Barclays 2015 Annual Report Download - page 122

120 I Barclays PLC Annual Report 2015 home.barclays/annualreport
Risk review
Material existing and emerging risks
Material existing and emerging risks to the Group’s future performance
This section describes the material risks to which senior management
pays particular attention, which they believe could cause the future
results of the Group’s operations, financial condition and prospects
to differ materially from current expectations. These expectations
include the ability to pay dividends, maintain appropriate levels of
capital and meet capital and leverage ratio targets, and achieve
stated commitments as outlined in the Strategic Report. In addition,
risks relating to the Group that are not currently known, or that are
currently deemed immaterial, may individually or cumulatively have
the potential to materially affect the future results of the Group’s
operations, financial condition and prospects.
Material risks and their impact are described below in two sections: i)
risks which senior management believes are likely to impact a single
Principal Risk; and ii) risks which senior management believes are likely
to affect more than one Principal Risk. Certain risks below have been
classified as an ‘emerging risk’, which is a risk that has the potential to
have a significant detrimental effect on the Group’s performance, but
currently the outcome and the time horizon for the crystallisation of its
possible impact is more uncertain and more difficult to predict than for
other risk factors that are not identified as emerging risks.
More information on the management of risks may be found in Barclays’
Approach to Managing Risk in the Barclays PLC 2015 Pillar 3 Report.
Material existing and emerging risks by
Principal Risk
Credit risk
The financial condition of the Group’s customers, clients and
counterparties, including governments and other financial
institutions, could adversely affect the Group.
The Group may suffer financial loss if any of its customers, clients or
market counterparties fails to fulfil their contractual obligations to the
Group. The Group may also suffer loss when the value of its investment
in the financial instruments of an entity falls as a result of that entity’s
credit rating being downgraded. In addition, the Group may incur
significant unrealised gains or losses due to changes in the Group’s
credit spreads or those of third parties, as these changes affect the fair
value of the Group’s derivative instruments, debt securities that the
Group holds or issues, and loans held at fair value.
i) Deterioration in political and economic environment
The Group’s performance is at risk from deterioration in the economic
and political environment which may result from a number of
uncertainties, including the following:
a) Specific regions
Political instability, economic uncertainty or deflation in regions in which
the Group operates could weaken growth prospects and have an
adverse impact on customers’ ability to service debt and so result in
higher impairment charges for the Group. These include:
China (emerging risk)
Economic uncertainty in China continues to affect a number of emerging
economies, particularly those with high fiscal deficits and those reliant
on short-term external financing and/or material reliance on commodity
exports. Their vulnerability has been further impacted by the fall, and
sustained volatility in oil prices, the strong US dollar and the winding
down of quantitative easing policies by some central banks. The impact
on the Group may vary depending on the vulnerabilities present in each
country, but the impact may result in increased impairment charges
through sovereign defaults, or the inability or unwillingness of clients
and counterparties in that country to meet their debt obligations.
South Africa
The negative economic outlook in South Africa continues, with a
challenging domestic and external environment. Recent political events
including changes to leaders in the Finance Ministry have added to the
domestic challenges. Real GDP growth remains low as a result of
declining global demand, in particular China, prices for key mineral
exports, a downturn in tourism, persistent power shortages and slowing
house price growth. In the retail sector, concerns remain over the level of
consumer indebtedness and affordability as the slowdown in China
impacts the mining sector with job losses increasing. Emerging market
turmoil has added further pressure on the Rand, which has continued to
depreciate against major currencies. The decline in the economic
outlook may impact a range of industry sectors in the corporate
portfolio, with clients with higher leverage being impacted most.
b) Interest rate rises, including as a result of slowing of monetary
stimulus, could impact consumer debt affordability and corporate
profitability
To the extent that central banks increase interest rates in certain
developed markets, particularly in our main markets, the UK and the US,
they are expected to be small and gradual in scale during 2016, albeit
following differing timetables. The first of these occurred in the US with
a quarter point rise in December 2015. While an increase may support
Group income, any sharper than expected changes could cause stress in
the loan portfolio and underwriting activity of the Group, particularly in
relation to non-investment grade lending, leading to the possibility of the
Group incurring higher impairment. Higher credit losses and a
requirement to increase the Group’s level of impairment allowance would
most notably occur in the Group’s retail unsecured and secured
portfolios as a result of a reduction in recoverability and value of the
Group’s assets, coupled with a decline in collateral values.
Interest rate increases in developed markets may also negatively impact
emerging economies, as capital flows to mature markets to take
advantage of the higher returns and strengthening economic
fundamentals.
ii) Specific sectors
The Group is subject to risks arising from changes in credit quality and
recovery rate of loans and advances due from borrowers and
counterparties in a specific portfolio. Any deterioration in credit quality
could lead to lower recoverability and higher impairment in a specific
sector. The following provides examples of areas of uncertainties to the
Group’s portfolio which could have a material impact on performance.
a) UK property
With UK property representing the most significant portion of the overall
PCB credit exposure, the Group is at risk from a fall in property prices in
both the residential and commercial sectors in the UK. Strong house
price growth in London and the South East of the UK, fuelled by foreign
investment, strong buy to let (BTL) demand and subdued housing
supply, has resulted in affordability levels reaching record levels; average
house prices as at the end of 2015 were more than seven times average
earnings. A fall in house prices, particularly in London and the South
East of the UK, would lead to higher impairment and negative capital
impact as loss given default (LGD) rates increase. Potential losses would
likely be most pronounced in the higher loan to value (LTV) segments.
The proposal on BTL properties announced by the UK Chancellor of the
Exchequer in 2015, changing both the level of tax relief on rental income
and increasing levels of stamp duty from April 2016, may cause some
dislocation in the BTL market. Possible impacts include a reduced
appetite in the BTL market and an influx of properties for sale causing
downward pricing pressure, as well as reduced affordability as increased
tax liabilities reduce net retail yields. As a consequence this may lead to
an increase in BTL defaults at a time when market values may be
suppressed, with the potential that, while the Group carefully manages
such exposures, it may experience increased credit losses and
impairment from loans with high LTV ratios.
b) Natural Resources (emerging risk)
The risk of losses and increased impairment is more pronounced where
leverage is higher, or in sectors currently subject to strain, notably oil and
gas, mining and metals and commodities. Sustained oil price depression
continues and is driven by ongoing global excess supply. While the
positioning of these portfolios is relatively defensive and focuses on
investment grade customers or collateralised positions, very severe
stress in this market does have the potential to significantly increase
credit losses and impairment.