Barclays 2008 Annual Report Download - page 73

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Business review
Credit risk
Credit risk is the risk of suffering financial loss, should any of the Group’s
customers, clients or market counterparties fail to fulfil their contractual
obligations to the Group. The credit risk that the Group faces arises mainly
from wholesale and retail loans and advances. However, credit risk may also
arise where the downgrading of an entity’s credit rating causes the fair
value of the Group’s investment in that entity’s financial instruments to fall.
In a recessionary environment, such as that ongoing in the United
Kingdom, the United States and other economies, credit risk increases.
Credit risk may also be manifested as country risk where difficulties may
arise in the country in which the exposure is domiciled, thus impeding or
reducing the value of the assets, or where the counterparty may be the
country itself.
Another form of credit risk is settlement risk, which is the possibility
that the Group may pay a counterparty but fail to receive the
corresponding settlement in return. The Group is exposed to many
different industries and counterparties in the normal course of its
business, but its exposure to counterparties in the financial services
industry is particularly significant. This exposure can arise through trading,
lending, deposit-taking, clearance and settlement and many other
activities and relationships. These counterparties include brokers and
dealers, commercial banks, investment banks, mutual and hedge funds
and other institutional clients. Many of these relationships expose the
Group to credit risk in the event of default of a counterparty and to
systemic risk affecting its counterparties. Where the Group holds collateral
against counterparty exposures, it may not be able to realise it or liquidate
it at prices sufficient to cover the full exposures. Many of the hedging and
other risk management strategies utilised by the Group also involve
transactions with financial services counterparties. The failure of these
counterparties to settle or the perceived weakness of these counterparties
may impair the effectiveness of the Group’s hedging and other risk
management strategies.
The Group’s credit risk governance structure, management and
measurement methodologies, together with an analysis of exposures to
credit risk is detailed in the ‘Credit risk management’ section on page 80
and the ‘Credit Risk’ note to the financial statements on page 264.
Barclays Capital credit market exposures
An analysis of Barclays Capital’s credit market exposures is detailed on
pages 106 to 118.
Market risk
Market risk is the risk that the Group’s earnings or capital, or its ability to
meet business objectives, will be adversely affected by changes in the level
or volatility of market rates or prices such as interest rates, credit spreads,
commodity prices, equity prices and foreign exchange rates. Market risk
has increased due to the volatility of the current financial markets.
Barclays PLC Annual Report 2008 71
The main market risk arises from trading activities. Barclays is also
exposed to market risk through non-traded interest rate risk and the
pension fund.
The Group’s market risk governance structure, management and
measurement methodologies, together with an analysis of exposures
to both traded and non-traded market risk is detailed in the ‘Market risk
management’ section on page 119 and the ‘Market Risk’ note to the
financial statements on page 278. Pension risk is analysed in note 30
on page 234.
The Group’s future earnings could be affected by depressed asset
valuations resulting from a deterioration in market conditions. Financial
markets are sometimes subject to stress conditions where steep falls in
asset values can occur, as demonstrated by recent events affecting asset
backed CDOs and the US sub-prime residential mortgage market and
which may occur in other asset classes during an economic downturn.
Severe market events are difficult to predict and, if they continue to occur,
could result in the Group incurring additional losses.
In 2007 and in 2008, the Group recorded material net losses on
certain credit market exposures, including ABS CDO Super Senior
exposures. As market conditions change, the fair value of these exposures
could fall further and result in additional losses or impairment charges,
which could have a material adverse effect on the Group’s earnings. Such
losses or impairment charges could derive from: a decline in the value of
exposures; a decline in the ability of counterparties, including monoline
insurers, to meet their obligations as they fall due; or the ineffectiveness of
hedging and other risk management strategies in circumstances of severe
stress.
Liquidity risk
This is the risk that the Group is unable to meet its obligations when
they fall due as a result of customer deposits being withdrawn, cash
requirements from contractual commitments, or other cash outflows,
such as debt maturities. Such outflows would deplete available cash
resources for client lending, trading activities and investments. In extreme
circumstances, lack of liquidity could result in reductions in balance
sheet and sales of assets, or potentially an inability to fulfil lending
commitments. This risk is inherent in all banking operations and can
be affected by a range of institution-specific and market-wide events
including, but not limited to, credit events, merger and acquisition
activity, systemic shocks and natural disasters. The Group’s liquidity
risk management has several components:
– intra-day monitoring to maintain sufficient liquidity to meet all
settlement obligations;
– mismatch limits to control expected cash flows from maturing assets
and liabilities;