Barclays 2006 Annual Report Download - page 240

Notes to the accounts
For the year ended 31st December 2006
Barclays PLC
Annual Report 2006
236
52 Financial risks (continued)
time and by forecasting future cash flows to ensure that requirements can be met. The third is maintaining a diverse and stable funding base.
Finally, the Group maintains a portfolio of highly marketable assets that can easily be liquidated as protection against any unforeseen interruption to
cash flows.
The Group’s funding base comprises a mixture of different funding sources, including retail and corporate customer deposits, and short- and long-
term debt issuances. Although current accounts are repayable on demand and savings accounts at short notice, the Group’s broad base of
customers – numerically and by depositor type – helps to protect against unexpected fluctuations. Such accounts form a stable funding base for the
Group’s operations and liquidity needs. Important factors in assuring liquidity are competitive rates and the maintenance of depositors’ confidence.
Such confidence is based on a number of factors including the Group’s reputation, the strength of earnings and the Group’s financial position.
The ability to raise funds is in part dependent on maintaining the Bank’s credit rating. The funding impact of a credit downgrade is regularly
estimated. Whilst the impact of a single downgrade may affect the price at which funding is available, the effect on liquidity is not considered material
in Group terms.
Liquidity Risk Measurement
Based on principles agreed by the FSA, monitoring and reporting of liquidity risk involves the measurement of cash flows and projections for the next
day, week and month.
In addition to cash flow management, Treasury also monitors unmatched medium-term assets and the level and type of undrawn lending
commitments, the usage of overdraft facilities and the impact of contingent liabilities such as standby letters of credit and guarantees.
Treasury develops and implements the process for submitting the Group’s projected cash flows to stress scenarios. The output of stress testing
informs the Group’s contingency funding plan. This is maintained by Treasury and is aligned with the Group and country business resumption plans
to encompass decision-making authorities, internal and external communication and, in the event of a systems failure, the restoration of liquidity
management and payment systems.
Sources of liquidity are regularly reviewed to maintain a wide diversification by currency, geography, provider, product and term. An important source
of structural liquidity is provided by our core retail deposits in the UK, Europe and Africa, comprising mainly current accounts and savings accounts.
To avoid reliance on a particular group of customers or market sectors, the distribution of sources and the maturity profile of deposits are also
carefully managed.
An analysis of the Group’s liquidity position is presented at Note 56.
Insurance Risk Management
Insurance risk is the risk that the Group will have to make higher than anticipated payments to settle claims arising from its long-term and short-term
insurance businesses.
Long-term insurance business
For long-term insurance contracts where death is the insured risk, the most significant factors that could detrimentally affect the frequency and
severity of claims are the incidence of disease, such as AIDS, or general changes in lifestyle, such as in eating, exercise and smoking. Where survival
is the insured risk, advances in medical care and social conditions are the key factors that increase longevity.
The Group manages its exposure to risk by operating in part as a unit-linked business, prudent product design, applying strict underwriting criteria,
transferring risk to reinsurers, managing claims and establishing prudent reserves.
Short-term insurance business
For payment protection contracts where inability to make payments under a loan contract is the insured risk, the most significant factors are the
health of the policyholder and the possibility of unemployment which depends upon, among other things, long-term and short-term economic
factors. The Group manages its exposure to such risks through prudent product design, efficient claims management, prudent reserving
methodologies and bases, regular product, economic and market reviews and regular adequacy tests on the size of the reserves.
Absa insures property and motor vehicles, for which the most significant factors that could affect the frequency and severity of claims are climatic
change and crime. Absa manages its exposure to risk by diversifying insurance risks accepted and transferring risk to reinsurers.
Derivatives held for risk management
The Group uses both cash flow hedging and fair value hedging techniques to achieve hedge accounting for interest rate portions. For example,
cash flow hedge relationships have been established between interest rate swaps receive fixed with pay variable legs and cash flows generated by
customer assets on which we receive a variable interest rate (including forecast customer assets which are expected to be originated in the future).
The cash flows on the variable leg of the swap and the interest flows on the assets are both based on the same benchmark rate (e.g. LIBOR or
EURIBOR). Fair value hedge relationships are also established between interest rate swaps with receive fixed/pay variable legs and fixed rate liabilities
(e.g. issued loan stock).
Various techniques are used to ensure that the hedge relationship results in an effective reduction in the risks intended to be hedged. For cash flow
hedging a hypothetical interest rate swap is created which would completely offset the risks which are being hedged. The ratio of movements (due to
changes in the risk being hedged) in the fair value of this instrument (or the hedged item for fair value hedges) and the movement in the fair value of
the actual interest rate swaps used as hedges is calculated to determine how close the actual interest rate swap is to a perfect hedging instrument.
In some circumstances these ratios are calculated for various scenarios and regression analysis is used to assess the level of effectiveness.