REG - Royal Bk Scot.Grp. - Annual Financial Report <Origin Href="QuoteRef">RBS.L</Origin> - Part 3
23/02/2018 07:05
- Part 3: For the preceding part double click ID:nRSW7514Fb
contributions. See 'The Group is subject to pension risks and will
be required to make additional contributions as a result of the restructuring
of its pension schemes in relation to the implementation of the UK
ring-fencing regime. In addition, the Group expects to make additional
contributions to cover pension funding deficits if there are degraded economic
conditions of if there is any devaluation in the asset portfolio held by the
pension trustee.'
In addition, the Group is exposed to risks arising out of geopolitical events
or political developments, such as trade barriers, exchange controls,
sanctions and other measures taken by sovereign governments that can hinder
economic or financial activity levels. Furthermore, unfavourable political,
military or diplomatic events, including secession movements or the exit of
other Member States from the EU, armed conflict, pandemics, state and
privately sponsored cyber and terrorist acts or threats, and the responses to
them by governments, could also adversely affect economic activity and have an
adverse effect upon the Group's business, financial condition and results of
operations.
The financial performance of the Group has been, and may continue to be,
materially affected by customer and counterparty credit quality and
deterioration in credit quality could arise due to prevailing economic and
market conditions and legal and regulatory developments.
The Group has exposure to many different industries, customers and
counterparties, and risks arising from actual or perceived changes in credit
quality and the recoverability of monies due from borrowers and other
counterparties are inherent in a wide range of the Group's businesses.
Risk factors continued
In particular, the Group has significant exposure to certain individual
customers and other counterparties in weaker business sectors and geographic
markets and also has concentrated country exposure in the UK, the US and
across the rest of Europe principally Germany, the Netherlands, Ireland and
France.
At 31 December 2017, current exposure in the UK was £363.0 billion, in the US
was £18.4 billion and in Western Europe (excluding the UK) was £60.0
billion); and within certain business sectors, namely personal and financial
institutions (at 31 December 2016, personal lending amounted to £176.6
billion, and lending to banks and other financial institutions was £37.8
billion.
Provisions held on loans in default have decreased in recent years due to
asset sales and the portfolio run-down in Ulster Bank Ireland DAC and the
NatWest Markets franchise's legacy portfolios. If the risk profile of these
loans were to increase, including as a result of a degradation of economic or
market conditions, this could result in an increase in the cost of risk and
the Group may be required to make additional provisions, which in turn would
reduce earnings and impact the Group's profitability.
The Group's lending strategy or processes may also fail to identify or
anticipate weaknesses or risks in a particular sector, market or borrower
category, which may result in an increase in default rates, which may, in
turn, impact the Group's profitability. Any adverse impact on the credit
quality of the Group's customers and other counterparties, coupled with a
decline in collateral values, could lead to a reduction in recoverability and
value of the Group's assets and higher levels of impairment allowances, which
could have an adverse effect on the Group's operations, financial position or
prospects.
The credit quality of the Group's borrowers and its other counterparties is
impacted by prevailing economic and market conditions and by the legal and
regulatory landscape in their respective markets.
Credit quality has improved in certain of the Group's core markets, in
particular the UK and Ireland, as these economies have improved. However, a
further deterioration in economic and market conditions or changes to legal or
regulatory landscapes could worsen borrower and counterparty credit quality
and also impact the Group's ability to enforce contractual security rights. In
particular, developments relating to Brexit may adversely impact credit
quality in the UK.
In addition, as the Group continues to implement its strategy and further
reduces its scale and global footprint, the Group's relative exposure to the
UK and certain sectors and asset classes in the UK will continue to increase
as its business becomes more concentrated in the UK as a result of the
reduction in the number of jurisdictions outside of the UK in which it
operates. The level of UK household indebtedness remains high and the ability
of some households to service their debts could be challenged by a period of
higher unemployment. Highly indebted households are particularly vulnerable to
shocks, such as falls in incomes or increases in interest rates, which
threaten their ability to service their debts.
In particular, in the UK, the Group is at risk from downturns in the UK
economy and volatility in property prices in both the residential and
commercial sectors. With UK home loans representing the most significant
portion of the Group's total loans and advances to the retail sector, the
Group has a large exposure to adverse developments in the UK residential
property sector. In the UK commercial real estate market, activity has
improved against 2016 but may be short-lived given continued political
uncertainty and progress of negotiations relating to the form and timing of
Brexit. There is a risk of further adjustment given the reliance of the UK
commercial real estate market in recent years on inflows of foreign capital
and, in some segments, stretched property valuations. As a result, the
continued house price weakness, particularly in London and the South East of
the UK, would be likely to lead to higher impairment and negative capital
impact as loss given default rate increases. In addition, reduced
affordability of residential and commercial property in the UK, for example,
as a result of higher interest rates, inflation or increased unemployment,
could also lead to higher impairments on loans held by the Group being
recognised.
The Group also remains exposed to certain counterparties operating in certain
industries which have been under pressure in recent years and any further
deterioration in the outlook the credit quality of these counterparties may
require the Group to make additional provisions, which in turn would reduce
earnings and impact the Group's profitability.
In addition, the Group's credit risk is exacerbated when the collateral it
holds cannot be realised as a result of market conditions or regulatory
intervention or is liquidated at prices not sufficient to recover the full
amount of the loan or derivative exposure that is due to the Group, which is
most likely to occur during periods of illiquidity and depressed asset
valuations, such as those experienced in recent years.
This has particularly been the case with respect to large parts of the Group's
commercial real estate portfolio. Any such deteriorations in the Group's
recoveries on defaulting loans could have an adverse effect on the Group's
results of operations and financial condition.
Concerns about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other financial
institutions, as the commercial and financial soundness of many financial
institutions may be closely related as a result of credit, trading, clearing
and other relationships. Even the perceived lack of creditworthiness of, or
questions about, a counterparty may lead to market-wide liquidity problems and
losses for, or defaults by, the Group. This systemic risk may also adversely
affect financial intermediaries, such as clearing agencies, clearing houses,
banks, securities firms and exchanges with which the Group interacts on a
daily basis.
Risk factors continued
The effectiveness of recent prudential reforms designed to contain systemic
risk in the EU and the UK is yet to be tested. Counterparty risk within the
financial system or failures of the Group's financial counterparties 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.
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 borrowing costs, its access to the debt capital markets and its
liquidity depend significantly on its credit ratings and, to a lesser extent,
on the UK sovereign ratings.
The credit ratings of RBSG, RBS plc and other Group members directly affect
the cost of funding and capital instruments issued by the Group, as well as
secondary market liquidity in those instruments. The implementation of
ring-fencing is expected to change the funding strategy of the Group as a
result of the RFB and the entities outside of the RFB raising debt capital
directly. A number of UK and other European financial institutions, including
RBSG, RBS plc and other Group entities, have been downgraded multiple times in
recent years in connection with rating methodology changes and credit rating
agencies' revised outlook relating to regulatory developments, macroeconomic
trends and a financial institution's capital position and financial
prospects.
The senior unsecured long-term and short-term credit ratings of RBSG and RBS
plc are investment grade by Moody's, S&P and Fitch. The outlook for RBSG is
currently stable for S&P, Fitch and Moody's and the outlook for RBS plc is
currently stable for S&P and Fitch and under review for downgrade for Moody's.
This outlook is consistent with previous statements made by Moody's that the
implementation of the ring-fencing regime is likely to lead to downgrades in
the ratings of RBS plc.
Rating agencies regularly review the RBSG and Group entity credit ratings and
their ratings of long-term debt are based on a number of factors, including
the Group's financial strength as well as factors not within the Group's
control, such as political developments and conditions affecting the financial
services industry generally.
In particular, the rating agencies may further review the RBSG and Group
entity ratings as a result of the implementation of the UK ring-fencing
regime, pension and litigation/regulatory investigation risk, including
potential fines relating to investigations relating to legacy conduct issues,
and other macroeconomic and political developments, including in light of the
outcome of the negotiations relating to the form and timing of the UK's exit
from the EU.
A challenging macroeconomic environment, a delayed return to satisfactory
profitability and greater market uncertainty could negatively impact the
Group's credit ratings and potentially lead to ratings downgrades which could
adversely impact the Group's ability and cost of funding. The Group's ability
to access capital markets on acceptable terms and hence its ability to raise
the amount of capital and funding required to meet its regulatory requirements
and targets, including those relating to loss-absorbing instruments to be
issued by the Group, could be affected. See 'Implementation of the
ring-fencing regime in the UK which began in 2015 and must be completed before
1 January 2019 will result in material structural changes to the Group's
business. The steps required to implement the UK ring-fencing regime are
complex and entail significant costs and operational, legal and execution
risks, which risks may be exacerbated by the Group's other ongoing
restructuring efforts.'
Any reductions in the long-term or short-term credit ratings of RBSG or of
certain of its subsidiaries (particularly RBS plc), including downgrades below
investment grade, could adversely affect the Group's issuance capacity in the
financial markets, increase its funding and borrowing costs, require the Group
to replace funding lost due to the downgrade, which may include the loss of
customer deposits and may limit the Group's access to capital and money
markets and trigger additional collateral or other requirements in derivatives
contracts and other secured funding arrangements or the need to amend such
arrangements, limit the range of counterparties willing to enter into
transactions with the Group and its subsidiaries and adversely affect its
competitive position, all of which could have a material adverse impact on the
Group's earnings, cash flow and financial condition.
As discussed above, the success of the implementation of the UK ring-fencing
regime and the restructuring of the Group's NatWest Markets franchise, is in
part dependent upon the relevant banking entities obtaining a sustainable
credit rating and being able to satisfy their funding needs.
A failure to obtain such a rating, or any subsequent downgrades may threaten
the ability of the NatWest Markets franchise or other entities outside of the
RFB to satisfy their funding needs and to meet prudential capital
requirements. At 31 December 2017, a simultaneous one-notch long-term and
associated short-term downgrade in the credit ratings of RBSG and RBS plc by
the three main ratings agencies would have required the Group to post
estimated additional collateral of £1.4 billion, without taking account of
mitigating action by management. Individual credit ratings of RBSG, RBS plc,
RBS N.V., RBS International, RBS Securities Inc., National Westminster Bank
Plc, Ulster Bank Ltd, Ulster Bank Ireland DAC and Adam & Company PLC are also
important to the Group when competing in certain markets such as corporate
deposits and over-the-counter derivatives.
Risk factors continued
The major credit rating agencies downgraded and changed their outlook to
negative on the UK's sovereign credit rating in June 2016 and September 2017
following the UK's decision to leave the EU. Any further downgrade in the UK
Government's credit ratings could adversely affect the credit ratings of Group
entities and may result in the effects noted above. Further political
developments, including in relation to Brexit or the outcome of any further
Scottish referendum could negatively impact the credit ratings of the UK
Government and result in a downgrade of the credit ratings of RBSG and Group
entities.
The Group's businesses are exposed to the effect of movements in currency
rates, which could have a material adverse effect on the results of
operations, financial condition or prospects of the Group.
As part of its strategy, the Group has revised its focus to become a
UK-focused domestic bank. However, 6.5% of its revenues are derived in
foreign currencies. The Group's foreign exchange exposure arises from
structural foreign exchange risk, including capital deployed in the Group's
foreign subsidiaries, branches and joint arrangements, and non-trading foreign
exchange risk, including customer transactions and profits and losses that are
in a currency other than the functional currency of the transacting entity.
The Group also relies on MREL issuances in foreign currency. The Group
maintains policies and procedures to ensure the impact of exposures to
fluctuations in currency rates are minimised. Nevertheless, changes in
currency rates, particularly in the sterling-US dollar and euro-sterling
exchange rates, affect the value of assets, liabilities, (including the total
amount of MREL eligible instruments), 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 and may also require
incremental MREL to be issued.
Changes in foreign exchange rates may result from the decisions of the Bank of
England, ECB, the US Federal Reserve and from political or global market
events outside the Group's control and lead to sharp and sudden variations in
foreign exchange rates, such as those seen in the sterling/US dollar exchange
rates since the occurrence of the EU Referendum. Throughout 2017, ongoing UK
negotiations to exit the EU, amongst other factors, resulted in continued
volatility in the sterling exchange rate relative to other major currencies.
Continued or increasing volatility in currency rates can materially affect the
Group's results of operations, financial condition or prospects.
Continued low interest rates have significantly affected and will continue to
affect the Group's business and results of operations. A continued period of
low interest rates, and yield curves and spreads may affect net interest
income, the effect of which may be heightened during periods of liquidity
stress.
Interest rate and foreign exchange risks, discussed below, are significant for
the Group. Monetary policy has been highly accommodative in recent years,
including as a result of certain policies implemented by the Bank of England
and HM Treasury such as the Term Funding Scheme, which have helped to support
demand at a time of very pronounced fiscal tightening and balance sheet
repair. In the UK, the Bank of England lowered interest rates to 0.25% in
August 2016 and raised them to 0.5% in November 2017.
However, there remains considerable uncertainty as to whether or when the Bank
of England and other central banks will further increase interest rates. While
the ECB has been conducting a quantitative easing programme since January 2015
designed to improve confidence in the Eurozone and encourage more private bank
lending, there remains considerable uncertainty as to whether such measures
have been or will be sufficient or successful and the extension of this
programme until the end of September 2018 (or beyond) may put additional
pressure on margins. Continued sustained low or negative interest rates or any
divergences in monetary policy approach between the Bank of England and other
major central banks could put further pressure on the Group's interest margins
and adversely affect the Group's profitability and prospects.
A continued period of low interest rates and 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.
Conversely while increases in interest rates may support Group income, sharp
increases in interest rates could lead to generally weaker than expected
growth, or even contracting GDP, reduced business confidence, higher levels of
unemployment or underemployment, adverse changes to levels of inflation,
potentially higher interest rates and falling property prices in the markets
in which the Group operates. In turn, this could cause stress in the loan
portfolio of the Group, particularly in relation to non-investment grade
lending or real estate loans and consequently to an increase in delinquency
rates and default rates among customers, leading to the possibility of the
Group incurring higher impairment charges. Similar risks result from the
exceptionally low levels of inflation in developed economies, which in Europe
particularly could deteriorate into sustained deflation if policy measures
prove ineffective. Reduced monetary stimulus and the actions and commercial
soundness of other financial institutions have the potential to impact market
liquidity.
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.
The Group's businesses and performance are affected by financial market
conditions. The performance and volatility of financial markets affect bond
and equity prices and have caused, and may in the future cause, changes in the
value of the Group's investment and trading portfolios.
Risk factors continued
Financial markets have recently experienced and may in the near term
experience significant volatility, including as a result of concerns about
Brexit, political and financial developments in the US and in Europe,
including as a result of general elections, geopolitical developments and
developments relating to trade agreements volatility and instability in the
Chinese and global stock markets, expectations relating to or actions taken by
central banks with respect to monetary policy, and weakening fundamentals of
the Chinese economy, resulting in further short-term changes in the valuation
of certain of the Group's assets. Uncertainty about potential fines for past
misconduct and concerns about the longer-term viability of business models
have also weighed heavily on the valuations of some financial institutions in
Europe and in the UK, including the Group.
Any further deterioration in economic and financial market conditions or weak
economic growth could require the Group to recognise further significant
write-downs and realise increased impairment charges or goodwill impairments,
all of which may have a material adverse effect on its financial condition,
results of operations and capital ratios. As part of its transformation
programme, the Group is executing the run-down or disposal of a number of
businesses, assets and portfolios.
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, the
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, such as credit market exposures, and the value
ultimately realised by the Group may be materially different from the current
or estimated fair value. 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.
In addition, for accounting purposes, the Group carries some of its issued
debt, such as debt securities, at the current market price on its balance
sheet. 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 Group's businesses are subject to substantial regulation and oversight.
Significant regulatory developments and increased scrutiny by the Group's key
regulators has had and is likely to continue to increase compliance and
conduct risks and could have a material adverse effect on how the Group
conducts its business and on its results of operations and financial
condition.
The Group is subject to extensive laws, regulations, corporate governance
requirements, administrative actions and policies in each jurisdiction in
which it operates. Many of these have been introduced or amended recently and
are subject to further material changes.
Among others, the implementation and strengthening of the prudential and
recovery and resolution framework applicable to financial institutions in the
UK, the EU and the US, and future amendments to such rules, are considerably
affecting the regulatory landscape in which the Group operates and will
operate in the future, including as a result of the adoption of rules relating
to the UK ring-fencing regime, severe restrictions on proprietary trading, CRD
IV and the BRRD and certain other measures. Increased regulatory focus in
certain areas, including conduct, consumer protection regimes, anti-money
laundering, anti-tax evasion, payment systems, and antiterrorism laws and
regulations, have resulted in the Group facing greater regulation and scrutiny
in the UK, the US and other countries in which it operates.
Recent regulatory changes, proposed or future developments and heightened
levels of public and regulatory scrutiny in the UK, Europe and the US have
resulted in increased capital, funding and liquidity requirements, changes in
the competitive landscape, changes in other regulatory requirements and
increased operating costs, and have impacted, and will continue to impact,
product offerings and business models.
Such changes may also result in an increased number of regulatory
investigations and proceedings and have increased the risks relating to the
Group's ability to comply with the applicable body of rules and regulations in
the manner and within the time frames required.
Such risks are currently exacerbated by Brexit and the unprecedented degree of
uncertainty as to the respective legal and regulatory frameworks in which the
Group and its subsidiaries will operate when the UK is no longer a member of
the EU. For example, current proposed changes to the European prudential
regulatory framework for banks and investment banks may result in additional
prudential or structural requirements being imposed on financial institutions
based outside the EU wishing to provide financial services within the EU
(which may apply to the Group once the UK has formally exited the EU). See
'The Group has been, and will remain, in a period of major business
transformation and structural change through to at least 2019 as it implements
its own transformation programme and seeks to comply with UK ring-fencing and
recovery and resolution requirements as well as the Alternative Remedies
Package. Additional structural changes to the Group's operations will also be
required as a result of Brexit. These various transformation and restructuring
activities are required to occur concurrently, which carries significant
execution and operational risks, and the Group may not be a viable,
competitive and profitable bank as a result.'. In addition, the Group and its
counterparties may no longer be able to rely on the European passporting
framework for financial services and could be required to apply for
authorisation in multiple European jurisdictions, the costs, timing and
viability of which is uncertain.
Risk factors continued
Any of these developments (including failures to comply with new rules and
regulations) could have a significant impact on how the Group conducts its
business, its authorisations and licenses, the products and services it
offers, its reputation and the value of its assets, the Group's operations or
legal entity structure, including attendant restructuring costs and
consequently have a material adverse effect on its business, funding costs,
results of operations, financial condition and future prospects.
Areas in which, and examples of where, governmental policies, regulatory and
accounting changes and increased public and regulatory scrutiny could have an
adverse impact (some of which could be material) on the Group include, but are
not limited to, those set out above as well as the following:
· amendments to the framework or requirements relating to the quality and
quantity of regulatory capital to be held by the Group as well as liquidity
and leverage requirements, either on a solo, consolidated or subgroup level
(and taking into account the Group's new legal structure following the
implementation of the UK ring-fencing regime), including amendments to the
rules relating to the calculation of risk-weighted assets and reliance on
internal models and credit ratings as well as rules affecting the eligibility
of deferred tax assets;
· the design and implementation of national or supranational mandated
recovery, resolution or insolvency regimes or the implementation of additional
or conflicting loss-absorption requirements, including those mandated under UK
rules, BRRD, MREL or by the FSB's recommendations on TLAC;
· new or amended regulations or taxes that reduce profits attributable to
shareholders which may diminish, or restrict, the accumulation of the
distributable reserves or distributable items necessary to make distributions
or coupon payments or limit the circumstances in which such distributions may
be made or the extent thereof;
· the monetary, fiscal, interest rate and other policies of central banks
and other governmental or regulatory bodies;
· further investigations, proceedings or fines either against the Group
in isolation or together with other large financial institutions with respect
to market conduct wrongdoing;
· the imposition of government-imposed requirements and/or related fines
and sanctions with respect to lending to the UK SME market and larger
commercial and corporate entities;
· increased regulatory scrutiny with respect to mortgage lending,
including through the implementation of the FCA's UK mortgages market study
and other initiatives led by the Bank of England or European regulators;
· concerns expressed by the FPC and PRA around potential systemic risk
associated with recent increases in UK consumer lending and the impact of
consumer credit losses on banks' resilience in a stress scenario, which the
PRA has indicated that it will consider when setting capital buffers for
individual banks;
· additional rules and regulatory initiatives and review relating to
customer protection, including the FCA's Treating Customers Fairly regime and
increased focus by regulators on how institutions conduct business,
particularly with regard to the delivery of fair outcomes for customers and
orderly/transparent markets;
· the imposition of additional restrictions on the Group's ability to
compensate its senior management and other employees and increased
responsibility and liability rules applicable to senior and key employees;
· rules and regulations relating to, and enforcement of, anti-corruption,
anti-bribery, anti-money laundering, anti-terrorism, sanctions, anti-tax
evasion or other similar regimes;
· investigations into facilitation of tax evasion or avoidance or the
creation of new civil or criminal offences relating thereto;
· rules relating to foreign ownership, expropriation, nationalisation and
confiscation of assets;
· changes to financial reporting standards (including accounting
standards or guidance) and guidance or the timing of their implementation;
· changes to risk aggregation and reporting standards;
· changes to corporate governance requirements, senior manager
responsibility, corporate structures and conduct of business rules;
· competition reviews and investigations relating to the retail banking
sector in the UK, including with respect to SME banking and PCAs;
· financial market infrastructure reforms establishing new rules applying
to investment services, short selling, market abuse, derivatives markets and
investment funds, including the European Market Infrastructure Regulation and
the Markets in Financial Instruments Directive and Regulation in the EU and
the Dodd Frank Wall Street Reform Consumer Protection Act of 2010 in the US;
· increased regulatory scrutiny with respect to UK payment systems by the
Payments Systems Regulator and the FCA, including in relation to banks'
policies and procedures for handling push payment scams;
· increased attention to competition and innovation in UK payment systems
and developments relating to the UK initiative on Open Banking and the
European directive on payment services;
· new or increased regulations relating to customer data and privacy
protection, including the EU General Data Protection Regulation ('GDPR');
· restrictions on proprietary trading and similar activities within a
commercial bank and/or a group;
· the introduction of, and changes to, taxes, levies or fees applicable
to the Group's operations, such as the imposition of a financial transaction
tax, changes in tax rates, increases in the bank corporation tax surcharge in
the UK, restrictions on the tax deductibility of interest payments or further
restrictions imposed on the treatment of carry-forward tax losses that reduce
the value of deferred tax assets and require increased payments of tax;
· the regulation or endorsement of credit ratings used in the EU (whether
issued by agencies in European member states or in other countries, such as
the US);
· the Markets in Financial Instruments Directive ('MiFID') regulating the
provision of 'investment services and activities' in relation to a range of
customer-related areas and the revised directive ('MiFID II') and new
regulation (Markets in Financial Instruments Regulation or 'MiFIR') replacing
and changing MiFID to include expanded supervisory powers that include the
ability to ban specific products, services and practices;
Risk factors continued
· the European Commission's proposal to impose a requirement for any bank
established outside the EU, which has an asset base of a certain size and has
two or more institutions within the EU, to establish a single intermediate
parent undertaking ('IPU') in the European Union, under which all EU entities
within that group would operate; and
· other requirements or policies affecting the Group and its
profitability or product offering, including through the imposition of
increased compliance obligations or obligations which may lead to restrictions
on business growth, product offerings, or pricing.
Changes in laws, rules or regulations, or in their interpretation or
enforcement, or the implementation of new laws, rules or regulations,
including contradictory laws, rules or regulations by key regulators in
different jurisdictions, or failure by the Group to comply with such laws,
rules and regulations, may have a material adverse effect on the Group's
business, financial condition and results of operations. In addition,
uncertainty and lack of international regulatory coordination as enhanced
supervisory standards are developed and implemented may adversely affect the
Group's ability to engage in effective business, capital and risk management
planning.
The Group relies on valuation, capital and stress test models to conduct its
business, assess its risk exposure and anticipate capital and funding
requirements. Failure of these models to provide accurate results or
accurately reflect changes in the micro-and macroeconomic environment in which
the Group operates or findings of deficiencies by the Group's regulators
resulting in increased regulatory capital requirements could have a material
adverse effect on the Group's business, capital and results.
Given t- Part 3: For the preceding part double click ID:nRSW7514Fb
implementation of the UK
ring-fencing regime. In addition, the Group expects to make additional
contributions to cover pension funding deficits if there are degraded economic
conditions of if there is any devaluation in the asset portfolio held by the
pension trustee.'
In addition, the Group is exposed to risks arising out of geopolitical events
or political developments, such as trade barriers, exchange controls,
sanctions and other measures taken by sovereign governments that can hinder
economic or financial activity levels. Furthermore, unfavourable political,
military or diplomatic events, including secession movements or the exit of
other Member States from the EU, armed conflict, pandemics, state and
privately sponsored cyber and terrorist acts or threats, and the responses to
them by governments, could also adversely affect economic activity and have an
adverse effect upon the Group's business, financial condition and results of
operations.
The financial performance of the Group has been, and may continue to be,
materially affected by customer and counterparty credit quality and
deterioration in credit quality could arise due to prevailing economic and
market conditions and legal and regulatory developments.
The Group has exposure to many different industries, customers and
counterparties, and risks arising from actual or perceived changes in credit
quality and the recoverability of monies due from borrowers and other
counterparties are inherent in a wide range of the Group's businesses.
Risk factors continued
In particular, the Group has significant exposure to certain individual
customers and other counterparties in weaker business sectors and geographic
markets and also has concentrated country exposure in the UK, the US and
across the rest of Europe principally Germany, the Netherlands, Ireland and
France.
At 31 December 2017, current exposure in the UK was £363.0 billion, in the US
was £18.4 billion and in Western Europe (excluding the UK) was £60.0
billion); and within certain business sectors, namely personal and financial
institutions (at 31 December 2016, personal lending amounted to £176.6
billion, and lending to banks and other financial institutions was £37.8
billion.
Provisions held on loans in default have decreased in recent years due to
asset sales and the portfolio run-down in Ulster Bank Ireland DAC and the
NatWest Markets franchise's legacy portfolios. If the risk profile of these
loans were to increase, including as a result of a degradation of economic or
market conditions, this could result in an increase in the cost of risk and
the Group may be required to make additional provisions, which in turn would
reduce earnings and impact the Group's profitability.
The Group's lending strategy or processes may also fail to identify or
anticipate weaknesses or risks in a particular sector, market or borrower
category, which may result in an increase in default rates, which may, in
turn, impact the Group's profitability. Any adverse impact on the credit
quality of the Group's customers and other counterparties, coupled with a
decline in collateral values, could lead to a reduction in recoverability and
value of the Group's assets and higher levels of impairment allowances, which
could have an adverse effect on the Group's operations, financial position or
prospects.
The credit quality of the Group's borrowers and its other counterparties is
impacted by prevailing economic and market conditions and by the legal and
regulatory landscape in their respective markets.
Credit quality has improved in certain of the Group's core markets, in
particular the UK and Ireland, as these economies have improved. However, a
further deterioration in economic and market conditions or changes to legal or
regulatory landscapes could worsen borrower and counterparty credit quality
and also impact the Group's ability to enforce contractual security rights. In
particular, developments relating to Brexit may adversely impact credit
quality in the UK.
In addition, as the Group continues to implement its strategy and further
reduces its scale and global footprint, the Group's relative exposure to the
UK and certain sectors and asset classes in the UK will continue to increase
as its business becomes more concentrated in the UK as a result of the
reduction in the number of jurisdictions outside of the UK in which it
operates. The level of UK household indebtedness remains high and the ability
of some households to service their debts could be challenged by a period of
higher unemployment. Highly indebted households are particularly vulnerable to
shocks, such as falls in incomes or increases in interest rates, which
threaten their ability to service their debts.
In particular, in the UK, the Group is at risk from downturns in the UK
economy and volatility in property prices in both the residential and
commercial sectors. With UK home loans representing the most significant
portion of the Group's total loans and advances to the retail sector, the
Group has a large exposure to adverse developments in the UK residential
property sector. In the UK commercial real estate market, activity has
improved against 2016 but may be short-lived given continued political
uncertainty and progress of negotiations relating to the form and timing of
Brexit. There is a risk of further adjustment given the reliance of the UK
commercial real estate market in recent years on inflows of foreign capital
and, in some segments, stretched property valuations. As a result, the
continued house price weakness, particularly in London and the South East of
the UK, would be likely to lead to higher impairment and negative capital
impact as loss given default rate increases. In addition, reduced
affordability of residential and commercial property in the UK, for example,
as a result of higher interest rates, inflation or increased unemployment,
could also lead to higher impairments on loans held by the Group being
recognised.
The Group also remains exposed to certain counterparties operating in certain
industries which have been under pressure in recent years and any further
deterioration in the outlook the credit quality of these counterparties may
require the Group to make additional provisions, which in turn would reduce
earnings and impact the Group's profitability.
In addition, the Group's credit risk is exacerbated when the collateral it
holds cannot be realised as a result of market conditions or regulatory
intervention or is liquidated at prices not sufficient to recover the full
amount of the loan or derivative exposure that is due to the Group, which is
most likely to occur during periods of illiquidity and depressed asset
valuations, such as those experienced in recent years.
This has particularly been the case with respect to large parts of the Group's
commercial real estate portfolio. Any such deteriorations in the Group's
recoveries on defaulting loans could have an adverse effect on the Group's
results of operations and financial condition.
Concerns about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other financial
institutions, as the commercial and financial soundness of many financial
institutions may be closely related as a result of credit, trading, clearing
and other relationships. Even the perceived lack of creditworthiness of, or
questions about, a counterparty may lead to market-wide liquidity problems and
losses for, or defaults by, the Group. This systemic risk may also adversely
affect financial intermediaries, such as clearing agencies, clearing houses,
banks, securities firms and exchanges with which the Group interacts on a
daily basis.
Risk factors continued
The effectiveness of recent prudential reforms designed to contain systemic
risk in the EU and the UK is yet to be tested. Counterparty risk within the
financial system or failures of the Group's financial counterparties 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.
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 borrowing costs, its access to the debt capital markets and its
liquidity depend significantly on its credit ratings and, to a lesser extent,
on the UK sovereign ratings.
The credit ratings of RBSG, RBS plc and other Group members directly affect
the cost of funding and capital instruments issued by the Group, as well as
secondary market liquidity in those instruments. The implementation of
ring-fencing is expected to change the funding strategy of the Group as a
result of the RFB and the entities outside of the RFB raising debt capital
directly. A number of UK and other European financial institutions, including
RBSG, RBS plc and other Group entities, have been downgraded multiple times in
recent years in connection with rating methodology changes and credit rating
agencies' revised outlook relating to regulatory developments, macroeconomic
trends and a financial institution's capital position and financial prospects.
The senior unsecured long-term and short-term credit ratings of RBSG and RBS
plc are investment grade by Moody's, S&P and Fitch. The outlook for RBSG
is currently stable for S&P, Fitch and Moody's and the outlook for RBS plc
is currently stable for S&P and Fitch and under review for downgrade for
Moody's. This outlook is consistent with previous statements made by Moody's
that the implementation of the ring-fencing regime is likely to lead to
downgrades in the ratings of RBS plc.
Rating agencies regularly review the RBSG and Group entity credit ratings and
their ratings of long-term debt are based on a number of factors, including
the Group's financial strength as well as factors not within the Group's
control, such as political developments and conditions affecting the financial
services industry generally.
In particular, the rating agencies may further review the RBSG and Group
entity ratings as a result of the implementation of the UK ring-fencing
regime, pension and litigation/regulatory investigation risk, including
potential fines relating to investigations relating to legacy conduct issues,
and other macroeconomic and political developments, including in light of the
outcome of the negotiations relating to the form and timing of the UK's exit
from the EU.
A challenging macroeconomic environment, a delayed return to satisfactory
profitability and greater market uncertainty could negatively impact the
Group's credit ratings and potentially lead to ratings downgrades which could
adversely impact the Group's ability and cost of funding. The Group's ability
to access capital markets on acceptable terms and hence its ability to raise
the amount of capital and funding required to meet its regulatory requirements
and targets, including those relating to loss-absorbing instruments to be
issued by the Group, could be affected. See 'Implementation of the
ring-fencing regime in the UK which began in 2015 and must be completed before
1 January 2019 will result in material structural changes to the Group's
business. The steps required to implement the UK ring-fencing regime are
complex and entail significant costs and operational, legal and execution
risks, which risks may be exacerbated by the Group's other ongoing
restructuring efforts.'
Any reductions in the long-term or short-term credit ratings of RBSG or of
certain of its subsidiaries (particularly RBS plc), including downgrades below
investment grade, could adversely affect the Group's issuance capacity in the
financial markets, increase its funding and borrowing costs, require the Group
to replace funding lost due to the downgrade, which may include the loss of
customer deposits and may limit the Group's access to capital and money
markets and trigger additional collateral or other requirements in derivatives
contracts and other secured funding arrangements or the need to amend such
arrangements, limit the range of counterparties willing to enter into
transactions with the Group and its subsidiaries and adversely affect its
competitive position, all of which could have a material adverse impact on the
Group's earnings, cash flow and financial condition.
As discussed above, the success of the implementation of the UK ring-fencing
regime and the restructuring of the Group's NatWest Markets franchise, is in
part dependent upon the relevant banking entities obtaining a sustainable
credit rating and being able to satisfy their funding needs.
A failure to obtain such a rating, or any subsequent downgrades may threaten
the ability of the NatWest Markets franchise or other entities outside of the
RFB to satisfy their funding needs and to meet prudential capital
requirements. At 31 December 2017, a simultaneous one-notch long-term and
associated short-term downgrade in the credit ratings of RBSG and RBS plc by
the three main ratings agencies would have required the Group to post
estimated additional collateral of £1.4 billion, without taking account of
mitigating action by management. Individual credit ratings of RBSG, RBS plc,
RBS N.V., RBS International, RBS Securities Inc., National Westminster Bank
Plc, Ulster Bank Ltd, Ulster Bank Ireland DAC and Adam & Company PLC are
also important to the Group when competing in certain markets such as
corporate deposits and over-the-counter derivatives.
Risk factors continued
The major credit rating agencies downgraded and changed their outlook to
negative on the UK's sovereign credit rating in June 2016 and September 2017
following the UK's decision to leave the EU. Any further downgrade in the UK
Government's credit ratings could adversely affect the credit ratings of Group
entities and may result in the effects noted above. Further political
developments, including in relation to Brexit or the outcome of any further
Scottish referendum could negatively impact the credit ratings of the UK
Government and result in a downgrade of the credit ratings of RBSG and Group
entities.
The Group's businesses are exposed to the effect of movements in currency
rates, which could have a material adverse effect on the results of
operations, financial condition or prospects of the Group.
As part of its strategy, the Group has revised its focus to become a
UK-focused domestic bank. However, 6.5% of its revenues are derived in
foreign currencies. The Group's foreign exchange exposure arises from
structural foreign exchange risk, including capital deployed in the Group's
foreign subsidiaries, branches and joint arrangements, and non-trading foreign
exchange risk, including customer transactions and profits and losses that are
in a currency other than the functional currency of the transacting entity.
The Group also relies on MREL issuances in foreign currency. The Group
maintains policies and procedures to ensure the impact of exposures to
fluctuations in currency rates are minimised. Nevertheless, changes in
currency rates, particularly in the sterling-US dollar and euro-sterling
exchange rates, affect the value of assets, liabilities, (including the total
amount of MREL eligible instruments), 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 and may also require
incremental MREL to be issued.
Changes in foreign exchange rates may result from the decisions of the Bank of
England, ECB, the US Federal Reserve and from political or global market
events outside the Group's control and lead to sharp and sudden variations in
foreign exchange rates, such as those seen in the sterling/US dollar exchange
rates since the occurrence of the EU Referendum. Throughout 2017, ongoing UK
negotiations to exit the EU, amongst other factors, resulted in continued
volatility in the sterling exchange rate relative to other major currencies.
Continued or increasing volatility in currency rates can materially affect the
Group's results of operations, financial condition or prospects.
Continued low interest rates have significantly affected and will continue to
affect the Group's business and results of operations. A continued period of
low interest rates, and yield curves and spreads may affect net interest
income, the effect of which may be heightened during periods of liquidity
stress.
Interest rate and foreign exchange risks, discussed below, are significant for
the Group. Monetary policy has been highly accommodative in recent years,
including as a result of certain policies implemented by the Bank of England
and HM Treasury such as the Term Funding Scheme, which have helped to support
demand at a time of very pronounced fiscal tightening and balance sheet
repair. In the UK, the Bank of England lowered interest rates to 0.25% in
August 2016 and raised them to 0.5% in November 2017.
However, there remains considerable uncertainty as to whether or when the Bank
of England and other central banks will further increase interest rates. While
the ECB has been conducting a quantitative easing programme since January 2015
designed to improve confidence in the Eurozone and encourage more private bank
lending, there remains considerable uncertainty as to whether such measures
have been or will be sufficient or successful and the extension of this
programme until the end of September 2018 (or beyond) may put additional
pressure on margins. Continued sustained low or negative interest rates or any
divergences in monetary policy approach between the Bank of England and other
major central banks could put further pressure on the Group's interest margins
and adversely affect the Group's profitability and prospects.
A continued period of low interest rates and 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.
Conversely while increases in interest rates may support Group income, sharp
increases in interest rates could lead to generally weaker than expected
growth, or even contracting GDP, reduced business confidence, higher levels of
unemployment or underemployment, adverse changes to levels of inflation,
potentially higher interest rates and falling property prices in the markets
in which the Group operates. In turn, this could cause stress in the loan
portfolio of the Group, particularly in relation to non-investment grade
lending or real estate loans and consequently to an increase in delinquency
rates and default rates among customers, leading to the possibility of the
Group incurring higher impairment charges. Similar risks result from the
exceptionally low levels of inflation in developed economies, which in Europe
particularly could deteriorate into sustained deflation if policy measures
prove ineffective. Reduced monetary stimulus and the actions and commercial
soundness of other financial institutions have the potential to impact market
liquidity.
The Group's earnings and financial condition have been, and its future
earnings and financial condition may continue to be, materially affected by
deprhe complexity of the Group's business, strategy and capital
requirements, the Group relies on analytical models to manage its business,
assess the value of its assets and its risk exposure and anticipate capital
and funding requirements, including with stress testing. The Group's
valuation, capital and stress test models and the parameters and assumptions
on which they are based, need to be periodically reviewed and updated to
maximise their accuracy.
Failure of these models to accurately reflect changes in the environment in
which the Group operates or to be updated in line with the Group's business
model or operations, or the failure to properly input any such changes could
have an adverse impact on the modelled results or could fail to accurately
capture the Group's risk exposure or the risk profile of the Group's financial
instruments or result in the Group being required to hold additional capital
as a function of the PRA buffer. For example, as the Group implements its
transformation programme, including the restructuring and funding of its
NatWest Markets franchise and the implementation of the UK ring-fencing
regime, any impacted models would need to be correctly identified and adapted
in line with the implementation process. The Group also uses valuation models
that rely on market data inputs. If incorrect market data is input into a
valuation model, it may result in incorrect valuations or valuations different
to those which were predicted and used by the Group in its forecasts or
decision making. Internal stress test models may also rely on different, less
severe, assumptions or take into account different data points than those
defined by the Group's regulators.
Some of the analytical models used by the Group are predictive in nature. In
addition, a number of internal models used by Group subsidiaries are designed,
managed and analysed by the Group and may not appropriately capture the risks
and exposures at subsidiary level. Some of the Group's internal models are
subject to periodic review by its regulators and, if found deficient, the
Group may be required to make changes to such models or may be precluded from
using any such models, which could result in an additional capital requirement
which could have a material impact on the Group's capital position.
The Group could face adverse consequences as a result of decisions which may
lead to actions by management based on models that are poorly developed,
implemented or used, or as a result of the modelled outcome being
misunderstood or such information being used for purposes for which it was not
designed. Risks arising from the use of models could have a material adverse
effect on the Group's business, financial condition and results of operations,
minimum capital requirements and reputation.
The Group is subject to stress tests mandated by its regulators in the UK and
in Europe which may result in additional capital requirements or management
actions which, in turn, may impact the Group's financial condition, results of
operations and investor confidence or result in restrictions on
distributions.
The Group is subject to annual stress tests by its regulator in the UK and
also subject to stress tests by the European regulators with respect to RBSG,
RBS N.V. and Ulster Bank Ireland DAC. Stress tests provide an estimate of the
amount of capital banks might deplete in a hypothetical stress scenario. In
addition, if the stress tests reveal that a bank's existing regulatory capital
buffers are not sufficient to absorb the impact of the stress, it is possible
that it will need to take action to strengthen its capital position. There is
a strong expectation that the PRA would require a bank to take action if, at
any point during the stress, a bank were projected to breach any of its
minimum CET1 capital or leverage ratio requirements.
However, if a bank is projected to fail to meet its systemic buffers, it will
still be expected to strengthen its capital position over time but the
supervisory response is expected to be less intensive than if it were
projected to breach its minimum capital requirements. The PRA will also use
the annual stress test results to inform its determination of whether
individual banks' current capital positions are adequate or need
strengthening. For some banks, their individual stress-test results might
imply that the capital conservation buffer and countercyclical rates set for
all banks is not consistent with the impact of the stress on them. In that
case, the PRA can increase regulatory capital buffers for individual banks by
adjusting their PRA buffers.
Under the 2017 Bank of England stress tests, which were based on the balance
sheet of the Group for the year ended 31 December 2016, the Group's capital
position before the impact of strategic management actions that the PRA judged
could realistically be taken in the stress scenario remained below its CET1
capital hurdle rate and above its Tier 1 leverage hurdle rate. After the
impact of strategic management actions the Group's capital position would have
remained above its CET1 capital hurdle rate, but the PRA judged that Risk
factors continued
RBS did not meet its systemic reference point in this scenario. Given the
steps RBS had already taken to strengthen its capital position during 2017,
the PRA did not require the Group to submit a revised capital plan.
Failure by the Group to meet the thresholds set as part of the stress tests
carried out by its regulators in the UK and elsewhere may result in the
Group's regulators requiring the Group to generate additional capital,
increased supervision and/or regulatory sanctions, restrictions on capital
distributions and loss of investor confidence, which may impact the Group's
financial condition, results of operations and prospects.
The Group's operations entail inherent reputational risk, i.e., the risk of
brand damage and/or financial loss due to a failure to meet stakeholders'
expectations of the Group's conduct, performance and business profile.
Brand damage can be detrimental to the business of the Group in a number of
ways, including its ability to build or sustain business relationships with
customers, low staff morale, regulatory censure or reduced access to, or an
increase in the cost of, funding. In particular, negative public opinion
resulting from the actual or perceived manner in which the Group conducts or
modifies its business activities and operations, including as a result of the
transformation programme or other restructuring efforts, speculative or
inaccurate media coverage, the Group's financial performance, ongoing
investigations and proceedings and the settlement of any such investigations
and proceedings, IT failures or cyber-attacks resulting in the loss or
publication of confidential customer data or other sensitive information, the
level of direct and indirect government support, or the actual or perceived
strength or practices in the banking and financial industry may adversely
affect the Group's ability to keep and attract customers and, in particular,
corporate and retail depositors.
Modern technologies, in particular online social networks and other broadcast
tools which facilitate communication with large audiences in short time frames
and with minimal costs, may also significantly enhance and accelerate the
impact of damaging information and allegations.
Although the Group has implemented a Reputational Risk Policy across
customer-facing businesses to improve the identification, assessment and
management of customers, transactions, products and issues which represent a
reputational risk, the Group cannot ensure that it will be successful in
avoiding damage to its business from reputational risk, which could result in
a material adverse effect on the Group's business, financial condition,
results of operations and prospects.
The reported results of the Group are sensitive to the accounting policies,
assumptions and estimates that underlie the preparation of its financial
statements. Its results in future periods may be affected by changes to
applicable accounting rules and standards.
The preparation of financial statements requires management to make
judgements, estimates and assumptions that affect the reported amounts of
assets, liabilities, income and expenses. Due to the inherent uncertainty in
making estimates, results reported in future periods may reflect amounts which
differ from those estimates. Estimates, judgements and assumptions take into
account historical experience and other factors, including market practice and
expectations of future events that are believed to be reasonable under the
circumstances.
The accounting policies deemed critical to the Group'essed asset valuations resulting from poor market conditions.
The Group's businesses and performance are affected by financial market
conditions. The performance and volatility of financial markets affect bond
and equity prices and have caused, and may in the future cause, changes in the
value of the Group's investment and trading portfolios.
Risk factors continued
Financial markets have recently experienced and may in the near term
experience significant volatility, including as a result of concerns about
Brexit, political and financial developments in the US and in Europe,
including as a result of general elections, geopolitical developments and
developments relating to trade agreements volatility and instability in the
Chinese and global stock markets, expectations relating to or actions taken by
central banks with respect to monetary policy, and weakening fundamentals of
the Chinese economy, resulting in further short-term changes in the valuation
of certain of the Group's assets. Uncertainty about potential fines for past
misconduct and concerns about the longer-term viability of business models
have also weighed heavily on the valuations of some financial institutions in
Europe and in the UK, including the Group.
Any further deterioration in economic and financial market conditions or weak
economic growth could require the Group to recognise further significant
write-downs and realise increased impairment charges or goodwill impairments,
all of which may have a material adverse effect on its financial condition,
results of operations and capital ratios. As part of its transformation
programme, the Group is executing the run-down or disposal of a number of
businesses, assets and portfolios.
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, the
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, such as credit market exposures, and the value
ultimately realised by the Group may be materially different from the current
or estimated fair value. 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.
In addition, for accounting purposes, the Group carries some of its issued
debt, such as debt securities, at the current market price on its balance
sheet. 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 Group's businesses are subject to substantial regulation and oversight.
Significant regulatory developments and increased scrutiny by the Group's key
regulators has had and is likely to continue to increase compliance and
conduct risks and could have a material adverse effect on how the Group
conducts its business and on its results of operations and financial
condition.
The Group is subject to extensive laws, regulations, corporate governance
requirements, administrative actions and policies in each jurisdiction in
which it operates. Many of these have been introduced or amended recently and
are subject to further material changes.
Among others, the implementation and strengthening of the prudential and
recovery and resolution framework applicable to financial institutions in the
UK, the EU and the US, and future amendments to such rules, are considerably
affecting the regulatory landscape in which the Group operates and will
operate in the future, including as a result of the adoption of rules relating
to the UK ring-fencing regime, severe restrictions on proprietary trading, CRD
IV and the BRRD and certain other measures. Increased regulatory focus in
certain areas, including conduct, consumer protection regimes, anti-money
laundering, anti-tax evasion, payment systems, and antiterrorism laws and
regulations, have resulted in the Group facing greater regulation and scrutiny
in the UK, the US and other countries in which it operates.
Recent regulatory changes, proposed or future developments and heightened
levels of public and regulatory scrutiny in the UK, Europe and the US have
resulted in increased capital, funding and liquidity requirements, changes in
the competitive landscape, changes in other regulatory requirements and
increased operating costs, and have impacted, and will continue to impact,
product offerings and business models.
Such changes may also result in an increased number of regulatory
investigations and proceedings and have increased the risks relating to the
Group's ability to comply with the applicable body of rules and regulations in
the manner and within the time frames required.
Such risks are currently exacerbated by Brexit and the unprecedented degree of
uncertainty as to the respective legal and regulatory frameworks in which the
Group and its subsidiaries will operate when the UK is no longer a member of
the EU. For example, current proposed changes to the European prudential
regulatory framework for banks and investment banks may result in additional
prudential or structural requirements being imposed on financial institutions
based outside the EU wishing to provide financial services within the EU
(which may apply to the Group once the UK has formally exited the EU). See
'The Group has been, and will remain, in a period of major business
transformation and structural change through to at least 2019 as it implements
its own transformation programme and seeks to comply with UK ring-fencing and
recovery and resolution requirements as well as the Alternative Remedies
Package. Additional structural changes to the Group's operations will also be
required as a result of Brexit. These various transformation and restructuring
activities are required to occur concurrently, which carries significant
execution and operational risks, and the Group may not be a viable,
competitive and profitable bank as a result.'. In addition, the Group and its
counterparties may no longer be able to rely on the European passporting
framework for financial services and could be required to apply for
authorisation in multiple European jurisdictions, the costs, timing and
viability of which is uncertain.
Risk factors continued
Any of these developments (including failures to comply with new rules and
regulations) could have a significant impact on how the Group conducts its
business, its authorisations and licenses, the products and services it
offers, its reputation and the value of its assets, the Group's operations or
legal entity structure, including attendant restructuring costs and
consequently have a material adverse effect on its business, funding costs,
results of operations, financial condition and future prospects.
Areas in which, and examples of where, governmental policies, regulatory and
accounting changes and increased public and regulatory scrutiny could have an
adverse impact (some of which could be material) on the Group include, but are
not limited to, those set out above as well as the following:
· amendments to the framework or requirements relating to the
quality and quantity of regulatory capital to be held by the Group as well as
liquidity and leverage requirements, either on a solo, consolidated or
subgroup level (and taking into account the Group's new legal structure
following the implementation of the UK ring-fencing regime), including
amendments to the rules relating to the calculation of risk-weighted assets
and reliance on internal models and credit ratings as well as rules affecting
the eligibility of deferred tax assets;
· the design and implementation of national or supranational
mandated recovery, resolution or insolvency regimes or the implementation of
additional or conflicting loss-absorption requirements, including those
mandated under UK rules, BRRD, MREL or by the FSB's recommendations on TLAC;
· new or amended regulations or taxes that reduce profits
attributable to shareholders which may diminish, or restrict, the accumulation
of the distributable reserves or distributable items necessary to make
distributions or coupon payments or limit the circumstances in which such
distributions may be made or the extent thereof;
· the monetary, fiscal, interest rate and other policies of central
banks and other governmental or regulatory bodies;
· further investigations, proceedings or fines either against the
Group in isolation or together with other large financial institutions with
respect to market conduct wrongdoing;
· the imposition of government-imposed requirements and/or related
fines and sanctions with respect to lending to the UK SME market and larger
commercial and corporate entities;
· increased regulatory scrutiny with respect to mortgage lending,
including through the implementation of the FCA's UK mortgages market study
and other initiatives led by the Bank of England or European regulators;
· concerns expressed by the FPC and PRA around potential systemic
risk associated with recent increases in UK consumer lending and the impact of
consumer credit losses on banks' resilience in a stress scenario, which the
PRA has indicated that it will consider when setting capital buffers for
individual banks;
· additional rules and regulatory initiatives and review relating
to customer protection, including the FCA's Treating Customers Fairly regime
and increased focus by regulators on how institutions conduct business,
particularly with regard to the delivery of fair outcomes for customers and
orderly/transparent markets;
· the imposition of additional restrictions on the Group's ability
to compensate its senior management and other employees and increased
responsibility and liability rules applicable to senior and key employees;
· rules and regulations relating to, and enforcement of,
anti-corruption, anti-bribery, anti-money laundering, anti-terrorism,
sanctions, anti-tax evasion or other similar regimes;
· investigations into facilitation of tax evasion or avoidance or
the creation of new civil or criminal offences relating thereto;
· rules relating to foreign ownership, expropriation,
nationalisation and confiscation of assets;
· changes to financial reporting standards (including accounting
standards or guidance) and guidance or the timing of their implementation;
· changes to risk aggregation and reporting standards;
· changes to corporate governance requirements, senior manager
responsibility, corporate structures and conduct of business rules;
· competition reviews and investigations relating to the retail
banking sector in the UK, including with respect to SME banking and PCAs;
· financial market infrastructure reforms establishing new rules
applying to investment services, short selling, market abuse, derivatives
markets and investment funds, including the European Market Infrastructure
Regulation and the Markets in Financial Instruments Directive and Regulation
in the EU and the Dodd Frank Wall Street Reform Consumer Protection Act of
2010 in the US;
· increased regulatory scrutiny with respect to UK payment systems
by the Payments Systems Regulator and the FCA, including in relation to banks'
policies and procedures for handling push payment scams;
· increased attention to competition and innovation in UK payment
systems and developments relating to the UK initiative on Open Banking and the
European directive on payment services;
· new or increased regulations relating to customer data and
privacy protection, including the EU General Data Protection Regulation
('GDPR');
· restrictions on proprietary trading and similar activities within
a commercial bank and/or a group;
· the introduction of, and changes to, taxes, levies or fees
applicable to the Group's operations, such as the imposition of a financial
transaction tax, changes in tax rates, increases in the bank corporation tax
surcharge in the UK, restrictions on the tax deductibility of interest
payments or further restrictions imposed on the treatment of carry-forward tax
losses that reduce the value of deferred tax assets and require increased
payments of tax;
· the regulation or endorsement of credit ratings used in the EU
(whether issued by agencies in European member states or in other countries,
such as the US);
· the Markets in Financial Instruments Directive ('MiFID')
regulating the provision of 'investment services and activities' in relation
to a range of customer-related areas and the revised directive ('MiFID II')
and new regulation (Markets in Financial Instruments Regulation or 'MiFIR')
replacing and changing MiFID to include expanded supervisory powers that
include the ability to ban specific products, services and practices;
Risk factors continued
· the European Commission's proposal to impose a requirement for
any bank established outside the EU, which has an asset base of a certain size
and has two or more institutions within the EU, to establish a single
intermediate parent undertaking ('IPU') in the European Union, under which all
EU entities within that group would operate; and
· other requirements or policies affecting the Group and its
profitability or product offering, including through the imposition of
increased compliance obligations or obligations which may lead to restrictions
on business growth, product offerings, or pricing.
Changes in laws, rules or regulations, or in their interpretation or
enforcement, or the implementation of new laws, rules or regulations,
including contradictory laws, rules or regulations by key regulators in
different jurisdictions, or failure by the Group to comply with such laws,
rules and regulations, may have a material adverse effect on the Group's
business, financial condition and results of operations. In addition,
uncertainty and lack of international regulatory coordination as enhanced
supervisory standards are developed and implemented may adversely affect the
Group's ability to engage in effective business, capital and risk management
planning.
The Group relies on valuation, capital and stress test models to conduct its
business, assess its risk exposure and anticipate capital and funding
requirements. Failure of these models to provide accurate results or
accurately reflect changes in the micro-and macroeconomic environment in which
the Group operates or findings of deficiencies by the Group's regulators
resulting in increased regulatory capital requirements could have a material
adverse effect on the Group's business, capital and results.
Given the complexity of the Group's business, strategy and capital
requirements, the Group relies on analytical models to manage its business,
assess the value of its assets and its risk exposure and anticipate capital
and funding requirements, including with stress testing. The Group's
valuation, capital and stress test models and the parameters and assumptions
on which they are based, need to be periodically reviewed and updated to
maximise their accuracy.
Failure of these models to accurately reflect changes in the environment in
which the Group operates or to be updated in line with the Group's business
model or operations, or the failure to properly input any such changes could
have an adverse impact on the modelled results or could fail to accurately
capture the Group's risk exposure or the risk profile of the Group's financial
instruments or result in the Group being required to hold additional capital
as a function of the PRA buffer. For example, as the Group implements its
transformation programme, including the restructuring and funding of its
NatWest Markets franchise and the implementation of the UK ring-fencing
regime, any impacted models would need to be correctly identified and adapted
in line with the implementation process. The Group also uses valuation models
that rely on market data inputs. If incorrect market data is input into a
valuation model, it may result in incorrect valuations or valuations different
to those which were predicted and used by the Group in its forecasts or
decision making. Internal stress test models may also rely on different, less
severe, assumptions or take into account different data points than those
defined by the Group's regulators.
Some of the analytical models used by the Group are predictive in nature. In
addition, a number of internal models used by Group subsidiaries are designed,
managed and analysed by the Group and may not appropriately capture the risks
and exposures at subsidiary level. Some of the Group's internal models are
subject to periodic review by its regulators and, if found deficient, the
Group may be required to make changes to such models or may be precluded from
using any such models, which could result in an additional capital requirement
which could have a material impact on the Group's capital position.
The Group could face adverse consequences as a result of decisions which may
lead to actions by management based on models that are poorly developed,
implemented or used, or as a result of the modelled outcome being
misunderstood or such information being used for purposes for which it was not
designed. Risks arising from the use of models could have a material adverse
effect on the Group's business, financial condition and results of operations,
minimum capital requirements and reputation.
The Group is subject to stress tests mandated by its regulators in the UK and
in Europe which may result in additional capital requirements or management
actions which, in turn, may impact the Group's financial condition, results of
operations and investor confidence or result in restrictions on distributions.
The Group is subject to annual stress tests by its regulator in the UK and
also subject to stress tests by the European regulators with respect to RBSG,
RBS N.V. and Ulster Bank Ireland DAC. Stress tests provide an estimate of the
amount of capital banks might deplete in a hypothetical stress scenario. In
addition, if the stress tests reveal that a bank's existing regulatory capital
buffers are not sufficient to absorb the impact of the stress, it is possible
that it will need to take action to strengthen its capital position. There is
a strong expectation that the PRA would require a bank to take action if, at
any point during the stress, a bank were projected to breach any of its
minimum CET1 capital or leverage ratio requirements.
However, if a bank is projected to fail to meet its systemic buffers, it will
still be expected to strengthen its capital position over time but the
supervisory response is expected to be less intensive than if it were
projected to breach its minimum capital requirements. The PRA will also use
the annual stress test results to inform its determination of whether
individual banks' current capital positions are adequate or need
strengthening. For some banks, their individual stress-test results might
imply that the capital conservation buffer and countercyclical rates set for
all banks is not consistent with the impact of the stress on them. In that
case, the PRA can increase regulatory capital buffers for individual banks by
adjusting their PRA buffers.
Under the 2017 Bank of England stress tests, which ws results and financial
position, based upon materiality and significant judgements and estimates,
include goodwill, provisions for liabilities, deferred tax, loan impairment
provisions, fair value of financial instruments, which are discussed in detail
in 'Critical accounting policies and key sources of estimation uncertainty' on
pages 259 and 261. IFRS Standards and Interpretations that have been issued by
the International Accounting Standards Board (the IASB) but which have not yet
been adopted by the Group are discussed in 'Accounting developments' on pages
261 to 263.
Changes in accounting standards or guidance by accounting bodies or in the
timing of their implementation, whether mandatory or as a result of
recommended disclosure relating to the future implementation of such standards
could result in the Group having to recognise additional liabilities on its
balance sheet, or in further write-downs or impairments and could also
significantly impact the financial results, condition and prospects of the
Group.
In July 2014, the IASB published a new accounting standard for financial
instruments (IFRS 9) effective for annual periods beginning on or after 1
January 2018. It introduced a new framework for the recognition and
measurement of credit impairment, based on expected credit losses, rather than
the incurred loss model currently applied under IAS 39. The inclusion of loss
allowances with respect to all financial assets that are not recorded at fair
value tend to result in an increase in overall impairment balances when
compared with the previous basis of measurement under IAS 39. The Group
expects IFRS 9 to increase earnings and capital volatility in 2018 and
beyond.
The valuation of financial instruments, including derivatives, measured at
fair value can be subjective, in particular where models are used which
include unobservable inputs. 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. Resulting changes in the fair values of
the financial instruments has had and could continue to have a material
adverse effect on the Group's earnings, financial condition and capital
position.
Risk factors continued
The Group is exposed to conduct risk which may adversely impact the Group or
its employees and may result in conduct having a detrimental impact on the
Group's customers or counterparties.
In recent years, the Group has sought to refocus its culture on serving the
needs of its customers and continues to redesign many of its systems and
processes to promote this focus and strategy. However, the Group is exposed to
various forms of conduct risk in its operations. These include business and
strategic planning that does not adequately reflect the Group's customers'
needs, ineffective management and monitoring of products and their
distribution, actions taken that may not conform to the Group's
customer-centric focus, outsourcing of customer service and product delivery
via third parties that do not have appropriate levels of control, oversight
and culture, the possibility of alleged mis-selling of financial products or
the mishandling of complaints related to the sale of such product, or poor
governance of incentives and rewards. Some of these risks have materialised in
the past and ineffective management and oversight of conduct issues may result
in customers being poorly or unfairly treated and may in the future lead to
further remediation and regulatory intervention/enforcement.
The Group's businesses are also exposed to risks from employee misconduct
including non-compliance with policies and regulatory rules, negligence or
fraud (including financial crimes), any of which could result in regulatory
fines or sanctions and serious reputational or financial harm to the Group. In
recent years, a number of multinational financial institutions, including the
Group, have suffered material losses due to the actions of employees,
including, for example, in connection with the foreign exchange and LIBOR
investigations and the Group may not succeed in protecting itself from such
conduct in the future. It is not always possible to timely detect or deter
employee misconduct and the precautions the Group takes to detect and prevent
this activity may not always be effective.
The Group has implemented a number of policies and allocated new resources in
order to help mitigate against these risks. The Group has also prioritised
initiatives to reinforce good conduct in its engagement with the markets in
which it operates, together with the development of preventative and detective
controls in order to positively influence behaviour.
The Group's transformation programme is also intended to improve the Group's
control environment. Nonetheless, no assurance can be given that the Group's
strategy and control framework will be effective and that conduct and
financial crime issues will not have an adverse effect on the Group's results
of operations, financial condition or prospects.
The Group may be adversely impacted if its risk management is not effective
and there may be significant challenges in maintaining the effectiveness of
the Group's risk management framework as a result of the number of strategic
and restructuring initiatives being carried out by the Group simultaneously.
The management of risk is an integral part of all of the Group's activities.
Risk management includes the definition and monitoring of the Group's risk
appetite and reporting of the Group's exposure to uncertainty and the
consequent adverse effect on profitability or financial condition arising from
different sources of uncertainty and risks as described throughout these risk
factors.
Ineffective risk management may arise from a wide variety of events and
behaviours, including lack of transparency or incomplete risk reporting,
unidentified conflicts or misaligned incentives, lack of accountability
control and governance, lack of consistency in risk monitoring and management
or insufficient challenges or assurance processes.
Failure to manage risks effectively could adversely impact the Group's
reputation or its relationship with its customers, shareholders or other
stakeholders, which in turn could have a significant effect on the Group's
business prospects, financial condition and/or results of operations.
Risk management is also strongly related to the use and effectiveness of
internal stress tests and models. See 'The Group relies on valuation, capital
and stress test models to conduct its business, assess its risk exposure and
anticipate capital and funding requirements. Failure of these models to
provide accurate results or accurately reflect changes in the micro-and
macroeconomic environment in which the Group operates or findings of
deficiencies by the Group's regulators resulting in increased regulatory
capital requirements could have a material adverse effect on the Group's
business, capital and results.'
A failure by the Group to embed a strong risk culture across the organisation
could adversely affect the Group's ability to achieve its strategic
objective.
In response to weaknesses identified in previous years, the Group is currently
seeking to embed a strong risk culture within the Group based on a robust risk
appetite and governance framework. A key component of this approach is the
three lines of defence model designed to identify, manage and mitigate risk
across all levels of the organisation. This framework has been implemented and
improvements continue and will continue to be made to clarify and improve the
three lines of defence and internal risk responsibilities and resources,
including in response to feedback from regulators. Notwithstanding the Group's
efforts, changing an organisation's risk culture requires significant time,
investment and leadership, and such efforts may not insulate the Group from
future instances of misconduct. A failure by any of these three lines to carry
out their responsibilities or to effectively embed this culture could have a
material adverse effect on the Group through an inability to achieve its
strategic objectives for its customers, employees and wider stakeholders.
Risk factors continued
As a result of the commercial and regulatory environment in which it operates,
the Group may be unable to attract or retain senior management (including
members of the board) and other skilled personnel of the appropriate
qualification and competence. The Group may also suffer if it does not
maintain good employee relations.
The Group's current and future success depend on its ability to attract,
retain and remunerate highly skilled and qualified personnel, including senior
management (which includes directors and other key employees), in a highly
competitive labour market. This cannot be guaranteed, particularly in light of
heightened regulatory oversight of banks and the increasing scrutiny of, and
(in some cases) restrictions placed upon, employee compensation arrangements,
in particular those of banks in receipt of Government support (such as the
Group), which may place the Group at a competitive disadvantage.
In addition, the market for skilled personnel is increasingly competitive,
thereby raising the cost of hiring, training and retaining skilled personnel.
Certain of the Group's directors as well as members of its executive committee
and certain other senior managers and employees are also subject to the new
responsibility regime introduced under the Banking Reform Act 2013 which
introduces clearer accountability rules for those within the new regime. The
senior managers' regime and certification regime took effect on 7 March 2016,
whilst the conduct rules apply to the wider employee population from 7 March
2017, with the exception of some transitional provisions. The new regulatory
regime may contribute to reduce the pool of candidates for key management and
non-executive roles, including non-executive directors with the right skills,
knowledge and experience, or increase the number of departures of existing
employees, given concerns over the allocation of responsibilities and personal
liability introduced by the new rules.
In addition, in order to ensure the independence of the RFB as part of the
Group's implementation of the UK ring-fencing regime, the Group will be
required to recruit new independent directors and senior members of management
to sit on the boards of directors and board committees of the RFB and other
Group entities, and there may be a limited pool of competent candidates from
which such appointments can be made.
The Group's evolving strategy has led to the departure of a large number of
experienced and capable employees. The restructuring relating to the ongoing
implementation of the Group's transformation programme and related
cost-reduction targets may cause experienced staff members to leave and
prospective staff members not to join the Group. The lack of continuity of
senior management and the loss of important personnel coordinating certain or
several aspects of the Group's restructuring could have an adverse impact on
its implementation.
The failure to attract or retain a sufficient number of appropriately skilled
personnel to manage the complex restructuring required to implement the
Group's strategy could prevent the Group from successfully maintaining its
current standards of operation, implementing its strategy and meeting
regulatory commitments. This could have a material adverse effect on the
Group's business, financial condition and results of operations.
In addition, many of the Group's employees in the UK, Republic of Ireland and
continental Europe 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.
HM Treasury (or UKFI on its behalf) may be able to exercise a significant
degree of influence over the Group and any further offer or sale of its
interests may affect the price of securities issued by the Group.
On 6 August 2015, the UK Government made its first sale of RBSG ordinary
shares since its original investment in 2009 and sold approximately 5.4% of
its stake in RBSG. Following this initial sale, the UK Government exercised
its conversion rights under the B Shares on 14 October 2015 which resulted in
HM Treasury holding 72.88% of the ordinary share capital of RBSG.
The UK Government, through HM Treasury, held 70.5% of the issued ordinary
share capital of the Group as of 31 December 2017. The UK Government in its
November 2017 Autumn Budget indicated its intention to recommence the process
for the privatisation of RBSG before the end of 2018-2019 and to carry out
over the forecast period a programme of sales of RBSG ordinary shares expected
to sell down approximately two thirds of HM Treasury's current shareholding in
the Group, although there can be no certainty as to the commencement of any
sell-downs or the timing or extent thereof.
Any offers or sale, or expectations relating to the timing thereof, of a
substantial number of ordinary shares by HM Treasury, could negatively affect
prevailing market prices for the outstanding ordinary shares of RBSG and other
securities issued by the Group and lead to a period of increased price
volatility for the Group's securities.
Risk factors continued
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, its position as a majority shareholder (and UKFI's position as
manager of this shareholding) means that HM Treasury or UKFI might be able to
exercise a significant degree of influence over, among other things, the
election of directors and appointment of senior management, the Group's
capital strategy, dividend policy, remuneration policy or the conduct of the
Group's operations. The manner in which HM Treasury or UKFI exercises HM
Treasury's rights as majority shareholder could give rise to conflicts 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 operates in markets that are subject to intense scrutiny by the
competition authorities and its business and results of operations could be
materially affected by competition decisions and other regulatory
interventions.
The competitive landscape for banks and other financial institutions in the
UK, the rest of Europe and the US is changing rapidly. Recent regulatory and
legal changes have and may continue to result in new market participants and
changed competitive dynamics in certain key areas, such as in retail and SME
banking in the UK where the introduction of new entrants is being actively
encouraged by the UK Government. The competitive landscape in the UK is also
likely to be affected by the UK Government's implementation of the UK
ring-fencing regime and other customer protection measures
- More to follow, for following part double click ID:nRSW7514Fd ere based on the balance
sheet of the Group for the year ended 31 December 2016, the Group's capital
position before the impact of strategic management actions that the PRA judged
could realistically be taken in the stress scenario remained below its CET1
capital hurdle rate and above its Tier 1 leverage hurdle rate. After the
impact of strategic management actions the Group's capital position would have
remained above its CET1 capital hurdle rate, but the PRA judged that Risk
factors continued
RBS did not meet its systemic reference point in this scenario. Given the
steps RBS had already taken to strengthen its capital position during 2017,
the PRA did not require the Group to submit a revised capital plan.
Failure by the Group to meet the thresholds set as part of the stress tests
carried out by its regulators in the UK and elsewhere may result in the
Group's regulators requiring the Group to generate additional capital,
increased supervision and/or regulatory sanctions, restrictions on capital
distributions and loss of investor confidence, which may impact the Group's
financial condition, results of operations and prospects.
The Group's operations entail inherent reputational risk, i.e., the risk of
brand damage and/or financial loss due to a failure to meet stakeholders'
expectations of the Group's conduct, performance and business profile.
Brand damage can be detrimental to the business of the Group in a number of
ways, including its ability to build or sustain business relationships with
customers, low staff morale, regulatory censure or reduced access to, or an
increase in the cost of, funding. In particular, negative public opinion
resulting from the actual or perceived manner in which the Group conducts or
modifies its business activities and operations, including as a result of the
transformation programme or other restructuring efforts, speculative or
inaccurate media coverage, the Group's financial performance, ongoing
investigations and proceedings and the settlement of any such investigations
and proceedings, IT failures or cyber-attacks resulting in the loss or
publication of confidential customer data or other sensitive information, the
level of direct and indirect government support, or the actual or perceived
strength or practices in the banking and financial industry may adversely
affect the Group's ability to keep and attract customers and, in particular,
corporate and retail depositors.
Modern technologies, in particular online social networks and other broadcast
tools which facilitate communication with large audiences in short time frames
and with minimal costs, may also significantly enhance and accelerate the
impact of damaging information and allegations.
Although the Group has implemented a Reputational Risk Policy across
customer-facing businesses to improve the identification, assessment and
management of customers, transactions, products and issues which represent a
reputational risk, the Group cannot ensure that it will be successful in
avoiding damage to its business from reputational risk, which could result in
a material adverse effect on the Group's business, financial condition,
results of operations and prospects.
The reported results of the Group are sensitive to the accounting policies,
assumptions and estimates that underlie the preparation of its financial
statements. Its results in future periods may be affected by changes to
applicable accounting rules and standards.
The preparation of financial statements requires management to make
judgements, estimates and assumptions that affect the reported amounts of
assets, liabilities, income and expenses. Due to the inherent uncertainty in
making estimates, results reported in future periods may reflect amounts which
differ from those estimates. Estimates, judgements and assumptions take into
account historical experience and other factors, including market practice and
expectations of future events that are believed to be reasonable under the
circumstances.
The accounting policies deemed critical to the Group's results and financial
position, based upon materiality and significant judgements and estimates,
include goodwill, provisions for liabilities, deferred tax, loan impairment
provisions, fair value of financial instruments, which are discussed in detail
in 'Critical accounting policies and key sources of estimation uncertainty' on
pages 259 and 261. IFRS Standards and Interpretations that have been issued by
the International Accounting Standards Board (the IASB) but which have not yet
been adopted by the Group are discussed in 'Accounting developments' on pages
261 to 263.
Changes in accounting standards or guidance by accounting bodies or in the
timing of their implementation, whether mandatory or as a result of
recommended disclosure relating to the future implementation of such standards
could result in the Group having to recognise additional liabilities on its
balance sheet, or in further write-downs or impairments and could also
significantly impact the financial results, condition and prospects of the
Group.
In July 2014, the IASB published a new accounting standard for financial
instruments (IFRS 9) effective for annual periods beginning on or after 1
January 2018. It introduced a new framework for the recognition and
measurement of credit impairment, based on expected credit losses, rather than
the incurred loss model currently applied under IAS 39. The inclusion of loss
allowances with respect to all financial assets that are not recorded at fair
value tend to result in an increase in overall impairment balances when
compared with the previous basis of measurement under IAS 39. The Group
expects IFRS 9 to increase earnings and capital volatility in 2018 and beyond.
The valuation of financial instruments, including derivatives, measured at
fair value can be subjective, in particular where models are used which
include unobservable inputs. 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. Resulting changes in the fair values of
the financial instruments has had and could continue to have a material
adverse effect on the Group's earnings, financial condition and capital
position.
Risk factors continued
The Group is exposed to conduct risk which may adversely impact the Group or
its employees and may result in conduct having a detrimental impact on the
Group's customers or counterparties.
In recent years, the Group has sought to refocus its culture on serving the
needs of its customers and continues to redesign many of its systems and
processes to promote this focus and strategy. However, the Group is exposed to
various forms of conduct risk in its operations. These include business and
strategic planning that does not adequately reflect the Group's customers'
needs, ineffective management and monitoring of products and their
distribution, actions taken that may not conform to the Group's
customer-centric focus, outsourcing of customer service and product delivery
via third parties that do not have appropriate levels of control, oversight
and culture, the possibility of alleged mis-selling of financial products or
the mishandling of complaints related to the sale of such product, or poor
governance of incentives and rewards. Some of these risks have materialised in
the past and ineffective management and oversight of conduct issues may result
in customers being poorly or unfairly treated and may in the future lead to
further remediation and regulatory intervention/enforcement.
The Group's businesses are also exposed to risks from employee misconduct
including non-compliance with policies and regulatory rules, negligence or
fraud (including financial crimes), any of which could result in regulatory
fines or sanctions and serious reputational or financial harm to the Group. In
recent years, a number of multinational financial institutions, including the
Group, have suffered material losses due to the actions of employees,
including, for example, in connection with the foreign exchange and LIBOR
investigations and the Group may not succeed in protecting itself from such
conduct in the future. It is not always possible to timely detect or deter
employee misconduct and the precautions the Group takes to detect and prevent
this activity may not always be effective.
The Group has implemented a number of policies and allocated new resources in
order to help mitigate against these risks. The Group has also prioritised
initiatives to reinforce good conduct in its engagement with the markets in
which it operates, together with the development of preventative and detective
controls in order to positively influence behaviour.
The Group's transformation programme is also intended to improve the Group's
control environment. Nonetheless, no assurance can be given that the Group's
strategy and control framework will be effective and that conduct and
financial crime issues will not have an adverse effect on the Group's results
of operations, financial condition or prospects.
The Group may be adversely impacted if its risk management is not effective
and there may be significant challenges in maintaining the effectiveness of
the Group's risk management framework as a result of the number of strategic
and restructuring initiatives being carried out by the Group simultaneously.
The management of risk is an integral part of all of the Group's activities.
Risk management includes the definition and monitoring of the Group's risk
appetite and reporting of the Group's exposure to uncertainty and the
consequent adverse effect on profitability or financial condition arising from
different sources of uncertainty and risks as described throughout these risk
factors.
Ineffective risk management may arise from a wide variety of events and
behaviours, including lack of transparency or incomplete risk reporting,
unidentified conflicts or misaligned incentives, lack of accountability
control and governance, lack of consistency in risk monitoring and management
or insufficient challenges or assurance processes.
Failure to manage risks effectively could adversely impact the Group's
reputation or its relationship with its customers, shareholders or other
stakeholders, which in turn could have a significant effect on the Group's
business prospects, financial condition and/or results of operations.
Risk management is also strongly related to the use and effectiveness of
internal stress tests and models. See 'The Group relies on valuation, capital
and stress test models to conduct its business, assess its risk exposure and
anticipate capital and funding requirements. Failure of these models to
provide accurate results or accurately reflect changes in the micro-and
macroeconomic environment in which the Group operates or findings of
deficiencies by the Group's regulators resulting in increased regulatory
capital requirements could have a material adverse effect on the Group's
business, capital and results.'
A failure by the Group to embed a strong risk culture across the organisation
could adversely affect the Group's ability to achieve its strategic objective.
In response to weaknesses identified in previous years, the Group is currently
seeking to embed a strong risk culture within the Group based on a robust risk
appetite and governance framework. A key component of this approach is the
three lines of defence model designed to identify, manage and mitigate risk
across all levels of the organisation. This framework has been implemented and
improvements continue and will continue to be made to clarify and improve the
three lines of defence and internal risk responsibilities and resources,
including in response to feedback from regulators. Notwithstanding the Group's
efforts, changing an organisation's risk culture requires significant time,
investment and leadership, and such efforts may not insulate the Group from
future instances of misconduct. A failure by any of these three lines to carry
out their responsibilities or to effectively embed this culture could have a
material adverse effect on the Group through an inability to achieve its
strategic objectives for its customers, employees and wider stakeholders.
Risk factors continued
As a result of the commercial and regulatory environment in which it operates,
the Group may be unable to attract or retain senior management (including
members of the board) and other skilled personnel of the appropriate
qualification and competence. The Group may also suffer if it does not
maintain good employee relations.
The Group's current and future success depend on its ability to attract,
retain and remunerate highly skilled and qualified personnel, including senior
management (which includes directors and other key employees), in a highly
competitive labour market. This cannot be guaranteed, particularly in light of
heightened regulatory oversight of banks and the increasing scrutiny of, and
(in some cases) restrictions placed upon, employee compensation arrangements,
in particular those of banks in receipt of Government support (such as the
Group), which may place the Group at a competitive disadvantage.
In addition, the market for skilled personnel is increasingly competitive,
thereby raising the cost of hiring, training and retaining skilled personnel.
Certain of the Group's directors as well as members of its executive committee
and certain other senior managers and employees are also subject to the new
responsibility regime introduced under the Banking Reform Act 2013 which
introduces clearer accountability rules for those within the new regime. The
senior managers' regime and certification regime took effect on 7 March 2016,
whilst the conduct rules apply to the wider employee population from 7 March
2017, with the exception of some transitional provisions. The new regulatory
regime may contribute to reduce the pool of candidates for key management and
non-executive roles, including non-executive directors with the right skills,
knowledge and experience, or increase the number of departures of existing
employees, given concerns over the allocation of responsibilities and personal
liability introduced by the new rules.
In addition, in order to ensure the independence of the RFB as part of the
Group's implementation of the UK ring-fencing regime, the Group will be
required to recruit new independent directors and senior members of management
to sit on the boards of directors and board committees of the RFB and other
Group entities, and there may be a limited pool of competent candidates from
which such appointments can be made.
The Group's evolving strategy has led to the departure of a large number of
experienced and capable employees. The restructuring relating to the ongoing
implementation of the Group's transformation programme and related
cost-reduction targets may cause experienced staff members to leave and
prospective staff members not to join the Group. The lack of continuity of
senior management and the loss of important personnel coordinating certain or
several aspects of the Group's restructuring could have an adverse impact on
its implementation.
The failure to attract or retain a sufficient number of appropriately skilled
personnel to manage the complex restructuring required to implement the
Group's strategy could prevent the Group from successfully maintaining its
current standards of operation, implementing its strategy and meeting
regulatory commitments. This could have a material adverse effect on the
Group's business, financial condition and results of operations.
In addition, many of the Group's employees in the UK, Republic of Ireland and
continental Europe 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.
HM Treasury (or UKFI on its behalf) may be able to exercise a significant
degree of influence over the Group and any further offer or sale of its
interests may affect the price of securities issued by the Group.
On 6 August 2015, the UK Government made its first sale of RBSG ordinary
shares since its original investment in 2009 and sold approximately 5.4% of
its stake in RBSG. Following this initial sale, the UK Government exercised
its conversion rights under the B Shares on 14 October 2015 which resulted in
HM Treasury holding 72.88% of the ordinary share capital of RBSG.
The UK Government, through HM Treasury, held 70.5% of the issued ordinary
share capital of the Group as of 31 December 2017. The UK Government in its
November 2017 Autumn Budget indicated its intention to recommence the process
for the privatisation of RBSG before the end of 2018-2019 and to carry out
over the forecast period a programme of sales of RBSG ordinary shares expected
to sell down approximately two thirds of HM Treasury's current shareholding in
the Group, although there can be no certainty as to the commencement of any
sell-downs or the timing or extent thereof.
Any offers or sale, or expectations relating to the timing thereof, of a
substantial number of ordinary shares by HM Treasury, could negatively affect
prevailing market prices for the outstanding ordinary shares of RBSG and other
securities issued by the Group and lead to a period of increased price
volatility for the Group's securities.
Risk factors continued
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, its position as a majority shareholder (and UKFI's position as
manager of this shareholding) means that HM Treasury or UKFI might be able to
exercise a significant degree of influence over, among other things, the
election of directors and appointment of senior management, the Group's
capital strategy, dividend policy, remuneration policy or the conduct of the
Group's operations. The manner in which HM Treasury or UKFI exercises HM
Treasury's rights as majority shareholder could give rise to conflicts 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 operates in markets that are subject to intense scrutiny by the
competition authorities and its business and results of operations could be
materially affected by competition decisions and other regulatory
interventions.
The competitive landscape for banks and other financial institutions in the
UK, the rest of Europe and the US is changing rapidly. Recent regulatory and
legal changes have and may continue to result in new market participants and
changed competitive dynamics in certain key areas, such as in retail and SME
banking in the UK where the introduction of new entrants is being actively
encouraged by the UK Government. The competitive landscape in the UK is also
likely to be affected by the UK Government's implementation of the UK
ring-fencing regime and other customer protection measures introduced by the
Banking Reform Act 2013. The implementation of these reforms may result in the
consolidation of newly separated businesses or assets of certain financial
institutions with those of other parties to realise new synergies or protect
their competitive position and is likely to increase competitive pressures on
the Group.
The UK
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