20-F 1 dp37003_20f.htm FORM 20-F


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________
 
FORM 20-F
(Mark One)
 
 o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2012
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
 
o
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
 
 
Commission file number: 001-10306
 
THE ROYAL BANK OF SCOTLAND GROUP plc
 (Exact name of Registrant as specified in its charter)
 
United Kingdom
(Jurisdiction of incorporation)
 
RBS Gogarburn, PO Box 1000, Edinburgh EH12 1HQ, United Kingdom
(Address of principal executive offices)
 
Aileen Taylor, Group Secretary, Tel: +44 (0) 131 626 4099, Fax: +44 (0) 131 626 3081
 
PO Box 1000, Gogarburn, Edinburgh EH12 1HQ
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
 
 
Securities registered or to be registered pursuant to Section 12(b) of the Act:
 
Title of each class
Name of each exchange on which registered
American Depositary Shares, each representing 2 ordinary shares, nominal value £1 per share
Ordinary shares, nominal value £1 per share
American Depositary Shares Series F, H, L, M, N, P, Q, R, S, T and U each representing one Non-Cumulative Dollar Preference Share, Series F, H, L, M, N, P, Q, R, S, T and U respectively
Senior Floating Rate Notes due 2013
3.400% Senior Notes due 2013
3.250% Senior Notes due 2014
3.950% Senior Notes due 2015
4.875% Senior Notes due 2015
4.375% Senior Notes due 2016
5.625% Senior Notes due 2020
6.125% Senior Notes due 2021
6.125% Subordinated Tier 2 Notes due 2022
2.550% Senior Notes due 2015
Structured HybrId Equity LinkeD Securities (SHIELDS) due January 16, 2014  linked to the S&P 500 Index
Leveraged CPI Linked Securities due January 13, 2020
RBS US Large Cap TrendpilotTM Exchange Traded Notes due December 7, 2040
RBS US Mid Cap TrendpilotTM Exchange Traded Notes due January 25, 2041
RBS Gold TrendpilotTM Exchange Traded Notes due February 15, 2041
RBS Oil TrendpilotTM Exchange Traded Notes due September 13, 2041
RBS Global Big Pharma Exchange Traded Notes due October 25, 2041
RBS NASDAQ-100® TrendpilotTM Exchange Traded Notes due December 13, 2041
RBS China TrendpilotTM Exchange Traded Notes due April 18, 2042
RBS US Large Cap Alternator Exchange Traded NotesTM due September 5, 2042
RBS Rogers Enhanced Commodity Index Exchange Traded Notes due October 29, 2042
RBS Rogers Enhanced Agriculture Exchange Traded Notes due October 29, 2042
RBS Rogers Enhanced Energy Exchange Traded Notes due October 29, 2042
RBS Rogers Enhanced Precious Metals Exchange Traded Notes due October 29, 2042
RBS Rogers Enhanced Industrial Metals Exchange Traded Notes due October 29, 2042
New York Stock Exchange
New York Stock Exchange*
 
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
New York Stock Exchange
NYSE MKT
NYSE MKT
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
NYSE Arca
______________________________________
* Not for trading, but only in connection with the registration of American Depositary Shares representing such ordinary shares pursuant to the requirements of the Securities and Exchange Commission.
 
 
 

 
 
Securities registered or to be registered pursuant to Section 12(g) of the Act:
 
None
_______________
 
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
 
None
_______________
 
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of December 31, 2012, the close of the period covered by the annual report:
 
(Title of each class)
(Number of outstanding shares)
Ordinary shares of £1 each
B Shares
Dividend Access Share
11% cumulative preference shares
5½% cumulative preference shares
Non-cumulative dollar preference shares, Series F, H and L to U
Non-cumulative convertible dollar preference shares, Series 1
Non-cumulative euro preference shares, Series 1 to 3
Non-cumulative convertible sterling preference shares, Series 1
Non-cumulative sterling preference shares, Series 1
6,070,765,155
51,000,000,000
1
500,000
400,000
209,609,154
64,772
2,044,418
14,866
54,442

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
 
x  Yes o  No
 
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
 
o  Yes x  No
 
Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
x  Yes o  No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
o  Yes o  No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  x
Accelerated filer  o
 Non-Accelerated filer  o
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
 
o  U.S. GAAP
 
x  International Financial Reporting Standards as issued by the International Accounting Standards Board
 
o  Other

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
 
o  Item 17 o  Item 18

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
 
o  Yes x  No
 
 


 
 
 
 
 

 
 

SEC Form 20-F cross reference guide

Item
Item Caption
Pages
     
PART I
   
1
Identity of Directors, Senior Management, Advisers
Not applicable
     
2
Offer Statistics and Expected Timetable
Not applicable
     
3
Key Information
 
 
Selected financial data
9-10, 401-404, 443-444, 453, 477-479
 
Capitalisation and indebtedness
Not applicable
 
Reasons for the offer and use of proceeds
Not applicable
 
Risk factors
8, 459-471
     
4
Information on the Company
14-18, 63, 96-243, 375-376, 379-380, 384-386, 443-453
 
History and development of the Company
2-3, 5-7, 305-307, 387-389, 414, 456, 492, 505
 
Business overview
5-8, 26-58, 244-248, 305-307, 424-431, 454-457
 
Organisational structure
5-6, 424
 
Property, plant and equipment
384-386, 456
     
4A
Unresolved Staff Comments
Not applicable
     
5
Operating and Financial Review and Prospects
 
 
Operating results
7, 9-63, 244-246, 377-378, 454-455
 
Liquidity and capital resources
62-63, 87-115, 348-375, 377-380, 384-386, 394-399, 401-403, 414, 422-423, 452
 
Research and development, patents, licences etc
Not applicable
 
Trend information
5-7, 459-471
 
Off balance sheet arrangements
409-410, 413-414
 
Contractual obligations
97-111, 405-408
     
6
Directors, Senior Management and Employees
 
 
Directors and senior management
257-260
 
Compensation
279-301, 335-345, 432
 
Board practices
262-274, 279-280, 289-290, 309
 
Employees
28, 306, 335-337
 
Share ownership
297-299
     
7
Major Shareholders and Related Party Transactions
 
 
Major shareholders
309, 456
 
Related party transactions
433-434
 
Interests of experts and counsel
Not applicable
     
8
Financial Information
 
 
Consolidated statements and other financial information
305, 311-441, 479
 
Significant changes
6, 434

 
i

 
 
Item
Item Caption
Pages
     
9
The Offer and Listing
 
 
Offer and listing details
477-478
 
Plan of distribution
Not applicable
 
Markets
476
 
Selling shareholders
Not applicable
 
Dilution
Not applicable
 
Expenses of the issue
Not applicable
     
10
Additional Information
 
 
Share capital
Not applicable
 
Memorandum and articles of association
484-492
 
Material contracts
456-457
 
Exchange controls
484
 
Taxation
480-483
 
Dividends and paying agents
Not applicable
 
Statement of experts
Not applicable
 
Documents on display
492
 
Subsidiary information
Not applicable
     
11
Quantitative and Qualitative Disclosure about Market Risk
66-252, 348-375, 377-378
     
12
Description of Securities other than Equity Securities
458
     
     
PART II
   
13
Defaults, Dividend Arrearages and Delinquencies
Not applicable
     
14
Material Modifications to the Rights of Security Holders and Use of Proceeds
Not applicable
     
15
Controls and Procedures
271-273, 302-304, 312
16
[Reserved]
 
     
16
A Audit Committee financial expert
268-274
16
B Code of ethics
307
16
C Principal Accountant Fees and services
268-274, 345
16
D Exemptions from the Listing Standards for Audit Committees
Not applicable
16
E Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Not applicable
     
16
F Change in Registrant’s Certifying Accountant
Not applicable
16
G Corporate Governance
262-267
16
H Mine Safety Disclosure
Not applicable
     
     
PART III
   
17
Financial Statements
Not applicable
 
   
18
Financial Statements
311-441
 
   
19
Exhibits
506
     
 
Signature
507

 
ii

 
2
Presentation of information
4
Forward-looking statements
5
Description of business
7
Competition
8
Risk factors
9
Key financials
10
Summary consolidated income statement
11
Results summary
14
Analysis of results
26
Divisional performance
59
Consolidated balance sheet
62
Cash flow
63
Capital resources
64
Analysis of balance sheet pre and post disposal groups
66
Risk and balance sheet management
 
 

 
 
1

 
 
Presentation of information
 
 
In this document, and unless specified otherwise, the term ‘company’ or ‘RBSG’ means The Royal Bank of Scotland Group plc, ‘RBS’, ‘RBS Group’ or the ‘Group’ means the company and its subsidiaries, ‘the Royal Bank’ means The Royal Bank of Scotland plc and ‘NatWest’ means National Westminster Bank Plc.

The company publishes its financial statements in pounds sterling (‘£’ or ‘sterling’). The abbreviations ‘£m’ and ‘£bn’ represent millions and thousands of millions of pounds sterling, respectively, and references to ‘pence’ represent pence in the United Kingdom (‘UK’). Reference to ‘dollars’ or ‘$’ are to United States of America (‘US’) dollars. The abbreviations ‘$m’ and ‘$bn’ represent millions and thousands of millions of dollars, respectively, and references to ‘cents’ represent cents in the US. The abbreviation ‘€’ represents the ‘euro’, the European single currency, and the abbreviations ‘€m’ and ‘€bn’ represent millions and thousands of millions of euros, respectively.

Certain information in this report is presented separately for domestic and foreign activities. Domestic activities primarily consist of the UK domestic transactions of the Group. Foreign activities comprise the Group's transactions conducted through those offices in the UK specifically organised to service international banking transactions and transactions conducted through offices outside the UK.

The geographic analysis in the Business Review, including the average balance sheet and interest rates, changes in net interest income and average interest rates, yields, spreads and margins in this report have been compiled on the basis of location of office - UK and overseas. Management believes that this presentation provides more useful information on the Group's yields, spreads and margins of the Group's activities than would be provided by presentation on the basis of the domestic and foreign activities analysis used elsewhere in this report as it more closely reflects the basis on which the Group is managed. ‘UK’ in this context includes domestic transactions and transactions conducted through the offices in the UK which service international banking transactions.

The results, assets and liabilities of individual business units are classified as trading or non-trading based on their predominant activity. Although this method may result in some non-trading activity being classified as trading, and vice versa, the Group believes that any resulting misclassification is not material.

International Financial Reporting Standards
As required by the Companies Act 2006 and Article 4 of the European Union IAS Regulation, the consolidated financial statements of the Group are prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the IFRS Interpretations Committee of the IASB as adopted by the European Union (together ‘IFRS’). They also comply with IFRS as issued by the IASB.

RBS Holdings N.V. (formerly ABN AMRO Holding N.V.)
In 2007, RFS Holdings B.V., which was jointly owned by the Group, the Dutch State (successor to Fortis) and Santander (together, the “Consortium Members”) completed the acquisition of ABN AMRO Holding N.V.

On 1 April 2010, the businesses acquired by the Dutch State were transferred to ABN AMRO Group N.V., itself owned by the Dutch State. In connection with the transfer ABN AMRO Holding N.V. was renamed RBS Holdings N.V. and its banking subsidiary was renamed The Royal Bank of Scotland N.V. (“RBS N.V.”). Certain assets of RBS N.V. continue to be shared by the Consortium Members.

In October 2011, the Group completed the transfer of a substantial part of the UK activities of RBS N.V. to the Royal Bank pursuant to Part VII of the UK Financial Services and Markets Act 2000. Substantially all of the Netherlands and EMEA businesses were transferred in September 2012. Further transfers are expected to take place during 2013 but are subject to certain authorisations including regulatory approval where necessary. The Group now anticipates that the transfers in China will be completed at a later date.
 
 
 
2

 
 
Presentation of information continued
 
 
Non-GAAP financial information
The directors manage the Group’s performance by class of business, before certain reconciling items, as is presented in the segmental analysis on pages 424 to 431 (the “managed basis”). Discussion of the Group’s performance focuses on the managed basis as the Group believes that such measures allow a more meaningful analysis of the Group’s financial condition and the results of its operations. These measures are non-GAAP financial measures. A body of generally accepted accounting principles such as IFRS is commonly referred to as ‘GAAP’. A non-GAAP financial measure is defined as one that measures historical or future financial performance, financial position or cash flows but which excludes or includes amounts that would not be so adjusted in the most comparable GAAP measure. Reconciliations of these non-GAAP measures are presented throughout this document or in the segmental analysis on pages 424 to 431. These non-GAAP financial measures are not a substitute for GAAP measures. Furthermore, RBS has divided its operations into “Core” and “Non- Core”. Certain measures disclosed in this document for Core operations and used by RBS management are non-GAAP financial measures as they represent a combination of all reportable segments with the exception of Non-Core. In addition, RBS has further divided parts of the Core business into “Retail & Commercial” consisting of the UK Retail, UK Corporate, Wealth, International Banking, Ulster Bank and US Retail & Commercial divisions. This is a non-GAAP financial measure. Lastly, the Basel III net stable funding ratio (see page 108) represents a non-GAAP financial measure given it is a metric that is not yet required to be disclosed by a government, governmental authority or self-regulatory organisation.
 
Disposal groups
Since 2011, the assets and liabilities relating to the RBS England and Wales and NatWest Scotland branch-based businesses, along with certain SME and corporate activities across the UK (‘UK branch-based businesses’), were classified within Disposal groups. Santander's withdrawal from the sale in October 2012 has led the Group to conclude that a sale within 12 months is unlikely; accordingly the balance sheet at 31 December 2012 does not classify the assets and liabilities of the UK branch-based businesses within Disposal groups. IFRS 5 ‘Non-current Assets Held for Sale and Discontinued Operations’ does not permit restatement on reclassification.

Discontinued operations
The Group sold the first tranche (34.7%) of the share capital of Direct Line Insurance Group plc (DLG) in October 2012 via an Initial Public Offering (IPO), consistent with the plan to cede control by the end of 2013. In accordance with IFRS 5, DLG has been recognised as a discontinued operation with consequent changes to the presentation of comparative information. The assets and liabilities relating to DLG are included in Disposal groups as at 31 December 2012.

Share consolidation
Following approval at the Group’s Annual General Meeting on 30 May 2012, the sub-division and consolidation of the Group’s ordinary shares on a one-for-ten basis took effect on 6 June 2012. Consequently, prior year disclosures relating to or affected by numbers of ordinary shares or share price have been restated.

Glossary
A glossary of terms is provided on pages 494 to 501.
 

 
 
3

 
 
Forward-looking statements

 
Certain sections in this document contain ‘forward-looking statements’ as that term is defined in the United States Private Securities Litigation Reform Act of 1995, such as statements that include the words ‘expect’, ‘estimate’, ‘project’, ‘anticipate’, ‘believes’, ‘should’, ‘intend’, ‘plan’, ‘could’, ‘probability’, ‘risk’, ‘Value-at-Risk (VaR)’, ‘target’, ‘goal’, ‘objective’, ‘will’, ‘endeavour’, ‘outlook’, ‘optimistic’, ‘prospects’ and similar expressions or variations on such expressions.

In particular, this document includes forward-looking statements relating, but not limited to: the Group’s restructuring plans, divestments, capitalisation, portfolios, net interest margin, capital ratios, liquidity, risk weighted assets (RWAs), return on equity (ROE), profitability, cost:income ratios, leverage and loan:deposit ratios, funding and risk profile; discretionary coupon and dividend payments; certain ring-fencing proposals; sustainability targets; regulatory investigations; the Group’s future financial performance; the level and extent of future impairments and write-downs, including sovereign debt impairments; and the Group’s potential exposures to various types of political and market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. These statements are based on current plans, estimates and projections, and are subject to inherent risks, uncertainties and other factors which could cause actual results to differ materially from the future results expressed or implied by such forward-looking statements. For example, certain market risk disclosures are dependent on choices about key model characteristics and assumptions and are subject to various limitations. By their nature, certain of the market risk disclosures are only estimates and, as a result, actual future gains and losses could differ materially from those that have been estimated.

Other factors that could cause actual results to differ materially from those estimated by the forward-looking statements contained in this document include, but are not limited to: global economic and financial market conditions and other geopolitical risks, and their impact on the financial industry in general and on the Group in particular; costs or exposures borne by the Group arising out of the origination or sale of mortgages or mortgage-backed securities in the US; the continuing economic crisis in Europe; competition and consolidation in the banking sector; political risks; the risk of full nationalisation of the Group and its UK bank subsidiaries; HM Treasury exercising influence over the operations of the Group and any proposed offer or sale of its interest affecting the price of securities issued by the Group; the extent of future write-downs and impairment charges caused by depressed asset valuations; deteriorations in borrower and counterparty credit quality; the value or effectiveness of any credit protection purchased by the Group; changes in interest rates, yield curves, foreign currency exchange rates, credit spreads, bond prices, commodity prices, equity prices and basis, volatility and correlation risks; changes in required contributions to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers; pension fund shortfalls; the ability to access sufficient sources of capital, liquidity and funding when required; ineffective management of capital or changes to capital adequacy or liquidity requirements; changes in the credit ratings of the Group and the UK Government; the ability to access the contingent capital arrangements with HM Treasury and the conversion of the Contingent B Shares in accordance with their terms; changes in UK and foreign laws, regulations, accounting standards and taxes, including changes in regulatory capital regulations and liquidity requirements; the ability to implement strategic plans on a timely basis, or at all, including the disposal of certain non-core assets and of certain assets and businesses required as part of the State Aid restructuring plan; regulatory or legal changes (including those requiring any restructuring of the Group’s operations) in the UK, the US and other countries in which the Group operates or a change in UK Government policy; changes to the monetary and interest rate policies of central banks and other governmental and regulatory bodies; resolution procedures under current and proposed resolution and recovery schemes which may result in various actions being taken in relation to any securities of the Group; organisational restructuring in response to legislative and regulatory proposals in the United Kingdom (UK), European Union (EU) and United States (US); the implementation of recommendations made by the Independent Commission on Banking and their potential implications and equivalent EU and US legislation; litigation, government and regulatory investigations including investigations relating to the setting of LIBOR and other interest rates; changes to the valuation of financial instruments recorded at fair value; impairments of goodwill; the ability of the Group to generate sufficient future taxable profits to recover certain deferred tax assets; general operational risks; the Group’s dependency on its information technology systems; employee misconduct; reputational risk; the ability of the Group to attract or retain senior management or other key employees; insurance claims; limitations on, or additional requirements imposed on, the Group’s activities as a result of HM Treasury’s investment in the Group; and the success of the Group in managing the risks involved in the foregoing.

The forward-looking statements contained in this document speak only as of the date of this announcement, and the Group does not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

The information, statements and opinions contained in this document do not constitute a public offer under any applicable legislation or an offer to sell or solicitation of any offer to buy any securities or financial instruments or any advice or recommendation with respect to such securities or other financial instruments.
 

 
 
4

 
 
Business review

 
Description of business
Introduction
The Royal Bank of Scotland Group plc is the holding company of a large global banking and financial services group. Headquartered in Edinburgh, the Group operates in the United Kingdom, the United States and internationally through its principal subsidiaries, the Royal Bank and NatWest. Both the Royal Bank and NatWest are major UK clearing banks. In the United States, the Group's subsidiary RBS Citizens is a large commercial banking organisation. Globally, the Group has a diversified customer base and provides a wide range of products and services to personal, commercial and large corporate and institutional customers.

Following the placing and open offers in December 2008 and in April 2009, HM Treasury owned approximately 70.3% of the enlarged ordinary share capital of the company. In December 2009, the company issued a further £25.5 billion of new capital to HM Treasury. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as Core Tier 1 capital. Following the issuance of the B shares, HM Treasury's holding of ordinary shares of the company remained at 70.3% although its economic interest rose to 84.4%.

At 31 December 2012, HM Treasury’s holding in the company’s ordinary shares was 65.3% and its economic interest was 81.1%.

The Group had total assets of £1,312.3 billion and owners' equity of £68.1 billion at 31 December 2012. The Group's risk asset ratios at 31 December 2012, were a Total capital ratio of 14.5%, a Core Tier 1 capital ratio of 10.3% and a Tier 1 capital ratio of 12.4%.

Organisational structure and business overview
Organisational change
In January 2012, the Group announced changes to its wholesale banking operations in light of a changed market and regulatory environment. The changes saw the reorganisation of the Group’s wholesale businesses into ‘Markets’ and ‘International Banking’ and the exit from and downsizing of selected activities. The changes ensure the wholesale businesses continue to deliver against the Group’s strategy.

The changes include an exit from cash equities, corporate brokering, equity capital markets and mergers and acquisitions advisory businesses. Significant reductions in balance sheet, funding requirements and cost base in the remaining wholesale businesses will be implemented.

Global Banking & Markets (GBM) and Global Transaction Services (GTS) divisions have been reorganised as follows:

·
The ‘Markets’ business maintains its focus on fixed income, with strong positions in debt capital raising, securitisation, risk management, foreign exchange and rates. It will serve the corporate and institutional clients of all Group businesses.

·
GBM's corporate banking business has been combined with the international businesses of the GTS arm into a new ‘International Banking’ unit and provides clients with a 'one-stop shop' access to the Group’s debt financing, risk management and payments services. This international corporate business will be self-funded through its stable corporate deposit base.
 
·
The domestic small and mid-size corporates previously served by GTS are now managed within RBS's domestic corporate banking businesses in the UK, Ireland (Ulster Bank) and the US (US Retail & Commercial).

Our wholesale business retains its international footprint ensuring that it can serve our customers' needs globally. We believe that, despite current challenges to the sector, wholesale banking services can play a central role in supporting cross border trade and capital flows, financing requirements and risk management and we remain committed to this business.

The Group’s activities are organised on a divisional basis as follows:

UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through a number of channels including: the RBS and NatWest network of branches and ATMs in the United Kingdom, telephony, online and mobile. UK Retail remains committed to delivering ‘Helpful and Sustainable’ banking and to the commitments set out in its Customer Charter - the results of which are externally assessed and published every six months.

UK Corporate is a leading provider of banking, finance and risk management services to the corporate and SME sector in the United Kingdom. It offers a full range of banking products and related financial services through a nationwide network of relationship managers, and also through telephone and internet channels. The product range includes asset finance through the Lombard brand.

Wealth provides private banking and investment services in the UK through Coutts & Co and Adam & Company, offshore banking through RBS International, NatWest offshore and Isle of Man Bank, and international private banking through Coutts & Co Ltd.

International Banking serves the world’s largest companies with a leading client proposition focused on financing, transaction services and risk management. International Banking serves as the delivery channel for Markets products to corporate clients and serves international subsidiaries of both International Banking and clients from UK Corporate, Ulster Bank and US Retail & Commercial through its international network.

Ulster Bank is a leading retail and commercial bank in Northern Ireland and the Republic of Ireland. It provides a comprehensive range of financial services through both its Retail Banking division, which provides loan and deposit products through a network of branches and direct channels, and its Corporate Banking division, which provides services to businesses and corporate customers.

US Retail & Commercial provides financial services primarily through the Citizens and Charter One brands. US Retail & Commercial is engaged in retail and corporate banking activities through its branch network in 12 states in the United States and through non-branch offices in other states.

The divisions discussed above are collectively referred to as Retail & Commercial.
 
 
 
5

 
 
Business review continued

 
Markets is a leading origination, sales and trading business across debt finance, fixed income, currencies and investor products. The division offers a unified service to the Group’s corporate and institutional clients. The Markets’ sales and research teams build strong ongoing client partnerships, provide market perspective and access, and work with the division’s trading and structuring teams to meet the client’s objectives across financing, risk management, investment, securitisation and liquidity.

Direct Line Group is a retail general insurer with leading market positions in the United Kingdom, a strong presence in the direct motor channel in Italy and Germany and a focused position in UK SME commercial insurance. The Group operates under highly recognised brands such as Direct Line and Churchill and is comprised of five primary segments: motor, home, rescue and other personal lines, commercial and international.

In the UK, Direct Line Group utilises a multi-brand, multi-product and multi-distribution channel business model that covers most major customer segments for personal lines general insurance. The Group also has a focused presence in the commercial market. The Group occupies leading market positions in terms of in-force policies and has the most highly recognised brands in the UK for personal motor and home insurance including Direct Line and Churchill. Other primary Direct Line Group brands include Privilege and Green Flag; NIG, a provider of insurance solutions to UK SMEs and Direct Line For Business (“DL4B”), the Group’s direct commercial brand. The Group is also a major provider of insurance through a number of strategic partnerships. In Italy and Germany the Group operates under the Direct Line brand. It is planned for control of DLG to be ceded by the end of 2013.

Central Functions comprises Group and corporate functions, such as treasury, finance, risk management, legal, communications and human resources. The Centre manages the Group's capital resources and Group-wide regulatory projects and provides services to the operating divisions.

Non-Core division manages separately assets that the Group intends to run off or dispose of. The division contains a range of businesses and asset portfolios primarily from the legacy GBM businesses, higher risk profile asset portfolios including excess risk concentrations, and other illiquid portfolios. It also includes a number of other portfolios and businesses including regional markets businesses that the Group has concluded are no longer strategic.

Business Services supports the customer-facing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services. Business Services drives efficiencies and supports income growth across multiple brands and channels by using a single, scalable platform and common processes wherever possible. It also leverages the Group's purchasing power and is the Group's centre of excellence for managing large-scale and complex change. For reporting purposes, Business Services costs are allocated to the divisions above. It is not deemed a reportable segment.

Business divestments
To comply with the European Commission State aid requirements the Group agreed a series of restructuring measures to be implemented over a four year period from December 2009. These measures supplement the Strategic Plan previously announced by the Group. These include the divestment of Direct Line Insurance Group plc, the sale of 80.01% of the Group’s Global Merchant Services business (completed in 2010) and the sale of substantially all of the RBS Sempra Commodities joint venture business (largely completed in 2010), as well as the divestment of the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct SME customers across the UK.

In 2010, the Group reached agreement with Santander UK plc (‘Santander’) on the sale of certain UK branch-based businesses broadly comprising the RBS branch-based business in England and Wales and the NatWest branch-based business in Scotland, along with certain SME and corporate activities across the UK. However, in October 2012, the Group announced that it had received notification of Santander’s decision to pull out of its agreed purchase of these businesses. Santander's decision followed extensive work by both parties to separate the businesses into a largely standalone form and to prepare the businesses, customers and staff for transfer. RBS is continuing to work to fulfil its obligations to divest these businesses.

Also in October 2012, the Group sold via an initial public offering 520.8 million ordinary shares in Direct Line Insurance Group plc, representing 34.7% of the total issued share capital. This is consistent with the European Commission’s requirement to cede control by the end of 2013 and complete full divestment from the Group by the end of 2014.

Recent developments
Liability Management Exercise
In January 2013, The Royal Bank of Scotland plc completed a cash tender offer for approximately £2 billion principal amount of certain US Dollar, Euro, Sterling, Swiss Franc and Singapore Dollar denominated senior unsecured securities.

Markets & International Banking Executive changes
On 6 February 2013, the Group announced that John Hourican, Chief Executive, Markets & International Banking, will leave the Group once he has completed a handover of his responsibilities. With effect from 1 March 2013, Suneel Kamlani and Peter Nielsen will be co-heads of the Markets division and John Owen will continue to lead the International Banking division and will all report directly to the Group Chief Executive.

Sale of Direct Line Insurance Group plc ordinary shares
On 13 March 2013, the Group announced a further sale of its stake in Direct Line Insurance Group plc. The further sale resulted in RBS selling 251.4 million shares, raising gross proceeds of £505 million. The Group now holds 48.5% of the issued ordinary share capital of Direct Line Insurance Group plc.
 
Executive director
Joe MacHale will step down from the Board on 4 May 2013.
 
 
 
 
 
6

 
 
Business review continued

 
Competition
The Group faces strong competition in all the markets it serves. Banks’ balance sheets have strengthened whilst loan demand remains subdued as many customers continue to delever and the UK economy has remained weak. Competition for retail deposits remains strong as institutions continue to target strong and diverse funding platforms for their balance sheets.

Competition for corporate and institutional customers in the UK and abroad is from UK banks and from large foreign universal banks that offer combined investment and commercial banking capabilities. In addition, the Group’s Markets division faces strong competition from dedicated investment banks. In asset finance, the Group competes with banks and specialist asset finance providers, both captive and non-captive. In European and Asian corporate and institutional banking markets the Group competes with the large domestic banks active in these markets and with the major international banks.

In the small business banking market, the Group competes with other UK clearing banks, specialist finance providers and building societies.

In the personal banking segment, the Group competes with UK clearing banks and building societies, major retailers and life assurance companies. In the mortgage market, the Group competes with UK clearing banks and building societies. The ambitions of non-traditional players in the UK market remain strong, with new entrants active and potentially seeking to build their platforms by acquiring businesses made available through restructuring of incumbents. The Group distributes life assurance products to banking customers in competition with independent advisors and life assurance companies.

In the UK credit card market large retailers and specialist card issuers are active in addition to the UK banks. In addition to physical distribution channels, providers compete through direct marketing activity and the internet.
 
In Wealth Management, The Royal Bank of Scotland International competes with other UK and international banks to offer offshore banking services. Coutts and Adam & Company compete as private banks with UK clearing and private banks, and with international private banks. Competition in wealth management remains strong as banks maintain their focus on competing for affluent and high net worth customers.

Direct Line Group competes in personal lines insurance and, to a more limited extent, in commercial insurance. There is strong competition from a range of insurance companies which now operate telephone and internet direct sales businesses. Competition in the UK motor market remains intense, and price comparison internet sites now play a major role in the marketplace. These sites have extended their scope to home insurance and other lines. Direct Line Group also competes with local insurance companies in the direct motor insurance markets in Italy and Germany.

In Ireland, Ulster Bank competes in retail and commercial banking with the major Irish banks and building societies, and with other UK and international banks and building societies active in the market. The challenging conditions in the Irish economy persist and many of the domestic Irish banks have required State support and are engaged in significant restructuring actions.

In the United States, RBS Citizens competes in the New England, Mid-Atlantic and Mid-West retail and mid-corporate banking markets with local and regional banks and other financial institutions. The Group also competes in the US in large corporate lending and specialised finance markets, and in fixed-income trading and sales. Competition is principally with the large US commercial and investment banks and international banks active in the US. The economic recovery in the US is proving weaker than expected and loan demand is weak in Citizens’ markets.
 

 
 
7

 
 
Business review continued


Risk factors
Set out below is a summary of certain risks which could adversely affect the Group; it should be read in conjunction with the Risk and balance sheet management section of the Business review (pages 66 to 252). This summary should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties. A fuller description of these and other risk factors is included on pages 459 to 471.

·
The Group’s businesses, earnings and financial condition have been and will continue to be negatively affected by global economic conditions, the instability in the global financial markets and increased competition and political risks including proposed referenda on Scottish independence and UK membership of the EU. Together with a perceived increased risk of default on the sovereign debt of certain European countries and unprecedented stresses on the financial system within the Eurozone, these factors have resulted in significant changes in market conditions including interest rates, foreign exchange rates, credit spreads, and other market factors and consequent changes in asset valuations.

·
The actual or perceived failure or worsening credit of the Group’s counterparties or borrowers and depressed asset valuations resulting from poor market conditions have adversely affected and could continue to adversely affect the Group.

·
The Group’s ability to meet its obligations’ including its funding commitments depends on the Group’s ability to access sources of liquidity and funding. The inability to access liquidity and funding due to market conditions or otherwise could adversely affect the Group’s financial condition. Furthermore, the Group’s borrowing costs and its access to the debt capital markets and other sources of liquidity depend significantly on its and the UK Government’s credit ratings.

·
The Group is subject to a number of regulatory initiatives which may adversely affect its business, including the UK Government’s implementation of the final recommendations of the Independent Commission on Banking’s final report on competition and possible structural reforms in the UK banking industry, the US Federal Reserve’s proposal for applying US capital, liquidity and enhanced prudential standards to certain of the Group’s US operations.

·
The Group’s business performance, financial condition and capital and liquidity ratios could be adversely affected if its capital is not managed effectively or as a result of changes to capital adequacy and liquidity requirements, including those arising out of Basel III implementation (globally or by European or UK authorities), or if the Group is unable to issue Contingent B Shares to HM Treasury under certain circumstances.

·
As a result of the UK Government’s majority shareholding in the Group it can, and in the future may decide to, exercise a significant degree of influence over the Group including on dividend policy, modifying or cancelling contracts or limiting the Group’s operations. The offer or sale by the UK Government of all or a portion of its shareholding in the company could affect the market price of the equity shares and other securities and acquisitions of ordinary shares by the UK Government (including through conversions of other securities or further purchases of shares) may result in the delisting of the Group from the Official List.

·
The Group or any of its UK bank subsidiaries may face the risk of full nationalisation or other resolution procedures and various actions could be taken by or on behalf of the UK Government, including actions in relation to any securities issued, new or existing contractual arrangements and transfers of part or all of the Group’s businesses.

·
The Group is subject to substantial regulation and oversight, and any significant regulatory or legal developments could have an adverse effect on how the Group conducts its business and on its results of operations and financial condition. In addition, the Group is, and may be, subject to litigation and regulatory investigations that may impact its business, results of operations and financial condition.

·
The Group’s ability to implement its Strategic Plan depends on the success of its efforts to refocus on its core strengths and its balance sheet reduction programme. As part of the Group’s Strategic Plan and implementation of the State Aid restructuring plan agreed with the European Commission and HM Treasury, the Group is undertaking an extensive restructuring which may adversely affect the Group’s business, results of operations and financial condition and give rise to increased operational risk.

·
The Group could fail to attract or retain senior management, which may include members of the Group Board, or other key employees, and it may suffer if it does not maintain good employee relations.

·
Operational and reputational risks are inherent in the Group’s businesses.

·
The value of certain financial instruments recorded at fair value is determined using financial models incorporating assumptions, judgements and estimates that may change over time or may ultimately not turn out to be accurate.

·
The Group’s insurance businesses are subject to inherent risks involving claims on insured events.

·
Any significant developments in regulatory or tax legislation could have an effect on how the Group conducts its business and on its results of operations and financial condition, and the recoverability of certain deferred tax assets recognised by the Group is subject to uncertainty.

·
The Group may be required to make contributions to its pension schemes and government compensation schemes, either of which may have an adverse impact on the Group’s results of operations, cash flow and financial condition.
 

 
 
8

 
 
Business review continued


Key financials
 
for the year ended 31 December
2012 
£m 
2011 
£m 
2010 
£m 
Total income
17,941 
24,651 
26,622 
Operating loss before tax
(5,165)
(1,190)
(154)
Loss attributable to ordinary and B shareholders
(5,971)
(1,997)
(1,125)
Cost:income ratio
99% 
70% 
66% 
Basic and diluted loss from continuing operations per ordinary and B share (1)
(53.7p)
(21.3p)
(2.9p)


at 31 December
2012 
£m 
2011 
£m 
2010 
£m 
Funded balance sheet (2)
870,392 
977,249 
1,026,499 
Total assets
1,312,295 
1,506,867 
1,453,576 
Loans and advances to customers
500,135 
515,606 
555,260 
Deposits
622,684 
611,759 
609,483 
Owners' equity
68,130 
74,819 
75,132 
Risk asset ratios
- Core Tier 1
10.3% 
10.6% 
10.7% 
 
- Tier 1
12.4% 
13.0% 
12.9% 
 
- Total
14.5% 
13.8% 
14.0% 
Notes:
(1)
Prior year data have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares, which took effect in June 2012.
(2)
Funded balance sheet represents total assets less derivatives.


Overview of results
The results of RFS Holdings B.V., the entity that acquired ABN AMRO, are fully consolidated in the Group’s financial statements. The interests of the State of the Netherlands and Santander in RFS Holdings are included in non-controlling interests. Legal separation of ABN AMRO Bank N.V. took place on 1 April 2010. As a result, RBS presents the interests of the Consortium Members in ABN AMRO as discontinued operations.
 

 
 
9

 
 
Business review continued

 
Summary consolidated income statement for the year ended 31 December 2012

 
2012 
2011 
2010 
 
£m 
£m 
£m 
Net interest income
11,402 
12,303 
13,782 
Fees and commissions receivable
5,709 
6,379 
8,193 
Fees and commissions payable
(834)
(962)
(1,892)
Other non-interest income
1,664 
6,931 
6,425 
Insurance net premium income
— 
— 
114 
Non-interest income
6,539 
12,348 
12,840 
Total income
17,941 
24,651 
26,622 
Operating expenses
(17,827)
(17,134)
(17,456)
Profit before insurance net claims and impairment losses
114 
7,517 
9,166 
Insurance net claims
— 
— 
(85)
Impairment losses
(5,279)
(8,707)
(9,235)
Operating loss before tax
(5,165)
(1,190)
(154)
Tax charge
(469)
(1,127)
(703)
Loss from continuing operations
(5,634)
(2,317)
(857)
(Loss)/profit from discontinued operations, net of tax
     
  - Direct Line Group
(184)
301 
(176)
  - Other
12 
47 
(633)
(Loss)/profit from discontinued operations, net of tax
(172)
348 
(809)
Loss for the year
(5,806)
(1,969)
(1,666)
Non-controlling interests
123 
(28)
665 
Other owners’ dividends
(288)
— 
(124)
Loss attributable to ordinary and B shareholders
(5,971)
(1,997)
(1,125)
       
Basic and diluted loss from continuing operations per ordinary and B share (1)
(53.7p)
(21.3p)
(2.9p)

Note:
(1)
Prior year data have been adjusted for the sub-division and one-for-ten consolidation of ordinary shares, which took effect in June 2012.
 

 
 
10

 
 
Business review continued


Results summary
2012 compared with 2011
Operating loss before tax
Operating loss before tax for the year was £5,165 million compared with £1,190 million in 2011.

Total income
Total income decreased by 27% to £17,941 million in 2012, principally reflecting own credit adjustments partially offset by movements in the fair value of the Asset Protection Scheme (APS) and higher net gains on the redemption of own debt.

Net interest income
Net interest income declined by 7% to £11,402 million largely reflecting lower interest-earning asset balances. Group net interest margin (NIM) was up 3 basis points despite very low interest rates and strong deposit competition.

Non-interest income
Non-interest income decreased to £6,539 million from £12,348 million in 2011. This included movements in the fair value of the APS resulting in a £44 million charge (2011 - £906 million), net gain on redemption of own debt of £454 million (2011 - £255 million) and a loss on own credit adjustments of £4,649 million (2011 - £1,914 million gain). On a managed basis non-interest income decreased by £928 million in 2012 principally driven by lower net fees and commissions, largely due to weaker consumer spending volumes in the UK together with legislation changes in the US, and a fall in insurance net premium income, primarily due to lower written premiums in Direct Line Group.

The APS, which the Group exited from during the year, was accounted for as a credit derivative and movements in the fair value of the contract were recorded in income from trading activities. The APS fair value charge was £44 million in 2012 bringing the cumulative charge for the APS to £2.5 billion.

Liability management exercises undertaken by the Group during 2012 resulted in a net gain of £454 million (2011 - £255 million).

The continuing strengthening RBS’s credit profile resulted in a £4,649 million accounting charge in relation to own credit adjustments versus a gain of £1,914 million in 2011. This reflected a tightening of more than 340 basis points in the Group’s credit spreads over the year.

Operating expenses
Operating expenses increased to £17,827 million from £17,134 million in 2011. This included Payment protection Insurance (PPI) costs of £1,110 million (2011 - £850 million), Interest Rate Hedging Products redress and related costs of £700 million, regulatory fines of £381 million, integration and restructuring costs of £1,550 million compared with £1,059 million in 2011, bank levy of £175 million compared with £300 million in 2011 and write-down of goodwill and other intangible assets of £124 million, principally as a result of exits from selective countries and lower revenue projections by Markets. On a managed basis operating expenses fell by 6% to £14,619 million, with staff costs down 6% as headcount fell by 9,600 to 137,200. The decline in expenses was largely driven by Non-Core run-down and lower variable compensation (particularly in Markets), including variable compensation award reductions and clawbacks following the settlements reached with UK and US authorities in relation to attempts to manipulate LIBOR. The run-off of discontinued businesses in Markets and International Banking, following the restructuring announced in January 2012, and simplification of processes and headcount reduction in UK Retail also yielded cost benefits.

To reflect current experience of PPI complaints received, the Group increased its PPI provision by £1,110 million in 2012 compared with £850 million in 2011, bringing the cumulative charge taken to £2.2 billion, of which £1.3 billion (59%) in redress had been paid by 31 December 2012.

Following an industry-wide review conducted in conjunction with the Financial Services Authority, a charge of £700 million has been booked for redress in relation to certain interest-rate hedging products sold to small and medium-sized businesses classified as retail clients under FSA rules.

On 6 February 2013, RBS reached agreement with the Financial Services Authority, the US Department of Justice and the Commodity Futures Trading Commission in relation to the setting of LIBOR and other trading rates, including financial penalties of £381 million. The Group continues to co-operate with other bodies in this regard and expects it will incur some additional financial penalties.

Integration and restructuring costs of £1,550 million increased by £491 million versus £1,059 million in 2011, primarily driven by costs incurred in relation to the strategic restructuring of Markets and International Banking (M&IB) that took place during 2012.

The UK bank levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The cost of the levy to the Group for 2012 was £175 million compared with £300 million in 2011.
 

 
 
11

 
 
Business review continued


Impairment losses
Impairment losses were £5,279 million, compared with £8,707 million in 2011, with Core impairments falling by £464 million and Non-Core by £1,696 million, mostly in the Ulster Bank and commercial real estate portfolios. There was also the non-repeat of the sovereign debt impairment in 2011. On a managed basis Impairment losses fell to £5,279 million from £7,439 million in 2011.

In 2011, the Group recorded an impairment loss of £1,099 million in respect of its AFS portfolio of Greek government debt. In 2012, the vast majority of this portfolio was exchanged for Greek sovereign debt and European Financial Stability Facility notes; the Greek sovereign debt received in the exchange was sold.

Risk elements in lending represented 9.1% of gross loans and advances to customers excluding reverse repos at 31 December 2012 (2011 - 8.6%).

Provision coverage of risk elements in lending was 52% (2011 - 49%).

Tax
The tax charge for 2012 was £469 million (2011 - £1,127 million). The high tax charge in the year reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland), the reduction in the carrying value of deferred tax assets in Ireland in view of continuing losses, the reduction in the carrying value of deferred tax assets in Australia following the strategic changes to the Markets and International Banking businesses announced in January 2012 and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2012 and July 2012 on the net deferred tax balance.

Loss per share
Basic and diluted loss from continuing operations per ordinary and B share was 53.7p per share compared with 21.3p per share in 2011.
 
2011 compared with 2010
Operating loss before tax
Operating loss before tax for the year was £1,190 million compared with £154 million in 2010.

Total income
Total income decreased 7% to £24,651 million in 2011, principally reflecting own credit adjustments offset by lower net interest income, lower trading income in Markets and Non-Core, a fall in insurance net premium income, movements in the fair value of the APS and lower net gains on the redemption of own debt.
 
Net interest income
Net interest income fell 11% to £12,303 million largely driven by the run-off of balances and exit of higher margin, higher risk segments in Non-Core. Group NIM was 14 basis points lower, reflecting the cost of carrying a higher liquidity portfolio and by the impact of non-performing assets in the Non-Core division. However, R&C NIM was up 6 basis points, with strengthening asset margins in the first half of the year offsetting the impact of a competitive deposit market.

Non-interest income
Non-interest income decreased to £12,348 million from £12,840 million in 2010. This included movements in the fair value of the APS resulting in a £906 million charge (2010 - £1,550 million), gain on redemption of own debt of £255 million (2010 - £553 million) and a gain on movements in own credit adjustments of £1,914 million (2010 - £242 million gain). On a managed basis non-interest income decreased by £3,374 million in 2011 principally driven by lower trading income in Markets and Non-Core, and a fall in insurance net premium income. Volatile market conditions led to a reduction in Markets trading income, driven by the deterioration in global credit markets as sovereign difficulties in the eurozone grew. Non-Core trading losses increased by £690 million, reflecting costs incurred as part of the division’s focus on reducing capital trading assets.

A gain on the movement in own credit adjustments of £1,914 million was recorded in 2011 as Group credit spreads widened. This compares with a smaller gain of £242 million in 2010.

The APS is accounted for as a credit derivative and movements in the fair value of the contract were recorded in income from trading activities. The APS fair value charge was £906 million in 2011. The cumulative charge for the APS was £2,456 million as at 31 December 2011.
 

 
 
12

 
 
Business review continued


Operating expenses
Operating expenses decreased to £17,134 million (2010 - £17,456 million) of which integration and restructuring costs were £1,059 million compared with £1,032 million in 2010. On a managed basis operating expenses fell by 7% to £15,478 million, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra  and specific country exits. Staff costs fell 9% driven by lower Markets and International Banking variable compensation as a result of its decrease in revenues, and in Non-Core, given the impact of a 32% reduction in headcount and continues business disposals and country exits.
 
A charge of £850 million was booked in relation to PPI claims following the British Bankers’ Association decision, in May 2011, not to appeal the findings of the Judicial Review.

Integration and restructuring costs remained broadly flat at £1,059 million, reflecting significant Markets restructuring in 2011.

The Finance Act 2011 introduced an annual bank levy in the UK. The levy is based on the total chargeable equity and liabilities as reported in the balance sheet at the end of a chargeable period. The cost of the levy to the Group for 2011 was £300 million.

Insurance net claims
Insurance claims were £85 million lower in 2011, reflecting the dissolution of the Group’s bancassurance joint venture at the end of 2010.

Impairment losses
Impairment losses fell to £8,707 million from £9,235 million in 2010, with Core impairments falling by £260 million and Non-Core by £1,557 million, despite continuing challenges in Ulster Bank and corporate real estate portfolios. This was partially offset by impairments taken on the Group’s available-for-sale bond portfolio, as a result of the decline in the value of Greek sovereign bonds. On a managed basis impairment losses fell to £7,439 million from £9,256 million in 2010.

An impairment of £1,099 million was taken on the Group’s AFS bond portfolio in 2011 as a result of the decline in the value of Greek sovereign bonds. As of 31 December 2011, the bonds were marked at 21% of par value.

Risk elements in lending represented 8.6% of gross loans and advances to customers excluding reverse repos at 31 December 2011 (2010 - 7.3%).

Provision coverage of risk elements in lending was 49% (2010 - 47%).

Tax
The tax charge for 2011 was £1,127 million (2010 - £703 million). The high tax charge for the year reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.

Loss per share
Basic and diluted loss from continuing operations per ordinary and B share was 21.3p per share compared with 2.9p per share in 2010.
 

 
 
13

 
 
Business review continued


Analysis of results
Net interest income
 
2012 
2011 
2010 
 
£m 
£m 
£m 
Interest receivable (1)
18,530 
21,036 
22,352 
Interest payable
(7,128)
(8,733)
(8,570)
Net interest income
11,402 
12,303 
13,782 
       
Yields, spreads and margins of the banking business
Gross yield on interest-earning assets of the banking business (2)
3.13 
3.23 
3.29 
Cost of interest-bearing liabilities of the banking business
(1.55)
(1.68)
(1.47)
Interest spread of the banking business (3)
1.58 
1.55 
1.82 
Benefit from interest-free funds
0.34 
0.34 
0.21 
Net interest margin of the banking business (4)
1.92 
1.89 
2.03 
       
Gross yield (2)
     
  - Group
3.13 
3.23 
3.29 
  - UK
3.49 
3.57 
3.40 
  - Overseas
2.56 
2.77 
3.14 
Interest spread (3)
     
  - Group
1.58 
1.55 
1.82 
  - UK
1.84 
1.82 
1.99 
  - Overseas
1.25 
1.22 
1.58 
Net interest margin (4)
     
  - Group
1.92 
1.89 
2.03 
  - UK
2.04 
2.04 
2.17 
  - Overseas
1.74 
1.69 
1.84 
       
The Royal Bank of Scotland plc base rate (average)
0.50 
0.50 
0.50 
London inter-bank three month offered rates (average)
     
  - Sterling
0.82 
0.87 
0.70 
  - Eurodollar
0.43 
0.33 
0.34 
  - Euro
0.53 
1.36 
0.75 

Notes:
(1)
Interest income includes £565 million (2011 - £627 million; 2010 - £588 million) in respect of loan fees forming part of the effective interest rate of loans and receivables.
(2)
Gross yield is the interest earned on average interest-earning assets of the banking book.
(3)
Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business.
(4)
Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business.
(5)
The analysis into UK and overseas has been compiled on the basis of location of office.
(6)
Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities.
(7)
Interest income includes amounts (unwind of discount) recognised on impaired loans and receivables. The average balances of such loans are included in average loans and advances to banks and loans and advances to customers.
 

 
 
14

 
 
Business review continued
 
 

     
2012
 
2011
     
Average 
balance 
Interest 
Rate 
 
Average 
balance 
Interest 
Rate 
     
£m 
£m 
 
£m 
£m 
%
Assets
               
Loans and advances to banks
- UK
33,656 
248 
0.74 
 
29,852 
277 
0.93 
 
- Overseas
40,342 
245 
0.61 
 
41,716 
403 
0.97 
Loans and advances to customers
- UK
277,321 
11,326 
4.08 
 
293,777 
11,970 
4.07 
 
- Overseas
151,692 
4,862 
3.21 
 
171,938 
5,857 
3.41 
Debt securities
- UK
49,872 
1,015 
2.04 
 
55,074 
1,258 
2.28 
 
- Overseas
40,077 
834 
2.08 
 
58,027 
1,271 
2.19 
Interest-earning assets
- UK
360,849 
12,589 
3.49 
 
378,703 
13,505 
3.57 
 
- Overseas
232,111 
5,941 
2.56 
 
271,681 
7,531 
2.77 
Total interest-earning assets
- banking business (1)
592,960 
18,530 
3.13 
 
650,384 
21,036 
3.23 
 
- trading business (6)
240,131 
     
278,975 
   
Interest-earning assets
 
833,091 
     
929,359 
   
Non-interest-earning assets
 
597,281 
     
605,796 
   
Total assets
 
1,430,372 
     
1,535,155 
   
                 
Percentage of assets applicable to overseas operations
37.8% 
     
40.2% 
   
                 
Liabilities
               
Deposits by banks
- UK
18,276 
196 
1.07 
 
17,224 
242 
1.41 
 
- Overseas
20,200 
404 
2.00 
 
47,371 
740 
1.56 
Customer accounts: demand deposits
- UK
121,252 
643 
0.53 
 
112,777 
666 
0.59 
 
- Overseas
35,087 
210 
0.60 
 
43,177 
483 
1.12 
Customer accounts: savings deposits
- UK
84,972 
1,479 
1.74 
 
76,719 
1,177 
1.53 
 
- Overseas
26,989 
133 
0.49 
 
25,257 
130 
0.51 
Customer accounts: other time deposits
- UK
35,848 
522 
1.46 
 
39,672 
481 
1.21 
 
- Overseas
23,776 
504 
2.12 
 
33,971 
594 
1.75 
Debt securities in issue
- UK
60,709 
1,681 
2.77 
 
108,406 
2,606 
2.40 
 
- Overseas
22,294 
342 
1.53 
 
42,769 
765 
1.79 
Subordinated liabilities
- UK
15,609 
435 
2.79 
 
16,874 
470 
2.79 
 
- Overseas
5,461 
380 
6.96 
 
5,677 
270 
4.76 
Internal funding of trading business
- UK
(21,140)
264 
(1.25)
 
(40,242)
149 
(0.37)
 
- Overseas
11,992 
(65)
(0.54)
 
(8,783)
(40)
0.46 
Interest-bearing liabilities
- UK
315,526 
5,220 
1.65 
 
331,430 
5,791 
1.75 
 
- Overseas
145,799 
1,908 
1.31 
 
189,439 
2,942 
1.55 
Total interest-bearing liabilities
- banking business
461,325 
7,128 
1.55 
 
520,869 
8,733 
1.68 
 
- trading business (6)
248,647 
     
307,564 
   
Interest-bearing liabilities
 
709,972 
     
828,433 
   
Non-interest-bearing liabilities:
               
Demand deposits
- UK
46,420 
     
46,495 
   
 
- Overseas
27,900 
     
19,909 
   
Other liabilities (2)
 
572,820 
     
565,279 
   
Owners' equity
 
73,260 
     
75,039 
   
Total liabilities and owners' equity
 
1,430,372 
     
1,535,155 
   
                 
Percentage of liabilities applicable to overseas operations
33.9% 
     
37.1% 
   

For the notes to this table refer to page 14.
 

 
15

 
 
Business review continued

 
Average balance sheet and related interest continued

   
2010
   
Average 
balance 
Interest 
Rate 
   
£m 
£m 
%
Assets
       
Loans and advances to banks
- UK
20,334 
207 
1.02 
 
- Overseas
30,031 
368 
1.23 
Loans and advances to customers
- UK
309,764 
11,818 
3.82 
 
- Overseas
195,822 
6,894 
3.52 
Debt securities
- UK
60,209 
1,253 
2.08 
 
- Overseas
62,671 
1,812 
2.89 
Interest-earning assets
- UK
390,307 
13,278 
3.40 
 
- Overseas
288,524 
9,074 
3.14 
Total interest-earning assets
- banking business (1)
678,831 
22,352 
3.29 
 
- trading business (6)
276,330 
   
Interest-earning assets
 
955,161 
   
Non-interest-earning assets
 
717,043 
   
Total assets
 
1,672,204 
   
         
Percentage of assets applicable to overseas operations
 
44.1% 
   
         
Liabilities
       
Deposits by banks
- UK
21,816 
334 
1.53 
 
- Overseas
59,799 
999 
1.67 
Customer accounts: demand deposits
- UK
121,186 
624 
0.51 
 
- Overseas
39,127 
607 
1.55 
Customer accounts: savings deposits
- UK
68,142 
935 
1.37 
 
- Overseas
25,587 
213 
0.83 
Customer accounts: other time deposits
- UK
39,934 
431 
1.08 
 
- Overseas
43,996 
914 
2.08 
Debt securities in issue
- UK
111,277 
2,212 
1.99 
 
- Overseas
72,175 
1,065 
1.48 
Subordinated liabilities
- UK
19,442 
398 
2.05 
 
- Overseas
8,714 
19 
0.22 
Internal funding of trading business
- UK
(41,451)
(140)
0.34 
 
- Overseas
(6,864)
(41)
0.60 
Interest-bearing liabilities
- UK
340,346 
4,794 
1.41 
 
- Overseas
242,534 
3,776 
1.56 
Total interest-bearing liabilities
- banking business
582,880 
8,570 
1.47 
 
- trading business (6)
293,993 
   
Interest-bearing liabilities
 
876,873 
   
Non-interest-bearing liabilities:
       
Demand deposits
- UK
46,692 
   
 
- Overseas
23,994 
   
Other liabilities (2)
 
647,739 
   
Owners' equity
 
76,906 
   
Total liabilities and owners' equity
 
1,672,204 
   
         
Percentage of liabilities applicable to overseas operations
 
41.3% 
   

For the notes to this table refer to page 14.
 

 
 
16

 
 
Business review continued

 
Analysis of change in net interest income - volume and rate analysis
Volume and rate variances have been calculated based on movements in average balances over the period and changes in interest rates on average interest-earning assets and average interest-bearing liabilities. Changes due to a combination of volume and rate are allocated pro rata to volume and rate movements.

 
2012 over 2011
 
Increase/(decrease) due to changes in:
 
Average 
volume 
Average 
rate 
Net 
change 
 
£m 
£m 
£m 
Interest-earning assets
     
Loans and advances to banks
     
  UK
32 
(61)
(29)
  Overseas
(13)
(145)
(158)
Loans and advances to customers
     
  UK
(673)
29 
(644)
  Overseas
(664)
(331)
(995)
Debt securities
     
  UK
(115)
(128)
(243)
  Overseas
(376)
(61)
(437)
Total interest receivable of the banking business
     
  UK
(756)
(160)
(916)
  Overseas
(1,053)
(537)
(1,590)
 
(1,809)
(697)
(2,506)
       
Interest-bearing liabilities
     
Deposits by banks
     
  UK
(14)
60 
46 
  Overseas
505 
(169)
336 
Customer accounts: demand deposits
     
  UK
(48)
71 
23 
  Overseas
78 
195 
273 
Customer accounts: savings deposits
     
  UK
(133)
(169)
(302)
  Overseas
(8)
(3)
Customer accounts: other time deposits
     
  UK
50 
(91)
(41)
  Overseas
200 
(110)
90 
Debt securities in issue
     
  UK
1,279 
(354)
925 
  Overseas
325 
98 
423 
Subordinated liabilities
     
  UK
35 
— 
35 
  Overseas
11 
(121)
(110)
Internal funding of trading business
     
  UK
99 
(214)
(115)
  Overseas
13 
12 
25 
Total interest payable of the banking business
     
  UK
1,268 
(697)
571 
  Overseas
1,124 
(90)
1,034 
 
2,392 
(787)
1,605 
       
Movement in net interest income
     
  UK
512 
(857)
(345)
  Overseas
71 
(627)
(556)
 
583 
(1,484)
(901)
 

 
 
17

 
 
Business review continued


Analysis of change in net interest income - volume and rate analysis continued

 
2011 over 2010
 
Increase/(decrease) due to changes in:
 
Average 
 volume 
Average 
rate 
Net 
change 
 
£m 
£m 
£m 
Interest-earning assets
     
Loans and advances to banks
     
  UK
90 
(20)
70 
  Overseas
124 
(89)
35 
Loans and advances to customers
     
  UK
(616)
768 
152 
  Overseas
(825)
(212)
(1,037)
Debt securities
     
  UK
(111)
116 
  Overseas
(127)
(414)
(541)
Total interest receivable of the banking business
     
  UK
(637)
864 
227 
  Overseas
(828)
(715)
(1,543)
 
(1,465)
149 
(1,316)
       
Interest-bearing liabilities
     
Deposits by banks
     
  UK
67 
25 
92 
  Overseas
197 
62 
259 
Customer accounts: demand deposits
     
  UK
47 
(89)
(42)
  Overseas
(58)
182 
124 
Customer accounts: savings deposits
     
  UK
(126)
(116)
(242)
  Overseas
3
80 
83 
Customer accounts: other time deposits
     
  UK
(53)
(50)
  Overseas
189 
131 
320 
Debt securities in issue
     
  UK
58 
(452)
(394)
  Overseas
494 
(194)
300 
Subordinated liabilities
     
  UK
58 
(130)
(72)
  Overseas
(260)
(251)
Internal funding of trading business
     
  UK
(4)
(285)
(289)
  Overseas
10 
(11)
(1)
Total interest payable of the banking business
     
  UK
103 
(1,100)
(997)
  Overseas
844 
(10)
834 
 
947 
(1,110)
(163)
       
Movement in net interest income
     
  UK
(534)
(236)
(770)
  Overseas
16 
(725)
(709)
 
(518)
(961)
(1,479)
 

 
 
18

 
 
Business review continued
 
 
Non-interest income
The following tables reconcile the managed basis results (a non-GAAP financial measure) to the statutory basis results.

 
2012 
2011 
2010 
 
£m 
£m 
£m 
Fees and commissions receivable
     
  - managed basis
5,715 
6,384 
8,194 
  - Direct Line Group discontinued operations
(6)
(5)
— 
  - RFS Holdings minority interest
— 
— 
(1)
Statutory basis
5,709 
6,379 
8,193 
       
Fees and commissions payable
     
  - managed basis
(1,269)
(1,460)
(2,211)
  - Direct Line Group discontinued operations
436 
498 
319 
  - RFS Holdings minority interest
(1)
— 
— 
Statutory basis
(834)
(962)
(1,892)
       
Income from trading activities
     
  - managed basis
3,531 
3,313 
6,070 
  - own credit adjustments
(1,813)
293 
(7)
  - Asset Protection Scheme
(44)
(906)
(1,550)
  - Direct Line Group discontinued operations
— 
— 
  - RFS Holdings minority interest
(1)
Statutory basis
1,675 
2,701 
4,517 
       
Gain on redemption of own debt - statutory basis
454 
255 
553 
       
Other operating income
     
  - managed basis
2,397 
2,527 
1,213 
  - own credit adjustments
(2,836)
1,621 
249 
  - integration and restructuring costs
— 
78 
— 
  - strategic disposals
113 
(104)
171 
  - Direct Line Group discontinued operations
(138)
(147)
(124)
  - RFS Holdings minority interest
(1)
— 
(154)
Statutory basis
(465)
3,975 
1,355 
       
Non-interest income (excluding insurance net premium income)
6,539 
12,348 
12,726 
Insurance net premium income
     
  - managed basis
3,718 
4,256 
5,128 
  - Direct Line Group discontinued operations
(3,718)
(4,256)
(5,014)
Statutory basis
— 
— 
114 
       
Total non-interest income - managed basis
14,092 
15,020 
18,394 
       
Total non-interest income - statutory basis
6,539 
12,348 
12,840 
 

 
 
19

 
 
Business review continued
 
 
Non-interest income continued
2012 compared with 2011
Non-interest income was down 47% at £6,539 million primarily due to the accounting charge for improved own credit of £4,649 million compared with a credit of £1,914 million in 2011, partially offset by a lower fair value charge of £44 million compared with £906 million in 2011 on the APS. On a managed basis non-interest income was down 6% at £14,092 million with higher profits on available-for-sale bond disposals in Group Treasury more than offset by a 10% decline in fees and commissions, largely due to a decline in UK Retail fees as a result of weaker consumer spending volumes, and lower insurance net premium income.

The APS, which the Group exited in October 2012, was accounted for as a credit derivative and movements in the fair value of the contract were recorded in income from trading activities. The APS fair value charge was £44 million in 2012 versus £906 million in 2011, bringing the cumulative charge for the APS to £2.5 billion.

Liability management exercises undertaken by the Group during 2012 resulted in a net gain of £454 million (2011 - £255 million).

Net fees and commissions fell by 10% largely due to a decline in UK Retail fees, as a result of weaker consumer spending volumes, and in Markets, primarily due to the run-off in the cash equity business.

Markets trading income was sustained, despite the significant reduction in trading assets following its restructuring early in 2012.

The decrease in other operating income predominantly reflected own credit adjustments and the disposal of RBS Aviation Capital in June 2012, which resulted in lower rental income in Non-Core partially offset by a lower fair value charge on the APS.

The continuing strengthening of RBS’s credit profile resulted in a £4,649 million accounting charge in relation to own credit adjustment versus a gain of £1,914 million in 2011. This reflected a tightening of more than 340 basis points in the Group’s cash market credit spreads over the year.
 
2011 compared with 2010
Non-interest income decreased by £492 million in 2011 principally driven by lower trading income in Markets and Non-Core, partially offset by a higher gain on movements in own credit adjustments. On a managed basis non-interest income decreased by £3,374 million in 2011 principally driven by lower trading income in Markets and Non-Core and a fall in insurance net premium income.

A gain on the movement in own credit adjustments of £1,914 million was recorded in 2011 as Group credit spreads widened. This compares with a smaller gain of £242 million in 2010.

The APS is accounted for as a credit derivative and movements in the fair value of the contract were recorded in income from trading activities. The APS fair value charge was £906 million in 2011. The cumulative charge for the APS was £2,456 million as at 31 December 2011.

In 2011, the Group redeemed certain mortgage backed debt securities in exchange for cash, resulting in gains totalling £255 million. This compared with a gain of £553 million in 2010 on a liability management exercise to redeem a number of Tier 1 and upper Tier 2 securities.

A charge of £850 million was booked in relation to PPI claims following the British Bankers’ Association decision, in May 2011, not to appeal the findings of the Judicial Review.

Volatile market conditions led to a reduction in Markets trading income, driven by the deterioration in global credit markets as sovereign difficulties in the eurozone grew.

Non-Core trading losses increased by £690 million, reflecting costs incurred as part of the division’s focus on reducing capital trading assets, with activity including the restructuring of monoline exposures, which mitigated both significant immediate and future regulatory uplifts in risk-weighted assets.
 
On a statutory basis insurance net premium income was reclassified to discontinued operations. On a managed basis insurance net premium income fell by 17% largely driven by Direct Line Group’s exit from certain business segments, along with reduced volumes driven by the de-risking of the motor book. Insurance net premium income in Non-Core also decreased as legacy policies ran-off.

2010 results included £482 million of income recorded for GMS prior to its disposal in November 2010.
 

 
20

 
 
Business review continued
 
 
Operating expenses and insurance claims
The following tables reconcile the managed basis results (a non-GAAP financial measure) to the statutory basis results.

 
2012 
2011 
2010 
 
£m 
£m 
£m 
Staff costs
     
  - managed basis
7,639 
8,163 
8,956 
  - integration and restructuring costs
885 
489 
614 
  - bonus tax
— 
27 
99 
  - Direct Line Group discontinued operations
(447)
(322)
(292)
  - RFS Holdings minority interest
(1)
(1)
Statutory basis
8,076 
8,356 
9,379 
       
Premises and equipment
     
  - managed basis
2,198 
2,278 
2,276 
  - integration and restructuring costs
152 
173 
126 
  - Direct Line Group discontinued operations
(118)
(28)
(22)
  - RFS Holdings minority interest
— 
— 
— 
Statutory basis
2,232 
2,423 
2,380 
       
Other administrative expenses
     
  - managed basis
3,248 
3,395 
3,716 
  - Payment Protection Insurance costs
1,110 
850 
— 
  - Interest Rate Hedging Products redress and related costs
700 
— 
— 
  - regulatory fines
381 
— 
— 
  - integration and restructuring costs
371 
386 
272 
  - bank levy
175 
300 
— 
  - Direct Line Group discontinued operations
(395)
(495)
(424)
  - RFS Holdings minority interest
— 
Statutory basis
5,593 
4,436 
3,571 
       
Administrative expenses
15,901 
15,215 
15,330 
       
Depreciation and amortisation
     
  - managed basis
1,534 
1,642 
1,762 
  - Direct Line Group discontinued operations
(52)
(36)
(25)
  - amortisation of purchased intangible assets
178 
222 
369 
  - integration and restructuring costs
142 
11 
20 
  - RFS Holdings minority interest
— 
— 
(1)
Statutory basis
1,802 
1,839 
2,125 
       
Write-down of goodwill and other intangible assets - statutory basis
124 
80 
Operating expenses
17,827 
17,134 
17,456 
       
Insurance net claims
     
  - managed basis
2,427 
2,968 
4,783 
  - Direct Line Group discontinued operations
(2,427)
(2,968)
(4,698)
Statutory basis
— 
— 
85 
       
Staff costs as a percentage of total income
45% 
34% 
35% 
 
 
 
21

 
 
Business review continued
 
 
2012 compared with 2011
Operating expenses increased by £693 million, or 4% primarily due to charges resulting from legacy conduct issues partially offset by Non-Core run-down and run-off of exited businesses in Markets and International Banking, following the restructuring announced in January 2012. Simplification of processes and headcount reduction in UK Retail also yielded cost benefits. On a managed basis operating expenses fell by £859 million, or 6%, with staff costs also down 6% (but broadly stable as a percentage of total income) as headcount fell by 9,600 to 137,200. The decline in expenses was largely driven by Non-Core run-down and lower variable compensation (particularly in Markets), including bonus award reductions and clawbacks following the settlements reached with UK and US authorities in relation to attempted LIBOR manipulation.

Staff expenses were cut by 3%. On a managed basis staff costs were down 6%, as headcount fell by 9,600 to 137,200.

To reflect current experience of PPI complaints received, RBS increased its PPI provision by £1,110 million in 2012, bringing the cumulative charge taken to £2.2 billion, of which £1.3 billion in redress had been paid by 31 December 2012.

On 31 January 2013, the Financial Services Authority announced the findings of its industry-wide review of the sale of Interest Rate Hedging Products to some small and medium-sized businesses that were classified as retail clients under FSA rules. As a result, RBS provided £700 million in 2012 to meet the costs of redress.

On 6 February 2013, RBS reached agreement with the Financial Services Authority, the US Department of Justice and the Commodity Futures Trading Commission in relation to the setting of LIBOR and other trading rates, including financial penalties of £381 million. The Group continues to co-operate with other bodies in this regard and expects it will incur some additional financial penalties.

2011 compared with 2010
Group expenses fell by 2% in 2011, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits, partially offset by PPI costs. On a managed basis Group expenses were 7% lower in 2011, driven by cost savings achieved as a result of the cost reduction programme and Non-Core run-off, largely reflecting the disposal of RBS Sempra and specific country exits.

Staff costs fell 11%, driven by lower Markets and International Banking discretionary compensation as a result of its decrease in revenues, and in Non-Core, given the impact of a 32% reduction in headcount and continued business disposals and country exits. On a managed basis staff costs fell 9%.

In May 2011, following the decision of the British Bankers’ Association not to appeal the judgement of the judicial review, the Group recorded a provision of £850 million in respect of the costs of PPI redress.

The Group’s cost reduction programme delivered cost savings with an underlying run rate of over £3 billion by the end of 2011.
 
Integration costs
 
2012 
2011 
2010 
 
£m 
£m 
£m 
Staff costs
— 
38 
210 
Premises and equipment
(2)
Other administrative expenses
51 
143 
Depreciation and amortisation
— 
11 
20 
 
— 
106 
376 
Note:
(1)
Integration costs in 2011 excluded a £2 million charge included within net interest income and a loss of £3 million within other operating income in respect of integration activities.


2012 compared with 2011
Integration costs were nil compared with £106 million in 2011. Integration costs decreased primarily due to a reduction of RBS N.V. (formerly ABN AMRO) integration activity during the year.

2011 compared with 2010
Integration costs were £106 million compared with £376 million in 2010. Integration costs decreased primarily due to a reduction of RBS N.V. (formerly ABN AMRO) integration activity during the year.

Accruals in relation to integration costs are set out below.
 
At 
1 January 
2012 
(Credit)/charge 
to income 
statement 
- continuing 
operations 
Utilised 
during 
the year 
At 
31 December 
2012 
 
£m 
£m 
£m 
£m 
Premises and equipment
11 
(2)
— 
Other administrative expenses
— 
 
14 
— 
— 
14 
 
 
 
22

 
 
Business review continued
 
 
Restructuring costs

 
2012 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
2011 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
2010 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Staff costs
737 
(37)
700 
356 
(14)
342 
353 
(12)
341
Premises and equipment
145 
(4)
141 
156 
(1)
155 
117 
— 
117
Other administrative expenses
270 
(9)
261
276 
(8)
268 
104 
(8)
96
Depreciation and amortisation
142 
— 
142 
— 
— 
 
1,294 
(50)
1,244 
788 
(23)
765 
574 
(20)
554 

2012 compared with 2011
Restructuring costs were £1,244 million compared with £765 million in 2011. The increase was primarily driven by costs incurred in relation to the strategic restructuring of Markets and International Banking announced in January 2012. On a managed basis restructuring costs were £1,294 million compared with £788 million in 2011.

2011 compared with 2010
Restructuring costs were £765 million compared with £554 million in 2010. The increase is due to the number of Group restructuring projects increasing during the year. On a managed basis restructuring costs were £788 million compared with £574 million in 2010.
 
Accruals in relation to restructuring costs are set out below.
 
At 
1 January 
2012 
Currency 
translation 
adjustments 
Charge 
to income 
statement 
- continuing 
operations 
Charge 
to income 
statement 
- discontinued 
operations 
Utilised 
during 
the year 
Transfer to 
disposal 
groups 
At 
31 December 
2012 
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Staff costs - redundancy
126 
626 
37 
(336)
(24)
434 
Staff costs - other
40 
— 
74 
— 
(3)
— 
111 
Premises and equipment
166 
— 
141 
(22)
— 
289 
Other administrative expenses
110 
(2)
261 
(107)
(7)
264 
Depreciation and amortisation
— 
— 
142 
— 
(142)
— 
— 
 
442 
1,244 
50 
(641)
(31)
1,067 

Divestment costs
 
2012 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
2011 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
2010 
(managed)
Discontinued 
operations 
Continuing 
 operations 
(statutory)
 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
£m 
Staff costs
148 
(37)
111 
95 
(11)
84 
51 
— 
51 
Premises and equipment
(11)
(2)
11 
— 
11 
— 
Other administrative expenses
99 
(37)
62 
59 
(9)
50 
25 
— 
25 
 
256 
(85)
171 
165 
(20)
145 
82 
— 
82 
 
2012 compared with 2011
Divestment costs were £171 million compared with £145 million in 2011 as the preparation for the European Commission mandated divestments continued throughout 2012. On a managed basis divestment costs were £256 million compared with £165 million in 2011. 

 2011 compared with 2010
Divestment costs of £145 million compared with £82 million in 2010 related to the European Commission mandated divestments. On a managed basis divestment costs were £165 million in 2011 compared wtih £82 million in 2010.

Accruals in relation to divestment costs are set out below.
 
At 
1 January 
2012 
Charge/(credit) 
to income 
statement 
- continuing 
operations 
Charge 
to income 
statement 
- discontinued 
operations 
Utilised 
during 
the year 
Transfer to 
disposal 
groups 
At 
31 December 
2012 
 
£m 
£m 
£m 
£m 
£m 
£m 
Staff costs - redundancy
45 
47 
37 
(41)
(1)
87 
Staff costs - other
64 
— 
(19)
— 
46 
Premises and equipment
— 
(2)
11 
(9)
— 
— 
Other administrative expenses
21 
62 
37 
(43)
(4)
73 
 
67 
171 
85 
(112)
(5)
206 
 

 
 
23

 
 
Business review continued


Impairment losses
The following tables reconcile the managed basis results (a non-GAAP financial measure) to the statutory basis results.

 
2012 
2011 
2010 
 
£m 
£m 
£m 
New impairment losses
5,620 
9,234 
9,646 
Less: recoveries of amounts previously written-off
(341)
(527)
(411)
Charge to income statement
5,279 
8,707 
9,235 
       
Comprising:
     
Loan impairment losses
5,315 
7,241 
9,144 
Securities
     
  - managed basis
(36)
198 
112 
  - sovereign debt impairment
— 
1,099 
— 
  - interest rate hedge adjustments on impaired available-for-sale
    sovereign debt
— 
169 
— 
Direct Line Group discontinued operations
— 
— 
(21)
Statutory basis
(36)
1,466 
91 
       
Charge to income statement
5,279 
8,707 
9,235 

2012 compared with 2011
Total impairment losses fell by £3,428 million, or 39%, to £5,279 million. Within this, loan impairment losses declined by £1,926 million to £5,315 million, primarily driven by a £1,518 million fall in Non-Core impairments, mostly in the Ulster Bank and commercial real estate portfolios.

Core loan impairments were down £408 million, or 12%, largely due to lower default rates in UK Retail and an improved credit environment for US Retail & Commercial, which helped drive impairment reductions of £259 million and £165 million respectively. Core Ulster Bank impairments stabilised, though still at a very high level (£1,364 million in 2012 versus £1,384 million in 2011).

Loan impairments as a percentage of gross loans and advances improved by 30 basis points, principally reflecting the improved credit profile in Non-Core and the better US credit environment.

Loan impairment provisions rose to £21.3 billion, increasing coverage of risk elements in lending to 52%, compared with 49% in 2011.

2011 compared with 2010
Impairment losses decreased by 6% compared with 2010, driven largely by a £1,569 million reduction in Non-Core loan impairments, despite continuing challenges in Ulster Bank and corporate real estate portfolios. This was partially offset by impairments taken on the Group’s available-for-sale bond portfolio, as a result of the decline in the value of Greek sovereign bonds. On a managed basis impairment losses decreased by 20% compared to 2010.

Retail & Commercial impairment losses fell by £227 million, driven by improving credit metrics in UK Retail and US Retail & Commercial partially offset by increases in Ulster Bank, largely reflecting a deterioration in credit metrics on the mortgage portfolio, and a single name provision in International Banking.

Total Core and Non-Core Ulster Bank impairment losses decreased by 4%, as the £223 million increase in Core Ulster Bank losses was more than offset by a decrease in losses recognised in Non-Core.

The Group held Greek government bonds with a notional amount of £1.45 billion. As a result of Greece’s continuing fiscal difficulties, the Group recorded impairment charges on these bonds totalling £1,099 million during the year. These charges were recorded to write the bonds down to their market price as at 31 December 2011 (c.21% of notional).
 
 
 
24

 
 
Business review continued


Tax

 
2012 
2011 
2010 
 
£m 
£m 
£m 
Tax charge
(469)
(1,127)
(703)
       
 
%
%
UK corporation tax rate
24.5 
26.5 
28.0 
Effective tax rate
nm 
nm 
nm 

nm = not meaningful

The actual tax charge differs from the expected tax credit computed by applying the standard rate of UK corporation tax as follows:

 
2012 
2011 
2010 
 
£m 
£m 
£m 
Expected tax credit
1,265 
315 
44 
Sovereign debt impairment where no deferred tax asset recognised
— 
(275)
— 
Other losses in year where no deferred tax asset recognised
(511)
(530)
(450)
Foreign profits taxed at other rates
(383)
(417)
(517)
UK tax rate change impact
(149)
(112)
(83)
Unrecognised timing differences
59 
(20)
11 
Non-deductible goodwill impairment
— 
(24)
(3)
Items not allowed for tax
     
  - losses on disposals and write-downs
(49)
(72)
(311)
  - UK bank levy
(43)
(80)
— 
  - regulatory fines
(93)
— 
— 
  - employee share schemes
(9)
(113)
(32)
  - other disallowable items
(246)
(258)
(296)
Non-taxable items
     
  - gain on sale of RBS Aviation Capital
26 
— 
— 
  - gain on sale of Global Merchant Services
— 
12 
221 
  - gain on redemption of own debt
— 
— 
11 
  - other non-taxable items
104 
242 
341 
Taxable foreign exchange movements
(1)
Losses brought forward and utilised
Reduction in carrying value of deferred tax asset in respect of losses in
     
  - Australia
(191)
— 
— 
  - Ireland
(203)
— 
— 
Adjustments in respect of prior years
(47)
199 
355 
Actual tax charge
(469)
(1,127)
(703)

2012 compared with 2011
The high tax charge in 2012 reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland), the reduction in the carrying value of deferred tax assets in Ireland in view of continuing losses, the reduction in the carrying value of deferred tax assets in Australia following the strategic changes to the Markets and International Banking businesses announced in January 2012, and the effect of the two reductions of 1% in the rate of UK corporation tax enacted in March 2012 and July 2012 on the net deferred tax balance.

2011 compared with 2010
The high tax charge in 2011 reflects profits in high tax regimes (principally US) and losses in low tax regimes (principally Ireland), losses in overseas subsidiaries for which a deferred tax asset has not been recognised (principally Ireland and the Netherlands) and the effect of two reductions of 1% in the rate of UK corporation tax enacted in March 2011 and July 2011 on the net deferred tax balance.
 
 
 
25

 
 
 
 
Business review continued

 
Divisional performance

Operating profit/(loss) by division
2012 
2011 
2010 
£m 
£m 
£m 
UK Retail
1,891 
2,021 
1,348 
UK Corporate
1,796 
1,924 
1,893 
Wealth
253 
248 
283 
International Banking
594 
755 
1,311 
Ulster Bank
(1,040)
(984)
(683)
US Retail & Commercial
754 
537 
349 
Retail & Commercial
4,248 
4,501 
4,501 
Markets
1,509 
899 
2,724 
Direct Line Group
441 
454 
(295)
Central items
143 
191 
630 
Core
6,341 
6,045 
7,560 
Non-Core
(2,879)
(4,221)
(5,715)
Managed basis
3,462 
1,824 
1,845 
Reconciling items
     
Own credit adjustments
(4,649)
1,914 
242 
Asset Protection Scheme
(44)
(906)
(1,550)
Payment Protection Insurance costs
(1,110)
(850)
— 
Interest Rate Hedging Products redress and related costs
(700)
— 
— 
Regulatory fines
(381)
— 
— 
Sovereign debt impairment
— 
(1,099)
— 
Interest rate hedge adjustments on impaired available-for-sale sovereign debt
— 
(169)
— 
Amortisation of purchased intangible assets
(178)
(222)
(369)
Integration and restructuring costs
(1,550)
(1,064)
(1,032)
Gain on redemption of own debt
454 
255 
553 
Strategic disposals
113 
(104)
171 
Bank levy
(175)
(300)
— 
Bonus tax
— 
(27)
(99)
Write-down of goodwill and other intangible assets
(518)
(11)
(10)
RFS Holdings minority interest
(20)
(7)
(150)
Operating loss including the results of Direct Line Group discontinued operations
(5,296)
(766)
(399)
Direct Line Group discontinued operations*
131 
(424)
245 
Group
(5,165)
(1,190)
(154)
 
* Included within Direct Line Group discontinued operations are the managed basis divisional results of Direct Line Group (DLG), certain DLG related activities in Central items and Non-Core, and related one-off and other items including write-down of goodwill, integration and restructuring costs and strategic disposals.

 
26

 
Business review continued

Impairment losses/(recoveries) by division
2012 
£m 
2011 
£m 
2010 
£m 
UK Retail
529 
788 
1,160 
UK Corporate
838 
793 
767 
Wealth
46 
25 
18 
International Banking
111 
168 
86 
Ulster Bank
1,364 
1,384 
1,161 
US Retail & Commercial
91 
326 
519 
Retail & Commercial
2,979 
3,484 
3,711 
Markets
37 
38 
65 
Central items
40 
(2)
Core
3,056 
3,520 
3,780 
Non-Core
2,223 
3,919 
5,476 
Managed basis
5,279 
7,439 
9,256 
Reconciling items
     
Sovereign debt impairment
— 
1,099 
— 
Interest rate hedge adjustments on impaired available-for-sale sovereign debt
— 
169 
— 
Group
5,279 
8,707 
9,256 
 
Net interest margin by division
2012 
2011 
2010 
UK Retail
3.58 
3.95 
3.89 
UK Corporate
3.06 
3.06 
2.89 
Wealth
3.73 
3.23 
3.26 
International Banking
1.64 
1.73 
1.92 
Ulster Bank
1.88 
1.87 
2.03 
US Retail & Commercial
3.00 
3.06 
2.82 
Retail & Commercial
2.92 
2.97 
2.91 
Non-Core
0.31 
0.63 
1.02 
       
Group net interest margin
1.92 
1.89 
2.03 


Risk-weighted assets by division
2012 
£bn 
2011 
£bn 
2010 
£bn 
UK Retail
45.7 
48.4 
48.8 
UK Corporate
86.3 
79.3 
84.2 
Wealth
12.3 
12.9 
12.5 
International Banking
51.9 
43.2 
51.7 
Ulster Bank
36.1 
36.3 
31.6 
US Retail & Commercial
56.5 
59.3 
57.4 
Retail & Commercial
288.8 
279.4 
286.2 
Markets
101.3 
120.3 
110.3 
Other
5.8 
12.0 
18.0 
Core
395.9 
411.7 
414.5 
Non-Core
60.4 
93.3 
153.7 
Group before benefit of Asset Protection Scheme
456.3 
505.0 
568.2 
Benefit of Asset Protection Scheme
— 
(69.1)
(105.6)
Group before RFS Holdings minority interest
456.3 
435.9 
462.6 
RFS Holdings minority interest
3.3 
3.1 
2.9 
Group
459.6 
439.0 
465.5 
 
 
 
27

 
 
 
Divisional performance continued
Employee numbers at 31 December
(full time equivalents rounded to the nearest hundred)

 
2012 
2011 
2010 
UK Retail
26,000 
27,700 
28,200 
UK Corporate
13,300 
13,600 
13,200 
Wealth
5,300 
5,700 
5,200 
International Banking
4,400 
5,400 
5,300 
Ulster Bank
4,500 
4,200 
4,200 
US Retail & Commercial
14,700 
15,400 
15,900 
Retail & Commercial
68,200 
72,000 
72,000 
Markets
11,200 
13,900 
15,700 
Direct Line Group
14,200 
14,900 
14,500 
Central items
6,800 
6,200 
4,700 
Core
100,400 
107,000 
106,900 
Non-Core
3,100 
4,700 
6,900 
 
103,500 
111,700 
113,800 
Business Services
33,200 
34,000 
34,400 
Integration and restructuring
500 
1,100 
300 
Group
137,200 
146,800 
148,500 
 

 
 
28

 
Business review continued

 
UK Retail
 
2012 
2011 
2010 
£m 
£m 
£m 
Net interest income
3,990 
4,302 
4,054 
Net fees and commissions
884 
1,066 
1,100 
Other non-interest income
95 
140 
322 
Non-interest income
979 
1,206 
1,422 
Total income
4,969 
5,508 
5,476 
Direct expenses
     
  - staff
(800)
(839)
(889)
  - other
(372)
(437)
(480)
Indirect expenses
(1,377)
(1,423)
(1,514)
 
(2,549)
(2,699)
(2,883)
Profit before impairment losses and insurance net claims
2,420 
2,809 
2,593 
Insurance net claims
— 
— 
(85)
Impairment losses
(529)
(788)
(1,160)
Operating profit
1,891 
2,021 
1,348 
       
Analysis of income by product
     
Personal advances
916 
1,089 
993 
Personal deposits
661 
961 
1,102 
Mortgages
2,367 
2,277 
1,984 
Cards
863 
950 
962 
Other, including bancassurance in 2010
162 
231 
435 
Total income
4,969 
5,508 
5,476 
       
Analysis of impairments by sector
     
Mortgages
92 
182 
177 
Personal
307 
437 
682 
Cards
130 
169 
301 
Total impairment losses
529 
788 
1,160 
       
Loan impairment charge as % of gross customer loans and advances (excluding reverse repurchase
  agreements) by sector
     
Mortgages
0.1% 
0.2% 
0.2% 
Personal
3.5% 
4.3% 
5.8% 
Cards
2.3% 
3.0% 
4.9% 
Total
0.5% 
0.7% 
1.1% 
       
Performance ratios
     
Return on equity (1)
24.4% 
24.5% 
16.3% 
Net interest margin
3.58% 
3.95% 
3.89% 
Cost:income ratio
51% 
49% 
53% 
       
 
 
 
29

 
Business review continued

 
UK Retail continued

 
2012 
£bn 
2011 
£bn 
2010 
£bn 
Capital and balance sheet
     
Loans and advances to customers (gross) (2)
     
  - mortgages
99.1 
95.0 
90.6 
  - personal
8.8 
10.1 
11.7 
  - cards
5.7 
5.7 
6.1 
 
113.6 
110.8 
108.4 
Loan impairment provisions
(2.6)
(2.7)
(2.7)
Net loans and advances to customers
111.0 
108.1 
105.7 
       
Risk elements in lending (2)
4.6 
4.6 
4.6 
Provision coverage (3)
58% 
58% 
59% 
       
Customer deposits (2)
107.6 
101.9 
96.1 
Assets under management (excluding deposits)
6.0 
5.5 
5.7 
Loan:deposit ratio (excluding repos)
103% 
106% 
110% 
Risk-weighted assets
45.7 
48.4 
48.8 
 
 
Notes:
(1)
Divisional return on equity is based on divisional operating profit after tax divided by average notional equity (based on 10% of the monthly average of divisional RWAs, adjusted for capital deductions).
(2)
Includes businesses outlined for disposal: gross loans and advances to customers £7.6 billion (2011 - £7.3 billion; 2010 - £6.8 billion), risk elements in lending £0.5 billion (2011 and 2010 - £0.5 billion) and customer deposits £8.5 billion (2011 - £8.8 billion; 2010 - £9.0 billion).
(3)
Provision coverage percentage represents loan impairment provisions as a percentage of risk elements in lending.

Over the last four years UK Retail has undertaken stretching initiatives and undergone significant change in order to meet its goal to consistently improve the service it offers to its customers. Highlights in 2012 include:

·  
Continued progress on the RBS and NatWest Customer Charter commitments supporting our goal of becoming Britain’s most helpful retail bank;

·  
Providing more than £500 million of cheaper mortgages through the Government’s Funding for Lending Scheme (FLS), launched at the end of June 2012 and opened for drawings in August 2012, which represents 14% of all completions in the last quarter of 2012;

·  
Seeking and responding to customer feedback to enhance the retail mobile banking app which is used by more than two million customers to manage their money and complete over one million transactions every week;

·  
Increasing online banking webchat functionality to allow customers real-time access to an advisor, direct from their computer, who can answer queries and action basic account services 24 hours a day; and

·  
Continued to invest in simplifying processes to make it easier for customers to bank with us, including introducing more than 200 cash deposit machines and ATMs to further reduce queuing times in branches.
 
However, the business has also had setbacks in the year. Customers suffered from disruptions to payment systems in June. Throughout this time UK Retail staff worked tirelessly to deal quickly with the issues and provide full redress and compensation to customers affected. In addition, the provision relating to historic Payment Protection Insurance (PPI) mis-selling was increased by £1.1 billion in 2012, bringing total PPI expense to date to £2.2 billion. This expense is not included in operating profit. With the new UK conduct regulator examining many products and services along with associated disclosures and sales practices, there are likely to be further impacts to business practices and potential additional costs of redress. The business is actively working to ensure its products set and sales practices are appropriate.

Ross McEwan joined UK Retail as its new Chief Executive in September 2012 and spent considerable time engaging with customers and employees around the country and reviewing business processes and performance. With his management team, he has developed a range of initiatives, building upon existing efforts, which focus on simplifying processes and providing a better experience for all customers. Ultimately, with a lot of hard work, the goal is to be the best retail bank in the UK.

 
30

 
Business review continued
  
 
2012 compared with 2011
Operating profit fell by 6% as a 10% decline in income was only partly offset by lower costs, down 6%, and improved impairment losses, down 33%.

Mortgage balances grew by £4.1 billion with the share of new business at 10%, ahead of our stock level of 8%. Growth as a result of FLS was starting to appear by the end of the year as mortgage applications moved through the pipeline to completion. Deposit growth of 6% was in line with the market and drove a 300 basis point improvement in the loan:deposit ratio to 103%.

Net interest income was down 7% due to weaker deposit margins and reduction in unsecured balances, partly offset by mortgage growth. Unsecured balances now represent 13% of total loans and advances to customers compared with 23% in 2008, following realignment of risk appetite and strong mortgage growth. Net interest margin declined as a result of lower rates on current account hedges and increased competition on savings rates in the early part of the year, partly offset by widening asset margins.

Non-interest income was 19% lower mainly due to:
·  
lower unauthorised overdraft fees as we continue to help customers manage their finances by providing mobile text alerts and further improving mobile banking functionality;

·  
weak consumer confidence lowering spending and associated fees on cards; and
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