guarantee schemes
These schemes guarantee eligible debt issued by qualifying institutions for a fee. The fee, payable to HM Treasury is based on a per annum rate of 25 (asset-backed securities guarantee scheme) and 50 (credit guarantee scheme) basis points plus 100% of the institution's median five-year credit default swap spread during the twelve months to 1 July 2008. The asset-backed securities scheme closed to new issuance on 31 December 2009 and the credit guarantee scheme on 28 February 2010.

At 31 December 2011, the Group had issued debt guaranteed by the Government totalling £21.3 billion (2010 - £41.5 billion; 2009 - £51.5 billion).


Other related parties
(a)
In their roles as providers of finance, Group companies provide development and other types of capital support to businesses. These investments are made in the normal course of business and on arm's length terms. In some instances, the investment may extend to ownership or control over 20% or more of the voting rights of the investee company. However, these investments are not considered to give rise to transactions of a materiality requiring disclosure under IAS 24.

(b)
The Group recharges The Royal Bank of Scotland Group Pension Fund with the cost of administration services incurred by it. The amounts involved are not material to the Group.

(c)
In accordance with IAS 24, transactions or balances between Group entities that have been eliminated on consolidation are not reported.

(d)
The captions in the primary financial statements of the parent company include amounts attributable to subsidiaries. These amounts have been disclosed in aggregate in the relevant notes to the financial statements.

42 Post balance sheet events
There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.

 
 
378

 
Notes on the accounts continued
 
 
43 Consolidating financial information
The Royal Bank of Scotland plc ('RBS plc') is a wholly owned subsidiary of The Royal Bank of Scotland Group plc ('RBSG plc') and is able to offer and sell certain securities in the US from time to time pursuant to a registration statement on Form F-3 filed with the SEC with a full and unconditional guarantee from RBSG plc.

RBS plc utilises an exception provided in Rule 3-10 of Regulation S-X, and therefore does not file its financial statements with the SEC.  In accordance with the requirements to qualify for the exception, presented below is condensed consolidating financial information for:

·  
RBSG plc on a stand-alone basis as guarantor;
·  
RBS plc on a stand-alone basis as issuer;
·  
Non-guarantor Subsidiaries of RBSG plc and RBS plc on a combined basis ('Subsidiaries');
·  
Consolidation adjustments; and
·  
RBSG plc consolidated amounts ('RBSG Group').

Under IAS 27, RBSG plc and RBS plc account for investments in their subsidiary undertakings at cost less impairment. Rule 3-10 of Regulation S-X requires a company to account for its investments in subsidiary undertakings using the equity method, which would increase/(decrease) the results for the period of RBSG plc and RBS plc in the information below by £(1,890) million and £(2,699) million respectively for the year ended 31 December 2011 (£3,553 million and £(699) million for the year ended 31 December 2010; £(1,169) million and £825 million for the year ended 31 December 2009). The net assets of RBSG plc and RBS plc in the information below would also be increased by £15,430 million and £6,389 million respectively at 31 December 2011 (£15,908 million and £9,466 million at 31 December 2010; £12,154 million and £9,533 million at 31 December 2009).
 
The amounts in the tables below do not include amounts attributable to non-controlling interests.

Income statement
 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries 
£m 
Consolidation 
Adjustments 
£m 
RBSG 
Group 
£m 
 
For the year ended 31 December 2011
Net interest income
514 
3,473 
8,595 
97 
12,679 
Non-interest income
(566)
8,122 
9,984 
(1,282)
16,258 
Total income
(52)
11,595 
18,579 
(1,185)
28,937 
           
Operating expenses
18 
(8,195)
(10,084)
235 
(18,026)
Insurance net claims
— 
— 
(2,968)
— 
(2,968)
Impairment losses
— 
(1,533)
(7,186)
10 
(8,709)
Operating (loss)/profit before tax
(34)
1,867 
(1,659)
(940)
(766)
Tax
(73)
(755)
(442)
20 
(1,250)
Profit/(loss) from continuing operations
(107)
1,112 
(2,101)
(920)
(2,016)
Profit from discontinued operations, net of tax
— 
— 
47 
— 
47 
(Loss)/profit for the year
(107)
1,112 
(2,054)
(920)
(1,969)
           
For the year ended 31 December 2010
         
Net interest income
426 
3,980 
10,058 
(255)
14,209 
Non-interest income
(4,894) 7,658  10,904  3,991  17,659 
Total income
(4,468)
11,638 
20,962 
3,736 
31,868 
           
Operating expenses
(3)
(7,683)
(10,966)
424 
(18,228)
Insurance net claims
— 
— 
(4,783)
— 
(4,783)
Impairment losses
— 
(3,571)
(6,634)
949 
(9,256)
Operating (loss)/profit before tax
(4,471)
384 
(1,421)
5,109 
(399)
Tax
(83)
(598)
75 
(28) 
(634)
Loss from continuing operations
(4,554)
(214)
(1,346)
5,081 
(1,033)
Loss from discontinued operations, net of tax
— 
— 
(593)
(40) 
(633)
Loss for the year
(4,554)
(214)
(1,939)
5,041 
(1,666)

 
 
379

 
 
Notes on the accounts continued


 
 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries
£m
Consolidation
adjustments
£m
RBSG
Group
£m
 
For the year ended 31 December 2009
Net interest income
313 
3,776 
9,715 
(416)
13,388 
Non-interest income
(1,572) 7,079  10,927  3,204  19,638 
Total income
(1,259)
10,855 
20,642 
2,788 
33,026 
           
Operating expenses
(27)
(6,073)
(10,368)
(949)
(17,417)
Insurance net claims
— 
— 
(4,357)
— 
(4,357)
Impairment losses
— 
(5,924)
(8,010)
35 
(13,899)
Operating loss before tax
(1,286)
(1,142)
(2,093)
1,874 
(2,647)
Tax
(217)
602 
504 
(460)
429 
Loss from continuing operations
(1,503)
(540)
(1,589)
1,414 
(2,218)
Loss from discontinued operations, net of tax
— 
— 
(105)
— 
(105)
Loss for the year
(1,503)
(540)
(1,694)
1,414 
(2,323)

Balance sheets
 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries 
£m 
Consolidation 
Adjustments 
£m 
RBSG 
Group 
£m 
 
At 31 December 2011
Assets
         
Cash and balances at central banks
— 
64,261 
15,008 
— 
79,269 
Loans and advances to banks
18,368 
109,040 
352,420 
(396,518)
83,310 
Loans and advances to customers
4,056 
351,123 
316,881 
(156,454)
515,606 
Debt securities
1,568 
181,460 
102,311 
(76,259)
209,080 
Equity shares
— 
10,486 
5,478 
(781)
15,183 
Investments in Group undertakings
53,871 
32,164 
12,107 
(98,142)
— 
Settlement balances
— 
4,059 
3,713 
(1)
7,771 
Derivatives
1,502 
537,297 
24,781 
(33,962)
529,618 
Intangible assets
— 
876 
7,251 
6,731 
14,858 
Property, plant and equipment
— 
2,244 
9,629 
(5)
11,868 
Deferred tax
2,584 
1,115 
178 
3,878 
Prepayments, accrued income and other assets
24 
5,338 
8,046 
(2,432)
10,976 
Assets of disposals groups
— 
18,715 
6,709 
26 
25,450 
Total assets
79,390 
1,319,647 
865,449 
(757,619)
1,506,867 
           
Liabilities
         
Deposits by banks
1,091 
234,297 
235,983 
(362,567)
108,804 
Customer accounts
977 
296,902 
376,643 
(171,567)
502,955 
Debt securities in issue
8,373 
114,524 
113,307 
(73,583)
162,621 
Settlement balances
— 
3,517 
3,960 
— 
7,477 
Short positions
— 
24,858 
16,950 
(769)
41,039 
Derivatives
79 
530,855 
27,011 
(33,962)
523,983 
Accruals, deferred income and other liabilities
704 
8,840 
14,862 
(1,281)
23,125 
Retirement benefit liabilities
— 
25 
423 
1,791 
2,239 
Deferred tax
— 
— 
2,381 
(436)
1,945 
Insurance liabilities
— 
— 
6,347 
(35)
6,312 
Subordinated liabilities
8,777 
30,014 
9,393 
(21,865)
26,319 
Liabilities of disposal groups
— 
20,478 
3,517 
— 
23,995 
Total liabilities
20,001 
1,264,310 
810,777 
(664,274)
1,430,814 
           
Non-controlling interests
— 
— 
1,570 
(336)
1,234 
Owners’ equity
59,389 
55,337 
53,102 
(93,009)
74,819 
Total equity
59,389 
55,337 
54,672 
(93,345)
76,053 
Total liabilities and equity
79,390 
1,319,647 
865,449 
(757,619)
1,506,867 


 
 
380

 
 
 
Notes on the accounts continued

43 Consolidating financial information continued

 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries 
£m 
Consolidation 
Adjustments 
£m 
RBSG 
Group 
£m 
 
At 31 December 2010
Assets
         
Cash and balances at central banks
— 
44,921 
12,093 
— 
57,014 
Loans and advances to banks
19,535 
100,965 
343,198 
(363,180)
100,518 
Loans and advances to customers
6,689 
349,179 
340,881 
(141,489)
555,260 
Debt securities
1,454 
189,208 
106,684 
(79,866)
217,480 
Equity shares
— 
1,016 
21,982 
(800)
22,198 
Investments in Group undertakings
49,125 
27,504 
12,119 
(88,748)
— 
Settlement balances
— 
3,529 
8,068 
11,605 
Derivatives
1,475 
432,812 
35,230 
(42,440)
427,077 
Intangible assets
— 
443 
7,060 
6,945 
14,448 
Property, plant and equipment
— 
2,301 
14,247 
(5)
16,543 
Deferred tax
794 
5,161 
416 
6,373 
Prepayments, accrued income and other assets
28 
4,760 
9,696 
(1,908)
12,576 
Assets of disposals groups
— 
4,765 
7,719 
— 
12,484 
Total assets
78,308 
1,162,197 
924,138 
(711,067)
1,453,576 
           
Liabilities
         
Deposits by banks
— 
197,973 
207,685 
(306,868)
98,790 
Customer accounts
1,029 
295,358 
392,733 
(178,427)
510,693 
Debt securities in issue
8,742 
128,073 
161,006 
(79,449)
218,372 
Settlement balances
— 
3,343 
7,648 
— 
10,991 
Short positions
— 
25,687 
17,862 
(431)
43,118 
Derivatives
231 
424,503 
41,673 
(42,440)
423,967 
Accruals, deferred income and other liabilities
1,034 
8,058 
14,603 
(606)
23,089 
Retirement benefit liabilities
— 
23 
796 
1,469 
2,288 
Deferred tax
— 
— 
2,415 
(273)
2,142 
Insurance liabilities
— 
— 
6,829 
(35)
6,794 
Subordinated liabilities
8,048 
29,299 
9,932 
(20,226)
27,053 
Liabilities of disposal groups
— 
2,336 
7,092 
— 
9,428 
Total liabilities
19,084 
1,114,653 
870,274 
(627,286)
1,376,725 
           
Non-controlling interests
— 
— 
1,616 
103 
1,719 
Owners’ equity
59,224 
47,544 
52,248 
(83,884)
75,132 
Total equity
59,224 
47,544 
53,864 
(83,781)
76,851 
Total liabilities and equity
78,308 
1,162,197 
924,138 
(711,067)
1,453,576 


 
 
381

 
 
 
Notes on the accounts continued


 
 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries 
£m 
Consolidation 
Adjustments 
£m 
RBSG 
Group 
£m 
 
At 31 December 2009
Assets
         
Cash and balances at central banks
— 
21,099 
31,162 
— 
52,261 
Loans and advances to banks
31,238 
77,365 
305,163 
(322,013)
91,753 
Loans and advances to customers
2,777 
338,548 
510,117 
(123,049)
728,393 
Debt securities
1,286 
214,598 
141,004 
(89,634)
267,254 
Equity shares
— 
1,025 
19,265 
(762)
19,528 
Investments in Group undertakings
64,766 
29,385 
12,282 
(106,433)
— 
Settlement balances
11 
4,159 
7,863 
— 
12,033 
Derivatives
1,169 
450,913 
63,856 
(74,484)
441,454 
Intangible assets
— 
210 
10,986 
6,651 
17,847 
Property, plant and equipment
— 
2,447 
16,945 
19,397 
Deferred tax
1,728 
5,391 
(82) 
7,039 
Prepayments, accrued income and other assets
43 
9,988 
12,780 
(1,826)
20,985 
Assets of disposals groups
— 
7,150 
11,392 
— 
18,542 
Total assets
101,292 
1,158,615 
1,148,206 
(711,627)
1,696,486 
           
Liabilities
         
Deposits by banks
93 
188,548 
203,497 
(249,994)
142,144 
Customer accounts
13,264 
289,792 
487,290 
(176,144)
614,202 
Debt securities in issue
11,788 
129,814 
212,737 
(86,771)
267,568 
Settlement balances
— 
4,541 
5,872 
(3,147)
10,413 
Short positions
 
23,811
19,799 
 
40,463 
Derivatives
446 
430,005 
68,174 
(74,484)
424,141 
Accruals, deferred income and other liabilities
1,357 
9,949 
21,025 
(2,004)
30,327 
Retirement benefit liabilities
— 
16 
1,057 
1,890 
2,963 
Deferred tax
— 
— 
3,340 
(529)
2,811 
Insurance liabilities
— 
— 
10,281 
— 
10,281 
Subordinated liabilities
8,762 
30,513 
18,428 
(20,051)
37,652 
Liabilities of disposal groups
— 
— 
12,782 
— 
18,890 
Total liabilities
35,710 
1,113,097 
1,064,282 
(611,234)
1,601,855 
           
Non-controlling interests
— 
— 
2,166 
14,729 
16,895 
Owners’ equity
65,582 
45,518 
81,758 
(115,122)
77,736 
Total equity
65,582 
45,518 
83,924 
(100,393)
94,631 
           
Total liabilities and equity
101,292 
1,158,615 
1,148,206 
(711,627)
1,696,486 

 
 
382

 
 
 
Notes on the accounts continued
  
43 Consolidating financial information continued

Cash flow statements
 
RBSG 
plc 
£m 
RBS 
plc 
£m 
 
Subsidiaries 
£m 
Consolidation 
Adjustments 
£m 
RBSG 
Group 
£m 
 
For the year ended 31 December 2011
Net cash flows from operating activities
3,815 
2,084 
23,256 
(25,830)
3,325 
Net cash flows from investing activities
(4,568)
5,933 
(3,534)
 2,183 
14 
Net cash flows from financing activities
334 
4,258 
(3,502)
(2,831) 
(1,741)
Effects of exchange rate changes on cash and cash equivalents
(55)
(1,322)
(491)
395 
(1,473)
Net (decrease)/increase in cash and cash equivalents
(474)
10,953 
15,729 
(26,083)
125 
Cash and cash equivalents at 1 January 2011
2,357 
114,379 
169,284 
(133,490)
152,530 
Cash and cash equivalents at 31 December 2011
1,883 
125,332 
185,013 
(159,573)
152,655 
           
For the year ended 31 December 2010
         
Net cash flows from operating activities
(9,038)
29,444 
6,381 
(7,496)
19,291 
Net cash flows from investing activities
(1,878)
5,646 
362 
(779)
3,351 
Net cash flows from financing activities
(3,180)
252 
(13,133)
1,681 
(14,380)
Effects of exchange rate changes on cash and cash equivalents
321 
761 
(1,005)
82 
Net (decrease)/increase in cash and cash equivalents
(14,091)
35,663 
(5,629)
(7,599)
8,344 
Cash and cash equivalents at 1 January 2010
16,448 
78,716 
174,913 
(125,891)
144,186 
Cash and cash equivalents at 31 December 2010
2,357
114,379 
169,284 
(133,490)
152,530 

 
 
 
383

 
Notes on the accounts continued

 
For the year ended 31 December 2009
         
Net cash flows from operating activities
16,365 
49,844 
1,887 
(69,088)
(992)
Net cash flows from investing activities
(15,720)
(53,061)
50,103 
18,732 
54 
Net cash flows from financing activities
10,817 
12,246 
15,752 
(20,024)
18,791 
Effects of exchange rate changes on cash and cash equivalents
(83)
(3,762)
(7,356)
2,609 
(8,592)
Net increase in cash and cash equivalents
11,379 
5,267 
60,386 
(67,771)
9,261 
Cash and cash equivalents at 1 January 2009
5,069 
73,449 
114,527 
(58,120)
134,925 
Cash and cash equivalents at 31 December 2009
16,448 
78,716 
174,913 
(125,891)
144,186 



 
384

 


Additional information

 
386
Financial summary
394
Exchange rates
395
Economic and monetary environment
396
Supervision
397
Regulatory developments and reviews
398
Description of property and equipment
398
Major shareholders
398
Material contracts
404
ADR payment information
405
Risk factors
 
 
 
385

 
Additional information continued

Financial summary
The Group's financial statements are prepared in accordance with IFRS. Selected data under IFRS for each of the five years ended 31 December 2011 are presented below.

Summary consolidated income statement
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Net interest income
12,679 
14,209 
13,388 
15,482 
11,550 
Non-interest income (1,2,3)
16,258 
17,659 
19,638 
5,248 
17,922 
Total income
28,937 
31,868 
33,026 
20,730 
29,472 
Operating expenses (4,5,6,7,8)
(18,026)
(18,228)
(17,417)
(35,065)
(13,383)
Profit/(loss) before insurance net claims and impairment losses
10,911 
13,640 
15,609 
(14,335)
16,089 
Insurance net claims
(2,968)
(4,783)
(4,357)
(3,917)
(4,528)
Impairment losses (9,10)
(8,709)
(9,256)
(13,899)
(7,439)
(1,925)
Operating (loss)/profit before tax
(766)
(399)
(2,647)
(25,691)
9,636 
Tax (charge)/credit
(1,250)
(634)
429 
2,167 
(2,011)
(Loss)/profit from continuing operations
(2,016)
(1,033)
(2,218)
(23,524)
7,625 
Profit/(loss) from discontinued operations, net of tax
47 
(633)
(105)
(11,018)
87 
(Loss)/profit for the year
(1,969)
(1,666)
(2,323)
(34,542)
7,712 
           
(Loss)/profit attributable to:
         
Non-controlling interests
28 
(665)
349 
(10,832)
163 
Preference shareholders
— 
105 
878 
536 
246 
Paid-in equity holders
— 
19 
57 
60 
— 
Ordinary and B shareholders
(1,997)
(1,125)
(3,607)
(24,306)
7,303 


Notes:
(1)
Includes loss on strategic disposals of £104 million (2010 - £171 million gain; 2009 - £132 million gain; 2008 - £442 million gain).
(2)
Includes gain on redemption of own debt of £255 million (2010 - £553 million; 2009 - £3,790 million).
(3)
Includes movement in fair value of own debt of £1,846 million profit (2010 - £174 million profit; 2009 - £142 million loss; 2008 - £1,232 million profit).
(4)
Includes Payment Protection Insurance costs of £850 million.
(5)
Includes integration and restructuring costs of £1,064 million (2010 - £1,032 million; 2009 - £1,286 million; 2008 - £1,357 million; 2007 - £108 million).
(6)
Includes amortisation of purchased intangible assets of £222 million (2010 - £369 million; 2009 - £272 million; 2008 - £443 million; 2007 - £162 million).
(7)
Includes write-down of goodwill and other intangible assets of £11 million (2010 - £10 million; 2009 - £363 million; 2008 - £16,911 million).
(8)
Includes gains on pensions curtailment of £2,148 million in 2009.
(9)
Includes sovereign debt impairment of £1,099 million.
(10)
Includes interest rate hedge adjustments on impaired available-for-sale Greek government bonds of £169 million.


Summary consolidated balance sheet
2011 
£m 
201
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Loans and advances
598,916 
655,778 
820,146 
1,012,919 
1,047,998 
Debt securities and equity shares
224,263 
239,678 
286,782 
293,879 
347,682 
Derivatives and settlement balances
537,389 
438,682 
453,487 
1,010,391 
293,991 
Other assets
146,299 
119,438 
136,071 
84,463 
151,158 
Total assets
1,506,867 
1,453,576 
1,696,486 
2,401,652 
1,840,829 
           
Owners' equity
74,819 
75,132 
77,736 
58,879 
53,038 
Non-controlling interests
1,234 
1,719 
16,895 
21,619 
38,388 
Subordinated liabilities
26,319 
27,053 
37,652 
49,154 
38,043 
Deposits
611,759 
609,483 
756,346 
897,556 
994,657 
Derivatives, settlement balances and short positions
572,499 
478,076 
475,017 
1,025,641 
363,073 
Other liabilities
220,237 
262,113 
332,840 
348,803 
353,630 
Total liabilities and equity
1,506,867 
1,453,576 
1,696,486 
2,401,652 
1,840,829 


 
386

 
Additional information continued

 
Financial summary continued

Other financial data
2011 
2010 
2009 
2008 
2007 
(Loss)/earnings per ordinary and B share from continuing operations - pence (1)
(1.8)
(0.5)
(6.3)
(146.2)
64.0 
Diluted (loss)/earnings per ordinary and B share from continuing operations - pence (1,2)
(1.8)
(0.5)
(6.3)
(146.2)
63.4 
Dividends per ordinary share - pence (1)
 
— 
— 
19.3 
27.0 
Dividend payout ratio (3)
— 
— 
— 
— 
43% 
Share price per ordinary share at year end - £
0.20 
0.39 
0.29 
0.49 
3.72 
Market capitalisation at year end - £bn
22.3 
42.8 
31.
19.5 
44.4 
Net asset value per ordinary and B share - £
0.64 
0.64 
0.65 
1.15 
3.74 
Return on average total assets (4)
(0.13%)
(0.07%)
(0.18%)
(1.19%)
0.65% 
Return on average ordinary and B shareholders' equity (5)
(2.9%)
(0.7%)
(7.2%)
(50.1%)
18.7% 
Average owners' equity as a percentage of average total assets
4.9% 
4.6% 
2.8% 
2.9% 
3.9% 
Risk asset ratio - Tier 1
13.0% 
12.9% 
14.1% 
10.0% 
7.3% 
Risk asset ratio - Total
13.8% 
14.0% 
16.1% 
14.1% 
11.2% 
Ratio of earnings to combined fixed charges and preference share dividends (6, 7)
         
  - including interest on deposits
0.91 
0.94 
0.75 
 0.05 
1.45 
  - excluding interest on deposits
0.25 
0.38 
(0.30)
(7.80)
5.73 
Ratio of earnings to fixed charges only (6, 7)
         
  - including interest on deposits
0.91 
0.95 
0.80 
0.05 
1.47 
  - excluding interest on deposits
0.25 
0.44 
(0.46)
(9.74)
6.53 
 
 

Notes:
(1)
The number of ordinary shares in issue in 2008 and 2007 were adjusted retrospectively for the bonus element of the rights issue completed in June 2008 and the capitalisation issue in September 2008.
(2)
None of the convertible securities had a dilutive effect in 2011, 2010, 2009 or 2008. All of the convertible preference shares had a dilutive effect in 2007 and as such were included in the computation of diluted earnings per share.
(3)
Dividend payout ratio represents the interim dividend paid and final dividend proposed as a percentage of profit attributable to ordinary and B shareholders before discontinued operations, integration and restructuring costs, amortisation of purchased intangible assets and net gain on sale of strategic investments and subsidiaries (net of tax).
(4)
Return on average total assets represents (loss)/profit attributable to ordinary and B shareholders as a percentage of average total assets.
(5)
Return on average ordinary and B shareholders' equity represents (loss)/profit attributable to ordinary and B shareholders expressed as a percentage of average ordinary and B shareholders' equity.
(6)
For this purpose, earnings consist of income before tax and non-controlling interests, plus fixed charges less the unremitted income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).
(7)
The earnings for the years ended 31 December 2011, 2010, 2009 and 2008, were inadequate to cover total fixed charges and preference share dividends. The coverage deficiency for total fixed charges and preference share dividends for the years ended 31 December 2011, 2010, 2009 and 2008 were £766 million, £523 million, £3,582 million and £26,287 million, respectively. The coverage deficiency for fixed charges only for the years ended 31 December 2011, 2010, 2009 and 2008 were £766 million, £399 million, £2,647 million and £25,691 million, respectively.
 

 
 
387

 
Additional information continued
 
Analysis of loans and advances to customers
The following table analyses loans and advances to customers before impairment provisions by remaining maturity, geographical area and type of customer.

 
Within 
1 year 
£m 
After 1 year 
but within 
5 years 
£m 
After 
5 years 
£m 
2011 
Total 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
UK
               
Central and local government
2,836 
33 
1,748 
4,617 
3,919 
3,174 
3,091 
3,135 
Finance
35,598 
2,445 
1,115 
39,158 
38,975 
36,283 
42,432 
70,006 
Residential mortgages
2,397 
4,963 
93,016 
100,376 
101,157 
92,583 
80,967 
73,916 
Personal lending
12,386 
3,797 
3,619 
19,802 
23,236 
25,254 
26,989 
28,186 
Property
12,218 
13,527 
9,909 
35,654 
41,957 
48,895 
52,127 
50,051 
Construction
2,911 
1,319 
774 
5,004 
6,340 
7,780 
10,171 
10,202 
Manufacturing
4,848 
1,375 
860 
7,083 
9,111 
11,432 
15,074 
13,452 
Service industries and business activities
14,752 
9,437 
11,175 
35,364 
45,685 
51,855 
58,638 
53,965 
Agriculture, forestry and fishing
987 
325 
1,193 
2,505 
2,758 
2,913 
2,972 
2,473 
Finance leases and instalment credit
2,789 
4,846 
3,581 
11,216 
13,374 
16,186 
17,363 
15,632 
Accrued interest
361 
57 
423 
558 
992 
2,463 
2,344 
Total domestic
92,083 
42,072 
127,047 
261,202 
287,070 
297,347 
312,287 
323,362 
Overseas residents
49,565 
26,880 
13,498 
89,943 
87,750 
89,891 
119,656 
98,845 
Total UK offices
141,648 
68,952 
140,545 
351,145 
374,820 
387,238 
431,943 
422,207 
                 
Overseas
               
US
33,446 
31,854 
25,031 
90,331 
90,753 
93,569 
126,277 
135,059 
Rest of the World
42,004 
23,193 
28,693 
93,890 
107,742 
264,712 
327,391 
277,721 
Total Overseas offices
75,450 
55,047 
53,724 
184,221 
198,495 
358,281 
453,668 
412,780 
Loans and advances to customers - gross
217,098 
123,999 
194,269 
535,366 
573,315 
745,519 
885,611 
834,987 
Loan impairment provisions
     
(19,760)
(18,055)
(17,126)
(10,889)
(6,449)
Loans and advances to customers - net
     
515,606 
555,260 
728,393 
874,722 
828,538 
                 
Fixed rate
30,924 
23,452 
47,752 
102,128 
110,364 
238,756 
183,693 
351,336 
Variable rate
186,174 
100,547 
146,517 
433,238 
462,951 
506,763 
701,918 
483,651 
Loans and advances to customers - gross
217,098 
123,999 
194,269 
535,366 
573,315 
745,519 
885,611 
834,987 
 
 
 
388

 
Additional information continued


 
Financial summary continued
Loan impairment provisions
For a discussion of the factors considered in determining the amount of provisions, see ‘Impairment loss provision methodology’ on pages 160 and 161 and ‘Critical accounting policies’ on page 282. The following table shows the movements in loan impairment provisions.

 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Provisions at the beginning of the year
         
Domestic
8,199 
6,670 
4,474 
3,258 
3,037 
Foreign
9,983 
10,613 
6,542 
3,194 
898 
 
18,182 
17,283 
11,016 
6,452 
3,935 
Transfer to disposal groups
         
Domestic
(773)
(25)
— 
— 
— 
Foreign
— 
(47)
(324)
(767)
— 
 
(773)
(72)
(324)
(767)
— 
Currency translation and other adjustments
         
Domestic
(3)
(79)
(228)
107 
5 
Foreign
(280)
122 
(302)
1,334 
178 
 
(283)
43 
(530)
1,441 
183 
Disposals of subsidiaries
         
Domestic
— 
— 
— 
(108)
10 
Foreign
(2,172)
(65)
(70)
2,211 
 
(2,172)
(65)
(178)
2,221 
Amounts written-off
         
Domestic
(2,374)
(2,252)
(2,895)
(1,446)
(1,222)
Foreign
(2,153)
(3,790)
(4,044)
(1,702)
(789)
 
(4,527)
(6,042)
(6,939)
(3,148)
(2,011)
Recoveries of amounts previously written-off
         
Domestic
158 
151 
175 
116 
158 
Foreign
369 
260 
224 
203 
184 
 
527 
411 
399 
319 
342 
Charged to income statement - continuing operations (1)
         
Domestic
2,749 
3,948 
5,370 
2,701 
1,395 
Foreign
4,492 
5,196 
7,720 
3,777 
508 
 
7,241 
9,144 
13,090 
6,478 
1,903 
Charged to income statement - discontinued operations
         
Domestic
— 
— 
— 
(3)
25 
Foreign
(8)
42 
1,044 
616 
18 
 
(8)
42 
1,044 
613 
43 
Unwind of discount (recognised in interest income)
         
Domestic
(220)
(214)
(226)
(151)
(150)
Foreign
(264)
(241)
(182)
(43)
(14)
 
(484)
(455)
(408)
(194)
(164)
Provisions at the end of the year (2)
         
Domestic
7,728 
8,199 
6,670 
4,474 
3,258 
Foreign
12,155 
9,983 
10,613 
6,542 
3,194 
 
19,883 
18,182 
17,283 
11,016 
6,452 
Gross loans and advances to customers
         
Domestic
261,203 
287,070 
297,347 
312,287 
323,362 
Foreign
274,163 
286,245 
448,172 
573,324 
511,625 
 
535,366 
573,315 
745,519 
885,611 
834,987 
 
 
 
389

 
Additional information continued
 

 
2011 
2010 
2009 
2008 
2007 
Closing customer provisions as a % of gross loans and advances to customers (3)
         
Domestic
2.96% 
2.86% 
2.24%
1.43%
1.01%
Foreign
4.39% 
3.44% 
2.33%
1.12%
0.62%
Total
3.69% 
3.15% 
2.30%
1.23%
0.77%
Customer charge to income statement as a % of gross loans and advances to customers (3)
         
Domestic
1.05% 
1.38% 
1.81%
0.86%
0.44%
Foreign
1.64% 
1.82% 
1.95%
0.75%
0.10%
Total
1.35% 
1.60% 
1.89%
0.79%
0.23%


Notes:
(1)
There were no amounts relating to loans and advances to banks (2010 - £13 million release; 2009 - £34 million charge; 2008 - £118 million charge; 2007 - nil).
(2)
Includes closing provisions against loans and advances to banks of £123 million (2010 - £127 million; 2009 - £157 million; 2008 - £127 million; 2007 - £3 million).
(3)
For the purpose of these ratios, closing customer provisions and customer charge relating to loans and advances to banks are excluded.

The following table shows additional information in respect of loan impairment provisions.
 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Loan impairment provisions at end of year
         
Customers
19,760 
18,055 
17,126 
10,889 
6,449 
Banks
123 
127 
157 
127 
3 
 
19,883 
18,182 
17,283 
11,016 
6,452 
           
Average loans and advances to customers (gross)
578,057 
610,131 
821,155 
858,333 
567,900 
           
As a % of average loans and advances to customers during the year
         
Total customer provisions charged to income statement
1.3% 
1.5% 
1.6% 
0.7%
0.4%
Amounts written-off (net of recoveries) - customers
0.7% 
0.9% 
0.8% 
0.3% 
0.3%

Analysis of closing customer loan impairment provisions
The following table analyses customer loan impairment provisions by geographical area and type of domestic customer.

 
2011
 
2010
 
2009
 
2008
 
2007
 
Closing 
provision 
% of 
 loans 
to total 
loans 
 
Closing 
provision 
% of 
 loans 
to total 
loans 
 
Closing 
provision 
% of 
 loans 
to total 
loans 
 
Closing 
provision 
% of 
 loans 
to total 
loans 
 
Closing 
provision 
% of 
 loans 
to total 
loans 
 
£m 
 
£m 
 
£m 
 
£m 
 
£m 
Domestic
                           
Central and local government
— 
0.9 
 
— 
0.7 
 
— 
0.4 
 
— 
0.3 
 
— 
0.4 
Manufacturing
135 
1.3 
 
100 
1.6 
 
153 
1.5 
 
127 
1.7 
 
93 
1.6 
Construction
502 
0.9 
 
605 
1.1 
 
355 
1.0 
 
254 
1.1 
 
75 
1.2 
Finance
40 
7.3 
 
98 
6.8 
 
26 
4.9 
 
67 
4.8 
 
52 
8.4 
Service industries and
  business activities
1,218 
6.6 
 
1,073 
8.0 
 
962 
7.0 
 
778 
6.6 
 
562 
6.5 
Agriculture, forestry and
  fishing
36 
0.5 
 
27 
0.5 
 
20 
0.4 
 
19 
0.3 
 
21 
0.3 
Property
2,657 
6.2 
 
2,071 
7.3 
 
908 
6.6 
 
490 
5.9 
 
85 
6.0 
Residential mortgages
384 
18.7 
 
302 
17.6 
 
196 
12.4 
 
36 
9.1 
 
36 
8.8 
Personal lending
1,919 
3.7 
 
2,504 
4.1 
 
2,527 
3.4 
 
2,235 
3.0 
 
2,054 
3.4 
Finance leases and
  instalment credit
366 
2.1 
 
435 
2.3 
 
341 
2.2 
 
194 
2.0 
 
132 
1.9 
Accrued interest
— 
0.1 
 
— 
0.1 
 
— 
0.1 
 
— 
0.3 
 
— 
0.3 
Total domestic
7,257 
48.3 
 
7,215 
50.1 
 
5,488 
39.9 
 
4,200 
35.1 
 
3,110 
38.8 
Foreign
10,517 
51.7 
 
8,190 
49.9 
 
8,562 
60.1 
 
4,745 
64.9 
 
2,289 
61.2 
Impaired book provisions
17,774 
100.0 
 
15,405 
100.0 
 
14,050 
100.0 
 
8,945 
100.0 
 
5,399 
100.0 
Latent book provisions
1,986 
   
2,650 
   
3,076 
   
1,944 
   
1,050 
 
Total provisions
19,760 
   
18,055 
   
17,126 
   
10,889 
   
6,449 
 


 
390

 
Additional information continued

Financial summary continued
Analysis of write-offs
The following table analyses amounts written-off by geographical area and type of domestic customer.

 
2011 
£m 
2010 
£m 
2009
£m
2008
£m
2007
£m
Domestic
         
Manufacturing
114 
94 
217
61
29
Construction
228 
110 
243
51
21
Finance
24 
105
31
47
Service industries and business activities
358 
411 
702
299
190
Agriculture, forestry and fishing
3
5
4
Property
490 
395 
320
34
9
Residential mortgages
23 
16 
2
1
Personal lending
1,004 
1,148 
1,188
938
909
Finance leases and instalment credit
129 
67 
115
26
13
Total domestic
2,374 
2,252 
2,895
1,446
1,222
Foreign
2,153 
3,790 
4,044
1,702
789
Total write-offs
4,527 
6,042 
6,939
3,148
2,011



Analysis of recoveries
The following table analyses recoveries of amounts written-off by geographical area and type of domestic customer.

 
2011 
£m 
2010 
£m 
2009
£m
2008
£m
2007
£m
Domestic
         
Manufacturing
1
2
Construction
Finance
— 
— 
2
2
Service industries and business activities
10 
13
12
7
Property
Residential mortgages
3
Personal lending
111
128 
99
96
143
Finance leases and instalment credit
10 
57
4
8
Total domestic
158 
151 
175
116
158
Foreign
369 
260 
224
203
184
Total recoveries
527 
411 
399
319
342

Renegotiated loans
Renegotiated loans are those loans restructured in response to a borrower's financial difficulties where no impairment provision is required. Restructured loans where an impairment provision is required continue to be reported as impaired loans.  Loans renegotiated during the year amounted to:

 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Renegotiated loans (1)
7,674 
5,758 
2,698 
2,637 
930 

Note:
(1)
Restructured loan data include only those arrangements above thresholds set individually by the divisions, ranging from nil to £10 million.

 
391

 
Additional information continued
 
Risk elements in lending
Risk elements in lending (REIL) comprises impaired loans and accruing loans past due 90 days or more as to principal or interest.

Impaired loans are all loans for which an impairment provision has been established; for collectively assessed loans, impairment loss provisions are not allocated to individual loans and the entire portfolio is included in impaired loans.

Loans are classified as accruing loans past due 90 days or more where they are past due 90 days but where no impairment provision is required because they are fully collateralised.


 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Impaired loans (2)
         
Domestic
14,528 
15,471 
13,572 
8,588 
5,599 
Foreign
24,219 
20,230 
21,453 
10,891 
4,763 
Total
38,747 
35,701 
35,025 
19,479 
10,362 
Accruing loans which are contractually overdue 90 days or more as to
  principal or interest
         
Domestic
1,697 
2,363 
2,224 
1,201 
217 
Foreign
401 
534 
1,000 
581 
152 
Total
2,098 
2,897 
3,224 
1,782 
369 
Total risk elements in lending
40,845 
38,598 
38,249 
21,261 
10,731 
           
Closing provisions for impairment as a % of total risk elements in lending
49% 
47% 
46% 
52% 
60% 
Risk elements in lending as a % of gross lending to customers excluding
  reverse repos (3)
8.6% 
7.3% 
5.4% 
2.5% 
1.6% 

Notes:
(1)
For the analysis above, 'Domestic' consists of the United Kingdom domestic transactions of the Group. 'Foreign' comprises the Group's transactions conducted through offices outside the UK and through those offices in the UK specifically organised to service international banking transactions.
(2)
The write-off of impaired loans affects the closing provisions for impairment as a % of total risk elements in lending (the coverage ratio).  The coverage ratio reduces if the loan written off carries a higher than average provision and increases if the loan written off carries a lower than average provision.
(3)
Includes REIL and gross lending relating to disposal groups.


 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Gross income not recognised but which would have been recognised under the
  original terms of impaired loans
         
Domestic
636 
579 
625 
393 
390 
Foreign
964 
830 
1,032 
338 
64 
 
1,600 
1,409 
1,657 
731 
454 
           
Interest on impaired loans included in net interest income
         
Domestic
220 
214 
226 
150 
165 
Foreign
264 
241 
182 
42 
15 
 
484 
455 
408 
192 
18

Potential problem loans
Potential problem loans (PPL) are loans for which an impairment event has taken place but no impairment provision is required. This category is used for fully collateralised advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.

 
2011 
£m 
2010 
£m 
2009 
£m 
2008 
£m 
2007 
£m 
Potential problem loans
739 
633 
1,009 
226 
671 

Both REIL and PPL are reported gross and take no account of the value of any security held which could reduce the eventual loss should it occur, nor of any provision marked. Therefore impaired assets which are highly collateralised, such as mortgages, will have a low coverage ratio of provisions held against the reported  impaired balance.

 
392

 
Additional information continued

Financial summary continued
Analysis of deposits - product analysis
The following table analyses the Group's deposits by type and geographical area.
 
2011 
£m 
2010 
£m 
2009
£m
UK
     
Domestic
     
Demand deposits
     
  - interest-free
63,875 
66,608 
45,855
  - interest-bearing
111,274 
136,359 
136,157
Time deposits
     
  - savings
79,310 
70,774 
67,450
  - other
61,651 
59,557 
65,937
Overseas residents
     
Demand deposits
     
  - interest-free
2,965 
2,512 
1,072
  - interest-bearing
20,773 
12,530 
13,618
Time deposits
     
  - savings
1,693 
1,512 
1,288
  - other
59,105 
46,023 
61,341
Total UK offices
400,646 
395,875 
392,718
Overseas
     
Demand deposits
     
  - interest-free
30,780 
29,919 
36,458
  - interest-bearing
44,413 
43,890 
91,482
Time deposits
     
  - savings
25,296 
24,472 
78,423
  - other
110,624 
115,327 
157,265
Total overseas offices
211,113 
213,608 
363,628
Total deposits
611,759 
609,483 
756,346
       
Held-for-trading
137,326 
116,189 
106,477
Designated as at fair value through profit or loss
5,627 
4,824 
8,580
Amortised cost
468,806 
488,470 
641,289
Total deposits
611,759 
609,483 
756,346
       
Overseas
     
US
135,919 
135,642 
126,075
Rest of the World
75,194 
77,966 
237,553
Total overseas offices
211,113 
213,608 
363,628
 

Certificates of deposit and other time deposits
The following table shows details of the Group's certificates of deposit and other time deposits over $100,000 or equivalent by remaining maturity.
 
2011
Within 
3 months 
£m 
Over 3 
 months 
but within 
6 months 
£m 
Over 6 
 months 
but within 
12 months 
£m 
Over 
12 months 
£m 
Total 
£m 
UK based companies and branches
         
Certificates of deposit
6,092 
1,367 
949 
331 
8,739 
Other time deposits
23,082 
4,080 
3,070 
10,816 
41,048 
           
Overseas based companies and branches
         
Certificates of deposit
6,689 
666 
553 
169 
8,077 
Other time deposits
15,413 
3,671 
2,930 
5,439 
27,453 
 
51,276 
9,784 
7,502 
16,755 
85,317 


 
393

 
Additional information continued
 
Other contractual cash obligations
The table below summarises the Group's other contractual cash obligations by payment date.

2011
0-3 months 
£m 
3-12 months 
£m 
1-3 years 
£m 
3-5 years 
£m 
5-10 years 
£m 
10-20 years 
£m 
Operating leases
208 
260 
802 
651 
1,234 
1,480 
Contractual obligations to purchase goods or services
111 
372 
548 
93 
— 
 
319 
632 
1,350 
744 
1,240 
1,480 
             
2010
           
Operating leases
132 
365 
837 
678 
1,178 
1,714 
Contractual obligations to purchase goods or services
104 
336 
484 
26 
— 
— 
 
236 
701 
1,321 
704 
1,178 
1,714 

The Group's undrawn formal facilities, credit lines and other commitments to lend were £239,963 million (2010 - £266,822 million). While the Group has given commitments to provide these funds, some facilities may be subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.

Exchange rates
Except as stated, the following tables show, for the dates or periods indicated, the Noon Buying Rate in New York for cable transfers in sterling as certified for customs purposes by the Federal Reserve Bank of New York.

US dollars per £1
February 
2012 
January 
2012 
December 
2011 
November 
2011 
October 
2011 
September 
2011 
Noon Buying Rate
           
High
1.5951 
1.5754 
1.5698 
1.6076 
1.6141 
1.6190 
Low
1.5677 
1.5301 
1.5386 
1.5467 
1.5398 
1.5358 
             
   
2011 
2010 
2009 
2008 
2007 
Noon Buying Rate
           
Period end rate
 
1.5537 
1.5392 
1.6167 
1.4619 
1.9843 
Average rate for the year (1)
 
1.6105 
1.5415 
1.5707 
1.8424 
2.0073 
             
Consolidation rate (2)
           
Period end rate
1.5475 
1.5524 
1.6222 
1.4604 
2.0043 
Average rate for the year
1.6039 
1.5455 
1.5657 
1.8528 
2.0015 


Notes:
(1)
The average of the Noon Buying Rates on the last US business day of each month during the year.
(2)
The rates used by the Group for translating US dollars into sterling in the preparation of its financial statements.
(3)
On 23  March 2012, the Noon Buying Rate was £1.00 = US$1.5864.


 
394

 
Additional information continued

Economic and monetary environment
When economies are emerging from recessions rooted in high levels of debt and stresses in the financial system, growth is slower than in the typical recovery. That was the experience of our major markets in 2011. It is what we should expect in 2012 and beyond.

In the UK, growth weakened. Total economic activity, as measured by gross domestic product (GDP), grew by 0.9% compared with 2.1% in 2010. At the start of the year, expectations had been more positive, the consensus forecast for growth having been 2.1%. Yet the year ended with the economy contracting.

Unemployment rose sharply, from less than 8% in mid-year to 8.4% in December. Wage growth was subdued and inflation reduced the spending power of earnings.

In commercial property, values edged higher, finishing the year up 2%. Strong performance in prime markets, particularly central London was the main source of gains. Again, however, momentum slowed towards the end of the year.

Housing market activity remained subdued. Prices probably fell slightly although the different measures disagree on the extent of the change.

Against this backdrop, the Bank of England continued its ultra-loose monetary policy stance. Despite persistently above-target inflation, interest rates remained unchanged at a record low of 0.5%, the Bank of England judging elevated inflation to be the result of temporary factors. In fact, its greater concern was that the weak economy would cause inflation to be too low and in October, the Monetary Policy Committee announced that it would increase its asset purchase programme by £75 billion.

In the United States, GDP growth slowed to 1.7% compared with 3.0% in 2010. Unlike the UK, however, growth accelerated as the year progressed. Unemployment began to fall, although at 8.5% in December it was high compared with previous recoveries.

Housing remained a drag anchor. Prices fell by around a further 4% and were almost a third below their peak level. Sales volumes were subdued and an overhang of properties on which borrowers had defaulted remained.

Judging that the pace of recovery was too slow to reduce unemployment sufficiently, the Federal Reserve tried to stimulate the economy in the third quarter with unconventional measures designed to push down medium to long-term interest rates. It also said it expected to keep the Fed Funds rate, its main policy rate, at its current low level at least until mid-2013.

Ireland emerged from three years of recession. The export sector led modest growth in the first half of the year, as it benefited from the boost to competitiveness delivered by falling wages, and stronger demand in some of Ireland’s main markets. However, the economy appears to have shrunk again in the second half.

For Ireland, gross national product (GNP) is a better measure of people’s material well-being. It reflects the income residents receive rather than the value of the incomes generated in the country, an important distinction when there is a large foreign-owned sector that remits profits overseas. GNP fell by an estimated 0.8%.

Unemployment averaged more than 14%. House prices dropped to a point where they were close to 50% below their peak level at the year end.

Looming over 2011 and prospects for 2012 was the likelihood that some euro area governments will not be able to repay in full monies they have borrowed. Uncertainty about how this problem will be solved damaged confidence. The policy prescribed for highly indebted countries, fiscal austerity, made their growth prospects worse because there are no compensating interest or exchange rate gains in a currency union. By the end of the year, the euro area was in recession, exacerbating the debt problem.

Europe’s leaders avoided both a disorderly default and a break-up of the euro area. However, it will take political will and public support to manage the immediate risk of defaults and to tackle the root causes of the acute challenges that have accumulated since the establishment of the single currency in 1999.

Absent the worst outcome for the euro area - a default that cannot be contained in one country and its banking system - growth in our main economies in 2012 will be slow as households and governments continue to labour under substantial debt burdens.

 
395

 
Additional information continued

Supervision
United Kingdom
The UK Financial Services Authority (FSA) is the consolidated supervisor of the Group. As at 31 December 2011, 26 companies in the Group (excluding subsidiaries of RBS NV), spanning a range of financial services sectors (banking, insurance and investment business), were authorised to conduct financial activities regulated by the FSA.

The UK authorised banks in the Group include the Royal Bank, NatWest, Coutts & Co and Ulster Bank Limited. Wholesale activities, other than Group Treasury activities, are concentrated in the Group's Global Banking & Markets and UK Corporate divisions, and are undertaken under the names of the Royal Bank and NatWest. UK retail banking activities are managed by the UK Retail division. The exception is Ulster Bank Limited, which is run as a separate division within the Group. Ulster Bank Limited provides banking services in Northern Ireland while the banking service in the Republic of Ireland is provided by Ulster Bank Ireland Limited, which is primarily supervised by the Central Bank of Ireland.

Investment management business is principally undertaken by companies in the Wealth division, including Coutts & Co, Adam & Company Investment Management Limited, and in the Global Banking & Markets division, through RBS Asset Management Limited.

General insurance business was principally undertaken by Direct Line Insurance plc and Churchill Insurance Company Limited. On 10 December 2011, the assets and liabilities of these companies were transferred under Part VII of the Financial Services and Markets Act 2000 to UK Insurance Limited, who now undertake general insurance business.

The Group is subject to extensive regulations that impose obligations on financial institutions to maintain appropriate policies, procedures and controls to ensure compliance with the rules and regulations to which they are subject.

United States
The Group is both a bank holding company and a financial holding company within the meaning of the US Bank Holding Company Act of 1956. As such, it is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (“the Federal Reserve”). Among other things, the Group's direct and indirect activities and investments in the United States are limited to those that are 'financial in nature' or 'incidental' or 'complementary' to a financial activity, as determined by the Federal Reserve. The Group is also required to obtain the prior approval of the Federal Reserve before acquiring directly or indirectly, the ownership or control of more than 5% of any class of the voting shares of any US bank or holding company. Under current Federal Reserve policy, the Group is required to act as a source of financial strength for its US bank subsidiaries. Among other things, this source of strength obligation could require the Group to inject capital into any of its US bank subsidiaries if any of them became undercapitalised.

Anti-money laundering, anti-terrorism and economic sanctions regulations are a major focus of the US government for financial institutions and are rigorously enforced by US government agencies.

The Group's US bank and non-bank subsidiaries and the Royal Bank's US branches are also subject to supervision and regulation by a variety of other US regulatory agencies. RBS Citizens NA is supervised by the Office of the Comptroller of the Currency, which is charged with the regulation and supervision of nationally chartered banks. Citizens Bank of Pennsylvania is subject to the regulation and supervision of the US Federal Deposit Insurance Corporation and the Pennsylvania Department of Banking and Insurance. Citizens Financial Group is under the supervision of the Federal Reserve as a bank holding company. The Royal Bank's New York branch is supervised by the New York State Banking Department, and its Connecticut branch is supervised by the Connecticut Department of Banking. Both branches are also subject to supervisory oversight by the Federal Reserve, through the Federal Reserve Bank of Boston.

The Group's US broker dealer, RBS Securities Inc. (RBSSI), formerly known as Greenwich Capital Markets, Inc., is subject to regulation and supervision by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) with respect to its securities activities. The futures activities of RBSSI are subject to regulation and oversight by the US Commodity Futures Trading Commission (CFTC) and the Chicago Mercantile Exchange (CME) Group-owned exchanges. The Group's US commodities business, RBS Sempra Commodities LLP and its subsidiaries, which was largely sold in 2010, are primarily regulated by the Federal Reserve Bank of Boston, the Federal Energy Regulatory Commission (FERC), the Commodity Futures Trading Commission (CFTC), the CME Group-owned exchanges, and The Intercontinental Exchange.

Netherlands
The consolidated supervisor of RBS N.V. is the Dutch Central Bank, De Nederlandsche Bank (DNB). The DNB operates as prudential supervisor of banks, insurance companies, pension funds and securities firms, and also as part of the European System of Central Banks.

Other jurisdictions
The Group operates in over 30 countries through a network of branches, local banks and non-bank subsidiaries and these activities are subject to supervision in most cases by a local regulator or central bank.


 
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Additional information continued


Regulatory developments and reviews
The Group works with domestic and international trade associations and proactively engages with regulators and other authorities such as the Basel Committee, the European Commission and governments, in order to understand the implications of proposed regulatory change and to contribute to the development of regulatory policy.

The Group and its subsidiaries have co-operated fully with various regulatory reviews and developments in the UK and internationally, including enquiries or investigations into alleged or possible breaches of regulations.

United Kingdom
In the UK, the Group has actively engaged with a large number of legislative and regulatory consultations. Reflecting global developments, financial stability - notably bank prudential requirements and the new regulatory framework - remains a key focus for the UK regulatory authorities.

The Group has continued to participate fully in the analysis of the cause of the financial crisis and the development of potential policy and reform. A wide range of ideas and proposals, aimed at strengthening the resilience of the banking system and addressing perceived shortcomings in existing regulation, have been advanced and continue to be developed. With respect to prudential requirements, the Group provided detailed feedback on the FSA's latest consultation on Strengthening Capital Standards and others, including on the supervisory formula method and liquidity swaps. Other consultations included HM Treasury’s further consultations on the structure of financial regulation, covered bonds and on Recovery and Resolution Plans (“Living Wills”).

The Group has actively engaged with, and contributed to, a number of inquiries regarding the future of banking. These included the Independent Commission on Banking and various Treasury Select Committee inquiries. It has contributed to debates led by the Financial Stability Board, European Commission and UK authorities on resolution frameworks, including possible mechanisms such as contingent capital and bail-in arrangements. It participated in the FSA's pilot for the development of Living Wills and will be developing suitable Living Wills in line with forthcoming regulatory requirements.

The Group has continued to play an active role in the development of requirements affecting products and processes. Examples include the Government’s Review of Consumer Credit and Personal Insolvency, the FSA’s review of mortgages (Mortgage Market Review) and of investment advice (Retail Distribution Review), the FSA’s proposals on Product Intervention and the European Directive on Mortgages. The Group worked closely with the Government (the Department of Business, Innovation and Skills) and the industry to develop and implement annual credit card statements to improve transparency for customers. The Group has also worked closely with the Government on its MyData initiative, with a view to empowering consumers by giving them greater access to their financial data, and on the Government’s proposals to introduce a charitable giving option at ATMs.

In 2011, regulatory changes which have been introduced to improve transparency for retail customers include the addition of interest rates on savings account statements and annual statements for personal current accounts.

UK regulated firms within the Group are members of the Financial Services Compensation Scheme (FSCS), which provides compensation to eligible customers of authorised financial services firms that are unable to meet their obligations. The FSCS is a contributor to depositor confidence and financial stability and the Group is supporting the FSCS in increasing awareness amongst UK consumers.

The FSA, in its 2011/2012 Business Plan, made reference to the proposed changes to the structure of regulation in the UK. The FSA will be responsible for transitioning to the new regulatory structure and the Group is committed to working with the authorities to establish a system that delivers the new structure.

The Group also continues to co-operate with the Information Commissioner’s Office, the UK’s independent public body set up to uphold information rights in the public interest, promoting openness by public bodies and data privacy for individuals. The Group monitors legal and regulatory changes and industry best practice and implements timely process improvements to ensure continued protection of individuals’ privacy rights and enhance information security management.

European Union/global developments
The Group follows closely the work and recommendations of the G20, as well as international standard setters such as the Basel Committee on Banking Supervision. Of note were the developments, particularly in Europe, to implement the proposals from the Basel Committee on Banking Supervision for an enhanced capital and liquidity framework. The Basel Committee also developed proposals for additional capital for globally systemically important banks. The Group remains closely involved in all aspects of the proposals on capital and liquidity, as well as on other related policy areas, such as countercyclical capital buffers and contingent capital

Also notable in 2011, was significant work by the European Commission and the new European Supervisory Authorities in such areas as financial sector taxation, corporate governance, crisis management, credit rating agencies and remuneration. The Group provided input in all these areas.

United States
In the US, the Group continues to engage constructively with regulators and other bodies on regulatory and legislative change and seeks to ensure proper implementation and compliance. Current issues include regulatory implementation of US financial regulatory reform legislation, mortgage and credit card lending and consumer disclosures, debit card interchange fees, and account overdraft protection.

Other jurisdictions
The Group is active in monitoring regulatory developments in each country in which it operates so that internal policies are sufficient to ensure the effective management of regulatory risk.


 
397

 
Additional information continued
 
Description of property and equipment
The Group operates from a number of locations worldwide, principally in the UK. At 31 December 2011, the Royal Bank and NatWest had 627 and 1,493 retail branches, respectively, in the UK. Ulster Bank has a foot print of 236 branches and an extensive network of business banking offices across Northern Ireland and the Republic of Ireland. US Retail & Commercial had 1,519 retail banking offices (including in-store branches) covering Connecticut, Delaware, Illinois, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Pennsylvania, Rhode Island and Vermont. A substantial majority of the UK branches are owned by the Royal Bank, NatWest and their subsidiaries or are held under leases with unexpired terms of over 50 years. The Group's principal properties include its headquarters at Gogarburn, Edinburgh, its principal offices in London at 135 and 280 Bishopsgate and the Drummond House administration centre located at South Gyle, Edinburgh.

Total capital expenditure on premises (excluding investment properties), computers and other equipment in the year ended 31 December 2011 was £820 million (2010 - £656 million; 2009 - £1,215 million).

Major shareholders
In December 2008, The Solicitor for the Affairs of Her Majesty's Treasury (HM Treasury) acquired 22,854 million ordinary shares representing 57.9% of the company's issued ordinary share capital. During 2009, HM Treasury acquired a further 16,791 million ordinary shares raising their holding to 70.3% of the company's issued ordinary share capital.

In December 2009, HM Treasury acquired 51 billion B shares in the company representing the entire issued B share capital. At 31 December 2011, HM Treasury’s holding in the company’s ordinary shares was 66.9%.

Other than detailed above, there have been no significant changes in the percentage ownership of major shareholders of the company's ordinary, B and preference shares during the three years ended 22 February 2012. All shareholders within a class of the company's shares have the same voting rights.

At 22 February 2012, the directors of the company had options to purchase a total of 10,455,306 ordinary shares of the company.

As at 31 December 2011, almost all of the company's US$ denominated preference shares and American Depository Shares representing ordinary shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.


Material contracts
The company and its subsidiaries are party to various contracts in the ordinary course of business. Material contracts include the following:

Consortium and Shareholders Agreement (CSA)
On 28 May 2007, Fortis Bank Nederland, the company, Santander and RFS Holdings entered into the CSA. Fortis Bank Nederland acceded to the CSA on 26 July 2007. On 3 October 2008, the Dutch State acquired Fortis Bank Nederland. On 24 December 2008 the Dutch State acceded to the CSA following its acquisition of the shares held by Fortis Bank Nederland in RFS Holdings pursuant to a Deed of Accession entered into between RFS Holdings, the company, Fortis Bank Nederland, Santander and the Dutch State. On 1 April 2010 the CSA was restated. It was the subject of a further amendment on 18 July 2011. The CSA (as amended and restated) governs the relationships amongst the parties thereto in relation to the acquisition by RFS Holdings of ABN AMRO (now RBS Holdings N.V.). The CSA (as amended and restated) details, inter alia, the equity interests in RFS Holdings, the governance of RFS Holdings, the arrangements for the transfer of certain ABN AMRO businesses, assets and liabilities to the Dutch State (previously Fortis Bank Nederland), the company and Santander, further funding obligations of the Dutch State, the company and Santander where funding is required by regulatory authorities in connection with the ABN AMRO businesses, the allocation of taxes and conduct of tax affairs and the steps that the Dutch State, the company and Santander expect to take to enable the company to become the sole shareholder of RFS Holdings.

Second Placing and Open Offer Agreement
Pursuant to a placing and open offer agreement dated 19 January 2009 entered into between the company, UBS, Merrill Lynch International and HM Treasury, (i) the company agreed to invite qualifying shareholders to apply to subscribe for new shares at the issue price of 31.75 pence per new share by way of the Second Open Offer, (ii) UBS and Merrill Lynch International were appointed as joint sponsors, joint bookrunners and joint placing agents and agreed to use reasonable endeavours to procure placees to subscribe for the new shares on such terms as may be agreed by the company and HM Treasury at not less than the issue price of 31.75 pence per new share on the basis that the new shares placed will be subject to clawback to the extent they are taken up under the Second Open Offer and (iii) HM Treasury agreed that, to the extent not placed or taken up under the Second Open Offer and subject to the terms and conditions set out in the Second Placing and Open Offer Agreement, HM Treasury would subscribe for such new shares itself at the issue price of 31.75 pence per new share.


 
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Material contracts continued
Pursuant to the terms of the Second Placing and Open Offer Agreement, the aggregate proceeds of the Second Placing and Open Offer (net of expenses) were used in full to fund the redemption on Admission (as defined in the Second Placing and Open Offer Agreement) of the preference shares held by HM Treasury at 101 per cent of their issue price (£5.05 billion) together with the accrued dividend on the preference shares (from and including 1 December 2008 to but excluding the Date of Admission (as defined in the Second Placing and Open Offer Agreement)) and the commissions payable to HM Treasury under the Second Placing and Open Offer Agreement.

HM Treasury is entitled to novate its rights under the Second Placing and Open Offer Agreement to any entity that is owned, directly or indirectly, by HM Treasury.

Pre-accession Commitments Letter
On 26 February 2009, the Royal Bank entered into a deed poll in favour of HM Treasury, pursuant to which the Royal Bank gave a series of undertakings on behalf of each member of the Group, with immediate effect unless otherwise agreed, in relation to the provision of information and the management of the assets, commitments and exposures (the "Proposed Assets") in the period prior to the Royal Bank's proposed accession to and participation in the UK Government's Asset Protection Scheme (APS).

The Royal Bank undertook to HM Treasury, among other things, to:

(i)
provide all such assistance and information and data as is reasonably requested which is pertinent to the implementation of the APS and the Royal Bank's potential participation in the APS;

(ii)
provide, as soon as practicable, an indicative list of the assets, commitments and exposures that the Royal Bank propose to include within the APS with a view to agreeing such list by 30 April 2009;

(iii)
provide, as promptly as practicable, information and data relating to the Proposed Assets reasonably requested for due diligence purposes and to provide certain other information concerning the Group's business and the financial performance and risk of the Proposed Assets;

(iv)
provide access to the Group's premises, books, records, senior executives, relevant personnel and professional advisers on reasonable terms;

(v)
consult with HM Treasury regarding the management and operations of the Proposed Assets and to ensure that the management of the Proposed Assets is in accordance with usual business practices and also without regard to the possible benefits under the APS;

(vi)
develop and, subject to market conditions, implement a liability management plan which is designed to enable the Group to meet certain Core Tier 1 capital targets for 2009; and

(vii)
use best endeavours (giving regard to reasonable operational requirements) to maintain regular, adequate and effective monitoring, reporting, risk management and audit controls and procedures in order, among other things, to ensure that risks relating to key business processes which affect the Proposed Assets are identified, assessed and reported and are managed and mitigated appropriately.

In addition, the Royal Bank agreed in principle that, if and only if the Royal Bank accedes to the APS, it would not claim, and would disclaim, certain UK tax losses and allowances arising to members of the Group in respect of any accounting period ending on or after 31 December 2008, provided that this undertaking would not apply in respect of any such tax benefits arising in the earlier of (a) the first accounting period beginning more than five years after the relevant accession date and (b) the first accounting period beginning after the relevant accession date in which the Group becomes profitable.

The company's commitments described in this section have been superseded by the Scheme Rules and the Accession Agreement (for details of the Accession Agreement see page 401), with the exception of a commitment to inform the Department for Business, Innovation and Skills prior to making significant reductions in the level of lending being made available to certain borrowers or counterparties, which will apply until 28 February 2011, in line with the duration of the commitments under the Lending Commitments Letter described below.

Lending Commitments Letter
On 26 February 2009, the company entered into a deed poll in favour of certain UK Government departments under which it undertook to support lending to creditworthy borrowers in the UK in a commercial manner with effect from 1 March 2009. On 18 May 2009, the company entered into an amendment to this deed poll which took effect from 29 May 2009 and on 20 November 2009, the company executed a further amendment to this deed poll. This lending commitment was a pre-requisite to the company's participation in the APS and other Government backed schemes, the objective of which was to reinforce the stability of the financial system and support the recovery of the economy.

Pursuant to this lending commitment, the company agreed to increase its lending in the 12 months commencing 1 March 2009 from its UK banking operations to UK businesses by, in aggregate, £16 billion above the amount previously budgeted.


 
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The company also made a commitment to increase lending to homeowners, including first time buyers, in the United Kingdom. The company undertook to increase its residential mortgage lending by at least £9 billion above the amount previously budgeted in the 12 months commencing 1 March 2009.

Such additional lending was subject to the company's ordinary course pricing and other terms, and certain commercial, risk, credit and regulatory considerations.

The company's compliance with its lending commitments is monitored by the UK Government, and is subject to a reporting process.

The company also made certain undertakings as regards marketing in support of its lending commitments and certain other matters relating to its business and residential lending practices and policies. The lending commitments made in the deed poll supersede the commitments given by the company in the First Placing and Open Offer Agreement and the Second Placing and Open Offer Agreement.

On 23 March 2010, the company agreed with the UK government certain adjustments to the above lending commitments for the 2010 commitment period (the 12 month period commencing 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the company committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the company agreed with the UK government to make available £8 billion of net mortgage lending in the 2010 commitment period. This was a decrease of £1 billion on the net mortgage lending target that previously applied to the 2010 commitment period which ended on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion. In the Budget of 23 March 2011, the Chancellor of the Exchequer confirmed that RBS had met these lending commitments, providing £30 billion of gross new facilities to SMEs and £26.9 billion to larger businesses (a total of £56.9 billion) and delivering £9.4 billion of net mortgage lending.
 
B Share Acquisition and Contingent Capital Agreement
On 26 November 2009, the company and HM Treasury entered into the Acquisition and Contingent Capital Agreement pursuant to which HM Treasury subscribed for the initial B shares and the Dividend Access Share (the "Acquisitions") and agreed the terms of HM Treasury's subscription for an additional £8 billion in aggregate in the form of further B shares (the "Contingent B shares"), which will be issued on the same terms as the initial B shares. The Acquisitions were subject to the satisfaction of various conditions, including the company having obtained the approval of its shareholders in relation to the Acquisitions.

The company and HM Treasury further agreed the terms of the £8 billion Contingent Subscription of the Contingent B shares in the Acquisition and Contingent Capital Agreement. For a period of five years from 22 December 2009 or, if earlier, until the occurrence of a termination event or until the company decides (with FSA consent) to terminate such Contingent Subscription (the "Contingent Period"), if the Core Tier 1 ratio of the company falls below five per cent (and if certain other conditions are met) HM Treasury has committed to subscribe for the Contingent B shares in no fewer than two tranches of £6 billion and £2 billion (or such smaller amounts as the company and HM Treasury may agree). Any unused portion of the £8 billion may be subscribed in one or more further tranches.

The company may, subject to certain conditions, at any time terminate the Contingent Subscription in whole or in part, with the consent of the FSA. The company is required to pay an annual fee, for the Contingent Period, in relation to the Acquisitions and the Contingent Subscription of £320 million less four per cent per annum of the value of any B shares subscribed for under the Contingent Subscription. Such fee is payable in cash or, with HM Treasury's consent, by waiving certain UK tax reliefs that are treated as deferred tax assets or through a further issue of B shares to HM Treasury. The annual fee ceases to be payable on termination of the Contingent Subscription and if the company terminates the Contingent Subscription in part, the fee will reduce proportionately.

The company gave certain representations and warranties to HM Treasury on the date of the Acquisition and Contingent Capital Agreement, on the date the circular was posted to shareholders, on the first date on which all of the conditions precedent were satisfied, or waived, and on the date of the Acquisitions. The company has agreed to give such representations and warranties again on each date (if any) a Contingent Subscription is triggered and on each date (if any) on which B shares are issued pursuant to a Contingent Subscription.

The company agreed to reimburse HM Treasury for its expenses incurred in connection with the Acquisitions and agreed to do so in connection with the Contingent B shares, if the Contingent Subscription is exercised.

The company agreed to a number of undertakings, including with respect to: (i) restrictions on the payment of dividends or other distributions on, and the redemption of, certain securities; (ii) expectations regarding the repurchase of the B shares by the company; (iii) renegotiations of the terms of the Contingent Subscription as a result of future legislative or regulatory changes; (iv) negotiating in good faith to maintain the status of the B shares and Dividend Access Share as Core Tier 1 capital; and (v) restrictions in relation to the company's share premium account.

 
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Material contracts continued
HM Treasury has agreed to waive its statutory pre-emption rights arising out of the B shares and the Dividend Access Share in respect of any future issue of equity securities by the company other than B shares and has agreed to vote its B shares and the Dividend Access Share, as applicable, in favour of each special resolution to disapply its pre- emption rights under the B shares and/or the Dividend Access Share then held by HM Treasury every time they arise. The pre-emption rights arising out of the B shares and the Dividend Access Share have also been disapplied in the Articles of Association.

HM Treasury has agreed that it shall not be entitled to exercise its option to convert B shares into ordinary shares to the extent that it holds more than 75 per cent of the ordinary shares of the company or to the extent that the exercise of such option would result in it holding more than 75 per cent of the ordinary shares of the company.

HM Treasury has agreed that it shall not be entitled to vote the B shares or the Dividend Access Share to the extent that votes cast on such B shares and the Dividend Access Share, together with any other votes which HM Treasury is entitled to cast in respect of any other ordinary shares held by or on behalf of HM Treasury, would exceed 75 per cent of the total votes eligible to be cast on a resolution proposed at a general meeting of the company.

For as long as it is a substantial shareholder of the company (within the meaning of the UKLA's Listing Rules), HM Treasury has undertaken not to vote on related party transaction resolutions at general meetings and to direct that its affiliates do not so vote.

Accession Agreement and the UK Asset Protection Scheme Terms and Conditions
The company acceded to the APS through an accession agreement (the "Accession Agreement") entered into with HM Treasury, which became effective on 22 December 2009. Supplemental agreements were signed on 27 August 2010, 20 December 2010, 25 January 2011, 10 February 2011, 30 June 2011, 22 July 2011 and 18 August 2011. The Accession Agreement incorporates by reference the terms and conditions of the APS set out in the document entitled ‘UK Asset Protection Scheme Terms and Conditions’ which is available on HM Treasury's website (the ‘Scheme Conditions’). The Accession Agreement which incorporates the Scheme Conditions is accounted for as a credit derivative and it tailors the APS to the company (by, amongst other things, setting applicable bank-specific thresholds and addressing various other bank-specific issues).

Under the APS, HM Treasury is liable to make payments to the company in respect of a pre-defined pool of assets and exposures (the "Covered Assets"). Payments under the APS are intended to protect the company, over time, for 90% of the amount by which cumulative losses on the whole portfolio of Covered Assets (as reduced by cumulative recoveries on the portfolio) exceed a fixed first loss threshold of £60 billion. Cumulative losses (as reduced by cumulative recoveries) below the first loss threshold, and a 10% vertical slice of any cumulative losses (as reduced by cumulative recoveries) exceeding the first loss threshold, are for the account of the company.

Protection under the APS is, subject to various requirements under the Scheme Conditions, provided in respect of the Covered Assets on the company's consolidated balance sheet as at 31 December 2008 with an aggregate covered amount of £282 billion (the covered pool has since reduced substantially). Protection under the APS may be lost or limited in certain specified circumstances, including the failure of a Covered Asset to satisfy certain asset eligibility criteria set out in the Scheme Conditions.

During the life of the APS, the company will pay HM Treasury a non-refundable annual fee (payable in advance) of £700 million per annum for the first three years of the APS and £500 million per annum until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. The annual fee can, subject to HM Treasury's consent, be paid wholly or partly by means of the waiver of certain UK tax reliefs that are treated as deferred tax assets or funded by the issuance of additional B shares to HM Treasury.

The company has the right, in certain circumstances, to withdraw from the APS permanently all or part of a Covered Asset. In addition, the company contractually has the right to terminate the APS exercisable at any time provided that the FSA has confirmed in writing to HM Treasury that it has no objection to the proposed termination. An exit fee and, potentially, a refund of HM Treasury's net payments under the APS may be payable by the company upon such termination. The Scheme Conditions also contain various provisions and restrictions on the management and administration of the Covered Assets and certain related assets. The company is obliged to manage certain such assets (those that are identified by reference to a ‘focus list’) in accordance with the asset management objective, which is to maximise the expected net present value of such assets (discounted at an HM Treasury rate), including by minimising losses and potential losses and maximising recoveries and potential recoveries. The company also has monitoring and reporting obligations under the Scheme Conditions which are aimed at transparency in respect of the Covered Assets to enable HM Treasury to manage and assess its exposure under the APS. In addition, the company has to establish a separate governance structure for the purposes of the APS. Further, the Scheme Conditions and the Accession Agreement also contain requirements for the development of a remuneration policy for the Group and specific remuneration requirements for certain officers and employees of the company.

 
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HM Treasury has the right to appoint one or more step-in managers to exercise extensive step-in rights in relation to all or some of the Covered Assets upon the occurrence of certain specified trigger events.

Certain Scheme Conditions are subject to modification at any time with retrospective effect at the discretion of HM Treasury without the company's consent. The modification rights arise broadly and subject to certain conditions where the operation, interpretation or application of such Scheme Conditions conflicts with any of the overriding general principles set out in the Scheme Conditions.

There are material restrictions on the form and substance of announcements or public statements (including any required by law or the rules of any securities exchange) made by the Group in relation to the APS or to HM Treasury in connection with the APS without HM Treasury's consent.

In connection with its participation in the APS, the company has agreed to a number of behavioural commitments in respect of lending for businesses in the UK, personal current accounts in the UK as well as to develop and implement a capital optimisation exercise designed to increase the Group’s Core Tier 1 capital.

The Tax Loss Waiver
On 26 November 2009, the company entered into three agreements (together comprising the Tax Loss Waiver) which provide the right, at the company’s option, subject to HM Treasury consent, to satisfy all or part of the annual fee in respect of the APS or the Contingent Subscription arrangement, and the exit fee payable in connection with any termination of the Group’s participation in the APS (but not the refund of the net payments it has received from HM Treasury under the APS), by waiving the entitlement to certain UK tax reliefs that are treated as deferred tax assets. The Tax Loss Waiver contains undertakings designed to prevent the Group from engaging in arrangements which have a main purpose of reducing the net cost to the Group of any waiver of tax reliefs pursuant to the Tax Loss Waiver.

State Aid Commitment Deed
As a result of the State Aid granted to the company, it was required to work with HM Treasury to submit a State Aid restructuring plan to the European Commission, which has now been approved under the State Aid rules. The company has agreed a series of measures to be implemented over a four year period, which supplement the measures in the company's strategic plan.

The Group entered into a State Aid Commitment Deed with HM Treasury which provides that the Group will comply or procure compliance with these measures and behavioural commitments. The Group agreed to do all acts and things necessary to ensure HM Treasury's compliance with its obligations under any European Commission decision approving State Aid to the Group.

The State Aid Commitment Deed also provides that if the European Commission adopts a decision that the UK Government must recover any State Aid (a "Repayment Decision") and the recovery order of the Repayment Decision has not been annulled or suspended by the Court of First Instance (now the General Court) or the European Court of Justice, then the Group must repay HM Treasury any aid ordered to be recovered under the Repayment Decision.

The State Aid Commitment Deed also provides for the Group's undertakings in respect of State Aid to be modified in certain limited circumstances. However, HM Treasury has undertaken that it will not, without the consent of the Group, agree modifications to the Group's undertakings with respect to State Aid which are significantly more onerous to the Group than those granted in order to obtain the State Aid approval.
 
State Aid Costs Reimbursement Deed
Under the State Aid Costs Reimbursement Deed, the Group has agreed to reimburse HM Treasury for fees, costs and expenses associated with the State Aid and State Aid approval.

Sale of RBS England and Wales and NatWest Scotland branch based business to Santander UK plc
On 4 August 2010, the Royal Bank, NatWest Plc and National Westminster Home Loans Limited entered into a Sale and Purchase Agreement with Santander UK plc pursuant to which the Royal Bank, NatWest Plc and National Westminster Home Loans Limited agreed to sell 311 Royal Bank of Scotland branded branches in England and Wales, seven NatWest branded branches in Scotland, the retail and SME customer accounts attached to these branches, the Direct SME business, and certain mid-corporate businesses and associated assets and liabilities to Santander UK plc for a premium of £350 million to net assets at closing. The parties agreed certain amendments to the Sale and Purchase Agreement on 30 August 2011. The consideration will be paid in cash and is subject to certain closing adjustments, including those relating to the performance of the business. The transaction is subject to regulatory, anti-trust and other conditions.
 
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Material contracts continued
RBS Sempra Commodities JV sales
On 16 February 2010, the Group announced that RBS Sempra Commodities JV, a joint venture owned by the Royal Bank and Sempra Energy, had agreed to sell to J.P. Morgan Ventures Energy Corporation (JPMorgan) its metals, oils and European energy business lines. The Group announced completion of the transaction on 2 July 2010, for a total cash consideration of US$1.6 billion, post interim distributions of which the company's share is approximately 47 per cent.

On 20 September 2010, the Group announced that RBS Sempra Commodities JV had agreed to sell its Sempra Energy Solutions business line to Noble Americas Gas & Power Corp. for consideration of approximately US$317 million in cash, plus the assumption of approximately US$265 million in debt. The Group’s share of the consideration is approximately 51 per cent, or US$162 million. The transaction closed on 1 November 2010.

On 7 October 2010, the Group announced that RBS Sempra Commodities JV had agreed to sell substantial assets of its commodities trading North American Power and Gas business lines to JPMorgan. The transaction closed on 1 December 2010 and JPMorgan acquired these net assets for consideration of US$220 million in cash based on the 30 June 2010 balance sheet, of which the Group’s share is approximately 51 per cent, i.e. US$112 million. The value of the gross assets acquired by JPMorgan was US$6 billion (unaudited) as of 30 June 2010.

Sale of Global Merchant Services business
On 6 August 2010, the Royal Bank, Citizens Financial Group, Inc., RBS Netherlands Holdings B.V., Ulster Bank Limited, Ulster Bank Ireland Limited, NatWest Plc and Ship Bidco Limited (a company representing Advent International (‘Advent’) and Bain Capital (‘Bain’) which has now changed its name to WorldPay (UK) Limited) entered into a Transfer Agreement pursuant to which the Royal Bank (either directly or through its group companies) sold 80.01 per cent of its Global Merchant Services business for an enterprise value of up to £2.025 billion. Approximately £1.45 billion (subject to customary post-closing adjustments) was received in cash on closing of the sale of the 80.01 per cent interest. Up to £200 million is receivable in the future if the returns realised by Advent and Bain exceed certain thresholds. The sale completed on 30 November 2010.

The Royal Bank, in its capacity as holder of a retained interest in the Global Merchant Services business, also entered into an Investment Agreement on 6 August 2010 (subsequently amended and restated on 29 November 2010) with Ship Bidco Limited (now WorldPay (UK) Limited), certain other acquisition vehicles, specified management and funds operated by Advent International and Bain Capital relating to the operations of the joint venture company which is the uppermost of the intermediate acquisition vehicles and the ultimate parent company of WorldPay (UK) Limited. The interests of the Royal Bank are insufficient to block major decisions of this joint venture company at the shareholder or board level.

Sale of RBS Aviation Capital to Sumitomo Mitsui Banking Corporation
On 16 January 2012, the Royal Bank and Sumitomo Mitsui Banking Corporation (SMBC) entered into a Sale and Purchase Agreement pursuant to which the Royal Bank agreed to sell its aircraft leasing business, RBS Aviation Capital, to SMBC, acting on behalf of a consortium comprising its parent, Sumitomo Mitsui Financial Group, and Sumitomo Corporation. As a result of the sale, the consortium will acquire RBS Aviation Capital for an approximate consideration of US$7.3 billion (£4.7 billion). The consideration will be paid in cash and will be subject to certain closing adjustments. The transaction is subject to regulatory and anti-trust conditions and it is expected that the sale will complete before the end of the third quarter of 2012.

 
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ADR payment information
Fees paid by ADR holders
The depositary collects its fees for delivery and surrender of ADSs directly from investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a portion of distributable property to pay the fees.

The depository may collect its annual fee for depository services by deductions from cash distributions or by directly billing investors or by changing the book-entry system accounts of participants acting for them. The depository may generally refuse to provide fee-attracting services until its fees for those services are paid.

 
 
Persons depositing or withdrawing shares must pay:
For:
$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
·      Issuance of ADSs, including issuances resulting from a distribution of shares or rights or other property.
   
 
·      Cancellation of ADSs for the purpose of withdrawal, including if the deposit agreement terminates.
   
$0.02 (or less) per ADS
·      Any cash distribution to ADS registered holders.
   
A fee equivalent to the fee that would be payable if securities distributed to you had been shares and the shares had been deposited for issuance of ADSs
·      Distribution of securities distributed to holders of securities of deposited securities to ADS registered holders.
   
Registration or transfer fees
·      Transfer and registration of shares on our share register to or from the name of the depository or its agent when you deposit or withdraw shares.
   
Expenses of the depository
·      Cable, telex and facsimile transmissions (when expressly provided in the deposit agreement).
   
 
·      Converting foreign currency to U.S. dollars.
   
Taxes and other governmental charges the depositary or the custodian have to pay on any ADS or share underlying an ADS, for example, stock transfer taxes, stamp duty or withholding taxes
·      As necessary.
 
   
Any charges incurred by the depository or its agents for servicing the deposited securities
·      As necessary.

Fees payable by the depository to the issuer
Fees incurred in past annual Period
From 1 January 2011 to 31 December 2011, the company received from the depository $300,000 for continuing annual stock exchange listing fees, standard out-of-pocket maintenance costs for the ADRs (consisting of the expenses of postage and envelopes for mailing annual and interim financial reports, printing and distributing dividend cheques, electronic filling of U.S. Federal tax information, mailing required tax forms, stationary, postage, facsimile, and telephone calls), any applicable performance indicators relating to the ADR facility, underwriting fees and legal fees.

Fees to be paid in the future.
The bank of New York Mellon, as depository, has agreed to reimburse the Company for expenses they incur that are related to establishment and maintenance expenses of the ADS program. The depository has agreed to reimburse the Company for its continuing annual stock exchange listing fees, the depository has also agreed to pay the standard out-of-pocket maintenance costs for the ADRs, which consist of the expenses of postage and envelopes for mailing annual and interim reports, printing and distributing dividend cheques, electronic filing of U.S. federal tax information, mailing required tax forms, stationary, postage, facsimile, and telephone calls. It has also agreed to reimburse the Company annually for certain investor relationship programs of special investor relations promotional activities. In certain instances, the depository has agreed to provide additional payments to the Company based on any applicable performance indicators relating to the ADR facility. There are limits on the amount of expenses for which the depository will reimburse the Company, but the amount of reimbursement available to the Company is not necessarily tied to the amount of fees the depository collects from investors.
 
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Risk factors
Set out below are certain risk factors which could adversely affect the Group's future results and cause them to be materially different from expected results. The Group's results could also be affected by competition and other factors. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.

The Group’s businesses and performance can be negatively affected by actual or perceived global economic and financial market conditions and by other geopolitical risks
The Group’s businesses and performance are affected by local and global economic conditions and perceptions of those conditions and future economic prospects. The outlook for the global economy over the near to medium-term remains challenging and many forecasts predict at best only stagnant or modest levels of gross domestic product (GDP) growth across a number of the Group’s key markets over that period. In the UK, latest estimates suggest the economy grew by only 1% in 2011, while the current consensus of forecasts predicts GDP growth of just 0.5% in 2012. GDP in the European Monetary Union (EMU) in 2011 was estimated to have grown by 1.6% in 2011 (although this was mainly boosted by Germany, the EMU’s largest economy, which grew by 3%). While the German economy has proven to be relatively robust, austerity measures in many EMU economies, initiated in response to increased sovereign debt risk, have resulted in weak economic and GDP growth. Economic growth in the EMU is predicted to fall in 2012 by 0.3% (source: Consensus Economics Inc, Eurostat, ONS). Despite significant interventions by governments and other non-governmental bodies during and since the financial crisis in 2008/2009, capital and credit markets around the world continue to be volatile and be subject to intermittent and prolonged disruptions. In particular, increasingly during the second half of 2011, a heightened risk of sovereign default relating to certain EU member states has had a negative impact on capital and credit markets. Such challenging economic and market conditions have exerted downward pressure on asset prices and on credit availability and upward pressure on funding costs, and continue to impact asset recovery rates and the credit quality of the Group’s businesses, customers and counterparties, including sovereigns. In particular, the Group has significant exposure to customers and counterparties within the EU (including the UK and Ireland), which includes sovereign debt exposures that have been, and may in the future be, affected by restructuring of their terms, principal, interest and maturity. These exposures have resulted in the Group making significant provisions and recognising significant write-downs in prior periods, which may also occur in future periods. These conditions, alone or in combination with regulatory changes or actions of market participants, may also cause the Group to experience reduced activity levels, additional write-downs and impairment charges and lower profitability, and may restrict the ability of the Group to access funding and liquidity. In particular, should the scope and severity of the adverse economic conditions currently experienced by some EU member states and elsewhere worsen, the risks faced by the Group would be exacerbated. Developments relating to the current economic conditions and unfavourable financial environment, including those discussed above, could have a material adverse effect on the Group’s business, results of operations, financial condition and prospects.

In Europe, countries such as Ireland, Italy, Greece, Portugal and Spain have been particularly affected by the recent financial and economic conditions. The perceived risk of default on the sovereign debt of those countries intensified in the latter part of 2011 particularly in relation to Greece and has continued into 2012. This raised concerns about the contagion effect such a default would have on other EU economies as well as the ongoing viability of the euro currency and the EMU. Yields on the sovereign debt of most EU member states have recently been volatile and trended upward. The EU, the European Central Bank and the International Monetary Fund have prepared rescue packages for some of the affected countries and a number of European states, including Ireland, Italy and Spain, are taking actions to stabilise their economies and reduce their debt burdens. The EU has also taken policy initiatives intended to address systemic stresses in the eurozone. Despite these actions, the long-term ratings of a majority of eurozone countries have recently been downgraded and further downgrades are possible. Furthermore, the effectiveness of these actions is not assured and the possibility remains that the euro could be abandoned as a currency by countries that have already adopted its use, or in an extreme scenario, abandonment of the euro could result in the dissolution of the EMU. This would lead to the re-introduction of individual currencies in one or more EMU member states.

The effects on the European and global economies of the potential dissolution of the EMU, exit of one or more EU member states from the EMU and the redenomination of financial instruments from the euro to a different currency, are impossible to predict fully. However, if any such events were to occur they would likely:
 
·
result in significant market dislocation;

·
heighten counterparty risk;

·
affect adversely the management of market risk and in particular asset and liability management due, in part, to redenomination of financial assets and liabilities; and

·
have a material adverse effect on the Group’s financial condition, results of operations and prospects.

By virtue of the Group’s global presence, the Group is also exposed to risks arising out of geopolitical events, such as the existence of trade barriers, the implementation of exchange controls and other measures taken by sovereign governments that can hinder economic or financial activity levels. Furthermore, unfavourable political, military or diplomatic events, armed conflict, pandemics and terrorist acts and threats, and the response to them by governments could also adversely affect levels of economic activity and have an adverse effect upon the Group’s business, financial condition and results of operations.

 
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Risk factors continued
The Group’s ability to meet its obligations including its funding commitments depends on the Group’s ability to access sources of liquidity and funding
Liquidity risk is the risk that a bank will be unable to meet its obligations, including funding commitments, as they fall due. This risk is inherent in banking operations and can be heightened by a number of factors, including an over reliance on a particular source of wholesale funding (including, for example, short-term and overnight funding), changes in credit ratings or market-wide phenomena such as market dislocation and major disasters. Credit markets worldwide have experienced severe reductions in liquidity and term-funding during prolonged periods in recent years. In particular, funding in the interbank markets, a traditional source of unsecured short-term funding, has been severely disrupted. Although credit markets generally improved during the first half of 2011, wholesale funding markets have continued to suffer, particularly for European banks as the sovereign debt crisis worsened during the second half of 2011. As a result, a number of banks were reliant on central banks as their principal source of liquidity and central banks increased their support provisions to banks with the European Central Bank providing significant liquidity in the last few months of 2011 (including long-term refinancing operations facilities (offering loans with a term of up to three years) and broader access to US dollar funding). Although these efforts appear to be having a positive impact, global credit markets remain disrupted. The market perception of bank credit risk has changed significantly recently and banks that are deemed by the market to be riskier have had to issue debt at a premium to the equivalent cost of debt for other banks that are perceived by the market as being less risky. Any uncertainty regarding the perception of credit risk across financial institutions may lead to further reductions in levels of interbank lending and associated term maturities and may restrict the Group’s access to traditional sources of liquidity.

The Group’s liquidity management focuses, among other things, on maintaining a diverse and appropriate funding strategy for its assets in line with the Group’s wider strategic plan. At certain times during periods of liquidity stress, the Group has been required to rely on shorter-term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. Such schemes require the pledging of assets as collateral, the eligibility and valuation of which is determined by the applicable central bank. Changes to these valuations or eligibility criteria can negatively impact the available assets and reduce available liquidity access particularly during periods of stress when such lines may be needed most. Further tightening of credit markets could have a materially adverse impact on the Group. There is also a risk that corporate and financial institution counterparties may seek to reduce their credit exposures to banks and other financial institutions, which may cause funding from these sources to no longer be available. There is also likely to be increased competition for funding due to the significant levels of refinancing expected to be required by financial institutions during 2012, which may also reduce the level of funding available from these sources. Under such circumstances, the Group may need to seek funds from alternative sources potentially at higher costs than has previously been the case or may be required to consider disposals of other assets not previously identified for disposal to reduce its funding commitments.

In the context of its liquidity management efforts, the Group has sought to increase the average maturity of its wholesale funding, which has had the effect of increasing the Group’s overall cost of funding. In addition, the Group expects to proportionately increase its reliance on longer-term secured funding, such as covered bonds.

Like many banking groups, the Group relies increasingly on customer deposits to meet a considerable portion of its funding and it is actively seeking to increase the proportion of its funding represented by customer deposits. However, such deposits are subject to fluctuation due to certain factors outside the Group’s control, such as a loss of confidence, increasing competitive pressures for retail customer deposits or the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors, which could result in a significant outflow of deposits within a short period of time. There is currently heavy competition among UK banks for retail customer deposits, which has increased the cost of procuring new deposits and impacted the Group’s ability to grow its deposit base and such competition is expected to continue. An inability to grow, or any material decrease in, the Group’s deposits could, particularly if accompanied by one of the other factors described above, have a materially adverse impact on the Group’s ability to satisfy its liquidity needs.

The occurrence of any of the risks described above could have a material adverse impact on the Group’s financial conditions and results of operations.

The Independent Commission on Banking has published its final report on competition and possible structural reforms in the UK banking industry. The UK Government has indicated that it supports and intends to implement the recommendations substantially as proposed, which could have a material adverse effect on the Group
The Independent Commission on Banking (ICB) was appointed by the UK Government in June 2010 to review possible structural measures to reform the UK banking system in order to promote, amongst other things, stability and competition. The ICB published its final report to the Cabinet Committee on Banking Reform on 12 September 2011, which set out the ICB’s views on possible reforms to improve stability and competition in UK banking. The final report made a number of recommendations, including in relation to (i) the implementation of a ring-fence of retail banking operations, (ii) increased loss absorbency (including bail-in i.e. the ability to write-down debt or convert it into an issuer’s ordinary shares in certain circumstances) and (iii) promotion of competition. On 19 December 2011 the UK Government published its response to the final report and indicated its support and intention to implement the recommendations set out in the final report substantially as proposed. The UK Government indicated that it will work towards putting in place the necessary legislation by May 2015, requiring compliance as soon as practicable thereafter and a final deadline for full implementation of 2019. The Group will continue to participate in the debate and to consult with the UK Government on the implementation of the recommendations set out in the final report and in the UK Government’s response, the effects of which could have a material adverse effect on the Group’s structure, results of operations, financial condition and prospects.

 
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The Group’s ability to implement its strategic plan depends on the success of the Group’s refocus on its core strengths and its balance sheet reduction programme
As a result of the global economic and financial crisis that began in 2008 and the changed global economic outlook, the Group is engaged in a financial and core business restructuring which is focused on achieving appropriate risk-adjusted returns under these changed circumstances, reducing reliance on wholesale funding and lowering exposure to capital-intensive businesses. A key part of this restructuring is the programme announced in February 2009 to run-down and sell the Group’s non-core assets and businesses and the continued review of the Group’s portfolio to identify further disposals of certain non-core assets and businesses. Assets identified for this purpose and allocated to the Group’s Non-Core division totalled £258 billion, excluding derivatives, at 31 December 2008. At 31 December 2011, this total had reduced to £93.7 billion (31 December 2010 - £137.9 billion), excluding derivatives, as further progress was made in business disposals and portfolio sales during the course of 2011. This balance sheet reduction programme continues alongside the disposals under the State Aid restructuring plan approved by the European Commission. As part of its core business restructuring, in January 2012 the Group announced changes to its wholesale banking operations, including the reorganisation of its wholesale businesses and the exit and downsizing of selected existing activities (including cash equities, corporate banking, equity capital markets, and mergers and acquisitions).

Because the ability to dispose of assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which remain challenging, there is no assurance that the Group will be able to sell or run-down (as applicable) those remaining businesses it is seeking to exit either on favourable economic terms to the Group or at all. In addition, material tax liabilities could arise on the disposal of assets. Furthermore, there is no assurance that any conditions precedent agreed will be satisfied, or consents and approvals required will be obtained in a timely manner, or at all. There is consequently a risk that the Group may fail to complete such disposals by any agreed longstop date.

The Group may be liable for any deterioration in businesses being sold between the announcement of the disposal and its completion, which period may be lengthy and may span many months. In addition, the Group may be exposed to certain risks until completion, including risks arising out of ongoing liabilities and obligations, breaches of covenants, representations and warranties, indemnity claims, transitional services arrangements and redundancy or other transaction related costs.

The planned reorganisation, exit and downsizing of business activities announced in January 2012 will be time intensive and costly, the extent to which is not fully ascertainable. The process of implementing these changes may result in further disruption to the Group and the businesses it is trying to exit or downsize.

The occurrence of any of the risks described above could negatively affect the Group’s ability to implement its strategic plan and could have a material adverse effect on the Group’s business, results of operations, financial condition, capital ratios and liquidity.

The occurrence of a delay in the implementation of (or any failure to implement) the approved proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank may have a material adverse effect on the Group
As part of the restructuring of its businesses, operations and assets, on 19 April 2011, the Group announced the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank. Subject to, among other matters, regulatory and other approvals, it is expected that the proposed transfers will be implemented on a phased basis over a period ending 31 December 2013. A large part of the proposed transfers is expected to have taken place by the end of 2012. On 17 October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of FSMA.

The process for implementing the proposed transfers is complex and any failure to satisfy any conditions or complete any preliminary steps to each proposed transfer may cause a delay in its completion (or result in its non-completion). If any of the proposed transfers are delayed (or are not completed) for any reason, such as a failure to secure required regulatory approvals, it is possible that the relevant regulatory authorities could impose sanctions which could adversely impact the minimum regulatory requirements for capital and liquidity of RBS N.V. and the Royal Bank. In addition, the FSA may impose additional capital and liquidity requirements in relation to the Royal Bank to the extent that such a delay in implementation (or non-completion) of any of the proposed transfers has consequential financial implications for the Royal Bank (for example increased intra-group large exposures). A delay in implementation of (or any failure to implement) any of the proposed transfers may therefore adversely impact RBS N.V.’s and the Royal Bank’s capital and liquidity resources and requirements, with consequential adverse impacts on their funding resources and requirements.

The occurrence of a delay in the implementation of (or any failure to implement) any of the proposed transfers may therefore have a material adverse effect on the Group’s business, results of operations and financial condition.

 
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Risk factors continued
The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan and is prohibited from making discretionary dividend or coupon payments on existing hybrid capital instruments (including preference shares and B Shares) which may impair the Group’s ability to raise new Tier 1 capital
The Group was required to obtain State Aid approval for the aid given to the Group by HM Treasury as part of the placing and open offer undertaken by the Group in December 2008, the issuance to HM Treasury of £25.5 billion of B shares in the capital of the Group which are, subject to certain terms and conditions, convertible into ordinary shares in the share capital of the Group and a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B Shares if certain conditions are met and the Group’s participation in the Asset Protection Scheme (APS). In that context, as part of the terms of the State Aid approval, the Group, together with HM Treasury, agreed the terms of a restructuring plan.

As part of the State Aid restructuring plan, there is a prohibition on the making of discretionary dividend (including on preference shares and B shares) or coupon payments on existing hybrid capital instruments for a two year period which ends on 30 April 2012. These restrictions prevent the Group, the Royal Bank and other Group companies (other than companies in the RBS Holdings N.V. group (which was renamed from ABN AMRO Holding N.V. on 1 April 2010), which are subject to different restrictions) from paying discretionary dividends on their preference shares and discretionary coupons on other Tier 1 securities, and the Group from paying dividends on its ordinary shares, for the same duration, and it may impair the Group’s ability to raise new capital through the issuance of ordinary shares and other securities issued by the Group.

The Group is subject to a variety of risks as a result of implementing the State Aid restructuring plan, including required asset disposals. In particular, the Group agreed to undertake a series of measures to be implemented over a four year period from December 2009, including the disposal of all or a controlling portion of RBS Insurance (with disposal of its entire interest in RBS Insurance required by 31 December 2014), Global Merchant Services (GMS), its interest in RBS Sempra Commodities LLP, and the Royal Bank branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct and other small and medium-size enterprise (SME) customers and certain mid-corporate customers across the UK. While the disposal of GMS is completed  and the disposal of RBS Sempra Commodities is largely completed, the sale processes in respect of the Royal Bank and NatWest branch-based business and RBS Insurance continue to progress. There is no assurance that the price that the Group receives or has received for any assets sold pursuant to the State Aid restructuring plan will be or has been at a level the Group considers adequate or which it could obtain in circumstances in which the Group was not required to sell such assets in order to implement the State Aid restructuring plan or if such sale were not subject to the restrictions contained in the terms thereof. Further, if the Group fails to complete any of the required disposals within the agreed timeframes for such disposals, under the terms of the State Aid approval, a divestiture trustee may be empowered to conduct the disposals, with the mandate to complete the disposal at no minimum price.

Furthermore, if the Group is unable to comply with the terms of the State Aid approval, it could constitute a misuse of aid. In circumstances where the European Commission doubts that the Group is complying with the terms of the State Aid approval, it may open a formal investigation. At the conclusion of any such investigation, if the European Commission decided that there had been misuse of aid, it could issue a decision requiring HM Treasury to recover the misused aid, which could have a material adverse impact on the Group.

In implementing the State Aid restructuring plan, the Group has lost, and will continue to lose, existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the Group’s business arising from implementing the State Aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals. Further, the loss of such revenues and related income may extend the time period over which the Group may pay any amounts owed to HM Treasury under the APS or otherwise. The implementation of the State Aid restructuring plan may also result in disruption to the retained business and give rise to significant strain on management, employee, operational and financial resources, impacting customers and employees and giving rise to separation costs which could be substantial.

The implementation of the State Aid restructuring plan may result in the emergence of one or more new viable competitors or a material strengthening of one or more of the Group’s existing competitors in the Group’s markets. The effect of this on the Group’s future competitive position, revenues and margins is uncertain and there could be an adverse effect on the Group’s operations and financial condition and its business generally.

The occurrence of any of the risks described above could have a material adverse effect on the Group’s business, results of operations, financial condition, capital position and competitive position.
 
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The Group and its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009 which may result in various actions being taken in relation to any securities
Under the Banking Act 2009, substantial powers have been granted to HM Treasury, the Bank of England and the FSA (together, the “Authorities”) as part of a special resolution regime. These powers enable the Authorities to deal with and stabilise UK incorporated institutions with permission to accept deposits pursuant to Part IV of the FSMA that are failing, or are likely to fail, to satisfy the threshold conditions (within the meaning of section 41 of the FSMA, which are the conditions that a relevant entity must satisfy in order to obtain its authorisation to perform regulated activities). The special resolution regime consists of three stabilisation options: (i) transfer of all or part of the business of the relevant entity and/or the securities of the relevant entity to a private sector purchaser; (ii) transfer of all or part of the business of the relevant entity to a “bridge bank” wholly-owned by the Bank of England; and (iii) temporary public ownership (nationalisation) of the relevant entity. HM Treasury may also take a holding company of the relevant entity into temporary public ownership where certain conditions are met. The Banking Act also provides for two new insolvency and administration procedures for relevant entities. Certain ancillary powers include the power to modify (including imposing additional obligations) and cancel certain contractual arrangements in certain circumstances.

If HM Treasury decides to take the Group into temporary public ownership pursuant to the powers granted under the Banking Act, it may take various actions in relation to any securities without the consent of holders of the securities. These could include: (i) transferring the securities free from any trust, liability or other encumbrance and free from any contractual, legislative or other restrictions on transfer; (ii) extinguishing any rights to acquire securities; (iii) delisting the securities; (iv) converting the securities into another form or class; or (v) disapplying any termination or acceleration rights or events of default under the terms of the securities which would be triggered by the transfer or certain related events.

Where HM Treasury makes a share transfer order in respect of securities issued by a holding company of a relevant entity, HM Treasury may make an order providing for the property, rights or liabilities of the holding company or of any relevant entity in the holding company group to be transferred and where such property is held on trust, removing or altering the terms of such trust.

Although the Banking Act includes provisions related to compensation in respect of transfer instruments and orders made under it (including securities that are transferred with respect to a relevant entity) there can be no assurance that compensation would be assessed to be payable or that any compensation would be recovered promptly and/or would equal any loss actually incurred. HM Treasury is also empowered by order to amend the law (including with retrospective effect) for the purpose of enabling the powers under the special resolution regime to be used effectively. In general, there is considerable uncertainty about the scope of the powers afforded to the Authorities under the Banking Act and how the Authorities may choose to exercise them. However, potential impacts may include full nationalisation of the Group, the total loss of value of securities and the inability of the Group to perform its obligations under its securities.

The financial performance of the Group has been, and continues to be, materially affected by deteriorations in borrower and counterparty credit quality and further deteriorations could arise due to prevailing economic and market conditions and legal and regulatory developments
The Group has exposure to many different industries and counterparties, and risks arising from actual or perceived changes in credit quality and the recoverability of monies due from borrowers and counterparties are inherent in a wide range of the Group’s businesses. In particular, the Group has significant exposure to certain individual counterparties in weakened business sectors and geographic markets and also has concentrated country exposure in the UK, the US and across the rest of Europe (particularly Ireland) and within certain business sectors, namely personal finance, financial institutions and commercial real estate. For a discussion of the Group’s exposure to country risk see pages 166 to 186. Furthermore, the Group expects its exposure to the UK to increase proportionately as its business becomes more concentrated in the UK, with exposures generally being reduced in other parts of its business as it implements its strategy, including the reduction of, and exit from, certain businesses in its GBM business.

The Group may continue to see adverse changes in the credit quality of its borrowers and counterparties, for example as a result of their inability to refinance their debts, with increasing delinquencies, defaults and insolvencies across a range of sectors and in a number of geographic markets. Since the credit quality of the Group’s borrowers and counterparties is impacted by prevailing economic and market conditions and by the legal and regulatory landscape in their respective markets, a significant 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. Any such losses could have an adverse effect on the Group’s results of operations and financial condition.



 
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Risk factors continued
Financial services institutions that deal with each other are inter-related as a result of trading, investment, clearing, counterparty and other relationships. Within the financial services industry, the default of any one institution could lead to defaults by other institutions. Concerns about, or a default by, one institution could lead to significant liquidity problems and losses or defaults by other institutions, as the commercial and financial soundness of many financial institutions may be closely related as a result of this 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 the US during recent years, there has been disruption in 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 governments. This disruption has lengthened the time to complete foreclosures, increased the backlog of repossessed properties and, in certain cases, has resulted in the invalidation of purported foreclosures. In addition, a number of other financial institutions have experienced increased repurchase demands in respect of US mortgage loans or other related securities originated and sold. However, the Group has not experienced a significant volume of repurchase demands in respect of similar loans or related securities it originated or sold and has not ceased any of its US foreclosure activities.

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.

The Group’s earnings and financial condition have been, and its future earnings and financial condition may continue to be, materially affected by depressed asset valuations resulting from poor market conditions
Financial markets continue to be subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by losses arising out of asset-backed collateralised debt obligations, residential mortgage-backed securities and the leveraged loan market. In dislocated markets, hedging and other risk management strategies may not be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties. Severe market events have resulted in the Group recording large write-downs on its credit market exposures in recent years. Any deterioration in economic and financial market conditions could lead to further impairment charges and write-downs. Moreover, market volatility and illiquidity (and the assumptions, judgements and estimates in relation to such matters that may change over time and may ultimately not turn out to be accurate) make it difficult to value certain of the Group’s exposures. Valuations in future periods, reflecting, among other things, then prevailing market conditions and changes in the credit ratings of certain of the Group’s assets, may result in significant changes in the fair values of the Group’s exposures, even in respect of exposures, such as credit market exposures, for which the Group has previously recorded write-downs. In addition, the value ultimately realised by the Group may be materially different from the current or estimated fair value. Any of these factors could require the Group to recognise further significant write-downs in addition to those already recorded or realised or realise increased impairment charges, which may have a material adverse effect on its financial condition, results of operations and capital ratios.

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, such as the APS, 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. 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, such as the APS. If market conditions improve and credit spreads for assets covered by the APS narrow, the value of the protection decreases and a loss is recognised. If credit spreads widen, the protection is more valuable, giving rise to a gain. Any such adjustments or fair value changes may have a material adverse impact on the Group’s financial condition and results of operations.
 
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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), yield curves 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 ongoing 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, particularly in the current environment, 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 Group’s borrowing costs, its access to the debt capital markets and its liquidity depend significantly on its and the UK Government’s credit ratings
The credit ratings of the Group, the Royal Bank and other Group members have been subject to change and may change in the future, which could impact their cost of, access to and sources of financing and liquidity. A number of UK and other European financial institutions, including the Group, the Royal Bank and other Group members, were downgraded during the course of 2011 in connection with a review of systemic support assumptions incorporated into bank ratings and the likelihood, in the case of UK banks, that the UK Government is more likely in the future to make greater use of its resolution tools to allow burden sharing with bondholders, and in connection with a general review of rating agencies’ methodologies.  Rating agencies continue to evaluate the rating methodologies applicable to UK and European financial institutions and any change in such rating agencies’ methodologies could materially adversely affect the credit ratings of Group companies. Any further reductions in the long-term or short-term credit ratings of the Group or one of its principal subsidiaries (particularly the Royal Bank) would increase its borrowing costs, require the Group to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the Group’s access to capital and money markets and trigger additional collateral requirements in derivatives contracts and other secured funding arrangements. At 31 December 2011, a one notch downgrade in the Group’s credit rating would have required the Group to post an estimated additional £12.5 billion of collateral without taking account of mitigating action by management. Furthermore, given the extent of the UK Government ownership of the Group, any downgrade in the UK Government’s credit ratings could materially adversely affect the credit ratings of Group companies and may have the effects noted above. Credit ratings of the Group, the Royal Bank, RBS N.V., Ulster Bank Limited and Citizens Financial Group Inc. are also important to the Group when competing in certain markets, such as over-the-counter derivatives. As a result, any further reductions in the Group’s long-term or short-term credit ratings or those of its principal subsidiaries could adversely affect the Group’s access to liquidity and its competitive position, increase its funding costs and have a material adverse impact on the Group’s earnings, cash flow and financial condition.

The Group’s business performance could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements
Effective management of the Group’s capital is critical to its ability to operate its businesses, and to pursue its strategy of returning to standalone strength. The Group is required by regulators in the UK, the US and other jurisdictions in which it undertakes regulated activities to maintain adequate capital resources. The maintenance of adequate capital is also necessary for the Group’s financial flexibility in the face of continuing turbulence and uncertainty in the global economy and specifically in its core UK, US and European markets. Accordingly, the purpose of the issuance of the £25.5 billion of B shares and the grant of the Contingent Subscription in 2009 and the previous placing and open offers completed in 2008 and 2009 was to allow the Group to strengthen its capital position.

The package of reforms to the regulatory capital framework published by the Basel Committee on Banking Supervision in December 2010 and January 2011 includes materially increasing the minimum common equity requirement and the total Tier 1 capital requirement. In addition, banks will be required to maintain, in the form of common equity (after the application of deductions), a capital conservation buffer to withstand future periods of stress, bringing the total common equity requirements to 7%. If there is excess credit growth in any given country resulting in a system-wide build-up of risk, a countercyclical buffer within a range of 0-2.5% of common equity is to be applied as an extension of the conservation buffer. In addition, a leverage ratio will be introduced, together with a liquidity coverage ratio and a net stable funding ratio. Further measures may include bail-in debt which could be introduced by statute, possibly impacting existing as well as future issues of debt and exposing them to the risk of conversion into equity and/or write-down of principal amount. Such measures would be in addition to proposals for the write-off of Tier 1 and Tier 2 debt (and its possible conversion into ordinary shares) if a bank becomes non-viable.
 
 
 
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Risk factors continued
In November 2011, the Basel Committee proposed that global systemically important banks be subject to an additional common equity Tier 1 capital requirement ranging from 1-2.5%, depending on a bank’s systemic importance. To provide a disincentive for banks facing the highest charge to increase materially their global systemic importance in the future, an additional 1% surcharge would be applied in such circumstances.

On 4 November 2011 the Financial Stability Board published its policy framework for addressing the systemic risks associated with global systemically important financial institutions (GSIFI). In this paper the Group was identified as a GSIFI. As a result the Group will be required to meet resolution planning requirements by the end of 2012 as well as have additional loss absorption capacity of 2.5% of risk-weighted assets which will need to be met with common equity. In addition, GSIFIs are to be subjected to more intensive and effective supervision. The additional capital requirements are to be applied to GSIFIs identified in 2014 (the Financial Stability Board will update its list every three years) and phased in beginning in 2016.

The implementation of the Basel III reforms will begin on 1 January 2013; however, the requirements are subject to a series of transitional arrangements and will be phased in over a period of time, to be fully effective by 2019.

The Basel III rules have not yet been approved by the EU and their incorporation into European and national law has, accordingly, not yet taken place. On 20 July 2011, the European Commission published a legislative package of proposals (known as CRD IV) to implement the changes through the replacement of the existing Capital Requirements Directive with a new Directive and Regulation. As with Basel III, the proposals contemplate the entry into force of the new legislation from 1 January 2013, with full implementation by 1 January 2019; however the proposals allow the UK to implement the stricter definition and/or level of capital more quickly than is envisaged under Basel III.

The ICB recommendations and the UK Government’s response supporting such recommendations includes proposals to increase capital and loss absorbency to levels that exceed the proposals under Basel III/CRD IV. These requirements, as well as the other recommendations of the ICB, are expected to be phased in between 2015 and 2019. As the implementation of the ICB recommendations will be the subject of legislation not yet adopted, the Group cannot predict the impact such rules will have on the Group’s overall capital requirements or how they will affect the Group’s compliance with capital and loss absorbency requirements of Basel III/CRD IV.

To the extent the Group has estimated the indicative impact that Basel III reforms may have on its risk-weighted assets and capital ratios, such estimates are preliminary and subject to uncertainties and may change. In particular, the estimates assume mitigating actions will be taken by the Group (such as deleveraging of legacy positions and securitisations, including non-core, as well as other actions being taken to de-risk market and counterparty exposures), which may not occur as anticipated, in a timely manner, or at all.

The Basel Committee changes and other future changes to capital adequacy and liquidity requirements in the UK and in other jurisdictions in which the Group operates, including any application of increasingly stringent stress case scenarios by the regulators in the UK, the US and other jurisdictions in which the Group undertakes regulated activities, may require the Group to raise additional Tier 1 (including Core Tier 1) and Tier 2 capital by way of further issuances of securities, and will result in existing Tier 1 and Tier 2 securities issued by the Group ceasing to count towards the Group’s regulatory capital, either at the same level as present or at all. The requirement to raise additional Core Tier 1 capital could have a number of negative consequences for the Group and its shareholders, including impairing the Group’s ability to pay dividends on or make other distributions in respect of ordinary shares and diluting the ownership of existing shareholders of the Group. If the Group is unable to raise the requisite Tier 1 and Tier 2 capital, it may be required to further reduce the amount of its risk-weighted assets and engage in the disposal of core and other non-core businesses, which may not occur on a timely basis or achieve prices which would otherwise be attractive to the Group. In addition, pursuant to the State Aid approval, should the Group’s Core Tier 1 capital ratio decline to below 5% at any time before 31 December 2014, or should the Group fall short of its funded balance sheet target level (after adjustments) for 31 December 2013 by £30 billion or more, the Group will be required to reduce its risk-weighted assets by a further £60 billion in excess of its plan through further disposals of identifiable businesses and their associated assets.

Pursuant to the acquisition and contingent capital agreement entered into between the Royal Bank and HM Treasury on 29 November 2009, the Group will also be subject to restrictions on payments on its hybrid capital instruments should its Core Tier 1 ratio fall below 6% or if it would fall below 6% as a result of such payment. At 31 December 2011, the Group’s Tier 1 and Core Tier 1 capital ratios were 13.0% and 10.6%, respectively, calculated in accordance with FSA requirements. Any change that limits the Group’s ability to manage effectively its balance sheet and capital resources going forward (including, for example, reductions in profits and retained earnings as a result of write-downs or otherwise, increases in risk-weighted assets, delays in the disposal of certain assets or the inability to syndicate loans as a result of market conditions, a growth in unfunded pension exposures or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and regulatory capital position.
 
 
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The Group is and may be subject to litigation and regulatory investigations that may have a material impact on its business
The Group’s operations are diverse and complex and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the UK, the EU, the US and other jurisdictions, including class action litigation, LIBOR related litigation and investigations and anti-money laundering, sanctions and compliance related investigations. The Group may also incur the risk of civil suits, criminal liability or regulatory actions as a result of its disclosure obligations to HM Treasury under the APS. In addition, the Group, like many other financial institutions, has come under greater regulatory scrutiny in recent years and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the early stages of a case or investigation. Adverse regulatory action or adverse judgments in litigation could result in restrictions or limitations on the Group’s operations or have a significant effect on the Group’s reputation or results of operations.

The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate
Under International Financial Reporting Standards (IFRS), the Group recognises at fair value: (i) financial instruments classified as held-for-trading or designated as at fair value through profit or loss; (ii) financial assets classified as available-for-sale; and (iii) derivatives. Generally, to establish the fair value of these instruments, the Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to prevailing market conditions. In such circumstances, the Group’s internal valuation models require the Group to make assumptions, judgements and estimates to establish fair value, which are complex and often relate to matters that are inherently uncertain. These assumptions, judgements and estimates will need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could continue to have a material adverse effect on the Group’s earnings and financial condition.

The Group operates in markets that are highly competitive and its business and results of operations may be adversely affected
The competitive landscape for banks and other financial institutions in the UK, the US and throughout the rest of Europe is subject to rapid change and recent regulatory and legal changes are likely to result in new market participants and changed competitive dynamics in certain key areas, such as in retail banking in the UK. The competitive landscape in the UK will be particularly influenced by the recommendations on competition included in the ICB’s final report, and the UK Government’s implementation of the recommendations, as discussed above. In order to compete effectively, certain financial institutions may seek to consolidate their businesses or assets with other parties. This consolidation, in combination with the introduction of new entrants into the markets in which the Group operates, is likely to increase competitive pressures on the Group.

In addition, certain competitors may have access to lower cost funding and/or be able to attract deposits on more favourable terms than the Group and may have stronger and more efficient operations. Furthermore, the Group’s competitors may be better able to attract and retain clients and key employees, which may have a negative impact on the Group’s relative performance and future prospects. In addition, future disposals and restructurings by the Group and the compensation structure and restrictions imposed on the Group may also have an impact on its ability to compete effectively. These and other changes to the competitive landscape could adversely affect the Group’s business, margins, profitability, financial condition and prospects.

The Group could fail to attract or retain senior management, which may include members of the Board, or other key employees, and it may suffer if it does not maintain good employee relations
The Group’s ability to implement its strategy and its future success depends on its ability to attract, retain and remunerate highly skilled and qualified personnel, including its senior management, which include directors and other key employees, competitively with its peers. This cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management and employee compensation arrangements, in particular those in receipt of Government support (such as the Group).

In addition to the effects of such measures on the Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place the Group at a significant competitive disadvantage and prevent the Group from successfully implementing its strategy, which could have a material adverse effect on the Group’s financial condition and results of operations.

 
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Risk factors continued
In addition, certain of the Group’s employees in the UK, continental Europe and other jurisdictions in which the Group operates are represented by employee representative bodies, including trade unions. Engagement with its employees and such bodies is important to the Group and a breakdown of these relationships could adversely affect the Group’s business, reputation and results. As the Group implements cost saving initiatives and disposes of, or runs-down, certain assets or businesses (including as part of its restructuring plans), it faces increased risk in this regard and there can be no assurance that the Group will be able to maintain good relations with its employees or employee representative bodies in respect of all matters. As a result, the Group may experience strikes or other industrial action from time to time, which could have an adverse effect on its business and results of operations and could cause damage to its reputation.

Each of the Group’s businesses is subject to substantial regulation and oversight. Significant regulatory developments, including changes in tax law, could have an adverse effect on how the Group conducts its business and on its results of operations and financial condition
The Group is subject to extensive financial services laws, regulations, corporate governance requirements, administrative actions and policies in each jurisdiction in which it operates. All of these are subject to change, particularly in the current regulatory and market environment, where there have been unprecedented levels of government intervention (including nationalisations and injections of government capital), changes to the regulations governing financial institutions and reviews of the industry, in the UK, the US and many European countries. In recent years, there has also been increasing focus in the UK, US and other jurisdictions in which the Group operates on compliance with anti-bribery, anti-money laundering, anti-terrorism and other similar sanctions regimes.

As a result of the environment in which the Group operates, increasing regulatory focus in certain areas and ongoing and possible future changes in the financial services regulatory landscape (including requirements imposed by virtue of the Group’s participation in government or regulator-led initiatives), the Group is facing greater regulation and scrutiny in the UK, the US and other countries in which it operates.

Although it is difficult to predict with certainty the effect that recent regulatory developments and heightened levels of public and regulatory scrutiny will have on the Group, the enactment of legislation and regulations in the UK, the other parts of Europe in which the Group operates and the US (such as the bank levy in the UK or the Dodd-Frank Wall Street Reform and Consumer Protection Act in the US) is likely to result in increased capital and liquidity requirements and changes in regulatory requirements relating to the calculation of capital and liquidity metrics or other prudential rules relating to capital adequacy frameworks, and may result in an increased number of regulatory investigations and actions. Any of these developments could have an adverse impact on how the Group conducts its business, applicable authorisations and licences, the products and services it offers, its reputation, the value of its assets, its funding costs and its results of operations and financial condition.

Areas in which, and examples of where, governmental policies, regulatory changes and increased public and regulatory scrutiny could have an adverse impact on the Group include those set out above as well as the following:
 
·
the transaction in the UK of regualatory and supervisory powers from the FSA to the Financial conduct Authority for conduct of business supervision and the Prudential Regulatory Authority for capital and liquidity supervision in 2013;
 
·
the monetary, fiscal, interest rate and other policies of central banks and other governmental or regulatory bodies;

·
requirements to separate retail banking from investment banking, and restrictions on proprietary trading and similar activities within a commercial bank and/or a group which contains a commercial bank;

·
the design and potential implementation of government mandated resolution or insolvency regimes;

·
the imposition of government imposed requirements with respect to lending to the UK SME market and larger commercial and corporate entities and residential mortgage lending;

·
requirements to operate in a way that prioritises objectives other than shareholder value creation;

·
changes to financial reporting standards (including accounting standards), corporate governance requirements, corporate structures and conduct of business rules;

·
the imposition of restrictions on the Group’s ability to compensate its senior management and other employees;

·
regulations relating to, and enforcement of, anti-bribery, anti-money laundering, anti-terrorism or other similar sanctions regimes;

·
rules relating to foreign ownership, expropriation, nationalisation and confiscation of assets;

·
other requirements or policies affecting the Group’s profitability, such as the imposition of onerous compliance obligations, further restrictions on business growth or pricing;

·
the introduction of, and changes to, taxes, levies or fees applicable to the Group’s operations (such as the imposition of financial activities taxes and changes in tax rates that reduce the value of deferred tax assets); and

·
the regulation or endorsement of credit ratings used in the EU (whether issued by agencies in EU member states or in other countries, such as the US).
 
 
 
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The Group’s results could be adversely affected in the event of goodwill impairment
The Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the Group tests goodwill for impairment annually, or more frequently when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of the value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. At 31 December 2011, the Group carried goodwill of £12.4 billion on its balance sheet. The value in use and fair value of the Group’s cash generating units are affected by market conditions and the performance of the economies in which the Group operates. Where the Group is required to recognise a goodwill impairment, it is recorded in the Group’s income statement, although it has no effect on the Group’s regulatory capital position. Any significant write-down of goodwill could have a material adverse effect on the Group’s results of operations.

The Group may be required to make further contributions to its pension schemes if the value of pension fund assets is not sufficient to cover potential obligations
The Group maintains a number of defined benefit pension schemes for past and a number of current employees. Pensions risk is the risk that the assets of the Group’s various defined benefit pension schemes which are long-term in nature do not fully match the timing and amount of the schemes’ liabilities, as a result of which the Group is required or chooses to make additional contributions to the schemes. Pension scheme liabilities vary with changes to long-term interest rates, inflation, pensionable salaries and the longevity of scheme members as well as changes in applicable legislation. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios, returns from them and any additional future contributions to the schemes, may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities. In these circumstances, the Group could be obliged, or may choose, to make additional contributions to the schemes, and during recent periods, the Group has voluntarily made such contributions to the schemes. Given the recent economic and financial market difficulties and the prospect that they may continue over the near and medium term, the Group may experience increasing pension deficits or be required or elect to make further contributions to its pension schemes and such deficits and contributions could be significant and have an adverse impact on the Group’s results of operations or financial condition. The most recent funding valuation at 31 March 2010 was agreed during 2011. It showed the value of liabilities exceeded the value of assets by £3.5 billion at 31 March 2010, a ratio of assets to liabilities of 84%.

In order to eliminate this deficit, the Group will pay additional contributions each year over the period 2011 until 2018. These contributions started at £375 million per annum in 2011, will increase to £400 million per annum in 2013 and from 2016 onwards be further increased in line with price inflation. These contributions are in addition to the regular contributions of around £300 million for future accrual of benefits.

Operational risks are inherent in the Group’s businesses
The Group’s operations are dependent on the ability to process a very large number of transactions efficiently and accurately while complying with applicable laws and regulations where it does business. The Group has complex and geographically diverse operations and operational risk and losses can result from internal and external fraud, errors by employees or third parties, failure to document transactions properly or to obtain proper authorisation, failure to comply with applicable regulatory requirements and conduct of business rules (including those arising out of anti-bribery, anti-money laundering and anti-terrorism legislation, as well as the provisions of applicable sanctions programmes), equipment failures, business continuity and data security system failures, natural disasters or the inadequacy or failure of systems and controls, including those of the Group’s suppliers or counterparties. Although the Group has implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures, to identify and rectify weaknesses in existing procedures and to train staff, it is not possible to be certain that such actions have been or will be effective in controlling each of the operational risks faced by the Group. Any weakness in these systems or controls, or any breaches or alleged breaches of such laws or regulations, could result in increased regulatory supervision, enforcement actions and other disciplinary action, and have an adverse impact on the Group’s business, applicable authorisations and licences, reputation, and results of operations. Notwithstanding anything contained in this risk factor, it should not be taken as implying that the Group will be unable to comply with its obligations as a company with securities admitted to the Official List of the UK Listing Authority (the “Official List”) nor that it, or its relevant subsidiaries, will be unable to comply with its or their obligations as supervised firms regulated by the FSA.



 
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Risk factors continued
HM Treasury (or UK Financial Investments Limited (UKFI) on its behalf) may be able to exercise a significant degree of influence over the Group and any proposed offer or sale of its interests may affect the price of securities issued by the Group
The UK Government, through HM Treasury, currently holds 66.9% of the issued ordinary share capital of the Group. On 22 December 2009, the Group issued £25.5 billion of B Shares to the UK Government. The B Shares are convertible, at the option of the holder at any time, into ordinary shares. The UK Government has agreed that it shall not exercise the rights of conversion in respect of the B Shares if and to the extent that following any such conversion it would hold more than 75% of the total issued shares in the Group. Any breach of this agreement could result in the delisting of the Group from the Official List and potentially other exchanges where its securities are currently listed and traded. HM Treasury (or the UKFI on its behalf) may sell all or a part of the ordinary shares that it owns at any time. Any offers or sale of a substantial number of ordinary shares or securities convertible or exchangeable into ordinary shares by or on behalf of HM Treasury, or an expectation that it may undertake such an offer or sale, could negatively affect prevailing market prices for the securities.

In addition, UKFI manages HM Treasury’s shareholder relationship with the Group and, although HM Treasury has indicated that it intends to respect the commercial decisions of the Group and that the Group will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury’s position as a majority shareholder (and UKFI’s position as manager of this shareholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over, among other things, the election of directors and the appointment of senior management. In addition, as the provider of the APS, HM Treasury has a range of rights that other shareholders do not have. These include rights under the terms of the APS over the Group’s remuneration policy and practice. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority shareholder or in which HM Treasury exercises its rights under the APS could give rise to conflict between the interests of HM Treasury and the interests of other shareholders. The Board has a duty to promote the success of the Group for the benefit of its members as a whole.

The Group’s insurance businesses are subject to inherent risks involving claims
Future claims in the Group’s insurance business may be higher than expected as a result of changing trends in claims experience resulting from catastrophic weather conditions, demographic developments, changes in the nature and seriousness of claims made, changes in mortality, changes in the legal and compensatory landscape and other causes outside the Group’s control. These trends could affect the profitability of current and future insurance products and services. The Group reinsures some of the risks it has assumed and is accordingly exposed to the risk of loss should its reinsurers become unable or unwilling to pay claims made by the Group against them.

The Group’s operations have inherent reputational risk
Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the Group’s business. Negative public opinion can result from the actual or perceived manner in which the Group conducts its business activities, from the Group’s financial performance, from the level of direct and indirect government support or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.

In the UK and in other jurisdictions, the Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers
In the UK, the Financial Services Compensation Scheme (FSCS) was established under the FSMA and is the UK’s statutory fund of last resort for customers of authorised financial services firms. The FSCS can pay compensation to customers if a firm is unable or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act. The FSCS is funded by levies on firms authorised by the FSA, including the Group. In the event that the FSCS raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the Group may have an adverse impact on its results of operations and financial condition. At 31 December 2011, the Group had accrued £157 million for its share of FSCS levies for the 2011/2012 and 2012/2013 FSCS years.

In addition, to the extent that other jurisdictions where the Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the US with the Federal Deposit Insurance Corporation), the Group may make further provisions and may incur additional costs and liabilities, which may have an adverse impact on its financial condition and results of operations.
 
 
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The recoverability and regulatory capital treatment of certain deferred tax assets recognised by the Group depends on the Group’s ability to generate sufficient future taxable profits and there being no adverse changes to tax legislation, regulatory requirements or accounting standards
In accordance with IFRS, the Group has recognised deferred tax assets on losses available to relieve future profits from tax only to the extent that it is probable that they will be recovered. The deferred tax assets are quantified on the basis of current tax legislation and accounting standards and are subject to change in respect of the future rates of tax or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax legislation or accounting standards may reduce the recoverable amount of the recognised deferred tax assets. In April 2011, the UK Government commenced a staged reduction in the rate of UK corporation tax from 28% to 23% over a four-year period. Such a change in the applicable tax rate will reduce the recoverable amount of the recognised deferred tax assets.
 
There is currently no restriction in respect of deferred tax assets recognised by the Group for regulatory purposes. Changes in regulatory capital rules may restrict the amount of deferred tax assets that can be recognised and such changes could lead to a reduction in the Group’s Core Tier 1 capital ratio. In particular, on 16 December 2010, the Basel Committee published the Basel III rules setting out certain changes to capital requirements which include provisions limiting the ability of certain deferred tax assets to be recognised when calculating the common equity component of Tier 1 capital. CRD IV which will implement Basel III in the EU includes similar limitations. The implementation of the Basel III restrictions on recognition of deferred tax assets within the common equity component of Tier 1 are subject to a phased-in deduction starting on 1 January 2014, to be fully effective by 1 January 2018.

The Group’s participation in the APS is costly and may not produce the benefits expected and the occurrence of associated risks may have a material adverse impact on the Group’s business, capital position, financial condition and results of operations
On 22 December 2009, the Group acceded to the APS with HM Treasury acting on behalf of the UK Government. Under the APS, the Group purchased credit protection over a portfolio of specified assets and exposures of the Royal Bank and certain members of the Group (“Covered Assets”) from HM Treasury in return for an annual fee. If losses on assets covered by the APS exceed £60 billion (net of recoveries), HM Treasury will bear 90% of further losses. The costs of participating in the APS include, among others, a fee of £700 million per annum, payable in advance to HM Treasury for each of the first three years of the APS and £500 million per annum thereafter until the earlier of (i) the date of termination of the APS and (ii) 31 December 2099. In order to terminate the Group’s participation in the APS, the Group must have FSA approval and must pay an exit fee.

Ultimately, there is a risk that the amounts received under the APS may be less than the costs of participation. In addition, the aggregate effect of the joining, establishment, operational and exit costs and fees and expenses of, and associated with, the APS may significantly reduce or even eliminate the aggregate benefit of the APS to the Group.

The Group’s choice of assets or exposures to be covered by the APS was based on certain predictions and assumptions at the time of its accession to the APS. There is therefore a risk that the Covered Assets will not be those with the greatest future losses or with the greatest need for protection and the Group’s financial condition, and income from operations may still suffer due to further impairments and credit write-downs. Notwithstanding the Group’s participation in the APS, the Group remains exposed to a substantial first loss amount of £60 billion (net of recoveries) in respect of the Covered Assets and for 10% of Covered Assets losses after the first loss amount. There is therefore no assurance that the Group’s participation in the APS will achieve the Group’s goals of improving and maintaining the Group’s capital ratios in the event of further losses. Moreover, the Group continues to carry the risk of losses, impairments and write-downs with respect to assets not covered by the APS.

The APS is a unique form of credit protection over a complex range of diversified assets and exposures in a number of jurisdictions. Due to the complexity, scale and unique nature of the APS and the uncertainty resulting from the recent economic recession, there may be unforeseen issues and risks that are relevant in the context of the Group’s participation in the APS and in the impact of the APS on the Group’s business, operations and financial condition. Such risks may have a material adverse effect on the Group. The Group may also be subject to further tax liabilities in the UK and overseas in connection with the APS and the associated intra-group arrangements which would not otherwise have arisen.

As a result of the significant volume, variety and complexity of assets and exposures and the resulting complexity and extensive governance, asset management, disclosure and information requirements of the APS documents, there is a risk that the Group may have included assets or exposures within the Covered Assets which are, or may later become (including by reason of failure to comply with the requirements of the APS or resulting from the disposal of an asset or exposure), ineligible for protection under the APS or for which the protection is limited, which would reduce the anticipated benefits to the Group of the APS. Further, there is no ability to nominate additional or alternative assets or exposures in place of any which may turn out not to be covered under the APS. In addition, HM Treasury may, following consultation with the Group, modify or replace certain of the UK APS terms and conditions (the “Scheme Conditions”) in such a manner as it considers necessary (acting reasonably) in certain circumstances. Such modifications or replacements may be retrospective and may have a material adverse effect on the expected benefits of the APS and, therefore, the Group’s financial condition and results of operations.

Lastly, the APS is treated as a credit derivative accounted for at fair value, which exhibits counter-cyclical behaviour. As a result, improving market conditions result in a charge to the income statement, and vice versa. Therefore, changes in the fair value of the APS can have a significant adverse impact on the Group’s results of operations.
 
 
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Risk factors continued
The extensive governance, asset management and information requirements under the Scheme Conditions may have an adverse impact on the Group and the expected benefits of the APS
There are extensive governance, asset management and information requirements under the Scheme Conditions in relation to the Covered Assets, other assets and the operations of the Group and HM Treasury also has the right to require the appointment of one or more step-in managers to exercise certain step-in rights in certain circumstances. The step-in rights are extensive and include certain oversight, investigation, approval and other rights, the right to require the modification or replacement of any of the systems, controls, processes and practices of the Group and extensive rights in relation to the direct management and administration of the Covered Assets.

If HM Treasury seeks to exercise its right to appoint one or more step-in managers in relation to the management and administration of Covered Assets held by RBS Holdings N.V. or its wholly-owned subsidiaries, RBS Holdings N.V. will, in certain circumstances, need to seek consent from the Dutch Central Bank to allow it to comply with such step-in. If this consent is not obtained by the date on which the step-in rights must be effective, and other options to effect compliance are not possible, those assets would need to be withdrawn by the Group from the APS where possible. If the Group cannot withdraw such Covered Assets from the APS, it would be likely to lose protection in respect of these assets under the APS and/or may be liable under its indemnity to HM Treasury.

Additionally pursuant to the accession agreement between HM Treasury and the Group relating to the accession to the APS, HM Treasury has the right to require the Royal Bank to appoint one or more Special Advisers (“SOC Special Advisers”) to exercise oversight functions over certain assets in the APS. On 18 June 2010, the Asset Protection Agency required that the Royal Bank appoint SOC Special Advisers in relation to certain assets and business areas in order to provide additional support to the Senior Oversight Committee of the Royal Bank. There have been four such appointments to date granting certain oversight rights in relation to certain specified assets and the work of each of the SOC Special Advisers is now substantially completed.

The obligations of the Group and the rights of HM Treasury may, individually or in the aggregate, impact the way the Group runs its business and may serve to limit the Group’s operations with the result that the Group’s business, results of operations and financial condition will suffer. In addition, the market’s reaction to such controls and limitations may have an adverse impact on the price of its securities.

Any changes to the expected regulatory capital treatment of the APS, the B Shares or the Contingent B Shares may have a material adverse impact on the Group
One of the key objectives of the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares was to improve capital ratios at a consolidated level for the Group and at an individual level for certain relevant Group members. In that context, the Group has entered and may in the future enter into further back-to-back arrangements with Group members holding assets or exposures to be covered by the APS in order to ensure the capital ratios of these entities are also improved by virtue of the APS. However, there is a risk that the regulatory capital treatment applied by relevant regulators may differ from that assumed by the Group in respect of the APS (including any back-to-back arrangements), the treatment of the B Share issuance and the £8 billion Contingent B Shares (if required).

If participation in the APS and the issuance of £25.5 billion of B Shares and, if required, the £8 billion Contingent B Shares are not sufficient to maintain the Group’s capital ratios as expected, this could cause the Group’s business, results of operations and financial condition to suffer, its credit ratings to drop, its ability to lend and access to funding to be further limited and its cost of funding to increase, and may result in intervention by the Authorities, which could include full nationalisation or other resolution procedures under the Banking Act as described above.

RBS has entered into a credit derivative and a financial guarantee contract with RBS N.V. which may adversely affect the Issuer Group’s results
RBS has entered into a credit derivative and a financial guarantee contract with RBS N.V., which is a subsidiary of RBSG, under which it has sold credit protection over the exposures held by RBS N.V. and its subsidiaries that are subject to the APS. These agreements may adversely affect the Issuer Group’s results as: (i) they cover 100% of losses on these assets whilst the APS provides 90% protection if losses on the whole APS portfolio exceed the first loss; and (ii) the basis of valuation of the APS and the financial guarantee contract are asymmetrical: the one measured at fair value and the other at the higher of cost less amortization and the amount determined in accordance with IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”.

If the Group is unable to issue the Contingent B Shares to HM Treasury, it may have a material adverse impact on the Group’s capital position, liquidity, operating results and future prospects
In the event that the Group’s Core Tier 1 capital ratio declines to below 5 per cent., HM Treasury is committed to subscribe for up to an additional £8 billion of Contingent B Shares if certain conditions are met. If such conditions are not met and are not waived by HM Treasury, and the Group is unable to issue the Contingent B Shares, the Group will be required to find alternative methods for achieving the requisite capital ratios. There can be no assurance that any of these alternative methods will be available or would be successful in increasing the Group’s capital ratios to the desired or requisite levels. If the Group is unable to issue the Contingent B Shares, the Group’s capital position, liquidity, operating results and future prospects will suffer, its credit ratings may drop, its ability to lend and access funding will be further limited and its cost of funding may increase.
 
 
418

 

Shareholder information

420
Financial calendar
420
Shareholder enquiries
421
Analyses of ordinary shareholders
422
Trading market
425
Dividend history
426
Taxation for US Holders
429
Exchange controls
430
Memorandum and Articles of Association
439
Incorporation and registration
439
Documents on display
440
Glossary of terms
448
Index
451
Important addresses
451
Principal offices
 
 

 
 
419

 
Shareholder information continued
 
 
Financial calendar
Annual General Meeting
30 May 2012
 
RBS Conference Centre
RBS Gogarburn
 
Edinburgh, EH12 1HQ
   
   
Interim results
3 August 2012


Dividends
Payment dates
 
Cumulative preference shares
31 May and 31 December 2012
   
Non-cumulative preference shares
30 March, 29 June, 28 September
and 31 December 2012
 
Ex-dividend date
 
Cumulative preference shares
2 May 2012
   
Record date
 
Cumulative preference shares
4 May 2012

For further information on the payment of dividends, see page 425.



Shareholder enquiries
Shareholdings in the company may be checked by visiting the ‘Shareholder information’ section of our website www.rbs.com/shareholder. You can also manage your shareholding online via the Investor Centre www.investorcentre.co.uk. You will need the shareholder reference number printed on your share certificate or tax voucher to gain access to this information.

Listed below are the most commonly used features on the Investor Centre:
 
·
holding enquiry - view balances, values, history, payments and reinvestments;

·
address change - change your registered address;

·
e-Comms sign-up - choose to receive email notification when your shareholder communications become available instead of paper communications;

·
outstanding payments - reissue any uncashed payments using our online replacement service; and

·
downloadable forms - including stock transfer and change of address forms.

You may also check your shareholding by contacting our Registrar:

Computershare Investor Services PLC
The Pavilions
Bridgwater Road
Bristol BS99 6ZZ
Telephone: +44 (0)870 702 0135
Fax: +44 (0)870 703 6009
Web: www.investorcentre.co.uk/contactus

Shareholders may also download forms from the ‘Shareholder information’ section of our website www.rbs.com/shareholder

Braille and audio Annual Review and Summary Financial Statement
Shareholders requiring a Braille or audio version of the Annual Review and Summary Financial Statement should contact the Registrar on +44 (0)870 702 0135.

ShareGift
The company is aware that shareholders who hold a small number of shares may be retaining these shares because dealing costs make it uneconomical to dispose of them. ShareGift, the charity share donation scheme, is a free service operated by The Orr Mackintosh Foundation (registered charity 1052686) to enable shareholders to donate shares to charity.

Donating your shares in this way will not give rise to either a gain or a loss for UK capital gains tax purposes and you may be able to reclaim UK income tax on gifted shares. Further information can be obtained from HM Revenue & Customs.

Should you wish to donate your shares to charity in this way you should contact ShareGift for further information:

ShareGift, The Orr Mackintosh Foundation
17 Carlton House Terrace, London SW1Y 5AH
Telephone: +44 (0)20 7930 3737
www.sharegift.org




 
420

 
Shareholder information continued

Share Fraud Warning
Share fraud includes scams where investors are called out of the blue and offered shares that often turn out to be worthless or non-existent, or an inflated price for shares they own. These calls come from fraudsters operating in ‘boiler rooms’ that are mostly based abroad. While high profits are promised, those who buy or sell shares in this way usually lose their money. The Financial Services Authority (FSA) has found most share fraud victims are experienced investors who lose an average of £20,000, with around £200 million lost in the UK each year.

Protect yourself
If you are offered unsolicited investment advice, discounted shares, a premium price for shares you own, or free company or research reports, you should take these steps before handing over any money;
 
·
get the name of the person and organisation contacting you;

·
check the FSA Register at www.fsa.gov.uk/fsaregister to ensure they are authorised;

·
use the details on the FSA Register to contact the firm;

·
call the FSA Consumer Helpline on 0845 606 1234 if there are no contact details on the Register or you are told they are out of date;

·
search our list of unauthorised firms and individuals to avoid doing business with; and

·
remember if it sounds too good to be true, it probably is.

If you use an unauthorised firm to buy or sell shares or other investments, you will not have access to the Financial Ombudsman Service or Financial Services Compensation Scheme (FSCS) if things go wrong.

Report a scam
If you are approached about a share scam you should tell the FSA using the share fraud reporting form at www.fsa.gov.uk/scams, where you can find out about the latest investment scams. You can also call the Consumer Helpline on 0845 606 1234. If you have already paid money to share fraudsters you should contact Action Fraud on 0300 123 2040.

Analyses of ordinary shareholders
 
 
At 31 December 2011
 
 
 
 
Shareholdings  
 
 
Number  
of shares  
 - millions  
 
 
 
 
%
Individuals
214,369 
1,350.6 
2.3 
Banks and nominee companies
14,835 
57,265.1 
96.7 
Investment trusts
144 
38.5 
0.1 
Insurance companies
171 
6.0 
— 
Other companies
1,351 
109.5 
0.2 
Pension trusts
36 
23.5 
— 
Other corporate bodies
94 
435.2 
0.7 
 
231,000 
59,228.4 
100.0 
       
Range of shareholdings:
     
1 - 1,000
74,654 
32.1 
0.1 
1,001 - 10,000
125,097 
466.2 
0.8 
10,001 - 100,000
29,372 
677.1 
1.1 
100,001 - 1,000,000
1,212 
332.7 
0.5 
1,000,001 - 10,000,000
448 
1,528.1 
2.6 
10,000,001 and over
217 
56,192.2 
94.9 
 
231,000 
59,228.4 
100.0 


 
421

 
Shareholder information continued
 
 
Trading market
Non-cumulative dollar preference shares
On 26 March 1997, 8 February 1999, 30 September 2004, 26 August 2004, 19 May 2005, 9 November 2005, 25 May 2006, 27 December 2006, 28 June 2007, 27 September 2007 and 4 October 2007, the company issued the following Series of American Depository Shares (ADSs) representing non-cumulative dollar preference shares of the company, in the United States, of which the following were outstanding at 31 December 2011:

6,255,408 Series F ("Series F ADSs") representing 6,255,408 non-cumulative dollar preference shares, Series F;

9,687,654 Series H ("Series H ADSs") representing 9,687,654 non-cumulative dollar preference shares, Series H;

30,027,877 Series L ("Series L ADSs") representing 30,027,877 non-cumulative dollar preference shares, Series L;

23,125,869 Series M (“Series M ADSs”) representing 23,125,869 non-cumulative dollar preference shares, Series M;

22,113,160 Series N ("Series N ADSs") representing 22,113,160 non-cumulative dollar preference shares, Series N;

9,883,307 Series P ("Series P ADSs") representing 9,883,307 non-cumulative dollar preference shares, Series P;

20,646,938 Series Q ("Series Q ADSs") representing 20,646,938 non-cumulative dollar preference shares, Series Q;

10,163,932 Series R ("Series R ADSs") representing 10,163,932 non-cumulative dollar preference shares, Series R;

26,449,040 Series S ("Series S ADSs") representing 26,449,040 non-cumulative dollar preference shares, Series S;

51,245,839 Series T ("Series T ADSs") representing 51,245,839 non-cumulative dollar preference shares, Series T; and

10,130 Series U ("Series U ADSs") representing 10,130 non-cumulative dollar preference shares, Series U.


Each of the respective ADSs set out above represents the right to receive one corresponding preference share, and is evidenced by an American Depository Receipt (ADR) and is listed on the New York Stock Exchange, a subsidiary of NYSE Euronext (NYSE).

The ADRs evidencing the ADSs above were issued pursuant to Deposit Agreements, among the company, The Bank of New York, as depository, and all holders from time-to-time of ADRs issued thereunder. Currently, there is no non-United States trading market for any of the non-cumulative dollar preference shares. All of the non-cumulative dollar preference shares are held by the depository, as custodian, in bearer form.

In May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt, resulting in the number of securities in issue reducing to the amounts shown above.

At 31 December 2011, there were 69 registered shareholders of Series F ADSs, 41 registered shareholders of Series H ADSs, 23 registered shareholders of Series L ADSs, 7 registered shareholders of Series M ADSs, 20 registered shareholders of Series N ADSs, 27 registered shareholders of Series P ADSs, 13 registered shareholders of Series Q ADSs, 3 registered shareholders of Series R ADSs, 1 registered shareholder of Series S ADSs, 16 registered shareholders of Series T ADSs and 1 registered shareholder of Series U ADSs.

PROs
In August 2001, the company issued US$1.2 billion perpetual regulatory tier one securities (PROs) in connection with a public offering in the United States. The PROs are listed on the NYSE.

ADSs representing ordinary shares
In October 2007, the company listed ADSs, each representing one ordinary share nominal value 25p each (or a right to receive one ordinary share), and evidenced by an ADR or uncertificated securities, on the NYSE. With effect from 7 November 2008, the ratio of one ADS representing one ordinary share changed to one ADS representing 20 ordinary shares. As at 31 December 2011, 14.8 million ADSs were outstanding. The ADSs were issued in connection with the company's bid for the outstanding share capital of ABN AMRO Holding N.V..

The ADSs described in the above paragraph were issued pursuant to a Deposit Agreement, among the company, The Bank of New York Mellon, as depository, and all owners and holders from time to time of ADSs issued thereunder. The ordinary shares of the company are listed and traded on the London Stock Exchange. All ordinary shares are deposited with the principal London office of The Bank of New York Mellon, as custodian for the depository.

 
422

 
Shareholder information continued

The following table shows, for the periods indicated, the high and low sales prices for each of the outstanding ADSs representing non-cumulative dollar preference shares and PROs, as reported on the NYSE or NASDAQ.
 
 
Figures in US$
 
Series F ADSs
Series H ADSs
Series L ADSs
Series M ADSs
Series N ADSs
Series P ADSs
Series Q ADSs
Series R ADSs
Series S ADSs
Series T ADSs
Series U ADSs
PROs (1)
By month
                         
Feb 2012
High
23.54
21.95
19.10
16.15
15.93
15.86
16.79
16.01
16.72
18.45
71.38
79.73
 
Low
21.65
19.76
17.12
14.95
14.80
14.78
15.75
14.73
15.31
17.41
65.00
69.95
Jan 2012
High
21.28
19.75
16.73
15.53
15.40
15.38
16.04
15.45
15.78
17.25
68.50
72.22
 
Low
17.60
16.76
15.46
11.63
11.53
11.41
12.24
11.41
11.83
13.08
53.63
66.58
Dec 2011
High
18.15
17.08
16.15
12.20
12.00
11.90
12.95
11.90
12.45
13.58
56.50
69.89
 
Low
16.21
15.35
13.87
11.26
11.15
10.99
11.87
10.74
11.48
12.72
53.50
66.25
Nov 2011
High
19.29
18.37
15.56
13.40
13.25
13.00
13.72
13.00
13.50
14.81
62.00
72.14
 
Low
16.50
15.72
14.52
11.02
10.89
10.70
11.72
10.52
11.16
12.11
55.00
66.33
Oct 2011
High
20.36
19.50
16.70
13.87
13.87
13.59
14.40
13.73
14.14
15.75
65.00
67.00
 
Low
16.70
16.10
14.99
10.21
10.20
10.01
10.73
10.01
10.40
11.63
46.00
63.58
Sep 2011
High
20.87
20.00
16.98
13.78
13.73
13.50
14.35
13.35
14.01
15.10
61.75
76.75
 
Low
17.36
16.80
15.37
10.31
10.11
9.97
10.62
9.98
10.22
11.43
48.00
67.00
                           
By quarter
                         
2011: Q4
High
20.36
19.50
16.70
13.87
13.87
13.59
14.40
13.73
14.14
15.75
65.00
72.14
 
Low
16.21
15.35
13.87
10.21
10.20
10.01
10.73
10.01
10.40
11.63
46.00
63.58
2011: Q3
High
23.95
22.47
18.49
17.47
17.39
16.84
17.65
16.86
17.51
18.96
78.25
91.91
 
Low
17.36
16.80
14.93
10.31
10.11
9.97
10.62
9.98
10.22
11.43
48.00
67.00
2011: Q2
High
25.05
23.95
19.40
18.80
18.82
18.40
19.40
18.35
18.88
20.60
84.00
96.69
 
Low
23.34
21.99
17.74
16.55
16.50
15.96
16.87
15.86
16.75
18.05
75.50
89.03
2011: Q1
High
23.90
22.83
19.27
17.82
17.80
17.57
18.25
17.34
17.95
19.62
79.50
93.70
 
Low
21.85
20.70
17.40
15.03
14.99
14.95
15.30
14.98
15.13
16.47
65.50
83.75
2010: Q4
High
23.97
23.71
19.47
17.75
17.73
17.77
17.91
17.75
17.73
18.64
78.25
97.06
 
Low
21.19
20.35
16.60
14.70
14.55
14.47
15.03
14.40
14.84
16.16
66.00
86.13
2010: Q3
High
23.97
23.85
19.88
16.80
16.83
16.71
17.59
16.68
17.39
18.44
75.00
95.10
 
Low
20.73
17.14
14.12
10.95
10.91
10.75
11.24
10.80
10.99
11.90
56.50
75.25
2010: Q2
High
21.20
19.90
16.63
14.15
14.11
14.13
14.54
14.13
14.35
15.40
65.75
85.13
 
Low
17.33
16.51
13.35
11.06
11.15
11.05
11.35
11.14
11.18
12.07
53.00
73.25
2010: Q1
High
20.51
19.58
16.61
14.23
13.95
14.07
14.21
13.92
14.12
14.94
66.00
84.75
 
Low
16.57
15.10
13.67
11.35
11.23
11.15
11.68
11.02
11.65
12.56
54.00
67.13
                           
By year
                         
2011
High
25.05
23.95
19.40
18.80
18.82
18.40
19.40
18.35
18.88
20.60
84.00
96.69
 
Low
16.21
15.35
13.87
10.21
10.11
9.97
10.62
9.98
10.22
11.43
46.00
63.58
2010
High
23.97
23.85
19.88
17.75
17.73
17.77
17.91
17.75
17.73
18.64
78.25
97.06
 
Low
16.57
15.10
13.35
10.95
10.91
10.75
11.24
10.80
10.99
11.90
53.00
67.13
2009
High
18.30
16.46
13.65
14.07
14.11
13.91
15.15
13.63
14.45
16.48
57.50
69.25
 
Low
3.00
2.77
2.21
2.63
2.55
2.43
2.64
2.37
2.58
2.78
8.98
20.00
2008
High
25.74
25.30
22.27
24.12
24.01
23.85
24.95
23.52
24.66
25.66
105.61
107.55
 
Low
5.10
5.00
4.37
4.51
4.20
4.50
4.34
4.16
4.36
5.43
39.84
53.60
2007
High
26.50
25.85
24.75
25.99
25.75
25.83
26.91
25.50
25.20
25.48
107.98
122.07
 
Low
23.60
22.70
17.90
19.68
19.50
19.25
20.71
18.96
20.26
22.61
98.34
100.49

Note:
(1)
Price quoted as a % of US$1,000 nominal.


 
423

 
Shareholder information continued
 
 
Trading market continued
Ordinary shares
The following table shows, for the periods indicated, the high and low sales prices for the company's ordinary shares on the London Stock Exchange, as derived from the Daily Official List of the UK Listing Authority. Prices for 2008 and 2007 were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.

By month
 
£
 
By quarter
 
£
 
By year
 
£
February 2012
High
0.2909 
 
2011: Q4
High
0.2727 
  
2011
High
0.4900 
 
Low
0.2665 
   
Low
0.1734 
   
Low
0.1734 
January 2012
High
0.2814 
 
2011: Q3
High
0.3980 
 
2010
High
0.5804 
 
Low
0.2007 
   
Low
0.1967 
   
Low
0.3125 
December 2011
High
0.2277 
 
2011: Q2
High
0.4443 
 
2009
High
0.5765 
 
Low
0.1940 
   
Low
0.3509 
   
Low
0.1030 
November 2011
High
0.2312 
 
2011: Q1
High
0.4900 
 
2008
High
3.7054 
 
Low
0.1734 
   
Low
0.3950 
   
Low
0.4140 
October 2011
High
0.2727 
 
2010: Q4
High
0.4949 
 
2007
High
6.0208 
 
Low
0.2152 
   
Low
0.3759 
   
Low
3.3265 
September 2011
High
0.2625 
 
2010: Q3
High
0.5210 
       
 
Low
0.2077 
   
Low
0.3896 
       
       
2010: Q2
High
0.5804 
       
         
Low
0.4143 
       
       
2010: Q1
High
0.4560 
       
         
Low
0.3125 
       

On 23 March 2012, the closing price of the ordinary shares on the London Stock Exchange was £0.28, equivalent to $0.44 per share translated at the Noon Buying Rate of $1.5864 per £1.00 on 23 March 2012.


ADSs
The following table shows, for the periods indicated, the high and low sales prices for the company's ordinary ADSs, as reported on the NYSE composite tape. Prices for 2008 were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.

By month
 
US$ 
 
By quarter
 
US$ 
 
By year
 
US$ 
February 2012
High
9.19 
 
2011: Q4
High
9.06 
 
2011
High
15.83 
 
Low
8.43 
   
 
Low
5.36 
   
Low
5.36 
January 2012
High
8.71 
 
2011: Q3
High
12.86 
 
2010
High
17.30 
 
Low
6.25 
   
Low
6.43 
   
Low
9.89 
December 2011
High
7.12 
 
2011: Q2
High
14.48 
 
2009
High
18.95 
 
Low
5.95 
   
Low
11.34 
   
Low
3.33 
November 2011
High
7.44 
  
2011: Q1
High
15.83 
 
2008
High
149.05 
 
Low
5.36 
   
Low
12.40 
   
Low
12.20 
October 2011
High
9.06 
 
2010: Q4
High
15.67 
       
 
Low
6.68 
   
Low
11.76 
       
September 2011
High
8.32 
 
2010: Q3
High
16.68 
       
 
Low
6.76 
   
Low
12.14 
       
       
2010: Q2
High
17.30 
       
         
Low
11.91 
       
       
2010: Q1
High
13.61 
       
         
Low
9.89 
       

With effect from 7 November 2008, the ratio of one ADS representing one ordinary share changed to one ADS representing 20 ordinary shares. The prices in the table for 2008 were adjusted accordingly.

On 23 March 2012, the closing price of the ordinary ADSs on the New York Stock Exchange was $8.97.

 
424

 
Shareholder information continued
 
Dividend history
Preference dividends

Amount per share
2011 
$
2011 
£  
2010 
£
2009 
£
2008 
£
2007 
£
Non-cumulative preference shares of US$0.01
           
  - Series E (redeemed January 2007) (1)
— 
— 
— 
— 
— 
0.04 
  - Series F (1)
1.91 
1.19 
1.06 
1.22 
1.04 
0.96 
  - Series G (redeemed January 2007) (1)
— 
— 
— 
— 
— 
0.04 
  - Series H (1)
1.81 
1.13 
1.03 
1.15 
0.99 
0.91 
  - Series K (redeemed January 2007) (1)
— 
— 
— 
— 
— 
0.04 
  - Series L (1)
1.44 
0.90 
0.86 
0.92 
0.78 
0.72 
  - Series M (2)
— 
— 
0.26 
1.02 
0.89 
0.80 
  - Series N (2)
— 
— 
0.26 
1.01 
0.88 
0.79 
  - Series P (2)
— 
— 
0.25 
0.99 
0.87 
0.78 
  - Series Q (2)
— 
— 
0.27 
1.07 
0.94 
0.84 
  - Series R (2)
— 
— 
0.25 
0.97 
0.85 
0.77 
  - Series S (2)
— 
— 
0.27 
1.05 
0.92 
0.41 
  - Series T (2)
— 
— 
0.29 
1.15 
1.01 
0.23 
  - Series U (2)
— 
— 
2,474 
5,019 
3,935 
— 
Non-cumulative convertible preference shares of US$0.01
           
  - Series 1 (1)
91.18 
56.87 
59.98 
60.33 
49.66 
45.58 
Non-cumulative preference shares of €0.01
           
  - Series 1 (2)
— 
— 
— 
49.46 
46.53 
39.63 
  - Series 2 (2)
— 
— 
— 
46.00 
41.79 
35.52 
  - Series 3 (2)
— 
— 
— 
3,125 
2,782 
— 
Non-cumulative convertible preference shares of £0.01
           
  - Series 1 (1)
118.48 
73.87 
73.87 
73.87 
73.87 
73.87 
Non-cumulative preference shares of £1
           
  - Series 1 (2)
— 
— 
— 
81.62 
80.73 
— 
  - Series 2 (redeemed April 2009) (2)
— 
— 
— 
54.71 
— 
— 

Notes:
(1)
Classified as subordinated liabilities.
(2)
Classified as equity.

The Group has undertaken that, unless otherwise agreed with the European Commission, neither the company nor any of its direct or indirect subsidiaries (other than companies in the RBS Holdings N.V. group, which are subject to different restrictions) will pay external investors any dividends or coupons on existing hybrid capital instruments (including preference shares, B shares and upper and lower tier 2 instruments) from 30 April 2010 for a period of two years thereafter ("the Deferral period"), or exercise any call rights in relation to these capital instruments between 24 November 2009 and the end of the deferral period, unless there is a legal obligation to do so. Hybrid capital instruments issued after 24 November 2009 will generally not be subject to the restriction on dividend or coupon payments or call options.

For further information, see Note 8 on the consolidated accounts.

Ordinary dividends
Ordinary dividends per share for 2007 in the table below were restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.

Amount per ordinary share and American Depository Share (1)
2011
pence
2010
pence
2009
pence
2008
pence
2007
pence
Interim (2)
8.5
Final (3)
19.3
Total
27.8

Notes:
(1)
Each American Depository Share represents 20 ordinary shares. As discussed under Trading market, the American Depository Shares were issued in October 2007 and consequently did not receive any dividends prior to the final dividend in respect of 2007.
(2)
In 2008, the company issued new ordinary shares by way of a capitalisation issue rather than paying an interim dividend.
(3)
Final dividends were proposed in the indicated year and paid in the following year.


 
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Taxation for US Holders
The following discussion summarises certain US federal and UK tax consequences of the ownership and disposition of ordinary shares, ADSs representing ordinary shares (ordinary ADSs), ADSs representing non-cumulative dollar preference shares (preference ADSs) or PROs by a beneficial owner that is a citizen or resident of the United States or that otherwise will be subject to US federal income tax on a net income basis in respect of the ordinary shares, ordinary ADSs, preference ADSs or PROs (a “US Holder”). This summary assumes that a US Holder is holding ordinary shares, ordinary ADSs, preference ADSs or PROs, as applicable, as capital assets. This summary does not address the tax consequences to a US Holder (i) that is resident (or, in the case of an individual, ordinarily resident) in the UK for UK tax purposes, (ii) that carries on a trade, profession or vocation through a branch, agency or permanent establishment in the UK in connection with which the ordinary shares, ordinary ADSs, preference ADSs or PROs are held, used or acquired, or (iii) generally, that is a corporation which alone or together with one or more associated companies, controls, directly or indirectly, 10% or more of the voting stock of the company, nor does this summary address the tax consequences to US Holders subject to special rules, such as certain financial institutions, dealers or traders in securities who use a mark-to-market method of tax accounting, persons holding ordinary shares, ordinary ADSs, preference ADSs or PROs as part of a hedging transaction, straddle, wash sale, conversion transaction or integrated transaction or persons entering into a constructive sale with respect to such securities, persons whose functional currency for US federal income tax purposes is not the US dollar, entities classified as partnerships for US federal income tax purposes, tax-exempt entities or persons that own or are deemed to own 10% or more of the voting stock of the company.

The statements and practices set forth below regarding US and UK tax laws, including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “Treaty”), and the US/UK double taxation convention relating to estate and gift taxes (the “Estate Taxation Treaty”), are based on those laws and practices as in force and as applied in practice on the date of this report. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, and possible changes in taxation law, of the acquisition, ownership and disposition of ordinary shares, ordinary ADSs, preference ADSs or PROs by consulting their own tax advisers.

The following discussion assumes that the company is not, and will not become, a passive foreign investment company - see ‘Passive Foreign Investment Company (PFIC) considerations’ on page 429.

Ordinary shares, ordinary ADSs and preference ADSs
Taxation of dividends
For the purposes of the Treaty, the Estate Taxation Treaty and the US Internal Revenue Code of 1986 as amended (the “Code”), US Holders of ordinary ADSs and preference ADSs should be treated as owners of the ordinary shares and the non-cumulative dollar preference shares underlying such ADSs.

The US Treasury has expressed concerns that parties to whom depositary receipts are released before shares are delivered to the depositary, or intermediaries in the chain of ownership between US holders and the issuer of the security underlying the depositary receipts, may be taking actions that are inconsistent with the claiming of foreign tax credits for US holders of depositary receipts. Such actions would also be inconsistent with the claiming of the reduced rate of US tax applicable to dividends received by certain non-corporate US holders. Accordingly, the availability of the reduced tax rate for dividends received by certain non-corporate US holders could be affected by actions taken by such parties or intermediaries.

The company is not required to withhold UK tax at source from dividend payments it makes or from any amount (including any amounts in respect of accrued dividends) distributed by the company. US Holders who are not resident or ordinarily resident in the UK and who do not carry on a trade, profession or vocation in the UK through a branch, agency or permanent establishment in connection with which their ordinary shares, ordinary ADSs or preference ADSs are held, used or acquired will not be subject to UK tax in respect of any dividends received on the relevant shares or ADSs.

Distributions by the company (other than certain pro-rata distributions of ordinary shares or rights to receive such shares) will constitute foreign source dividend income for US federal income tax purposes to the extent paid out of the current or accumulated earnings and profits of the company, as determined for US federal income tax purposes. Because the company does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions will be reported to US Holders as dividends. Payments will not be eligible for the dividends-received deduction generally allowed to corporate US holders.

Subject to applicable limitations that may vary depending upon a holder's individual circumstances, dividends paid to certain non-corporate US Holders in taxable years beginning before 1 January 2013 will be taxable at a maximum tax rate of 15%. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at this favourable rate.

 
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Dividends will be included in a US Holder's income on the date of the US Holder's (or in the case of ADSs, the depositary's) receipt of the dividend. The amount of any dividend paid in pounds sterling to be included in income by a US Holder will be the US dollar amount calculated by reference to the relevant exchange rate in effect on the date of such receipt regardless of whether the payment is in fact converted into US dollars. If the dividend is converted into US dollars on the date of receipt, the US Holder generally should not be required to recognise foreign currency gain or loss in respect of the dividend income. If the amount of such dividend is not converted into US dollars on the date of receipt, the US Holder may have foreign currency gain or loss.

Taxation of capital gains
A US Holder that is not resident (or, in the case of an individual, ordinarily resident) in the UK will not normally be liable for UK tax on capital gains realised on the disposition of an ordinary share, an ordinary ADS or a preference ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a branch or agency and, in each case, such ordinary share, ordinary ADS or preference ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), carried on through such permanent establishment, branch or agency. Special rules apply to individuals who are temporarily not resident or ordinarily resident in the UK.

A US Holder will, upon the sale or other disposition of an ordinary share, an ordinary ADS or a preference ADS, or upon the redemption of preference ADS, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption of a preference ADS, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding in the case of a redemption any amount treated as a dividend for US federal income tax purposes, which will be taxed accordingly) and the US Holder's tax basis in such share or ADS. This capital gain or loss will be long-term capital gain or loss if the US Holder held the share or ADS so sold, disposed or redeemed for more than one year.

A US Holder who is liable for both UK and US tax on a gain recognised on the disposal of an ordinary share, an ordinary ADS or a preference ADS will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.

Estate and gift tax
Subject to the discussion of the Estate Tax Treaty in the following paragraph, ordinary shares, ordinary ADSs or preference ADSs beneficially owned by an individual may be subject to UK inheritance tax (subject to exemptions and reliefs) on the death of the individual or in certain circumstances, if such shares or ADSs are the subject of a gift (including a transfer at less than market value) by such individual. Inheritance tax is not generally chargeable on gifts to individuals made more than seven years before the death of the donor. Ordinary shares, ordinary ADSs or preference ADSs held by the trustees of a settlement may also be subject to UK inheritance tax. Special rules apply to such settlements.

An ordinary share, an ordinary ADS or a preference ADS beneficially owned by an individual, whose domicile is determined to be the United States for purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual's death or on a lifetime transfer of such share or ADS, except in certain cases where the share or ADS (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the ordinary share, ordinary ADS or preference ADS is subject to both UK inheritance tax and US federal estate or gift tax.

UK stamp duty and stamp duty reserve tax (SDRT)
The following is a summary of the UK stamp duty and SDRT consequences of transferring an ADS (otherwise than to the custodian on cancellation of the ADS) or of transferring an ordinary share. A transfer of an ADS executed and retained in the United States will not give rise to stamp duty and an agreement to transfer an ADS will not give rise to SDRT. Stamp duty or SDRT will normally be payable on or in respect of transfers of ordinary shares and accordingly any holder who acquires or intends to acquire ordinary shares is advised to consult their own tax advisers in relation to stamp duty and SDRT.



 
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Shareholder information continued
 
 
Taxation for US Holders continued
PROs
United States
Payments of interest on a PRO (including any UK withholding tax, as to which see below) will constitute foreign source dividend income for US federal income tax purposes to the extent paid out of the current or accumulated earnings and profits of the company, as determined for US federal income tax purposes. Because the company does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions will be reported to US Holders as dividends. Payments will not be eligible for the dividends-received deduction generally allowed to corporate US holders. A US Holder who is entitled under the Treaty to a refund of UK tax, if any, withheld on a payment will not be entitled to claim a foreign tax credit with respect to the refundable tax.

Subject to applicable limitations that may vary depending upon a holder's individual circumstances, dividends paid to certain non-corporate US Holders in taxable years beginning before 1 January 2013 will be taxable at a maximum tax rate of 15%. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at this favourable rate. A US Holder will, upon the sale, exchange or redemption of a PRO, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding any amount in respect of mandatory interest and any missed payments which are to be satisfied on a missed payment satisfaction date, which would be treated as ordinary income) and the US Holder's tax basis in the PRO.

A US Holder who is liable for both UK and US tax on gain recognised on the disposal of PROs will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.

United Kingdom
Taxation of payments on the PROs
Payments on the PROs will constitute interest rather than dividends for UK withholding tax purposes. However, the PROs will constitute 'quoted eurobonds' within the meaning of section 987 of the Income Tax Act 2007 and therefore payments of interest will not be subject to withholding or deduction for or on account of UK tax as long as the PROs remain at all times listed on a 'recognised stock exchange' within the meaning of section 1005 of the Income Tax Act 2007, such as the main market of the New York Stock Exchange. In all other cases, an amount must be withheld on account of UK income tax at the basic rate (currently 20%) subject to any direction to the contrary by HM Revenue & Customs under the Treaty and except that the withholding obligation does not apply to payments to persons who the company reasonably believes are within the charge to corporation tax or fall within various categories enjoying a special tax status (including charities and pension funds), or are partnerships consisting of such persons (unless HM Revenue & Customs directs otherwise). Where interest has been paid under deduction of UK withholding tax, US Holders may be able to recover the tax deducted under the Treaty. Any paying agent or other person by or through whom interest is paid to, or by whom interest is received on behalf of an individual, may be required to provide information in relation to the payment and the individual concerned to HM Revenue & Customs. HM Revenue & Customs may communicate this information to the tax authorities of other jurisdictions.

HM Revenue & Customs confirmed at around the time of the issue of the PROs that interest payments would not be treated as distributions for UK tax purposes by reason of (i) the fact that interest may be deferred under the terms of issue; or (ii) the undated nature of the PROs, provided that at the time an interest payment is made, the PROs are not held by a company which is 'associated' with the company or by a 'funded company'. A company will be associated with the company if, broadly speaking, it is part of the same group as the company. A company will be a 'funded company' for these purposes if there are arrangements involving that company being put in funds (directly or indirectly) by the company, or an entity associated with the company. In this respect, HM Revenue & Customs has confirmed that a company holding an interest in the PROs which incidentally has banking facilities with any company associated with the company will not be a 'funded company' by virtue of such facilities.

Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a branch or agency in each case in connection with which the interest is received or to which the PROs are attributable. There are also exemptions for interest received by certain categories of agents (such as some brokers and investment managers).

EU Directive on taxation of savings income
Under the European Union Council Directive 2003/48/EC on the taxation of savings income, member states of the European Union are required to provide to the tax authorities of other member states details of payments of interest and other similar income paid by a person to an individual or certain other persons resident in another member state, except that Luxembourg and Austria may instead impose a withholding system for a transitional period unless during such period they elect otherwise.

Disposal (including redemption)
A disposal (including redemption) of PROs by a non-corporate US Holder will not give rise to any liability to UK tax on capital gains unless the US Holder carries on a trade (which for this purpose includes a profession or a vocation) in the UK through a branch or agency and the PROs are, or have been, held or acquired for the purposes of that trade, carried on through such branch or agency.


 
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Shareholder information continued

A transfer of PROs by a US Holder will not give rise to a charge to UK tax on accrued but unpaid interest payments, unless the US Holder is an individual or other non-corporate taxpayer and at any time in the relevant year of assessment or accounting period carries on a trade, profession or vocation in the UK through a branch or agency to which the PROs are attributable.

Annual tax charges
Corporate US Holders of PROs may be subject to annual UK tax charges (or tax relief) by reference to fluctuations in exchange rates and in respect of profits, gains and losses arising from the PROs, but only if such corporate US Holders carry on a trade in the UK through a UK permanent establishment to which the PROs are attributable.

Inheritance tax
In relation to PROs held through Depository Trust Company (DTC) (or any other clearing system), the UK inheritance tax position is not free from doubt in respect of a lifetime transfer, or death of, a US Holder who is not domiciled nor deemed to be domiciled in the UK for inheritance tax purposes; HM Revenue & Customs is known to consider that the situs of securities held in this manner is not necessarily determined by the place where the securities are registered. In appropriate circumstances, there may be a charge to UK inheritance tax as a result of a lifetime transfer at less than market value by, or on the death of, such US Holder. Inheritance tax is not generally chargeable on gifts to individuals made more than seven years before the death of the donor. However, exemption from, or a reduction of, any such UK tax liability may be available under the Estate Tax Treaty (see below). US Holders should consult their professional advisers in relation to such potential liability. PROs beneficially owned by an individual, whose domicile is determined to be the United States for the purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual's death or on a lifetime transfer of the PRO, except in certain cases where the PRO (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the PRO is subject to both UK inheritance tax and US federal estate or gift tax.

Stamp duty and SDRT
No stamp duty, SDRT or similar tax is imposed in the UK on the issue, transfer or redemption of the PROs.

Passive Foreign Investment Company (PFIC) considerations
A foreign corporation will be a PFIC in any taxable year in which, after taking into account the income and assets of the corporation and certain subsidiaries pursuant to applicable 'look-through rules', either (i) at least 75% of its gross income is 'passive income' or (ii) at least 50% of the average value of its assets is attributable to assets which produce passive income or are held for the production of passive income. The company does not believe that it was a PFIC for its 2011 taxable year. Although interest income is generally passive income, a special rule allows banks to treat their banking business income as non-passive.
To qualify for this rule, a bank must satisfy certain requirements regarding its licensing and activities. The company's possible status as a PFIC must be determined annually, however, and may be subject to change if the company fails to qualify under this special rule for any year in which a US Holder holds ordinary shares, ordinary ADSs, preference ADSs or PROs. If the company were to be treated as a PFIC in any year during which a US Holder holds ordinary shares, ordinary ADSs, preference ADSs or PROs, US Holders would generally be subject to adverse US federal income tax consequences. Holders should consult their own tax advisers as to the potential application of the PFIC rules to the ownership and disposition of the company's ordinary shares, ordinary ADSs, preference ADSs or PROs.

Foreign financial assets reporting
For taxable years beginning after 18 March 2010, certain US Holders who are individuals may be required to report information relating to the company’s securities, subject to certain exceptions (including an exception for securities held in accounts maintained by US financial institutions).  US Holders are urged to consult their tax advisers regarding the application of these rules in the US Holders’ particular circumstances.

Exchange controls
The company has been advised that there are currently no UK laws, decrees or regulations which would prevent the import or export of capital, including the availability of cash or cash equivalents for use by the Group, or the remittance of dividends, interest or other payments to non-UK resident holders of the company's securities.

There are no restrictions under the Articles of Association of the company or under UK law, as currently in effect, which limit the right of non-UK resident owners to hold or, when entitled to vote, freely to vote the company's securities.

 
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Shareholder information continued

Memorandum and Articles of Association
The company’s Memorandum and Articles of Association as in effect at the date of this annual report are registered with the Registrar of Companies of Scotland.

The following information is a summary of certain terms of the company’s Memorandum of Association (the “Memorandum”) and Articles of Association (the “Articles”) as in effect at the date of this Annual Report and certain relevant provisions of the Companies Act 2006 (the “2006 Act”) where appropriate and as relevant to the holders of any class of share. The current Articles were adopted on 28 April 2010. The Articles were updated primarily to reflect the coming into force of the remaining provisions of the 2006 Act and the implementation of the Shareholder Rights Directive in the UK. A further amendment was made to the Articles at a General Meeting held on 28 April 2010 in relation to the price at which certain classes of preference shares may be purchased. A further amendment was made on 19 April 2011 to the effect that, subject to existing class rights of shareholders, new preference shares can be issued with such rights and restrictions as the directors may determine.

The following summary description is qualified in its entirety by reference to the terms and provisions of the Memorandum and Articles (and, in the case of the summary description of the non-cumulative preference shares, the B Shares and the Dividend Access Share, by reference to the terms of issue of those shares determined by the Directors pursuant to the Articles prior to allotment). The Memorandum and Articles are registered with the Registrar of Companies of Scotland. Holders of any class of share are encouraged to read the full Memorandum and Articles, which have been filed as an exhibit to this annual report on Form 20-F

Incorporation and registration
The company was incorporated and registered in Scotland under the Companies Act 1948 as a limited company on 25 March 1968 under the name National and Commercial Banking Group Limited. On 3 September 1979 the name was changed to The Royal Bank of Scotland Group Limited and on 10 March 1982, it changed its name to its present name and was registered under the Companies Acts 1948 to 1980 as a public company with limited liability. The company is registered under Company No. SC 45551.

Purpose and objects
The 2006 Act greatly reduces the constitutional significance of a company’s memorandum of association and provides that a memorandum of association will record only the names of the subscribers and the number of shares each subscriber has agreed to take in the company. The 2006 Act further states that, unless a company’s articles provide otherwise, a company’s objects are unrestricted and abolishes the need for companies to have objects clauses. The company removed its objects clause together with all other provisions of its memorandum of association which by virtue of the 2006 Act were treated as forming part of the company’s articles. The articles of association contain an express statement regarding the limited liability of the shareholders.

Directors
At each annual general meeting of the company, any Director appointed since the last annual general meeting and any Directors who were not appointed at one of the preceding two annual general meetings shall retire from office and may offer themselves for re-election by the members. Directors may be appointed by the company by ordinary resolution or by the Board. A director appointed by the Board holds office only until the next annual general meeting, whereupon he will be eligible for re-election. Unless and until otherwise determined by ordinary resolution, the directors (other than alternate directors) shall be not more than twenty five. There is no stipulation in the Articles regarding a minimum number of directors; under the 2006 Act, and in the absence of express provision, the minimum number is two.

Directors’ interests
A director shall not vote at a meeting of the Board or a committee of the Board on any resolution of the Board concerning a matter in which he has an interest (otherwise than by virtue of his interest in shares, debentures or other securities of, or otherwise in or through, the company) which (together with any interest of any person connected with him) is, to his knowledge, material unless his interests arises only because the resolution relates to one or more of the following matters:

(i) the giving of any security or indemnity to him pursuant to the Articles or in respect of money lent, or obligations incurred, by him at the request of, or for the benefit of, the company or any of its subsidiary undertakings;

(ii) the giving of any security or indemnity to a third party in respect of a debt or obligation of the company or any of its subsidiary undertakings for which he has assumed responsibility (in whole or in part) under a guarantee or indemnity or by the giving of security;

(iii) a proposal concerning an offer of shares, debentures or other securities of the company, or any of its subsidiary undertakings, for subscription or purchase, in which offer he is, or may be, entitled to participate as a holder of securities or in the underwriting or sub-underwriting of which he is to participate;

(iv) any proposal concerning any other body corporate in which he is interested, directly or indirectly, whether as an officer or shareholder or otherwise, provided that he is not the holder of shares representing one per cent or more of any class of the equity share capital of such body corporate;

(v) any proposal concerning the adoption, modification or operation of a pension fund or retirement, death or disability benefits scheme or employees’ share scheme which relates both to directors and employees of the company or a subsidiary of the company and does not provide any privilege or advantage in respect of any director which it does not accord to the employees to which the fund or scheme relates;


 
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Shareholder information continued


(vi) a contract or arrangement for the benefit of the employees of the company or any of its subsidiary undertakings which does not accord him any privilege or advantage not generally accorded to the employees to whom the contract or arrangement relates; and

(vii) a proposal concerning any insurance which the company proposes to purchase and/or maintain for the benefit of any directors or for persons who include directors of the company.

Under the 2006 Act, a director must avoid a situation where he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the company’s interests. The 2006 Act allows directors of public companies, where appropriate, to authorise conflicts and potential conflicts where the articles of association contain a provision to this effect. The 2006 Act also allows the articles of association to contain other provisions for dealing with directors’ conflicts of interest to avoid a breach of duty.

Clause 92 of the Articles, gives the directors authority to authorise any matter which would or might otherwise constitute or give rise to a breach of the duty of a director under the 2006 Act to avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict with the company.

Authorisation of any matter pursuant to Clause 92 must be approved in accordance with normal board procedures by directors who have no interest in the matter being considered. In taking the decision, the directors must act in a way they consider, in good faith, will be most likely to promote the company’s success.

Any authorisation of a matter may be given on or subject to such conditions or limitations as the directors determine, whether at the time of authorisation or subsequently, including providing for the exclusion of the interested directors from the receipt of information or participation in discussion relating to the matter authorised by the directors and providing that interested directors in receipt of confidential information from a third party are not obliged to disclose such information to the company or use the information in relation to the company’s affairs. Any authorization may be terminated by the directors at any time.

A director is not, except as otherwise agreed by him, accountable to the company for any benefit which he, or a person connected with him, derives from any matter authorised by the directors and any contract, transaction or arrangement relating to such matter is not liable to be avoided on the grounds of such benefit.

Directors’ power to allot securities
In line with market practice, the Articles provide that the authority to allot shares and the disapplication of pre-emption rights will not be set out in the Articles, but subject to resolutions passed at the company’s annual general meeting to obtain these authorities on an annual basis.

Borrowing powers
The directors may exercise all the powers of the company to borrow money and to mortgage or charge its undertaking, property and uncalled capital and to issue debentures and other securities, whether outright or as collateral security for any debt, guarantee, liability or obligation of the company, or of any third party.

Qualifying shareholding
Directors are not required to hold any shares of the company by way of qualification.

Classes of shares
The company has issued and outstanding the following five general classes of shares, namely ordinary shares, preference shares, non-voting deferred shares, B Shares and a Dividend Access Share, to which the provisions set forth below apply. In addition, the company has as part of its share capital Additional Value Shares (“AVSs”). All of the issued AVSs were converted into non-voting deferred shares in December 2003. The terms of those AVSs are set out in Schedule 3 to the Articles. The terms of the issued B Shares (designated Series 1 Class B Shares) and the Dividend Access Share (designated a Series 1 Dividend Access Share) were determined by the directors pursuant to the Articles prior to the time of allotment, and apply as if they were set out in the Articles.

Dividends
General
Subject to the provisions of the 2006 Act and Clause 123 of the Articles, the company may, by ordinary resolution, declare dividends on ordinary shares save that no dividend shall be payable except out of profits available for distribution, or in excess of the amount recommended by the Board or in contravention of the special rights attaching to any share. Any dividend which has remained unclaimed for 12 years from the date of declaration shall be forfeited and shall revert to the company. The company may cease sending dividend warrants and cheques by post or otherwise to a member if such instruments have been returned undelivered to, or left uncashed by, that member on at least two consecutive occasions, or, following one such occasion, reasonable enquiries have failed to establish any new address or account of the registered holder. The company may resume sending warrants and cheques if the holder requests such recommencement in writing.
 
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Shareholder information continued

Preference shares
Each cumulative preference share confers the right to a fixed cumulative preferential dividend payable half-yearly. Each non-cumulative preference share confers the right to a preferential dividend (not exceeding a specified amount) payable in the currency of the relevant share. The rate of such dividend and the date of payment thereof, together with the terms and conditions of the dividend, are as may be determined by the directors prior to allotment. Cumulative preference share dividends are paid in priority to any dividend on any other class of share.

The non-cumulative preference shares rank for dividend after the cumulative preference shares but rank pari passu with each other and any shares expressed to rank, in terms of participation in the profits of the company, in some or all respects pari passu therewith and otherwise in priority to dividends payable on the ordinary shares and any other share capital in the company.

The directors may resolve prior to the issue and allotment of any series of non-cumulative preference shares that full dividends in respect of a particular dividend payment date will not be declared and paid if, (i) in its sole and absolute discretion, the directors resolve prior to the relevant dividend payment date that such dividend (or part thereof) shall not be paid and/or (ii) in the opinion of the directors, payment of a dividend would cause a breach of the UK Financial Services Authority ’ s capital adequacy requirements applicable to the company or its subsidiaries, or subject to the next following paragraph, insufficient distributable profits of the company are available to cover the payment in full of all dividends after having paid any dividends payable on any of the cumulative preference shares.

If dividends will be paid but, in the opinion of the directors, insufficient distributable profits of the company are available to cover the payment in full of dividends after having paid any dividends payable on any of the cumulative preference shares, dividends will be declared by the directors, pro rata on the non-cumulative preference shares to the extent of the available distributable profits.

The non-cumulative preference shares will carry no further rights to participate in the profits of the company and if, and to the extent, any dividend or part of any dividend is on any occasion not paid for any of the reasons described above, holders of non-cumulative preference shares will have no claim in respect of such non-payment.

If any dividend is not payable for the reasons described in clause (ii) of the third paragraph of this subsection, the directors may pay a special dividend not exceeding US$0.01, £ 0.01 or € 0.01 (depending on the currency of the relevant preference share) per share.

If the dividend payable on any series of non-cumulative preference shares on the most recent payment date is not paid in full, or if a sum is not set aside to provide for such payment in full, in either case for the reasons set forth in clause (ii) of the third paragraph of this subsection, no dividends may be declared on any other share capital of the company and no sum may be set aside for the payment of a dividend on any other share capital (in each case other than the cumulative preference shares), unless, on the date of declaration, an amount equal to the dividend payable in respect of the then current dividend period for such series of non-cumulative preference shares is set aside for payment in full on the next dividend payment date.

If any dividend payable on the non-cumulative preference shares is not paid in full or if a sum is not set aside to provide for such payment in full (in either case for the reasons set forth in clause (ii) of the third paragraph of this subsection), the company may not redeem or purchase or otherwise acquire any other share capital of the company and may not set aside any sum nor establish any sinking fund for its redemption, purchase or other such acquisition, until such time as dividends have been declared and paid in full in respect of successive dividend periods together aggregating not less than twelve months.

The non-payment of any dividend (in full or in part) by reason of the exercise of the directors’ discretion referred to in clause (i) of the third paragraph of this subsection, shall not prevent or restrict (a) the declaration and payment of dividends on any other series of non-cumulative preference shares or on any non-cumulative preference shares expressed to rank pari passu with the non-cumulative preference shares, (b) the setting aside of sums for the payment of such dividends, (c) except as set forth in the following paragraph, the redemption, purchase or other acquisition of shares in the company by the company, or (d) except as set forth in the following paragraph, the setting aside of sums, or the establishment of sinking funds, for any such redemption, purchase or other acquisition by the company.

If dividends are not declared and paid in full on any series of non-cumulative preference shares as a result of the directors’ discretion referred to in clause (i) of the third paragraph of this subsection, then the company may not redeem, purchase or otherwise acquire for any consideration any share capital ranking after such preference shares, and may not set aside any sum nor establish any sinking fund for the redemption, purchase or other acquisition thereof, until such time as the company has declared and paid in full dividends on such series of non-cumulative preference shares in respect of successive dividend periods together aggregating no less than twelve months. In addition, no dividend may be declared or paid on any of the company’s share capital ranking after such preference shares until the dividend in respect of a particular dividend payment date payable on the preference shares to which the directors’ discretion in clause (i) of the third paragraph of this subsection applies has been declared and paid in full.

With effect from 19 April 2011, subject to existing class rights of shareholders, new preference shares can be issued with such rights and restrictions as the directors may determine.

Non-voting deferred shares
The holders of non-voting deferred shares are not entitled to the payment of any dividend or other distribution.

 
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B Shares
Prior to the occurrence of a Trigger Event (as defined below) in respect of any Series 1 Class B Shares, those Series 1 Class B Shares rank equally with the holders of ordinary shares in respect of any cash dividends, and each Series 1 Class B Share will entitle its holder to the same cash dividend as is (or may, at the election of a holder of the ordinary share, be) payable to the holder of one ordinary share, as adjusted from time to time to reflect any consolidation, reclassification or subdivision in relation to the ordinary shares.

If a Trigger Event has occurred in respect of any Series 1 Class B Shares, the Series 1 Class B Shares in respect of which the Trigger Event has occurred will rank pari passu with the holders of the ordinary shares in respect of any dividends paid on the ordinary shares. Each Series 1 Class B Share will entitle its holder to the same dividend as is (or may, at the election of a holder of an ordinary share, be) payable to the holder of one (as adjusted from time to time) ordinary share. If a bonus issue of fully paid ordinary shares is made to holders of ordinary shares in lieu of a dividend, a holder of a Series 1 Class B Share in respect of which the Trigger Event has occurred will be entitled to receive the same number of ordinary shares as is payable to the holder of one (as adjusted from time to time) ordinary share, save that if the issue of such ordinary share(s) to such holder would result in it holding directly or indirectly more than 75% of the total issued ordinary shares, then such holder will instead receive further Series 1 Class B Shares of the same value.

A Trigger Event occurs in relation to the Series 1 Class B Shares in issue at the relevant time, if the daily volume weighted average price of the company’s ordinary shares on the London Stock Exchange equals or exceeds £0.65 per ordinary share (subject to adjustment) for 20 or more complete dealing days in any period of 30 consecutive dealing days.

Dividend Access Share
Subject to the discretions, limitations and qualifications described in this subsection, non-cumulative dividends on the Series 1 Dividend Access Share will be payable from 22 December 2009 in respect of the period up to and including the Series 1 Class B Dividend Stop Date (if any).

The company will pay dividends on the Series 1 Dividend Access Share when, as and if declared by its board of directors or a duly authorised committee of such board of directors (the ‘‘board of directors’’). Subject to the discretions, limitations and qualifications described in this section, the Series 1 Dividend Access Share will entitle the holder to receive out of the distributable profits of the company a non-cumulative dividend at the rate described below (the ‘‘Dividend Access Share Dividend’’), in priority to the payment of any dividend to the holders of any class of ordinary share or Class B Share and pari passu in such regard with the holder of any other dividend access share then in issue.

The board of directors may in its sole and absolute discretion resolve that no Dividend Access Share Dividend shall be paid on a Dividend Access Share Dividend payment date.

The board of directors will, by 31 October in each financial year of the company, decide whether or not to pay an interim dividend on the ordinary shares or make an interim Ordinary Share Bonus Issue in that financial year. If it is decided that an interim dividend on the ordinary shares or an interim Ordinary Share Bonus Issue is to be paid or made in any financial year, the corresponding semi-annual (hereinafter referred to as ‘‘first semi-annual’’) Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share in the same financial year will be paid or made at the time set out below. The record date for any first semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share will be the same as the record date for any interim dividend on the ordinary shares or interim Ordinary Share Bonus Issue in the relevant financial year or otherwise will be three business days before 31 October in each year. If paid or made, the first semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share in a financial year will be paid or made on the same date that the corresponding interim dividend on the ordinary shares is paid or interim Ordinary Share Bonus Issue is made. If it is decided that no such interim dividend on the ordinary shares or interim Ordinary Share Bonus Issue will be paid or made in a financial year, the first semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share in such financial year will, if to be paid or made, be so paid or made on 31 October in such financial year (commencing in 2010).

The board of directors will, by 31 May in each financial year of the company, decide whether or not to recommend a dividend on the ordinary shares or make an Ordinary Share Bonus Issue which is expressed to be a final dividend for the immediately preceding financial year. If it is decided that such a dividend on the ordinary shares or Ordinary Share Bonus Issue is to be recommended and is subsequently approved by shareholders, the corresponding semi-annual (hereinafter referred to as ‘‘second semi-annual’’) Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share expressed to be for the corresponding period will be paid at the time set out below. The record date for any second semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share will be the same as the record date for any final dividend on the ordinary shares or final Ordinary Share Bonus Issue for the relevant financial year or otherwise will be three business days before 31 May in each year. If paid or made, the second semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share in a financial year will be paid or made on the same date that the corresponding final dividend on the ordinary shares is paid or final Ordinary Share Bonus Issue is made. If it is decided that no such final dividend on the ordinary shares or Ordinary Share Bonus Issue will be paid or made in any year (the ‘‘current year’’) for the immediately preceding financial year, any second semi-annual Dividend Access Share Dividend or Bonus Issue on the Series 1 Dividend Access Share expressed to be for the corresponding period will, if to be paid or made, be so paid or made on 31 May in the current year (commencing in 2010).
 
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Any first semi-annual Dividend Access Share Dividend or second semi-annual Dividend Access Share Dividend will only be paid if (to the extent legally required) profits are available for distribution and are permitted by law to be distributed.

If paid or made, the first semi-annual Dividend Access Share Dividend on the Series 1 Dividend Access Share will be equivalent to (A) the greater of:

(i) 7% of the Reference Amount multiplied by the actual number of days in the period from (but excluding) the immediately preceding Relevant Date (or, if none, 22 December 2009), to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series 1 Class B Shares, to (and including) such earlier Series 1 Class B Dividend Stop Date), divided by 365 (or 366 in a leap year)

(ii) if a cash dividend or cash dividends on the ordinary shares or Ordinary Share Bonus Issue(s) is/are paid or made in the period from (but excluding) the immediately preceding Relevant Date (or, if none, 22 December 2009) to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series 1 Class B Shares, to (and including) such earlier Series 1 Class B Dividend Stop Date), 250% (as adjusted from time to time as described in the terms of issue of the Series 1 Dividend Access Share, the ‘‘Participation Rate’’) of the aggregate fair market value (as defined in the terms of issue of the Series 1 Dividend Access Share) of such cash dividend or cash dividends or Ordinary Share Bonus Issue per ordinary share multiplied by the then Reference Series 1 Class B Shares Number. Where a dividend in cash is announced which may at the election of a shareholder or shareholders be satisfied by the issue or delivery of ordinary shares in an Ordinary Share Bonus Issue, or where an Ordinary Share Bonus Issue is announced which may at the election of a shareholder or shareholders be satisfied by the payment of cash, then the fair market value of such dividend or Ordinary Share Bonus Issue will be deemed to be the amount of the dividend in cash or of the payment in cash (as the case may be) less (B) the fair market value (as defined in the terms of issue of the Series 1 Dividend Access Share) of the aggregate amount of any dividend or distribution paid or made on the Series 1 Class B Shares and/or on any ordinary shares issued on conversion of the B Shares (regardless of who holds such Series 1 Class B Shares or ordinary shares at the relevant time) in the period from (but excluding) the immediately preceding Relevant Date (or, if none, 22 December 2009) to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series 1 Class B Shares to (and including) such earlier Series 1 Class B Dividend Stop Date), provided that the first semi-annual Dividend Access Share Dividend will never be less than zero.

If paid or made, the second semi-annual Dividend Access Share Dividend on the Series 1 Dividend Access Share will be equivalent to (A) the greater of:

(i) 7% of the Reference Amount multiplied by the actual number of days in the period from (but excluding) the Relevant Date falling on (or nearest to) one year prior to the current Relevant Date (or, if none, 22 December 2009) to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series 1 Class B Shares, to (and including) such earlier Series 1 Class B Dividend Stop Date) divided by 365 (or 366 in a leap year) and

(ii) if a cash dividend or cash dividends on the ordinary shares or Ordinary Share Bonus Issue(s) is/are paid or made in the period from (but excluding) the Relevant Date falling on (or nearest to) one year prior to the current Relevant Date (or, if none, 22 December 2009) to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series 1 Class B Shares, to (and including) such earlier Series 1 Class B Dividend Stop Date) the Participation Rate of the aggregate fair market value of such cash dividend(s) or Ordinary Share Bonus Issue(s) per ordinary share multiplied by the then Reference Series 1 Class B Shares Number. Where a dividend in cash is announced which may at the election of a shareholder or shareholders be satisfied by the issue or delivery of ordinary shares in an Ordinary Share Bonus Issue, or where an Ordinary Share Bonus Issue is announced which may at the election of a shareholder or shareholders be satisfied by the payment of cash, then the fair market value of such dividend or Ordinary Share Bonus Issue will be deemed to be the amount of the dividend in cash or of the payment in cash (as the case may be) less (B) the fair market value of the aggregate amount of any dividend or distribution paid or made on the Series 1 Class B Shares and/or on any ordinary shares issued on conversion of the Series 1 Class B Shares (regardless of who holds such Series 1 Class B Shares or ordinary shares at the relevant time) in the period from (but excluding) the Relevant Date falling on (or nearest to) one year prior to the current Relevant Date (or, if none, 22 December 2009) to (and including) the current Relevant Date (or, if there has occurred prior to such current Relevant Date a Series 1 Class B Dividend Stop Date in respect of any Series 1 Class B Shares, then in respect of those Series  1 Class B Shares to (and including) such earlier Series 1 Class B Dividend Stop Date) and less the fair market value of the immediately preceding first semi-annual Dividend Access Share Dividend or Bonus Issue paid or made (if any), provided that the second semi-annual Dividend Access Share Dividend will never be less than zero.

If the Participation Rate is adjusted during the course of a financial year, the amount of the semi-annual Dividend Access Share Dividend in such financial year, if determined by reference to the Participation Rate, will itself be adjusted in such manner as the Independent Financial Adviser (acting as an expert) considers appropriate to take account of the date(s) on which the adjustment(s) to the Participation Rate become effective. A written opinion of the Independent Financial Adviser will be conclusive and binding on all parties, save in the case of manifest error.

 
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In the event of a change in the frequency of dividend payments on the ordinary shares such that they are not paid semi-annually consistent with the payment of Dividend Access Share Dividends on the Series 1 Dividend Access Share, the company will make such changes to the Dividend Access Share Dividend payment arrangements described above as, following consultation with the Independent Financial Adviser (acting as an expert), it determines are fair and reasonable to take account of such changed frequency.

Non-cumulative dividends on the Series 1 Dividend Access Share will be payable in respect of the period up to and including the Series 1 Class B Dividend Stop Date (if any). After the Series 1 Class B Dividend Stop Date (if any), the right of the holder of the Series 1 Dividend Access Share to Dividend Access Share Dividends in respect of any Series 1 Class B Shares in issue during each of the 30 consecutive dealing days during which the Trigger Event occurs will cease, but this is without prejudice to the right to Dividend Access Share Dividends in respect of any Series 1 Class B Shares not in issue on each such day.

Bonus Issue of Series 1 Class B Shares on the Series 1 Dividend Access Share
If the board of directors decides to pay a Dividend Access Share Dividend and either (i) no dividend has been paid on the ordinary shares and/or distribution made thereon in respect of the corresponding period, or (ii) a dividend has been paid and/or a distribution has been made on the ordinary shares otherwise than in cash in respect of the corresponding period, the board of directors may in its discretion determine that such Dividend Access Share Dividend will be paid in whole or in part by the company issuing Series 1 Class B Shares, credited as fully paid, to the holder of the Series 1 Dividend Access Share. The number of such further Series 1 Class B Shares to be issued to the holder will be such number of Series 1 Class B Shares as is certified by an Independent Financial Adviser (acting as an expert) to be as nearly as possible equal to (but not greater than) the cash amount (disregarding any tax credit) of such semi-annual Dividend Access Share Dividend or part thereof otherwise payable to such holder of the Series 1 Dividend Access Share, based on the fair market value of a Series 1 Class B Share at the time of such determination. A written opinion of such Independent Financial Adviser will be conclusive and binding on all parties, save in the case of manifest error. The additional Series 1 Class B Shares will rank pari passu in all respects with the fully paid Series 1 Class B Shares then in issue save only as regards participation in the relevant dividend.

Restrictions following non-payment of dividend
If any Dividend Access Share Dividend is not declared and paid in full in cash or otherwise, the company:

(i) may not, and will procure that no subsidiary undertaking of the company will, declare or pay dividends or other distributions on any Parity Securities (whether in cash or otherwise, and whether payable on the same date as the relevant Dividend Access Share Dividend or subsequently) or make any Ordinary Share Bonus Issue (whether to be made on the same date as the relevant Dividend Access Share Dividend or subsequently), and the company may not, and will procure that no subsidiary undertaking of the company shall, set aside any sum for the payment of these dividends or distributions; and

(ii) may not, and will procure that no subsidiary undertaking of the company will, redeem, purchase or otherwise acquire (whether on the same date as the relevant Dividend Access Share Dividend is payable or subsequently) for any consideration any of its Parity Securities or any depository or other receipts or certificates representing Parity Securities (other than any such purchases or acquisitions which are made in connection with any Employee Share Scheme (as defined in the terms of issue of the Series 1 Dividend Access Share)) and (save as aforesaid) the company may not, and will procure that no subsidiary undertaking of the company shall, set aside any sum or establish any sinking fund (whether on the same date as the relevant Dividend Access Share Dividend is payable or subsequently) for the redemption, purchase or other acquisition of Parity Securities or any depositary or other receipts or certificates representing Parity Securities, in each case until such time as Dividend Access Share Dividends are no longer payable or payment of Dividend Access Share Dividends in cash or otherwise has resumed in full, as the case may be.

Definitions in relation to this Dividend Access Share subsection
“Bonus Issue” means a bonus issue of Series 1 Class B Shares to the holder of the Series 1 Dividend Access Share.

“Independent Financial Adviser” means an independent financial institution appointed by the company and approved by HM Treasury.

“Ordinary Share Bonus Issue” means a bonus issue of fully paid ordinary shares to holders of ordinary shares in lieu of a dividend.

“Parity Securities” means ordinary shares, Series 1 Class B Shares and any other securities of the company or its subsidiary undertakings which rank pari passu with the ordinary shares, and/or Series 1 Class B Shares on a return of capital on a winding up, either issued by the company or issued by a subsidiary undertaking of the company with terms attached which benefit from a guarantee or support agreement entered into by the company which ranks pari passu with the ordinary shares, and/or Series 1 Class B Shares on a return of capital on a winding up.

‘‘Reference Amount’’ means £25,500,000,000 plus the aggregate Relevant Amount of any further Series 1 Class B Shares issued by the company to HM Treasury after 22 December 2009 and before the record date for the relevant Dividend Access Share Dividend, less the aggregate Relevant Amount of any Series 1 Class B Shares which were in issue during the 30 consecutive dealing days during which a Series 1 Class B
Dividend Trigger Event occurred. “Reference Series 1 Class B Shares Number” means the Reference Amount divided by the Relevant Amount.

 
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 “Relevant Amount” means £0.50 (subject to adjustment from time to time to reflect any consolidation, redesignation or subdivision in relation to the Series 1 Class B Shares) per Series 1 Class B Share.

“Relevant Date” means in respect of any semi-annual Dividend Access Share Dividend or Bonus Issue, the date on which the company pays or makes the same or (subject to adjustment for a change to the company’s accounting reference date), if the same is not paid or made, means 31 October of the relevant year in the case of a first semi-annual Dividend Access Share Dividend or Bonus Issue, and 31 May of the relevant year in the case of a second semi-annual Dividend Access Share Dividend or Bonus Issue.

“Series 1 Class B Dividend Stop Date” means the date falling 20 days after the Series 1 Class B Dividend Trigger Event.

“Series 1 Class B Dividend Trigger Event” means, in relation to the Series 1 Class B Shares in issue at the relevant time, the daily volume weighted average price of the company’s ordinary shares on the London Stock Exchange equals or exceeds £0.65 per ordinary share (subject to adjustment) for 20 or more complete dealing days in any period of 30 consecutive dealing days.

Distribution of assets on liquidation
Cumulative preference shares
In the event of a return of capital on a winding-up or otherwise, the holders of cumulative preference shares are entitled to receive out of t he surplus assets of the company available for distribution amongst the members (i) in priority to the holders of the non-cumulative preference shares and any other shares ranking pari passu therewith, the arrears of any fixed dividends including the amount of any dividend due for a payment after the date of commencement of any winding-up or liquidation but which is payable in respect of a half-year period ending on or before such date and (ii) pari passu with the holders of the non-cumulative preference shares and any other shares ranking pari passu therewith, the amount paid up or credited as paid up on such shares together with any premium.

Non-cumulative preference shares
Each non-cumulative preference share will confer on a winding up or liquidation (except (unless otherwise provided by the terms of issue) a redemption or purchase by the company of any shares in the capital of the company), the right to receive out of surplus assets of the company available for distribution amongst the members after payment of the arrears (if any) of the cumulative dividend on the cumulative preference shares and in priority to the holders of the ordinary shares, repayment of the amount paid up or credited as paid up on the non-cumulative preference shares together with any premium paid on issue pari passu with the holders of the cumulative preference shares and together with an amount equal to accrued and unpaid dividends.

Non-voting deferred shares
On a winding-up or other return of capital of the company, holders of non-voting deferred shares are entitled only to payment of the amounts paid up on the non-voting deferred shares, after repayment to the holders of ordinary shares of the nominal amount paid up on the ordinary shares held by them and payment of £ 100,000 on each ordinary share.

B Shares
On a winding-up, holders of the Series 1 Class B Shares will rank equally with the holders of the ordinary shares, the Series 1 Dividend Access Share and any other class of shares or securities of the company which rank equally with the Series 1 Class B Shares, the Series 1 Dividend Access Share or the ordinary shares on a winding-up or liquidation, and junior to all other shareholders and all creditors of the company. For these purposes, on a winding-up each holder of a Series 1 Class B Share will be deemed to hold one (as adjusted from time to time) ordinary share of the company for every Series 1 Class B Share held at the date of the commencement of such winding-up, and will be entitled to receive out of the surplus assets of the company remaining after payment of all prior-ranking claims, a sum equal to that payable to a holder of one (as adjusted) ordinary share in such event.

Dividend Access Share
On a winding-up, the holder of the Series 1 Dividend Access Share will ran k equally with the holders of the ordinary shares, the Series 1 Class B Shares and any other class of shares or securities of the company which rank equally with the Series 1 Dividend Access Share, the Series 1 Class B Shares or the ordinary shares on a winding-up or liquidation, and junior to all other shareholders and all creditors of the company. For these purposes, on a winding-up the holder of the Series 1 Dividend Access Share will be deemed to hold one (as adjusted from time to time) ordinary share of the company, and will be entitled to receive out of the surplus assets of the company remaining after payment of all prior-ranking claims, a sum equal to that payable to a holder of one (as adjusted) ordinary share in such event.

General
On a winding-up of the company, the liquidator may, with the authority of any extraordinary resolution and any other sanction required by the Insolvency Act 1986 and subject to the rights attaching to any class of shares after payment of all liabilities, including the payment to holders of preference shares, divide amongst the members in specie or kind the whole or any part of the assets of the company or vest the whole or any part of the assets in trustees upon such trusts for the benefit of the members and may determine the scope and terms of those trusts. No member shall be compelled to accept any assets on which there is a liability.

 
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Voting Rights
General
Subject to any rights or restrictions as to voting attaching to any shares or class of shares, on a show of hands every member who is present in person or by proxy at a general meeting shall have one vote (except that a proxy who is appointed by more than one member has one vote for and one vote against if the proxy has been instructed by one or more members to vote for the resolution and by one or more members to vote against the resolution) and on a poll every member present in person or by proxy shall have one vote for each 25 pence in nominal amount of shares held by him. No member shall, unless the directors otherwise determine, be entitled to vote at a general meeting or at a separate meeting of the holders of shares in the capital of the company, either in person or by proxy, in respect of any share held by him unless all monies presently payable by him in respect of that share have been paid. There is no obligation on the company to check and ensure that a proxy is voting at a general meeting in accordance with the voting directions provided by the appointing member.  The chairman of a general meeting does not have a casting vote in the event of an equality of votes, as this is not permitted under the 2006 Act. The quorum required for a meeting of members is not less than five members present in person and entitled to vote. If a meeting is adjourned because of the lack of a quorum, the members present in person or by proxy and entitled to vote will constitute a quorum at the adjourned meeting.

Meetings are convened upon written notice of not less than 21 days in respect of annual general meetings of members and not less than 14 days in respect of other meetings of members subject to certain conditions. An adjourned meeting may be called at shorter notice than applied to the original meeting, but where a meeting is adjourned for lack of quorum only if the adjourned meeting is held at least ten days after the original meeting and does not include any new business.

Cumulative preference shares
At a general meeting of the company, every holder of a cumulative preference share who is present in person or by proxy shall be entitled to one vote on a show of hands and, on a poll, every person who is present in person or by proxy shall have one vote for each 25 pence in nominal amount of shares held. No member shall be entitled to vote any share in person or by proxy unless all moneys owed in respect of that share have been paid.

Non-cumulative preference shares
Holders of non-cumulative preference shares are not entitled to attend or vote at any general meeting unless the business of the meeting includes the consideration of a resolution for the winding-up of the company or any resolution directly varying or abrogating the rights attached to any such shares and then in such case only to speak to and vote upon any such resolution. However, holders have the right to vote in respect of any matter when the dividend payable on their shares has not been declared in full for such number of dividend periods as the directors shall determine prior to the allotment thereof. Whenever a holder is entitled to vote at a general meeting, on a show of hands every shareholder who is present in person has one vote and, on a poll, every such holder who is present in person or by proxy shall have such number of votes as may be determined by the directors prior to allotment.

Non-voting deferred shares
The holders of non-voting deferred shares are not entitled to receive notice of or to attend or vote at any general meeting of the company or otherwise receive any shareholder communication.

B Shares
Holders of the Series 1 Class B Shares are not entitled to attend or vote at any general meeting unless the business of the meeting includes the consideration of a resolution for the winding-up of the company or any resolution varying or abrogating the rights attached to any such shares and then in such case only to speak to and vote upon any such resolution. If entitled to vote, each holder is entitled on a poll to two votes for each Series 1 Class B Share held.

Dividend Access Share
The holder of the Series 1 Dividend Access Share is not entitled to attend or vote at any general meeting unless the business of the meeting includes the consideration of a resolution for the winding-up of the company or any resolution varying or abrogating the rights attached to such share and then in such case only to speak to and vote upon any such resolution. If entitled to vote, the holder is entitled on a poll to one vote.

Redemption
Except as set forth in the following paragraph, unless the directors determine, prior to allotment of any particular series of non-cumulative preference shares, that such series shall be non-redeemable, the preference shares will be redeemable at the option of the company on any date which (subject to certain exceptions described in the terms of such shares) falls no earlier than such date (if any) as may be fixed by the directors, prior to allotment of such shares. On redemption, there shall be paid on each non-cumulative preference share the aggregate of its nominal amount together with any premium paid on issue, where applicable a redemption premium and accruals of dividend.

If the company wishes to issue redeemable shares, the Directors are authorised to determine the terms and manner of redemption.

Purchase
General
Under the 2006 Act a company requires shareholder authority to purchase its own shares, consolidate and sub-divide its shares and reduce its share capital. Whenever non-cumulative preference shares are issued in the future the Articles have no restriction on the maximum purchase price payable by the company unless such restriction is expressly applied by the directors in relation to an issuance of non-cumulative preference shares.


 
 
 
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Conversion rights
Convertible preference shares carry the right to convert into ordinary shares if they have not been the subject of a notice of redemption from the company, on or before a specified date determined by the directors. The right to convert will be exercisable by service of a conversion notice on the company within a specified period. The company will use reasonable endeavours to arrange the sale, on behalf of convertible preference  shareholders who have submitted a conversion notice, of the ordinary shares which result from such conversion and to pay to them the proceeds of such sale so that they receive net proceeds equal to the nominal value of the convertible preference shares which were the subject of the conversion notice and any premium at which such shares were issued, provided that ordinary shares will not be sold at below a benchmark price (as determined prior to the issue of the relevant convertible preference shares by the directors).

B Shares
The B Shares are convertible into Ordinary Shares at HM Treasury’s option at an initial conversion price of £0.50 per share, subject to adjustment. In December 2003, following the payment of aggregate dividends of £1 in respect of each AVS, all issued and outstanding AVSs were de-listed from the Official List and from trading on the London Stock Exchange’s market for listed securities and converted into non-voting deferred shares of £0.01 each.

Changes in share capital and variation of rights
Subject to the provisions of the 2006 Act and without prejudice to any rights attached to any existing shares or class of shares, any share may be issued with such rights or restrictions as the company may by ordinary resolution determine or, subject to and in default of such determination, as the Board shall determine. Subject to the provisions of the 2006 Act, the company may issue shares which are, or at the option of the company or the holder are liable, to be redeemed. Subject to the provisions of the 2006 Act and the Articles, unissued shares are at the disposal of the Board.

The company may by ordinary resolution: increase its share capital; consolidate and divide all or any of its share capital into shares of larger amount than its existing shares; subject to the provisions of the 2006 Act, subdivide its shares, or any of them, into shares of smaller amount than is fixed by the Memorandum; or cancel any shares which have not been taken or agreed to be taken by any person and diminish the amount of its share capital by the amount of the shares so cancelled.

Subject to the provisions of the 2006 Act, if at any time the capital of the company is divided into different classes of shares, the rights attached to any class of shares may (unless further conditions are provided by the terms of issue of the shares of that class) be varied or abrogated, whether or not the company is being wound up, either with the consent in writing of the holders of three-quarters in-nominal value of the issued shares of the class or with the sanction of an extraordinary resolution passed at a separate general meeting of holders of the shares of the class (but not otherwise). To any such separate general meeting the provision of the Articles relating to general meeting s will apply, save that:

(i) if at any adjourned meeting of such holders a quorum as defined above is not present, two people who hold shares of the class, or their proxies, are a quorum; and

(ii) any such holder present in person or by proxy may demand a poll

The rights attaching to any class of shares having preferential rights are not, unless otherwise expressly provided by the terms of issue thereof, deemed to be varied by the creation or issue of further shares ranking, as regards participation in t he profits or assets of the company, pari passu therewith, but in no respect in priority thereto.

Disclosure of interests in shares
The 2006 Act gives the company the power to require persons who it believes to be, or have been within the previous three years, interested in its shares, to disclose prescribed particulars of those interests. Failure to supply the information or supplying a statement which is materially false may lead to the Board imposing restrictions upon the relevant shares. The restrictions available are the suspension of voting or other rights conferred by membership in relation to meetings of the company in respect of the relevant shares and, additionally, in the case of a shareholding representing at least 0.25 per cent of the class of shares concerned, the withholding of payment of dividends on, and the restriction of transfers of, the relevant shares.

Limitations on rights to own share
There are no limitations imposed by UK law or the Memorandum and Articles on the right of non-residents or foreign persons to hold or vote the company's shares other than the limitations that would generally apply to all of the company's shareholders.

Members resident abroad
Members with registered addresses outside the United Kingdom are not entitled to receive notices from the company unless they have given the company an address within the United Kingdom at which such notices may be served.

Sending notices and other documents to shareholders
The company may communicate with members by electronic and/or website communications.  A member whose registered address is not within the United Kingdom shall not be entitled to receive any notice from the Company unless he gives the Company a postal address within the United Kingdom at which notices may be given to him.



 
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Documents on display
Documents concerning the company may be inspected at 36 St Andrew Square, Edinburgh, EH2 2YB.

Executive directors’ service contracts and copies of directors’ indemnities granted by the company in terms of section 236 of the Companies Act 2006 may be inspected at the company’s office at Gogarburn, Edinburgh, EH12 1HQ (telephone 0131 626 4114).

In addition, we file reports and other information with the SEC. You can read and copy these reports and other information at the SEC’s Public Reference Room at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. You can call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room or contact the offices of The New York Stock Exchange, on which certain of our securities are listed, at 20 Broad Street, New York, New York 10005. The SEC also maintains a website at www.sec.gov which contains in electronic form each of the reports and other information that we have filed electronically with the SEC.

Incorporation and registration
The company was incorporated and registered in Scotland under the Companies Act 1948 as a limited company on 25 March 1968 under the name National and Commercial Banking Group Limited, and changed its name to The Royal Bank of Scotland Group Limited on 3 September 1979. On 10 March 1982 it was re-registered under the Companies Acts 1948 to 1980 as a public company with limited liability. The company is registered under Company No. SC45551.


 
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Glossary of terms

Adjustable rate mortgage (ARM) - in the US, a variable-rate mortgage. ARMs include: hybrid ARMs which typically have a fixed-rate period followed by an adjustable-rate period; interest-only ARMs where interest only is payable for a specified number of years, typically for three to ten years; and payment-option ARMs that allow the borrower to choose periodically between various payment options.

Alt-A (Alternative A-paper) - a US description for mortgage loans with a higher credit quality than sub-prime loans but with features that disqualify the borrower from a traditional prime loan. Alt-A lending characteristics include limited documentation; high loan-to-value ratio; secured on non-owner occupied properties; and debt-to-income ratio above normal limits.

Arrears - the aggregate of contractual payments due on a debt that have not been met by the borrower. A loan or other financial asset is said to be 'in arrears' when payments have not been made.  When a customer is in arrears, the entire outstanding balance is said to be delinquent (see Delinquency).

Asset-backed commercial paper (ABCP) - a form of asset-backed security generally issued by a commercial paper conduit.

Asset-backed securities (ABS) - securities that represent interests in specific portfolios of assets. They are issued by a special purpose entity following a securitisation. The underlying portfolios commonly comprise residential or commercial mortgages but can include any class of asset that yields predictable cash flows. Payments on the securities depend primarily on the cash flows generated by the assets in the underlying pool and other rights designed to assure timely payment, such as guarantees or other credit enhancements. Collateralised bond obligations, collateralised debt obligations, collateralised loan obligations, commercial mortgage backed securities and residential mortgage backed securities are all types of ABS.

Asset protection scheme credit default swap - in 2009, the Group became party to the Asset Protection Scheme under which it purchased credit protection over a portfolio of specified assets and exposures (“covered assets”) from Her Majesty’s Treasury acting on behalf of the UK Government.  The contract is accounted for as a derivative financial instrument.  It is recognised at fair value and included in Derivatives on the balance sheet.  Changes in its fair value are recognised in profit or loss within Income from trading activities.

Assets under management - assets managed by the Group on behalf of clients.

Bank levy - a levy that applies to certain UK banks, building societies and the UK operations of foreign banks from 1 January 2011. The levy is payable based on a percentage of the chargeable equity and liabilities of the bank as at the balance sheet date.

Basel II - the capital adequacy framework issued by the Basel Committee on Banking Supervision in June 2006 in the form of the ‘International Convergence of Capital Measurement and Capital Standards’.

Basel III - in December 2010, the Basel Committee on Banking Supervision issued final rules: ‘Basel III: A global regulatory framework for more resilient banks and banking systems’ and ‘Basel III: International framework for liquidity risk measurement, standards and monitoring’. These strengthened global regulatory standards on bank capital adequacy and liquidity and will be phased in from 2013 with full implementation by 1 January 2019.

Basis point - one hundredth of a per cent i.e. 0.01 per cent. 100  basis points is 1 per cent. Used when quoting movements in interest rates or yields on securities.

Certificates of deposit (CDs) - bearer negotiable instruments acknowledging the receipt of a fixed term deposit at a specified interest rate.

Collateralised bond obligations (CBOs) - asset-backed securities for which the underlying asset portfolios are bonds, some of which may be sub-investment grade.

Collateralised debt obligations (CDOs) - asset-backed securities for which the underlying asset portfolios are debt obligations: either bonds (collateralised bond obligations) or loans (collateralised loan obligations) or both. The credit exposure underlying synthetic CDOs derives from credit default swaps. The CDOs issued by an individual vehicle are usually divided in different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are borne first by the equity securities, next by the junior securities, and finally by the senior securities; junior tranches offer higher coupons (interest payments) to compensate for their increased risk.

Collateralised debt obligation squared (CDO-squared) - a type of collateralised debt obligation where the underlying asset portfolio includes tranches of other CDOs.

Collateralised loan obligations (CLOs) - asset-backed securities for which the underlying asset portfolios are loans, often leveraged loans.

Collectively assessed loan impairment provisions - impairment loss provisions in respect of impaired loans, such as credit cards or personal loans, that are below individual assessment thresholds. Such provisions are established on a portfolio basis, taking account of the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends.

Commercial mortgage backed securities (CMBS) - asset-backed securities for which the underlying asset portfolios are loans secured on commercial real estate.

Commercial paper (CP) - unsecured obligations issued by a corporate or a bank directly or secured obligations (asset-backed CP), often issued through a commercial paper conduit, to fund working capital. Maturities typically range from two to 270 days. However, the depth and reliability of some CP markets means that issuers can repeatedly roll over CP issuance and effectively achieve longer term funding. CP is issued in a wide range of denominations and can be either discounted or interest-bearing.

 
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Commercial paper conduit - a special purpose entity that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed either by further commercial paper issuance, repayment of assets or liquidity drawings.

Commercial real estate - freehold and leasehold properties used for business activities. Commercial real estate includes office buildings, industrial property, medical centres, hotels, retail stores, shopping centres, agricultural land and buildings, warehouses, garages etc.

Constant proportion portfolio insurance notes (CPPI notes) - CPPI is the name given to a trading strategy that is designed to ensure that a fixed minimum return is achieved either at all times or more typically, at a set date in the future. Essentially the strategy involves continuously re- balancing the portfolio of investments during the term of the product between performance assets and safe assets using a pre-set formula. CPPI notes provide investors with a return linked to a CPPI portfolio.

Contractual maturity - the date in the terms of a financial instrument on which the last payment or receipt under the contract is due for settlement.

Core Tier 1 capital - called-up share capital and eligible reserves plus equity non-controlling interests, less intangible assets and other regulatory deductions.

Core Tier 1 capital ratio - core Tier 1 capital as a percentage of risk-weighted assets.

Cost:income ratio - operating expenses as a percentage of total income.

Coverage ratio - impairment provisions as a percentage of impaired loans.

Covered bonds - debt securities backed by a portfolio of mortgages that are segregated from the issuer's other assets solely for the benefit of the holders of the covered bonds.

CRD III - the CRD III package came into force on 1 January 2011.  It requires higher capital requirements for re-securitisations; upgrades disclosure standards for securitisation exposures; strengthens capital requirements for the trading book; and introduces new remuneration rules.

CRD IV - in July 2011, the European Commission published its proposed legislation for a Capital Requirements Directive and a Capital Requirements Regulation, which together form the CRD IV package. The package implements the Basel III capital proposals and also includes new proposals on sanctions for non-compliance with prudential rules, corporate governance and remuneration. It is due to be implemented from 1 January 2013 with transitional arrangements for some of its requirements.

Credit default swap (CDS) - a contract where the protection seller receives premium or interest-related payments in return for contracting to make payments to the protection buyer upon a defined credit event in relation to a reference financial asset or portfolio of financial assets. Credit events usually include bankruptcy, payment default and rating downgrades.

Credit derivative product company (CDPC) - a special purpose entity that sells credit protection under credit default swaps or certain approved forms of insurance policies. Sometimes they can also buy credit protection. CDPCs are similar to monoline insurers. However, unlike monoline insurers, they are not regulated as insurers.

Credit derivatives - contractual agreements that provide protection against a credit event on one or more reference entities or financial assets. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency or failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event. Credit derivatives include credit default swaps, total return swaps and credit swap options.

Credit enhancements - techniques that improve the credit standing of financial obligations; generally those issued by an SPE in a securitisation. External credit enhancements include financial guarantees and letters of credit from third-party providers. Internal enhancements include excess spread - the difference between the interest rate received on the underlying portfolio and the coupon on the issued securities; and over-collateralisation - on securitisation, the value of the underlying portfolio is greater than the securities issued.

Credit risk - the risk that the Group will incur losses owing to the failure of customers to meet their financial obligations to the Group.

Credit risk assets - loans and advances (including overdraft facilities), instalment credit, finance lease receivables and other traded instruments across all customer types.

Credit risk mitigation - techniques such as the taking of collateral or obtaining a guarantee or other form of credit protection from a related or third party that reduce the credit risk associated with an exposure.

Credit risk spread - the difference between the coupon on a debt instrument and the benchmark or the risk-free interest rate for the instrument's maturity structure. It is the premium over the risk-free rate required by the market for the credit quality of a particular debt instrument.

Credit valuation adjustments - adjustments to the fair values of derivative assets to reflect the creditworthiness of the counterparty.

 
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Glossary of terms continued
Currency swap - an arrangement in which two parties exchange specific principal amounts of different currencies at inception and subsequently interest payments on the principal amounts. Often, one party will pay a fixed rate of interest, while the other will pay a floating rate (though there are also fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are usually re-exchanged.

Customer accounts - money deposited with the Group by counterparties other than banks and classified as liabilities. They include demand, savings and time deposits; securities sold under repurchase agreements; and other short term deposits. Deposits received from banks are classified as deposits by banks.

Debt restructuring - see Renegotiated loans.

Debt securities - transferable instruments creating or acknowledging indebtedness. They include debentures, bonds, certificates of deposit, notes and commercial paper. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities can be secured or unsecured.

Debt securities in issue - unsubordinated debt securities issued by the Group. They include commercial paper, certificates of deposit, bonds and medium-term notes.

Deferred tax asset - income taxes recoverable in future periods as a result of deductible temporary differences (temporary differences between the accounting and tax base of an asset or liability that will result in tax deductible amounts in future periods) and the carry-forward of tax losses and unused tax credits.

Deferred tax liability - income taxes payable in future periods as a result of taxable temporary differences (temporary differences between the accounting and tax base of an asset or liability that will result in taxable amounts in future periods).

Defined benefit obligation - the present value of expected future payments required to settle the obligations of a defined benefit plan resulting from employee service.

Defined benefit plan - pension or other post-retirement benefit plan other than a defined contribution plan.

Defined contribution plan - pension or other post-retirement benefit plan where the employer's obligation is limited to its contributions to the fund.
 
Delinquency - a debt or other financial obligation is considered delinquent when one or more contractual payments are overdue. Delinquency is usually defined in terms of days past due. Delinquent and in arrears are synonymous.

Deposits by banks - money deposited with the Group by banks and recorded as liabilities. They include money-market deposits, securities sold under repurchase agreements, federal funds purchased and other short term deposits. Deposits received from customers are recorded as customer accounts.

Derivative - a contract or agreement whose value changes with changes in an underlying index such as interest rates, foreign exchange rates, share prices or indices and which requires no initial investment or an initial investment that is smaller than would be required for other types of contracts with a similar response to market factors. The principal types of derivatives are: swaps, forwards, futures and options.

Discontinued operation - a component of the Group that either has been disposed of or is classified as held for sale. A discontinued operation is either: a separate major line of business or geographical area of operations or part of a single co-ordinated plan to dispose of a separate major line of business or geographical area of operations; or a subsidiary acquired exclusively with a view to resale.

Effective interest rate method - the effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.

Equity risk - the risk of changes in the market price of the equities or equity instruments arising from positions, either long or short, in equities or equity-based financial instruments.

Exposure at default (EAD) - an estimate of the expected level of utilisation of a credit facility at the time of a borrower's default. The EAD may be higher than the current utilisation (e.g. in the case where further drawings may be made under a revolving credit facility prior to default) but will not typically exceed the total facility limit.

 
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Fannie Mae (Federal National Mortgage Association) - a US Government Sponsored Enterprise. It buys mortgages, principally issued by banks, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.

Federal Agencies - US federal agencies are independent bodies established by the US Government for specific purposes such as the management of natural resources, financial oversight or national security. A number of agencies, including Ginnie Mae, issue or guarantee publicly traded debt securities.

Federal Home Loan Mortgage Corporation - see Freddie Mac.

Federal National Mortgage Association - see Fannie Mae.

FICO score - a credit score calculated using proprietary software developed by the Fair Isaac Corporation in the US from a consumer's credit profile. The scores range between 300 and 850 and are used in credit decisions made by banks and other providers of credit.

Financial Services Compensation Scheme (FSCS) - the UK's statutory fund of last resort for customers of authorised financial services firms.  It pays compensation if a firm is unable to meet its obligations. The FSCS funds compensation for customers by raising management expenses levies and compensation levies on the financial services industry.

First/second lien - a lien is a charge such as a mortgage held by one party, over property owned by a second party, as security for payment of some debt, obligation, or duty owed by that second party. The holder of a first lien takes precedence over all other encumbrances on that property i.e. second and subsequent liens.

Forbearance - the term generally applied to an agreement, principally in relation to secured loans with retail customers experiencing temporary financial difficulty, to a payment moratorium, to reduced repayments or to roll up arrears. Forbearance loans are a subset of Renegotiated loans.

Forward contract - a contract to buy (or sell) a specified amount of a physical or financial commodity, at an agreed price, at an agreed future date.

Freddie Mac (Federal Home Loan Mortgage Corporation) - a US Government Sponsored Enterprise. It buys mortgages, principally issued by thrifts, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.

Funding and liquidity risk - the risk that the Group does not have sufficient financial resources to meet its commitments when they fall due, or can secure them only at excessive cost.
 
Futures contract - a contract which provides for the future delivery (or acceptance of delivery) of some type of financial instrument or commodity under terms established at the outset. Futures differ from forward contracts in that they are traded on recognised exchanges and rarely result in actual delivery; most contracts are closed out prior to maturity by acquisition of an offsetting position.

G10 - the Group of Ten comprises the eleven industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) that have agreed to participate in the International Monetary Fund’s (IMF’s) General Arrangements to Borrow.

Ginnie Mae (Government National Mortgage Association) - a US Government Agency that guarantees investors the timely payment of principal and interest on mortgage-backed securities for which the underlying asset portfolios comprise federally insured or guaranteed loans - mainly loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Ginnie Mae obligations are fully and explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the US Government.

Government Sponsored Enterprises (GSEs) - a group of financial services corporations created by the US Congress. Their function is to improve the efficiency of capital markets and to overcome statutory and other market imperfections which otherwise prevent funds from moving easily from suppliers of funds to areas of high loan demand. They include Fannie Mae and Freddie Mac.

Gross yield - the interest rate earned on average interest-earning assets i.e. interest income divided by average interest-earning assets.

Guaranteed mortgages - mortgages guaranteed by a government or government agency. In the US, government loan guarantee programmes are offered by the Federal Housing Administration, the Department of Veterans Affairs and the Department of Agriculture's Rural Housing Service. In the Netherlands, the Gemeentegarantie programme is run partly by the central government and partly by the municipalities.

Hedge funds - pooled investment vehicles that are not widely available to the public; their assets are managed by professional asset managers who participate in the performance of the fund.

Home equity loan - a type of loan in which the borrower uses the equity in their home as collateral. A home equity loan creates a charge against the borrower's house.

Impaired loans - all loans for which an impairment provision has been established; for collectively assessed loans, impairment loss provisions are not allocated to individual loans and the entire portfolio is included in impaired loans.

 
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Glossary of terms continued
Impairment allowance - see Loan impairment provisions.

Impairment losses - (a) for impaired financial assets measured at amortised cost, impairment losses - the difference between carrying value and the present value of estimated future cash flows discounted at the asset's original effective interest rate - are recognised in profit or loss and the carrying amount of the financial asset reduced by establishing a provision (allowance) (b) for impaired available-for-sale financial assets, the cumulative loss that had been recognised directly in equity is removed from equity and recognised in profit or loss as an impairment loss.

Individually assessed loan impairment provisions - impairment loss provisions for individually significant impaired loans assessed on a case-by-case basis, taking into account the financial condition of the counterparty and any guarantor and the realisable value of any collateral held.

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.

Internal Capital Adequacy Assessment Process (ICAAP) - the Group’s own assessment, as part of Basel II requirements, of its risks,  how it intends to mitigate those risks and how much current and future capital is necessary having considered other mitigating factors.

International Accounting Standards Board (IASB) - the independent standard-setting body of the IFRS Foundation. Its members are responsible for the development and publication of International Financial Reporting Standards (IFRSs) and for approving Interpretations of IFRS as developed by the IFRS Interpretations Committee.

Interest rate swap - a contract under which two counterparties agree to exchange periodic interest payments on a predetermined monetary principal, the notional amount.

Interest spread - the difference between the gross yield and the interest rate paid on average interest-bearing liabilities.

Internal funding of trading business - the internal funding of the trading book comprises net banking book financial liabilities that fund financial assets in the Group’s trading portfolios.  Interest payable on these financial liabilities is charged to the trading book.

Investment grade - generally represents a risk profile similar to a rating of BBB-/Baa3 or better, as defined by independent rating agencies.

Key management - directors of RBSG and members of the Group Management Committee.

Latent loss provisions - loan impairment provisions held against impairments in the performing loan portfolio that have been incurred as a result of events occurring before the balance sheet date but which have not been identified as impaired at the balance sheet date. The Group has developed methodologies to estimate latent loss provisions that reflect historical loss experience (adjusted for current economic and credit conditions) and the period between an impairment occurring and a loan being identified and reported as impaired.

Level 1: quoted price - level 1 financial instruments are valued using unadjusted quoted prices in active markets, for identical financial instruments. Examples include G10 government securities, listed equity shares, certain exchange-traded derivatives and certain US agency securities.

Level 2: valuation technique using observable inputs - level 2 financial instruments are valued using techniques based significantly on observable market data. Instruments in this category are valued using: (a) quoted prices for similar instruments or identical instruments in markets which are not considered to be active; or (b) valuation techniques where all the inputs that have a significant effect on the valuations are directly or indirectly based on observable market data.

Level 3: valuation technique with significant unobservable inputs - level 3 financial instruments are valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation, is not based on observable market data. Where inputs can be observed from market data without undue cost and effort, the observed input is used. Otherwise, the Group determines a reasonable level for the input. Level 3 financial instruments include cash instruments which trade infrequently, certain syndicated and commercial mortgage loans, unlisted equity shares, certain residual interests in securitisations, super senior tranches of high grade and mezzanine CDOs, other mortgage-based products and less liquid debt securities, certain structured debt securities in issue, and OTC derivatives where valuation depends upon unobservable inputs such as certain credit and exotic derivatives.

Leveraged finance - funding (leveraged finance) provided to a business resulting in an overall level of debt in relation to cash flow that exceeds that which would be considered usual for the business or for the industry in which it operates. Leveraged finance is commonly employed to achieve a specific, often temporary, objective: to make an acquisition, to effect a buy-out or to repurchase shares.

 
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Liquidity coverage ratio (LCR) - the ratio of the stock of high quality liquid assets to expected net cash outflows over the following 30 days. High-quality liquid assets should be unencumbered, liquid in markets during a time of stress and, ideally, be central bank eligible. These include, for example, cash and claims on central governments and central banks. The Basel III rules require this ratio to be at least 100% and it is expected to apply from 2015.

Liquidity enhancements - make funds available to ensure that the issuer of securities, usually a commercial paper conduit, can redeem the securities at maturity. They typically take the form of a committed facility from a third-party bank.

Loan impairment provisions - loan impairment provisions are established to recognise incurred impairment losses on a portfolio of loans classified as loans and receivables and carried at amortised cost. It has three components: individually assessed loan impairment provisions, collectively assessed loan impairment provisions and latent loss provisions.

Loan-to-deposit ratio - the ratio of loans and advances to customers net of provision for impairment losses and excluding reverse repurchase agreements to customer deposits excluding repurchase agreements.

Loan-to-value ratio - the amount of a secured loan as a percentage of the appraised value of the security e.g. the outstanding amount of a mortgage loan as a percentage of the property's value.

Loss given default (LGD) - the economic loss that may occur in the event of default i.e. the actual loss - that part of the exposure that is not expected to be recovered - plus any costs of recovery.

Market risk - the risk that the value of an asset or liability may change as a result of a change in market factors such as foreign exchange rates and commodity prices, interest rates, credit spreads and equity prices.

Master netting agreement - an agreement between two counterparties that have multiple derivative contracts with each other that provides for the net settlement of all contracts through a single payment, in a single currency, in the event of default on, or termination of, any one contract.

Medium term notes (MTNs) - debt securities usually with a maturity of five to ten years, but the term may be less than one year or as long as 50 years. They can be issued on a fixed or floating coupon basis or with an exotic coupon; with a fixed maturity date (non-callable) or with embedded call or put options or early repayment triggers. MTNs are generally issued as senior unsecured debt.

Monoline insurers - entities that specialise in providing credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default. This protection is typically in the form of derivatives such as credit default swaps.

Mortgage-backed securities - asset-backed securities for which the underlying asset portfolios are loans secured on property. See Residential mortgage backed securities and Commercial mortgage backed securities.

Mortgage servicing rights - the rights of a mortgage servicer to collect mortgage payments and forward them, after deducting a fee, to the mortgage lender.

Mortgage vintage - the year in which a mortgage loan was made to the customer.

Negative equity mortgages - mortgages where the value of the property mortgaged is less than the outstanding balance on the loan.

Net interest income - the difference between interest receivable on financial assets classified as loans and receivables or available-for-sale and interest payable on financial liabilities carried at amortised cost.

Net interest margin - net interest income as a percentage of average interest-earning assets.

Net stable funding ratio (NSFR) - introduced by Basel III, the NSFR is the ratio of available stable funding to required stable funding over a one year time horizon, assuming a stressed scenario. The ratio is required to be over 100% with effect from 2015. Available stable funding would include such items as equity capital, preferred stock with a maturity of over one year and liabilities with a maturity of over one year.  The required amount of stable funding is calculated as the sum of the value of the assets held and funded by the institution, multiplied by a specific required stable funding factor assigned to each particular asset type, added to the amount of potential liquidity exposure multiplied by the associated required stable funding factor.  The NSFR is subject to an observation period and to review to address any unintended consequences.

Non-conforming mortgages - mortgage loans that do not meet the requirements for sale to US Government agencies or US Government sponsored enterprises. These requirements include limits on loan-to-value ratios, loan terms, loan amounts, borrower creditworthiness and other requirements.

Operational risk - the risk of loss resulting from inadequate or failed processes, people, systems or from external events.

Option - an option is a contract that gives the holder the right but not the obligation to buy (or sell) a specified amount of the underlying physical or financial commodity, at a specific price, at an agreed date or over an agreed period. Options can be exchange-traded or traded over-the-counter.

 
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Glossary of terms continued
Over-the-counter (OTC) derivatives - are derivatives with tailored terms and conditions negotiated bilaterally, in contrast to exchange traded derivatives that have standardised terms and conditions.

Own credit adjustment - the effect of the Group’s own credit standing on the fair value of financial liabilities.

Past due - a financial asset such as a loan is past due when the counterparty has failed to make a payment when contractually due.

Potential problem loans (PPL) - loans for which an impairment event has taken place but no impairment provision is required. This category is used for fully collateralised advances which are not past due 90 days or revolving credit facilities where identification as 90 days overdue is not feasible.

Prime - prime mortgage loans generally have low default risk and are made to borrowers with good credit records and a monthly income that is at least three to four times greater than their monthly housing expense (mortgage payments plus taxes and other debt payments). These borrowers provide full documentation and generally have reliable payment histories.

Private equity investments - equity investments in operating companies not quoted on a public exchange. Capital for private equity investment is raised from retail or institutional investors and used to fund investment strategies such as leveraged buyouts, venture capital, growth capital, distressed investments and mezzanine capital.

Probability of default (PD) - the likelihood that a customer will fail to make full and timely repayment of credit obligations over a one year time horizon.

Regular way purchase or sale - a purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the marketplace concerned.

Regulatory capital - the amount of capital that the Group holds, determined in accordance with rules established by the FSA for the consolidated Group and by local regulators for individual Group companies.

Renegotiated loans - loans are generally renegotiated either as part of the ongoing banking relationship with a creditworthy customer or in response to a borrower's financial difficulties. In the latter case, renegotiation encompasses not only revisions to the terms of a loan such as a maturity extension, a payment moratorium, a concessionary rate of interest but also the restructuring of all or part of the exposure including debt forgiveness or a debt for equity swap. Loans renegotiated as part of the ongoing banking relationship with a creditworthy customer are treated as new loans.
Repurchase agreement (Repo) - see Sale and repurchase agreements.

Residential mortgage backed securities (RMBS) - asset-backed securities for which the underlying asset portfolios are residential mortgages.

Restructured loans - see Renegotiated loans.

Retail loans - loans made to individuals rather than institutions. The loans may be for car purchases, home purchases, medical care, home repair, holidays and other consumer uses.

Return on equity - profit attributable to ordinary and B shareholders divided by average shareholders’ equity as a percentage.

Reverse repurchase agreement (Reverse repo) - see Sale and repurchase agreements.

Risk appetite - an expression of the maximum level of risk that the Group is prepared to accept to deliver its business objectives.

Risk asset ratio (RAR) - total regulatory capital as a percentage of risk-weighted assets.

Risk elements in lending (REIL) - impaired loans and accruing loans which are contractually overdue 90 days or more as to principal or interest.

Risk-weighted assets  (RWAs) - assets adjusted for their associated risks using weightings established in accordance with the Basel Capital Accord as implemented by the FSA. Certain assets are not weighted but deducted from capital.

Sale and repurchase agreements - in a sale and repurchase agreement one party, the seller, sells a financial asset to another party, the buyer, at the same time the seller agrees to reacquire and the buyer to resell the asset at a later date. From the seller's perspective such agreements are repurchase agreements (repos) and from the buyer's reverse repurchase agreements (reverse repos).

Securitisation - a process by which assets or cash flows are transformed into transferable securities. The underlying assets or cash flows are transferred by the originator or an intermediary, typically an investment bank, to a special purpose entity which issues securities to investors. Asset securitisations involve issuing debt securities (asset-backed securities) that are backed by the cash flows of income-generating assets (ranging from credit card receivables to residential mortgage loans). Liability securitisations typically involve issuing bonds that assume the risk of a potential insurance liability (ranging from a catastrophic natural event to an unexpected claims level on a certain product type).

 
446

 
Shareholder information continued

Settlement balances - payables and receivables that result from purchases and sales of financial instruments recognised on trade date.  Asset settlement balances are amounts owed to the Group in respect of sales and liability settlement balances are amounts owed by the Group in respect of purchases.

Sovereign exposures - exposures to governments, ministries, departments of governments and central banks.

Special purpose entity (SPE) - an entity created by a sponsor, typically a major bank, finance company, investment bank or insurance company. An SPE can take the form of a corporation, trust, partnership, or a limited liability company. Its operations are typically limited for example in a securitisation to the acquisition and financing of specific assets or liabilities.

Structured credit portfolio (SCP) - a portfolio of certain of the Group’s illiquid assets - principally CDO super senior positions, negative basis trades and monoline exposures - held within Non-Core division.

Structured Investment Vehicle (SIV) - a limited-purpose operating company that undertakes arbitrage activities by purchasing highly rated medium and long-term, fixed-income assets and funding itself with short-term, highly rated commercial paper and medium-term notes.

Structured notes - securities that pay a return linked to the value or level of a specified asset or index. Structured notes can be linked to equities, interest rates, funds, commodities and foreign currency.

Student loan related assets - assets that are referenced to underlying student loans.

Subordinated liabilities - liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer.

Sub-prime - mortgage loans to customers with one or more high risk characteristics, such as: unreliable or poor payment histories; loan-to-value ratio of greater than 80%; high debt-to-income ratio; the loan is not secured on the borrower's primary residence; or a history of delinquencies or late payments on the loan.

Super senior CDO - the most senior class of instrument issued by a CDO vehicle. They benefit from the subordination of all other instruments, including AAA rated securities, issued by the CDO vehicle.

Tangible net asset value (TNAV) - owners’ equity attributable to ordinary and B shareholders less intangible assets divided by the number of ordinary and B shares in issue.

Tier 1 capital - core Tier 1 capital plus other Tier 1 securities in issue, less material holdings in financial companies.

Tier 1 capital ratio - Tier 1 capital as a percentage of risk-weighted assets.

Tier 2 capital - qualifying subordinated debt and other Tier 2 securities in issue, eligible collective impairment allowances, unrealised available-for-sale equity gains and revaluation reserves less certain regulatory deductions.

US Government National Mortgage Association - see Ginnie Mae.

Unaudited - financial information that has not been subjected to the audit procedures undertaken by the Group's auditor to enable them to express an opinion on the Group's financial statements.

US Federal Agencies - see Federal Agencies.

Value-at-risk (VaR) - a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels.

Wholesale funding - wholesale funding comprises Deposits by banks, Debt securities in issue and Subordinated liabilities.

Wrapped security - a debt security where the holder benefits from credit protection provided by a third party, typically a financial guarantor or monoline insurer.

Write-down - a reduction in the carrying value of an asset to record a decline in its fair value or value in use.

Wrong-way risk - the risk of loss when the risk factors driving the exposure to a counterparty or customer are positively correlated with the creditworthiness of that counterparty i.e. the size of the exposure increases at the same time as the risk of the counterparty or customer being unable to meet that obligation, increases.
 


 
 
447

 
Shareholder information continued
 
 
Index
 
Accounting
    Consolidated financial statements  
Accounting developments
284
 
Consolidated balance sheet
268
Accounting policies
273
 
Consolidated cash flow statement
272
Critical accounting policies
282
 
Consolidated income statement
266
     
Consolidated statement of changes in equity
269
Approval of accounts
268  
Consolidated statement of comprehensive income
267
     
Notes on the consolidated accounts
286
Asset-backed securities
136      
     
Contingent liabilities and commitments
359
Asset Protection Scheme
205      
     
Corporate governance
 
Audit Committee
   
Compliance with the UK Corporate Governance Code
254
Letter from the Chairman of the Group Audit Committee
221  
The Board and its committees
210
Report of the Group Audit Committee
222      
     
Debt securities in issue
 
Auditors
   
Risk and balance sheet management
133
Auditor’s remuneration
296  
Notes on the consolidated accounts
327
Independent auditor’s report
265      
     
Deposits
 
Available-for-sale financial assets
   
Customer accounts
299
Accounting policies
278  
Deposits by banks
299
Notes on the consolidated accounts
299      
     
Derivatives
 
Average balance sheet
13  
Risk and balance sheet management
143
     
Notes on the consolidated accounts
325
Balance sheet
       
Business review
53  
Description of business
4
Consolidated
268      
     
Directors
 
Bank levy
288  
Biographies
211
     
Interests in shares
262
Board Risk Committee report
   
Remuneration
249
Letter from the Chairman of the Board Risk Committee
   
Remuneration policy
237
Report of the Board Risk Committee
226  
Report of the directors
257
  227  
Service contracts
247
Business divestments
       
Business review
5  
Dividends
 
Notes on the consolidated accounts
335  
History
425
     
Notes on the consolidated accounts
298
Capital adequacy
       
Capital ratios
57, 69  
Earnings per share
 
Capital resources
57, 70  
Business review
9
Notes on the consolidated accounts
357  
Notes on the consolidated accounts
298
         
Cash flow statement
   
Employees
 
Business review
56  
Business review
25
Consolidated
272  
Costs
288
Notes on the consolidated accounts
368, 369  
Headcount
289
     
Report of the directors
257
Central functions/items
4, 47, 370  
Variable compensation
291
         
Charitable contributions
261  
Financial instruments
 
     
Accounting policies
277
     
Critical accounting policies
283
     
Notes on the consolidated accounts
299
         
     
Financial Services Compensation Scheme
360
 

 
 
448

 
Shareholder information continued

 
Financial summary
   
Material contracts
398
Five year financial summary
386
     
     
Net interest income
 
Forward-looking statements
3  
Business review
12
     
Notes on the consolidated accounts
286
Global Banking & Markets
4, 41, 370      
     
Non-Core
4, 48, 370
Global Transaction Services
4, 33, 370      
     
Non-interest income
 
Glossary of terms
440  
Business review
17
     
Notes on the consolidated accounts
287
Going concern
       
Report of the directors
259  
Operating expenses
 
     
Business review
18
Goodwill
   
Notes on the consolidated accounts
288
Accounting policies
275      
Notes on the consolidated accounts
329, 374  
Pensions
 
     
Accounting policies
274
Impairment
   
Critical accounting policies
283
Accounting policies
278  
Directors’ pension arrangements
251
Business review
21  
Notes on the consolidated accounts
292
Critical accounting policies
282  
Pension risk
203
Notes on the consolidated accounts
323      
     
Post balance sheet events
 
Income statement
      261, 378
Business review
9  
Presentation of information
 
Consolidated
256      
     
Property, plant and equipment
 
Insurance claims
   
Accounting policies
275
Accounting policy
276  
Notes on the consolidated accounts
332
Business review
18      
Critical accounting policies
284  
Provisions
 
Notes on the consolidated accounts
338  
Accounting policies
277
     
Notes on the consolidated accounts
323
Insurance premium income
       
Accounting policies
276  
Regulatory developments and reviews
397
Business review
17      
Notes on the consolidated accounts
338  
Related parties
377
         
Intangible assets
   
Remuneration Committee
 
Accounting policies
275  
Directors’ remuneration report
232
Segmental analysis of goodwill
374  
Letter from the Chair of the Remuneration Committee
230
Notes on the consolidated accounts
329      
         
Internal control
254      
         
Investigations
363      
         
Litigation
361      
         
Loans and advances
       
Loans and advances to banks
299      
Loans and advances to customers
299      
 

 
449

 
Shareholder information continued
 
 
Index continued

 
Risk and balance sheet management
   
Short-term borrowings
77
Business risk
202
     
Capital management
68
 
Statement of changes in equity
 
Compliance risk
197
 
Consolidated
269
Country risk
166
     
Credit risk
92
 
Statement of comprehensive income
 
Equity risk
91
 
Consolidated
267
Insurance risk
194
     
Interest rate risk
89
 
Statement of directors’ responsibilities
263
Liquidity and funding risk
74
     
Market risk
187
 
Subordinated liabilities
 
Operational risk
194
 
Consolidated
342
Pension risk
203
 
Parent company
398
Reputational risk
202
     
Structural foreign currency exposures
91
 
Summary of Group results
386
         
Risk-weighted assets
24, 57, 69  
Supervision
396
         
Securitisations and asset transfers
   
Tax
 
Notes on the consolidated accounts
355  
Accounting policies
277
Special purpose entities
82  
Business review
22
     
Critical accounting policies
284
Segmental reporting
   
Notes on the consolidated accounts
297
Business review
23  
Notes on the consolidated accounts - deferred tax
337
Description of business
4      
Notes on the consolidated accounts
370  
UK Corporate
4, 29, 370
         
Share-based payments
   
UK Retail
4, 26, 370
Accounting policies
281      
Notes on the consolidated accounts
290  
Ulster Bank
4, 35, 370
         
Share capital
   
US Retail & Commercial
4, 38, 370
Shareholder information
422      
Notes on the consolidated accounts
350  
Wealth
4, 31, 370
         
Shareholder information
   
Value-at-risk (VaR)
188
Analysis of ordinary shareholders
421      
Annual General Meeting
420      
Shareholder enquiries
420      
 


 
450

 
Shareholder information continued

Important addresses

Shareholder enquiries
Registrar
Computershare Investor Services PLC
The Pavilions
Bridgwater Road
Bristol BS99 6ZZ
Telephone: +44 (0)870 702 0135
Facsimile: +44 (0)870 703 6009
Website: www.investorcentre.co.uk/contactus

ADR Depositary Bank
BNY Mellon Shareowner Services
PO Box 358516
Pittsburgh, PA 15252-8516
Telephone: +1 888 269 2377 (US callers)
Telephone: +1 201 680 6825 (International)
Email: shrrelations@bnymellon.com
Website: www.bnymellon.com/shareowner

RBS Secretariat
The Royal Bank of Scotland Group plc
PO Box 1000
Gogarburn Edinburgh EH12 1HQ
Telephone: +44 (0)131 556 8555
Facsimile: +44 (0)131 626 3081

Investor Relations
280 Bishopsgate
London EC2M 4RB
Telephone: +44 (0)207 672 1758
Facsimile: +44 (0)207 672 1801
Email: investor.relations@rbs.com

Registered office
36 St Andrew Square
Edinburgh EH2 2YB
Telephone: +44 (0)131 556 8555
Registered in Scotland No. SC45551

Website
www.rbs.com



Principal offices

The Royal Bank of Scotland Group plc
PO Box 1000 Gogarburn Edinburgh EH12 1HQ
Telephone: +44 (0)131 626 0000

The Royal Bank of Scotland plc
PO Box 1000 Gogarburn Edinburgh EH12 1HQ
280 Bishopsgate London EC2M 4RB

National Westminster Bank Plc
135 Bishopsgate London EC2M 3UR

Citizens
Citizens Financial Group, Inc.
One Citizens Plaza Providence RI 02903 USA

Ulster Bank
11-16 Donegall Square East Belfast BT1 5UB
George's Quay Dublin 2

Direct Line Insurance (formerly RBS Insurance)
Churchill Court Westmoreland Road Bromley Kent BR1 1DP

RBS Holdings USA Inc.
600 Washington Blvd
Stamford CT
06901 USA

Coutts Group
440 Strand London WC2R 0QS

The Royal Bank of Scotland International Limited
Royal Bank House 71 Bath Street
St Helier Jersey Channel Islands JE4 8PJ

NatWest Offshore
23/25 Broad Street
St Helier Jersey Channel Islands JE4 OYX

RBS Holdings N.V.
Gustav Mahlerlaan 350
1082 ME Amsterdam
PO Box 12925
The Netherlands
 

 
451

 

Exhibit Index
 
Exhibit
Number
Description
 
1.1
Memorandum and Articles of Association of The Royal Bank of Scotland Group plc
2.1(1)
Form of Deposit agreement among The Royal Bank of Scotland Group plc, The Bank of New York as Depositary, and all Owners and Holders from time to time of American Depositary Receipts issued thereunder
2.2(2)
Form of American Depositary Receipt for ordinary shares of the par value of £0.25 each
2.3(3)
Letter dated May 12, 2008 from The Bank of New York Mellon as Depository to The Royal Bank of Scotland Group plc relating to the Prerelease of American Depository Receipts
2.4
Neither The Royal Bank of Scotland Group plc nor The Royal Bank of Scotland plc is party to any single instrument relating to long-term debt pursuant to which a total amount of securities exceeding 10% of the Group’s total assets (on a consolidated basis) is authorized to be issued. Each of The Royal Bank of Scotland Group plc and The Royal Bank of Scotland plc hereby agrees to furnish to the Securities and Exchange Commission (the “Commission”), upon its request, a copy of any instrument defining the rights of holders of its long-term debt or the rights of holders of the long-term debt of any of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed with the Commission.
4.1(4)
Service agreement for Stephen Hester
4.2(4)
Service agreement amendment for Stephen Hester
4.3(5)
Service agreement for Bruce Van Saun
4.4(6)
Form of Deed of Indemnity for Directors
4.5(4)
Amendment Agreement dated August 2008, relating to the Consortium and Shareholders’ Agreement dated 28 May 2007, among The Royal Bank of Scotland Group plc, Banco Santander, S.A., Fortis N.V., Fortis SA/NV and, by accession, Fortis Nederland (Holding) N.V., and RFS Holdings B.V. (as supplemented and amended by a Supplemental Consortium and Shareholders’ Agreement dated 17 September 2007)
4.6(4)
Deed of Accession dated December 2008 among The Royal Bank of Scotland Group plc, Banco Santander, S.A., Fortis Bank Nederland (Holding) N.V., The State of the Netherlands and RFS Holdings B.V.
4.7(4)
Second Placing and Open Offer Agreement dated 19 January 2009 among The Royal Bank of Scotland Group plc, UBS Limited, Merrill Lynch International and The Commissioners of Her Majesty’s Treasury
4.8(4)
Pre-accession Commitments Deed poll dated 26 February 2009 by The Royal Bank of Scotland plc
4.9(7),(8)
Lending Commitments Deed poll dated 26 February 2009 by The Royal Bank of Scotland plc
4.10(5)
Acquisition and contingent capital agreement dated 26 November 2009 among The Royal Bank of Scotland Group plc and The Commissioners of Her Majesty’s Treasury
 
 
 
452

 
 
   
4.11(5),(8)
Accession Agreement dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury, The Royal Bank of Scotland plc and The Royal Bank of Scotland Group plc relating to the UK Asset Protection Scheme
4.12(5)
Agreements to forego Tax reliefs dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury, The Commissioners for Her Majesty’s Revenue and Customs, The Royal Bank of Scotland plc, The Royal Bank of Scotland Group plc and ABN AMRO Bank N.V. in connection with an Exit Fee payable under an Accession Agreement relating to the UK Asset Protection Scheme
4.13(5)
Agreements to forego Tax reliefs dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury, The Commissioners for Her Majesty’s Revenue and Customs, The Royal Bank of Scotland plc, The Royal Bank of Scotland Group plc and ABN AMRO Bank N.V. in connection with an Acquisition and Contingent Capital Agreement
4.14(5)
Agreements to forego Tax reliefs dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury, The Commissioners for Her Majesty’s Revenue and Customs, The Royal Bank of Scotland plc, The Royal Bank of Scotland Group plc and ABN AMRO Bank N.V. in connection with an Accession Agreement relating to the UK Asset Protection Scheme
4.15(5),(8)
State Aid Commitment Deed dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury and The Royal Bank of Scotland Group plc
4.16(5),(8)
State Aid Cost Reimbursement Deed dated 26 November 2009 among The Commissioners of Her Majesty’s Treasury and The Royal Bank of Scotland Group plc
4.17(5)
Amendment to the Lending Commitments Deed poll dated 23 March 2010 by The Royal Bank of Scotland plc
4.18(8),(5)
Restated Consortium and Shareholders’ Agreement dated 1 April 2010, among The Royal Bank of Scotland Group plc, Banco Santander, S.A., The State of the Netherlands and RFS Holdings B.V.
4.19(5)
UK Asset Protection Scheme Terms and Conditions
4.20(9),(10)
Purchase and Sale Agreement dated 16 February 2010 in connection with the sale by RBS Sempra Commodities JV, a joint venture owned by the Royal Bank and Sempra Energy, of its metals, oils and European energy business lines
4.21(11)
Amendment to the Purchase and Sale Agreement dated 30 June 2010 in connection with the sale by RBS Sempra Commodities JV, a joint venture owned by the Royal Bank and Sempra Energy, of its metals, oils and European energy business lines
4.22(8),(11)
Sale and Purchase Agreement dated 4 August 2010 among The Royal Bank of Scotland plc, National Westminster Bank plc, National Westminster Home Loans Limited and Santander UK plc
4.23(8),(10)
Transfer Agreement dated 6 August 2010 among the Bank and Ship Bidco Limited.
4.24(10)
First Supplement to UK Asset Protection Scheme dated 27 August 2010
 
 
 
453

 
 
4.25(8),(10)
Second Supplement to UK Asset Protection Scheme dated 20 December 2010
4.26(10)
Third Supplement to UK Asset Protection Scheme dated 10 February 2011
4.27(8),(9),(10)
Purchase and Sale Agreement dated 20 September 2010 in connection with the sale by RBS Sempra Commodities JV of its Sempra Energy Solutions business line by and among Noble Americas Gas & Power Corp., RBS Sempra Commodities LLP, Sempra Energy and The Royal Bank of Scotland plc
4.28(8),(9),(10)
Transfer Agreement dated 7 October 2010 in connection with the sale by RBS Sempra  Commodities JV of its commodities trading North American Power and Gas business by and among J.P. Morgan Ventures Energy Corporation, RBS Sempra Commodities LLP, Sempra Energy Trading LLC, Sempra Energy and The Royal Bank of Scotland plc
4.29(8),(10)
Amendment Agreement dated 29 November 2010 among The Royal Bank of Scotland plc, Worldpay (UK) Limited, Worldpay Ecommerce Limited and Ship US Bidco, Inc.
4.30(8),(10)
Amended and Restated Investment Agreement relating to Ship Luxco Holding & Cy. S.C.A. dated 29 November 2010
4.31(8)
Amended Sale and Purchase Agreement dated 30 August 2011 among The Royal Bank of Scotland Group plc, National Westminster Bank plc, National Westminster Home Loans Limited and Santander UK plc.
4.32(8)
Agreement for the Sale and Purchase of RBS Aerospace Limited, RBS Aerospace (UK) Limited and RBS Australia Leasing Pty Limited dated January 16, 2012 among The Royal Bank of Scotland plc and Sumitomo Mitsui Banking Corporation
4.33(8)
Fourth Supplement to UK Asset Protection Scheme dated 30 June 2011
4.34(8)
Fifth Supplement to UK Asset Protection Scheme dated 22 July 2011
4.35
Sixth Supplement to UK Asset Protection Scheme dated 18 August 2011
4.36
Reporting issues document dated 31 January 2011 relating to the UK Asset Protection Scheme
4.37
Post Trigger Refinancing and Debt Restructurings document dated 15 February 2012 relating to the UK Asset Protection Scheme
4.38(8)
Reporting issues document relating to the Post-Accession Data, Quarterly Statements and Quarterly Statement Data dated 16 March 2012
7.1
Explanation of ratio calculations
8.1
Principal subsidiaries of The Royal Bank of Scotland Group plc
12.1
CEO certification required by Rule 13a-14(a)
12.2
CFO certification required by Rule 13a-14(a)
13.1
Certification required by Rule 13a-14(b)
15.1
Consent of independent registered public accounting firm

 
454

 
Notes:

(1)
Previously filed and incorporated by reference to Exhibit 1 to the Registration Statement on Form F-6 (Registration No. 333-144756) (filed on 20 July 2007)
(2)
Previously filed and incorporated by reference to Exhibit A of Exhibit 1 to the Registration Statement on Form F-6 (Registration No. 333-144756) (filed on 20 July 2007)
(3)
Previously filed and incorporated by reference to Exhibit 2.3 to the Group’s Annual Report on Form 20-F for the fiscal year ended 31 December 2007 (File No. 1-10306)
(4)
Previously filed and incorporated by reference to Exhibit 4.1, 4.2, 4.8, 4.9, 4.21 and 4.22, respectively, to the Group’s Annual Report on Form 20-F for the fiscal year ended 31 December 2008 (file No. 1-10306)
(5)
Previously filed and incorporated by reference to Exhibit 4.3, 4.19, 4.20, 4.21, 4.22, 4.23, 4.24, 4.25, 4.26, 4.27 and 4.28, respectively, to the Group’s Annual Report on Form 20-F for the fiscal year ended 31 December 2009 (File No. 1-10306)
(6)
Previously filed and incorporated by reference to Exhibit 4.11 to the Group’s Annual Report on Form 20-F for the fiscal year ended 31 December 2006 (file No. 1-10306) except that the sentence “PROVIDED THAT this Indemnity is given subject to the provisions of Section 309A Company Act 1985” has been replaced with “PROVIDED THAT this Indemnity is given subject to the provisions of Section 234 Company Act 2001”.
(7)
Previously filed and incorporated by reference to Exhibit 4.23 to the Group’s Annual Report on Form 20-F/A for the fiscal year ended 31 December 2008 (File No. 1-10306)
(8)
Confidential treatment has been requested. Confidential materials have been redacted and separately filed with the SEC.
(9)
The exhibits and schedules to this agreement have not been filed, but the table of contents (that is included in the agreement) briefly identifies the contents of such omitted exhibits and schedules. The Royal Bank of Scotland Group plc hereby agrees to furnish to the Securities and Exchange Commission, upon its request, a copy of any such omitted exhibits and schedules.
(10)
Previously filed and incorporated by reference to Exhibit 4.20, 4.23, 4.24, 4.25, 4.26, 4.27, 4.28, 4.29 and 4.30, respectively, to the Group’s Annual Report on Form 20-F for the fiscal year ended 31 December 2010 (File No. 1-10306)
(11)
Previously filed and incorporated by reference to Exhibit 4.21 and 4.22, respectively, to the Group’s Amendment to the Annual Report on Form 20-F/A for the fiscal year ended 31 December 2010 (File No. 1-10306)



 
455

 
SIGNATURE

The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.


The Royal Bank of Scotland Group plc
Registrant



 
/s/ Bruce Van Saun
 
Bruce Van Saun
 
Group Finance Director
 
March 27, 2012
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
456