Barclays 2006 Annual Report Download - page 78

Barclays PLC
Annual Report 2006
74
Risk management
Risk management – overview
Economic capital
Barclays assesses capital requirements by measuring the Group risk
profile using both internally and externally developed models. The
Group assigns economic capital primarily within seven risk categories:
Credit Risk, Market Risk, Business Risk, Operational Risk, Insurance Risk,
Fixed Assets and Private Equity.
The Group regularly enhances its economic capital methodology and
benchmarks outputs to external reference points. The framework has
been enhanced to reflect default probabilities during average credit
conditions, rather than those prevailing at the balance sheet date, thus
seeking to remove cyclicality from the economic capital calculation.
The framework also adjusts economic capital to reflect time horizon,
correlation of risks and risk concentrations.
Economic capital is allocated on a consistent basis across all of Barclays
businesses and risk activities. A single cost of equity is applied to
calculate the cost of risk. Economic capital allocations reflect varying
levels of risk.
The total average economic capital required by the Group, as
determined by risk assessment models and after considering the
Group’s estimated portfolio effects, is compared with the supply of
economic capital to evaluate economic capital utilisation. Supply of
economic capital is calculated as the average available shareholders’
equity after adjustment and including preference shares.
The economic capital methodology will form the basis of the
Group’s submission for the Basel II Internal Capital Adequacy
Assessment Process.
The average supply of capital to support the economic capital framework is set out below(a):
2006 2005
£m £m
Shareholders’ equity excluding minority interests less goodwill(b) 11,400 10,850
Retirement benefits liability 1,300 1,350
Cash flow hedging reserve 100 (250)
Available for sale reserve (50) (250)
Preference shares 3,200 2,350
Available funds for economic capital excluding goodwill 15,950 14,050
Average historic goodwill and intangible assets(b) 7,750 6,450
Available funds for economic capital(c) 23,700 20,500
Notes
(a) Averages for the period will not correspond to period-end balances disclosed in the balance sheet. Numbers are rounded to the nearest £50m for presentational
purposes only.
(b) Average goodwill relates to purchased goodwill and intangible assets from business acquisitions.
(c) Available funds for economic capital as at 31st December 2006 stood at £25,150m (31st December 2005: £21,850m).
Economic capital supply
The capital resources to support economic capital comprise adjusted
shareholders’ equity including Preference Shares but excluding other
minority interests. Preference Shares have been issued to optimise the
long-term capital base of the Group.
The capital resources to support economic capital are impacted by a
number of factors arising from the application of IFRSs and are modified
in calculating available funds for economic capital. This applies
specifically to:
•Cash flow hedging reserve – to the extent that the Group undertakes
the hedging of future cash flows, shareholders’ equity will include
gains and losses which will be offset against the gain or loss on the
hedged item when it is recognised in the income statement at the
conclusion of the future hedged transaction. Given the future offset
of such gains and losses, they are excluded from shareholders’
equity when calculating economic capital.
•Available for sale reserve – unrealised gains and losses on such
securities are included in shareholders’ equity until disposal or
impairment. Such gains and losses are excluded from shareholders’
equity for the purposes of calculating economic capital. Realised
gains and losses, foreign exchange translation differences and any
impairment charges recorded in the income statement will impact
economic profit.
•Retirement benefits liability – the Group has recorded a deficit with
a consequent reduction in shareholders’ equity. This represents a
non-cash reduction in shareholders’ equity. For the purposes of
calculating economic capital, the Group does not deduct the pension
deficit from shareholders’ equity.