Barclays 2006 Annual Report Download - page 237

Barclays PLC
Annual Report 2006 233
Financial statements
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52 Financial risks
The main sources of financial risk that the Group faces are those arising from financial instruments – credit risk, market risk, liquidity risk and
insurance risk. The Group devotes considerable resources to maintaining effective controls to manage, measure and mitigate each of these risks and
regularly reviews its risk management procedures and systems to ensure that these are the best available.
Financial instruments are fundamental to the Group’s business and constitute the core element of its operations. The risks associated with financial
instruments are a significant component of the risks faced by the Group. Financial instruments create, modify or reduce the liquidity, credit and
market risks of the Group’s balance sheet. These risks and the Group’s policies and objectives for managing such risks are outlined below.
Credit risk management
Credit risk is the risk of suffering financial loss from any of the Group’s customers, clients or market counterparties failing to fulfil their contractual
obligations to the Group. Credit risk mainly arises from loans and advances, but may also arise where the downgrading of an entity’s credit rating
causes the fair value the Group’s investment in that entity’s financial instruments to fall.
Credit risk is the Group’s most significant risk and it deploys considerable resources to controlling it. Nearly two-thirds of risk-based economic capital
is allocated to businesses for credit risks.
Each business has an embedded risk management team reporting to a Business Risk Director who reports to the Group Risk Director, who leads the
Group Risk function, including credit, which is charged with devising and implementing Group risk policy, such as ensuring:
•maximum exposure guidelines are in place relating to the exposures to any individual customer or counterparty;
•country risk policy specifies risk appetite by country and avoids excessive concentrations of credit in individual countries; and
•policies are in place that limit lending to certain industries, for example, commercial real estate.
A Credit Committee of Directors and experienced senior managers formulates overall Group credit policy and resolves all significant credit
policy issues.
Credit risk measurement
The Group’s credit rating systems use statistical modelling techniques throughout its business which assist the Group in front line credit decisions,
such as managing its existing portfolios and making new commitments.
The Group assesses the credit quality and assigns an internal risk rating to all borrowers and other counterparties, including retail customers.
Each internal rating corresponds to the statistical probability of a customer in that rating class defaulting within the next 12-month period.
The probability of default, the exposure at default and the loss given default are calculated for all loan portfolios. This allows the Group to monitor
its exposures, enabling it to derive measures such as Risk Tendency. Risk Tendency is a statistical estimate of the average loss for each loan portfolio
for a 12-month period, taking into account the size of the portfolio and its risk characteristics under current economic conditions, and is used to
track the change in risk as the portfolio of loans changes over time.
The Group monitors its financial exposure to individual counterparties, to industries and countries to ensure that no undue concentrations of
credit arise.
Credit risk mitigation
The Group uses a wide variety of techniques to reduce credit risk on its lending. The most basic of these is performing an assessment of the ability
of a borrower to service the proposed level of borrowing without distress. In addition, the Group commonly obtains security for the funds advanced,
such as in the case of a retail or commercial mortgage, a reverse repurchase agreement, or a commercial loan with a floating charge over book debts
and inventories. The Group also uses various forms of specialised legal agreements to reduce risk, including netting agreements which permit it to
offset positive and negative balances with customers in certain circumstances to minimise the exposure at default, financial guarantees, and the use
of covenants in commercial lending agreements. Other techniques include the use of credit derivatives and other forms of credit collateral.
In addition, the Group actively manages its exposures to clients, countries and industries through diversification, minimising individual
concentrations.