RBS 2006 Annual Report Download - page 184
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Please find page 184 of the 2006 RBS annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.RBS Group • Annual Report and Accounts 2006 183
Financial statements
Non-trading
The principal market risks arising from the Group’s non-trading
activities are interest rate risk, currency risk and equity risk.
Treasury activity and mismatches between the repricing of assets
and liabilities in its retail and commercial banking operations
account for most of the non-trading interest rate risk. Non-
trading currency risk derives from the Group’s investments in
overseas subsidiaries, associates and branches. The Group’s
venture capital portfolio and investments held by its general
insurance business are the principal sources of non-trading
equity price risk. The Group’s portfolios of non-trading financial
instruments mainly comprise loans (including finance leases),
debt securities, equity shares, deposits, certificates of deposit
and other debt securities issued, loan capital and derivatives.
To reflect their distinct nature, the Group’s long-term assurance
assets and liabilities attributable to policyholders have been
excluded from these market risk disclosures.
●Interest rate risk
Non-trading interest rate risk arises from the Group’s treasury
activities and retail and commercial banking businesses.
Treasury
The Group’s treasury activities include its money market
business and the management of internal funds flow within the
Group’s businesses. Money market portfolios include cash
instruments (principally debt securities, loans and deposits)
and related hedging derivatives.
Retail and commercial banking
Non-trading interest rate risk is calculated in each business on
the basis of establishing the repricing behaviour of each asset,
liability and off-balance sheet product. For many products, the
actual interest rate repricing characteristics differ from the
contractual repricing. In most cases, the repricing maturity is
determined by the market interest rate that most closely fits the
historical behaviour of the product interest rate. For non-interest
bearing current accounts, the repricing maturity is determined
by the stability of the portfolio. The repricing maturities used
are approved by Group Treasury and divisional asset and
liability committees at least annually. Key conventions are
reviewed annually by GALCO.
A static maturity gap report is produced as at the month-end
for each division, in each functional currency based on the
behaviouralised repricing for each product. It is Group policy
to include in the gap report, non-financial assets and liabilities,
mainly property, plant and equipment and the Group’s capital
and reserves, spread over medium and longer term maturities.
This report also includes hedge transactions, principally derivatives.
Any residual non-trading interest rate exposures are controlled
by limiting repricing mismatches in the individual balance
sheets. Potential exposures to interest rate movements in the
medium to long term are measured and controlled using a
version of the same VaR methodology that is used for the
Group’s trading portfolios but without discount factors. Net
accrual income exposures are measured and controlled in
terms of sensitivity over time to movements in interest rates.
Risk is managed within limits approved by GALCO through the
execution of cash and derivative instruments. Execution of the
hedging is carried out by the relevant division through the
Group’s treasury function. The residual risk position is reported
to divisional asset and liability committees, GALCO and Board.
●Currency risk
The Group does not maintain material non-trading open
currency positions other than the structural foreign currency
translation exposures arising from its investments in foreign
subsidiaries and associated undertakings and their related
currency funding. The Group’s policy in relation to structural
positions is to match fund the structural foreign currency
exposure arising from net asset value, including goodwill, in
foreign subsidiaries, equity accounted investments and
branches, except where doing so would materially increase the
sensitivity of either the Group’s or the subsidiary’s regulatory
capital ratios to currency movements. The policy requires
structural foreign exchange positions to be reviewed regularly
by GALCO. Foreign exchange differences arising on the
translation of foreign operations are recognised directly in
equity together with the effective portion of foreign exchange
differences arising on hedging liabilities.