bank-r-and-a

Overview Strategic report Corporate governance Risk management Financial statements Other information
Risk management continued
For the year ended 31 December 2013
All amounts are stated in £m unless otherwise indicated
3. Market risk
In plain english:
Market risk is the risk of losses arising due to changes in market prices. The Bank’s biggest exposure to market risk is from changes in interest rates.
The Bank also has a small exposure to market risk from changes in foreign currency exchange rates.
Market risk is the risk of loss as a result of the value of financial assets or liabilities (including off-balance sheet instruments) being adversely affected by
movements in market rates or prices. This loss can be reflected in the near term earnings by changing net interest income, or in the longer term because of
changes in the economic value of future cash flows.
The main source of market risk within the Bank is driven by mismatches between the repricing profiles of asset and liability customer products within the Retail
and Corporate businesses and certain characteristics embedded within these products and basis risk. Treasury also creates market risk through its various
portfolio management activities along with currency risk.
3.1 Interest rate risk
Interest rate risk policy statements, approved by the ERC on behalf of the Board, specify the scope of the Bank’s wholesale market activity, market risk limits
and delegated authorities. The policy is managed by the Bank Market Risk Forum (BMRF) and ALCO. Their prime task is to assess the interest rate risk inherent
in the maturity and repricing characteristics of the Bank’s assets and liabilities. The Bank seeks to minimise the volatility of future earnings from interest rate
changes and all interest rate risk exposure is removed from the Core and Non-core divisions and consolidated at the centre where it is managed from the Core
balance sheet within agreed limits. Treasury is responsible for interest rate risk management for the Bank. The principal analytical techniques involve assessing
the impact of different interest rate scenarios and changes in balances over various time periods.
The Board receives reports on the management of balance sheet risk and BMRF and ALCO review the balance sheet risk positions and the utilisation of
wholesale market risk limits.
3.1.1 Non-treasury interest rate risk
The Bank (excluding wholesale treasury risk) uses a PV01, gap report and earnings approach for managing interest rate risk, focusing in detail on the sensitivity
of assumed changes in interest rates on net interest income for one year.
BMRF monitors the non-trading interest rate risk, which is split between certain wholesale portfolios, banking and investment books, and the rest of the Bank’s
balance sheet. The following describes the Bank non-trading portfolios, excluding these certain wholesale portfolios. (These positions are managed by Treasury.)
All interest rate risk is centralised into Treasury using appropriate transfer pricing rates.
Gap reports are based on defined time periods. ALCO sets guidance limits around the gap, principally that the sum of positions maturing in greater than
12 months and non-sensitive balances (includes non-maturity deposits) are no more than a set limit.
Non-maturity deposits, which are non-interest bearing, are separated into a stable ‘core’ element, based on a long run average, and the residual balance, which
can fluctuate. In the gap report, the residual balance (along with interest bearing non-maturity deposits) is deemed to re-price or mature within one month. The
‘core’ non-maturity deposits are within the non-sensitive balance on the gap report, along with non-dated capital and other non-sensitive balances. ALCO sets
guidance around the treatment of non-sensitive balances to reinvest in fixed rate assets in periods up to five years to smooth the income based upon the
prevailing interest rate environment.
Risk limits are formally calculated at each month end. Interest rate risk and effectiveness of hedging is monitored daily using gap positions, incorporating new
business requirements. Draw down risk, in particular for fixed rate mortgages, is managed through weekly balance sheet meetings. The asset and liability
management team undertakes hedges for interest rate risk using derivative instruments and investment securities which are executed via the Treasury markets
team to external wholesale markets, and loans and deposits which are executed internally with the Treasury markets team.
Basis risk is the risk that different assets and liabilities re-price with reference to different indices and at different times. This exposes the Bank to income volatility
if indices do not move in a ratio of one to one. The overall exposure to basis risk has remained a net base rate asset throughout 2013 as customers continue to
favour variable rate mortgages (where the introductory rate is linked to Bank of England base rate) and a large proportion of the liquidity of the Bank is placed in
the Bank of England reserve account. Basis risk is monitored by BMRF and ALCO monthly and action is taken as required, which includes pricing, new products
or external hedging.
The table illustrates the greater than 12 month net gap position at the end of the period on the Bank’s balances, excluding wholesale treasury and customer
currency balances which are managed within the Treasury risk framework. The gap is driven by product pricing and product mix. The gap is calculated by
placing all assets and liabilities at the earliest of their re-pricing or maturity date and then summing by time band. The aim is to have assets evenly spread so
that the Bank is not exposed to sudden rate movements. The net position shows the amount that the Bank is either over or under invested at a point in time.
A £100m positive gap position would equate to the Bank’s income increasing by £1m per annum if rates increased by 1%. The maximum sensitivity for the
period shown below equates to approximately an £8.0m (2012: £10.9m) decrease in income if rates increased by 1%.
The Co-operative Bank plc Annual report and accounts 2013
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