Barclays 2005 Annual Report Download - page 56

Barclays PLC
Annual Report 2005
54
Risk management
Risk management and control – overview
Work has been undertaken to align Absa’s internal control framework
with Barclays. Absa has adopted the Barclays, COSO aligned, internal
control framework or has in place suitable COSO aligned alternatives,
which are acceptable to Barclays.
The Barclays principal risk categories and control requirements (see
previous reference) have been adopted by Absa and work is ongoing to
achieve full compliance in 2006.
Risk Appetite
Risk Appetite is the Group’s chosen method of balancing return and
risk, recognising a range of possible outcomes, as business plans are
implemented. Barclays framework, approved by the Board Risk
Committee, uses a formal, quantitive method based on advanced risk
analysis, building on the capability developed and used in Barclays
since the mid 1990s.
The objectives of the Risk Appetite framework are to:
•help protect the Group’s performance;
•enable unused risk capacity to be identified and thus profitable
opportunities to be highlighted;
•improve management confidence and debate regarding our risk
profile; and
•help executive management improve control and co-ordination
of risk-taking across businesses.
The Risk Appetite framework considers credit, market and operational
risk and is applied using two perspectives: ‘earnings volatility’ and
‘mandate and scale’.
Earnings volatility: This takes account of the potential volatility around
our forecast financial performance each year, with appetite being set in
the context of strategic objectives, including dividend sustainability and
preservation of Barclays rating in stress environments. The portfolio is
analysed in this way at four representative levels:
•expected performance (including the average credit losses based on
measurements over many years);
•a moderate stress level of loss that is likely to occur only
infrequently and is meant to correspond to a macroeconomic cycle;
•a severe stress which is much less likely;
•an extreme but highly improbable level of stressed loss which is
used to determine the Group’s Economic capital.
These ascending but increasingly less likely levels of loss are illustrated
in the following chart.
At 31st December 2005, the Group’s expected credit loss in one year
was £1,845m (see page 58). The economic capital (i.e. the loss in one
year under extreme stress) for all risk types was £14.1bn, estimated
with a probability of 1 in 5,000 years.
Mandate and Scale: This second perspective enables the setting of
limits to control unacceptable levels of loss that may arise as a result
of portfolio concentration. It is our objective that unexpected losses
remain within the scope of our communicated strategy and are of a
scale that is appropriate for our Group. This perspective uses simple,
descriptive measures and limits for relevant exposure types.
Overall, the Risk Appetite framework provides a basis for the allocation
of risk capacity to each business. Since the level of loss at each level of
probability is dependent on the portfolio of exposures in each business,
the statistical measurement for each key risk category gives the Group
clearer sight and better control of risk-taking throughout the enterprise.
The Risk Appetite framework is designed to be:
•simple and practical to apply by measurement and monitoring
of exposures;
•geared to risk/return where capacity is directly related to
opportunity;
•based on a top-down capacity for earnings volatility;
•based on bottom-up identification of risk factors in each business;
•relevant, recognising the impact and likelihood of losses;
•aggregated across businesses where appropriate.
Probability of loss
Risk Appetite concepts (diagram not to scale)
Economic capitalRisk
Tendency
Potential size of loss in one year
‘Expected’
(Mean)
Extreme Stress
Severe Stress
Moderate Stress