Barclays 2005 Annual Report Download - page 57

Barclays PLC
Annual Report 2005 55
Stress Testing
The Risk Appetite numbers are validated by estimating the Group
sensitivity to macroeconomic events using stress testing and scenario
analysis. Changes in certain macroeconomic variables represent
environmental stresses which may reveal systemic credit and market
risk sensitivities in our retail and wholesale portfolios. The stresses
considered include, for example, the following sensitivities:
•Gross Domestic Product weaker;
•employment weaker;
•interest rates higher or lower;
•interest rate curve shifts;
•equity prices lower;
•property prices weaker;
•credit spreads wider;
•country exposure stressed;
•industry exposure stressed;
•sterling stronger.
More complex scenarios, such as recessions, can be represented by
combinations of variables. These scenarios allow senior management
to gain a better understanding of how the Group is likely to react to
changing economic and geopolitical conditions. The stress test
simulates the balance sheet and profit and loss effects of stresses
across the Group, investigating the impact on profits and the ability
to maintain appropriate capital ratios. Insights gained are fully
integrated into the management process and the Risk Appetite
framework. These analyses and insights, and the close involvement
of management, also provide the basis for fulfilling the stress testing
requirements of the new Basel II Accord.
We estimate the capital needed to survive an extreme but highly
improbable level of stressed loss. The calculation is based on the
historical volatility of losses. Capitalisation occurs to a level sufficient
to provide a high level of confidence in the Group, with the level of
confidence consistent with the Group’s AA rating.
The Application of Economic Capital
Barclays manages both its economic capital supply and demand for
economic capital in order to optimise capital efficiency.
The management of the supply of capital occurs via the Group’s
shareholders’ capital and regulatory capital ratios as discussed on
page 56. See also the management of capital risk on page 72.
The Group assesses the internal demand for capital using its own
proprietary economic capital methodology developed and refined over
more than a decade.
Economic capital is estimated primarily for the risks listed under
principal risks on page 52 as well as insurance risk, risk associated with
fixed assets, and risk in private equity investments. The Group
computes and assigns economic capital by the risk categories to all
operating units. This enables the Group to apply a common, consistent
and additive metric to ensure that returns throughout the Group are
commensurate with the associated risks. An asset attracts the same
cost of capital wherever it is acquired across the Group, although
management may target differential hurdle rates which are appropriate
to the use of capital.
Barclays estimates the correlation between risk types and calculates
a diversification benefit which results in a reduction in allocated
economic capital for the Group and each of the businesses.
Economic capital is fully embedded in the management culture of the
Group via risk adjusted performance management (e.g. economic
profit), effective targeting of resources to value creating areas, pricing
tools, compensation and remuneration schemes and is integral to the
Risk Appetite framework. The economic capital framework will be an
important part to the Group’s implementation of the Basel II Accord.
Movements within the business clusters are summarised as follows:
Within UK banking, UK Retail Banking economic capital allocation
increased £100m to £2.3bn. The impact of growth was offset by a risk
transfer transaction within UK mortgages. UK Business Banking economic
capital allocation increased £500m to £2.95bn as a consequence of
asset growth and the acquisition of the Iveco Finance business.
Barclays Capital economic capital increased £450m to £2.55bn
reflecting underlying growth in loan and derivative portfolios,
additional equity investments and the recalibration of business and
operational risk economic capital.
Wealth Management ongoing business economic capital allocation
increased £100m to £400m as a consequence of general growth
across all businesses and the recalibration of business and operational
risk economic capital.
Wealth Management – closed life assurance activities economic capital
allocation reduced £50m to £50m reflecting the impact of IFRS
removing the volatility associated with embedded value accounting.
Barclaycard economic capital allocation increased £350m to £2.8bn,
due to growth in outstandings and the inclusion of Barclaycard US for
the full year.
International Retail and Commercial Banking excluding Absa economic
capital allocation increased £150m to £1.15bn due to the recalibration
of business and operational risk economic capital together with growth
exposure in Africa and Spain. Absa added £400m to the average
economic capital demand reflecting five months of the annual change
after excluding the risk borne by the minority interest.
Economic capital held at Group centre fell £350m to £1.05bn. The
economic capital required to support Absa, is only partially offset by
an increase in available funds to support economic capital.
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