LONDON SOUTHBANK UNIVERSITY

International Financial Reporting,

Standard of Data and Risk
Disclosure; PILLAR 3, Royal Bank
of Scotland
Royal Bank of
Scotland
Student Name: Md. Rabiul Alam
Student ID. 3328312
Lecturer: Muriel Claire

Table of Contents

1.0.Introduction and Rationale 3

2.0.Literature Review
3.0.Methodology

4.0.Discussion and Findings7

5.0.Conclusion and Recombination 15
References 17

Introduction and Rationale

Bonollo et al, (2013) reported that the main objective of Basel

committee of banking supervision is to discipline the market.

The key feature of sound banking system is to provide

prudential and meaningful information regarding key risk
matrices. It ultimately reduces the information asymmetry
among the market participant. Pillar 3 of Basel framework
concerns about the regulatory disclosure requirements with a
view to discipline the market. This information helps the market
participant to evaluate the regulatory capital and risk exposure
of the banks. Consequently, it increases the confidence of the
market participants, which help to avoid financial crisis (Coe
and Delaney, 2013). Pillar 3 is concern about the specific
method of measuring the credit risk, market risk and
operational risk of the banks. However, the experience of the
global financial crisis 2007-2009, informed that the existing
pillar 3 framework become failure to inform the market
regarding the material risk of the banking system. The Basel
committee then reviewed the circumstances and developed the
revised pillar 3. The main objective of revised pillar 3 is to
ensure comparability and consistency. The royal bank of
Scotland is retail bank. It is one of the subsidiaries of the royal
bank group plc. The bank has more than 700 branches
throughout the Scotland. The report concerns about the risk
exposure of the royal bank of the Scotland from the years 20082014. Moreover, the report includes the analysis of pillar 3
disclosure of the bank. Finally, the report discuss about the
international financial reporting system of the bank.

Literature Review
Reiland, (2014) stated that financial institutions are
continuously facing new revised set of standards and
interpretation under international financial reporting standards
(IFRS). There is continuous minor or major change in the
amendments of IFRS. These amendments are affecting various
aspects of reporting. The amendments come to the disclosure
requirements, recognition, and measurements of elements.
These amendments have also influence on the information

systems and the regulatory capitals of the banks. Moreover,

these changes have also impact on taking business decision. It
has an impact on the offering of new and innovative products
(Santos et al, 2014).
Schiebel, (2014) mentioned that IASB has developed a new
standard of IFRS 13, which is related to the fair value
measurements. The standard did not mention when to measure
the fair value. This new standard would not only apply to the
financial instruments but also be used for other assets and
liabilities. The standards also require the firms to record the
adjustments for its own default risk to its liabilities. This
standard has an impact on the financial institutions such as
banks in case of measuring portfolio of derivatives with risk
offsetting. The reporting fair value considers the credit risk of
the firms. Therefore, the reporting standards may make the
hedging ineffective. The amendment of IFRS 7 is related to the
disclosure of the information related to the financial
instruments (Singleton-Green, 2012). This disclosure
amendment has an impact on the banks and other financial
institutions. The banks require changing the management
information system as well as internal control. In 2011, the IASB
has made an amendment on the IAS 19, which is related to the
employee benefit plan. According to the amendments, the
banks have to record the actuarial gain in the comprehensive
income statement. This amendment also has impact on the
financial statements of the banks. It will increase the volatility
in the balance sheet (Stadler and Nobes, 2014).
Panizza et al, (2009) stated that global financial crisis has great
implication on the performance of the banks over the world.
Financial Crisis has been a most important issue after the
financial crisis of 2008. However, manipulation of the balance
sheet of the banks may causes of financial crisis. Not the single
factor works for the financial crisis. Some other factors also
lead to the financial crisis. Run on to the banks as well as
financial contagion also causes for financial crisis. Moreover,
spill over in the financial market also causes for the financial

crisis. The most basic reason for the financial crisis is the credit
crunches (Papell and Prudan, 2011).
Financial crisis comes after the rapid unusual boom in the asset
as well as credit market. Now the point is that, it is essential to
find out the reason behind the bubbles in the asset and the
credit market. The reasons are the considerable matters for the
market participants as well as for the policy makers. Obstfeld,
(2012) mentioned that financial has several stages. The stages
can be classified as the initial and small scale along with the
large scale of financial crisis. Moreover, financial crisis can also
be classified as the regional, national, and global. Proper
regulations and their implementation are essential to avoid
financial crisis. Without adequate regulations and proper
implementation also causes for global financial crisis. Financial
recession has great consequences. It leads to the lower
economic growth and imbalances in the macroeconomic
variables as well as inflation and unemployments.
Basel III is the recently developed regulations for the banking
industry. The Basel accord has been developed after the global
financial crisis. Basel III discuss about the capital adequacy and
the liquidity risk of the banks. Moreover, the recently developed
regulation also talks about the stress testing guideline for the
banks. The Basel committee has developed this accord in 20102011. The committee also decided to implement this accord
from 2013(Gualandri, 2014). Nevertheless, the fact is that the
schedule of the implementation of the accord has been
expanded to 2019. The accord was developed after the
experience of the global financial crisis. The Basel has realized
that there is insufficiency in the regulations. According to the
Basel III, every bank has to raise its capital requirements. The
basic objectives of the increment in the capital requirement are
the enhancement of bank liquidity as well as declining the
financial Leverage (Sabiwalsky, 2014). The focus of the Basel 3
accord is the risk of run on to the banks. On the other hand, the
focus of the Basel 1 and Basel 2 was bank loss reserve ratio.
The Basel III has been developed based on the three principles.

These are capital requirement and leverage ratio along with

liquidity position. According to Basel III, every bank has to
maintain tier 1 common on the risk weighted assets. The Basel
III requires every bank to maintain minimum tier 1 capital of
6%. On the other hand, the minimum tier1 capital in Basel 2
was only 4% (McNamara et al, 2014). Moreover, every bank has
to hold minimum tier 1 common equity of 7% from 2019.
Moreover, each bank has to hold more than 3% leverage ratio.
The Leverage ratio can be calculated as the ratio between the
tier 1 capital and the average total assets. In addition, the
Basel III has developed two liquidity ratios. These are liquidity
coverage ratio and net stable funding ratio. However, the
liquidity coverage ratio signify that the degrees of the
capability of the banks to hold high quality liquid assets
through which the banks can make payment of the net cash
outflows within 30 days.
According to the pillar 3 of the new Basel accord, the market
discipline is capable of reinforcing the minimum capital
standards. There is a proposal of Basel committee on the
development of the pillar 3. The primary goal of the Basel
committee on the banking supervision is to have a discipline in
the market (McNamara et al, 2014). Nevertheless, the fact is
that the pillar3 discuss about the disclosure requirement to
ensure the market discipline. Information asymmetry is the
main problems between the corporate agents and the
investors. Proper disclosure requirement is essential to reduce
information asymmetry from the banking system. Moreover, it
is required to manage a comparative risk profile. The
regulatory requirement of pillar 3 disclosures will be useful for
the market participants to assess the basic information
regarding regulatory capital and risk exposures of the banking
system. Therefore, it will increase confidence in the market
participants.
The current revised pillar 3 is related to the regulatory issues
mentioned in the pillar 1. The new revised pillar 3 concerns
about how to measure credit risk and market risk as well as

operational risk. The revised pillar 3 also concerns about the

risk weighted assets along with capital requirement. In addition,
the revised pillar 3 requires disclosing the supplementary so
that the market participants had better realise the abovementioned risks. Some studies mentioned after the empirical
studies on the global financial crisis 2007-2009. They found
that the current pillar 3 has not enough capability to detect the
major risk exposures of the banks. Therefore, the market
participants are deprived of the proper information and they fail
to take proper decision (Gualandri, 2014). Then the Basel
committee has been reviewing the program based on the
experience from the global financial crisis. Then the committee
decided to revise the disclosure requirements. The result is the
initiation of the revised pillar 3. The main objectives of the
revised pillar 3 are to ensure comparability and consistency.
The Basel committee has prepared an obligatory template for
disclosures to achieve the above-mentioned objectives.
However, the template has the flexibility so that the banks can
analyse the risk profile adequately (McNamara et al, 2014). In
addition, the templates give the opportunity to the senior
management to put comment on the risk profile of the banks.
The Basel committee also welcome investors and analysts as
well as rating agency to view on the revised pillar 3 disclosure
requirements. In addition, the audit committee is warmly
welcome to put comment on the disclosure requirements so
that there prevails good relation between the financial
statements and the risk exposures (Gualandri, 2014).
IFRS is a common global standard for preparing the financial
statement and accounts of the companies. The basic objective
of the IFRS is to ensure comparability among the financial
statements over the world. Kothari, (2012) mentioned that
increasing shareholding and trading across the world is the
main reason for the development of IFRS. The guideline of IFRS
is very useful for the multinational companies. It helps the
users to have the capability to realize and compare company
accounts. On the other hand, IAS 30 discusses about the

disclosure standards for the banks and other financial

institutions. The basic goal of IAS 30 is to provide information to
the users so that they can evaluate the financial performance
as well as the financial positions of the corporation. IAS 30
discuss about the standards to present the income statements.
Moreover, the standard talks about how to present the assets
and liability in the balance sheets (Mates, 2013). The
information related to the financial instruments is discussed in
IFRS 7. The IFRS 7 requires disclosing the risk of financial
instruments both in qualitative and quantitative way.

Methodology
The secondary sources have been used to collect relevant data.
As a secondary sources, Financial Times, IFAC, Economist,
Bloomberg, Big-4 firms reports and company annual reports
have been considered. As the work was based on the Royal
Bank of Scotland (RBS), their annual reports from 2008 to 2014
are used. The exposures to the risk elements of RBS were
scrutinised to come with final decision.

Discussion and Findings

Pillar 3 concerns about credit risk and market risk as well as

operational risk and securitisations. Every year the bank of
Scotland publishes pillar 3 disclosure. It also added some
information to it related to risk and capital management to the
group. However, the disclosures mainly focus on the capital
adequacy (Annual report, 2008). The disclosure also includes
the approaches of credit risk and it related risk weighted
assets. It also includes procedure of credit risk migration as well
as counterparty credit risk. The bank also discloses the detail
on the equity risk, market risk and operational risk along with
interest rate and equity risk. On the other hand, stress testing
is an inseparable part of Basel 2. The stress testing concerns

about the capital and risk management framework reported in

Annual report, 2009. Stress testing focus on the adverse effect
of the unexpected result. The bank has been performing stress
testing in both the group level and individual divisional level.
Credit risk is type of financial risk. The credit risk concern about
the risk related to the financial loss that is caused by the failure
of the customer to meet their financial obligation. However, the
bank authority has found a correlation between the
macroeconomic conditions and the amount of credit risk. The
better the macroeconomic conditions the better is the situation
of credit risk. It means the higher the performance of
macroeconomic variables the lower the credit risk reported in
Annual report, 2009.
There are several sources of credit risk. The two major sources
of credit risk are the lending and counterparty risk. However,
the counterparty risk comes from the derivatives markets as
well as securities financing transaction-financing market
(Annual report, 2010). The group has taken collateral to
mitigate the credit risk from the lending. The banks take both
physical and financial assets as collateral. The physical assets
are commercial real estate as well as residential property. The
most common financial collateral is bonds. Moreover, the bank
holds some debt securities that also possess credit risk. The
bank holds the debt securities for liquidity purpose (Annual
report, 2011). Therefore, the bank realizes the importance of
strong credit risk management. The loss can be mitigated
through strong credit risk management framework. The chief
credit risk officer is responsible for managing the credit risk of
the bank. The chief credit risk officer determines the how much
the credit would be concentrated.
The division wise credit risk of the bank is given below:
Credit Risk

UK Retail

2008
(m)

2009
(m)

201 2011( 2012 2013

0
m)
(m) (m)
(m)
97,069 103,0 1081 111,070 114,1 113,22

UK Corporate
Wealth
International
Banking
Ulster Bank
US Retail &
Commercial
Retail &
Commercial
Markets
Other
Core
Non-Core
Total Credit
Risk

29
126,73 109,9
6
08
17,604 15,95
1
450,32 224,3
1
55
8,995
7,152
64,695 42,04
2
82,862 52,10
4
127,83 1214
5
43
6,594
2,981

80
1066
11
1690
8
1346
13
8582

4624
6
1042
08
1153
71
1192
4
Na
557,5 5742
22
48
Na
151,2 1285
64
74
854,87 708,7 7028
6
86
22

105,078
20,079
72,737
37,781
56,546
403,291
114,327
64,517
582,135
92,709
674,844

Sources: annual report, 2008-2013

Credit Risk (m)

900,000
800,000
700,000
600,000
500,000
400,000
300,000
200,000
100,000
0

20
101,1
48
19,91
3
64,51
8
34,23
2
55,03
6
388,9
67
106,3
36
65,18
6
560,4
89
65,22
0
625,7
09

3
97,166
19,819
60,438
33,129
53,411
377,18
6
81,021
71,409
529,61
6
43,340
572,95
6

Source: Drawn from the data of annual

report, 2010-2013
From the above table and figure, it is observed that the total
credit risk of the bank of Scotland is 854,876 million pound in
2008, 708,786 million pound in 2009. The amount of the credit
risk is declining over the years. It indicates that overall credit
risk of the bank is downsizing over the years. There is a finding
of the bank that there is strong correlation between the
macroeconomic performance and the credit risk. From the
above data, we also found the same result. We have found that
at the time of global financial crisis, the credit risk of the bank
is highest. After the global financial crisis, the overall credit risk
of the bank is declining. It indicates the bank is performing
better in terms of managing the credit risk. It also observed
that the credit risk of the no core items is declining very rapidly.
It indicates the bank is performing better in the derivatives
market. On the other hand, it is observed that the credit risk of
the bank in the retail sector is increasing over time. It indicates
the credit management efficiency of the bank in the retail
lending is declining. Therefore, the bank should have strong
credit risk management framework for its retail lending.
However, the credit risk of the bank in the corporate lending is
decreasing gradually over the years (Annual report, 2012). It
implies that the credit risk management efficiency of the bank
in case of international banking is developing. It has been found
that the credit of the bank in the international banking is
declining very rapidly after the 2010. Now the point is that why
the credit of the bank in the international banking is that much
higher in the year 2008 and 2009. The reason can be the global
financial crisis. Finally, it can be said that the efficiency of
overall credit risk management is upgrading over the years
(Annual report, 2012).
The second most important risk for the bank is the market risk.
However, market risk arises due to the trading functionality of
the bank. Market risk is the change in the value of the financial
assets and liabilities of the bank due to the change in the

market price of the assets. The risk exposure depends on the

purpose of holding the securities. For example, the bank of
Scotland holds debt securities for trading. These debt securities
possess market risk. On the other hand, the bank also holds
debt securities for liquidity purpose. These debt securities
possess credit risk (Annual report, 2012).
According to Annual report (2013), Market risk can be also
defined as the loss incurred due to the change in interest rates,
credit spread as well as foreign exchange rate. This volatility of
the market variable leads to the fall of earnings. The bank
expose to both traded and non-traded market risk. The
fundamental goals of the trading activities of the bank are to
avail financing and risk hedging and investment purpose.
However, the banks market risk comes from the currencies
market; emerging market and asset backed securities as well
as traded credit. The bank also involve in trading of debt
instruments, loans along with securities financing and
derivatives (Annual report, 2013). The bank also has some
instruments on interest rate swap together with futures and
options. In case of derivatives instrument, the bank also
involved in the over the counter market transactions. However,
most of the non-traded market risk of the bank arises from the
retail and commercial loan that are held for not trading. The
market risk scenarios and required regulatory capital for the
market of the bank is given below:
Market Risk

Interest rate
position risk
requirement
Equity position risk
requirement
Option position risk
requirement

200
8
(m
)
120
3

2009
(m)

2010
(m)

2011(
m)

1178.
94

1155.
36

1,107

2012 201
(m) 3
(m
)
254
147

3.76

3.53

42

37.8

34.02

26

26

10

Commodity position
risk requirement
Foreign currency
position risk
requirement
Specific interest
rate risk of
securitisation
positions
Total (standard
method)
Pillar 1 model based
position risk
requirement
Total market risk
minimum capital
requirement

12

13

7.2

8.64

10

12

39

382

344

309.4
2

250

156

123

164
5
523
7

1584

1519.
98
4241.
97

1,398

451

333

3,725

2,95
9

2,08
6

765
2

6887

6198.
12

5,123

3,41
0

2,41
9

4713

Sources:
annual report, 2008-2013
From the above table, it has been observed that the overall
market risk of the bank is reducing over the years. It has been
observed that the market risk in 2008 is 1645 million pound
while market risk in 2013 is only 333 million pound. It indicates
the efficiency of market risk management of the bank is
increasing over the years. It is also observed that as the market
risk of the bank is decreasing, the minimum regulatory capital
for the market risk is also declining over the years. We see that
minimum capital requirement for the market risk exposure is
7652 million pound in 2008 while that in 2013 is 2419 million
pound. It is also observed that the interest rate risk exposure is
1203 million pound in 2008 while that in 2013 is only 147
million pound. It implies that the bank is managing the interest
rate risk very smoothly and efficiently. Moreover, it is observed
that the option position risk for the bank is 42 million pound in
2008 while that in 2013 is only 10. it also indicates that the
banks performing well in the option market. On the other hand,
the foreign currency exposure risk of the bank is increasing

over the years. The foreign currency risk capital requirement in

2008 is only 6 million while that in 2013 is 39. Therefore, the
bank should be concern about the foreign currency risk
management. Finally, the overall market risk of the bank is
declining over time. Therefore, the efficiency of market risk
management is also increasing over time.
The third important component of the risk is the operational
risk reported in Annual report, 2011. The risk that arises from
the failure of internal process and people as well as systems is
termed as operational risk. The risk arises from the day-to-day
operation of the business. Technology and loss of customer
data may also create the operational risk. The recent
transformation program of the bank is very complex. It may
affect all the business activities of the bank. Therefore, the
transformation program can increase the operational risk of the
bank. However, the bank has developed a program
management infrastructure to manage the added operational
risk in addition to operational risk management framework
(Annual report, 2010). However, the bank has identified that
this transformation system has affected many people and their
tasks in the bank. The bank has identified that employee need
enough capacity to adapt to the change and they need training.
The bank has implemented a new functional operational model
in 2014 with a view to ensuring that the bank is managing this
very standardised and sequential way. The bank also started to
develop operational risk management framework with a view to
downsizing the operational risk. The transformation program
was after a major IT incidence in 2012. The program has
developed the core banking services and the operating
practices. The program has three lines of defences. The main
concern of the operational risk of the bank is the cyber attack
to the bank important information. In 2014, the bank also
develops a cyber security enhancement program to monitor the
threat very closely reported in Annual report, 2014.
The operational risk executive committee of the bank of
Scotland is responsible for managing the operational risk of the

bank. The committee is a subcommittee of executive risk

forum. This committee determine and evaluate the major
operational risk including the emerging material operational
risk (Annual report, 2012). The basic objective of managing
operation risk is not to remove the risk rather to keep the risk in
the acceptable label.

The risk-weighted asset for only operational risk of the bank is

given below:
RWA-operational risk (m)
2010
2011
2012
37.1
37.9
45.8
Source: annual report, 2010-2014

2013
41.8

2014
36.8

RWA-operational risk (m)

50
45
40
35
30
25
20
15
10
5
0

Source: drawn from the data of annual

report, 2010-2014
The above table and figure shows that risk weighted assets for
operational risk of the bank of Scotland. From the above figure,
it is observed that operational risk of the bank has increased
after 2010 and 2011. In the year 2012, a major cyber attack
has been taken place. For this reason, the operational risk of
the bank is highest in the year. However, after 2012 the
operational risk of the bank is declining. The reason behind it is

that the bank has developed a modern transformation system

to mitigate the operational risk.
According to Annual report (2013), the bank of Scotland used to
prepare its consolidated financial statements based on the IFRS
guideline that has been taken by European Union. The reporting
of the bank also complies with the IASB. The bank has first time
accept the IAS 39 of recognition and measurement of financial
instruments and IAS 32 of disclosure ad presentation of
financial instrument. Moreover, the bank also accepts the IFRS
4 regarding the insurance contract in 2005 without changing
the balance sheet and income statement of the bank.
In May 2011, the IASB has revised six standards. These are SIC
12 of IFRS 10, 11, 12 and 13. The bank has analysed the impact
of the change. the bank determine the fair value of financial
instruments classified as held for trading and available for sales
and derivative instruments under IFRS guideline (Annual report,
2012). The bank reports the goodwill as the difference between
the fair value of acquired assets and the cost of acquisition as
required by IFRS. Moreover, the bank tests the goodwill every
year as required by the IFRS guideline. In addition, the bank
tries to amortise the goodwill very frequently to follow the
guideline of IFRS. The bank has reported deferred tax assets on
loss in 2008 with a view to adjusting it to the future profit based
on IFRS guideline. In 2008, the cost fund has increased to 11%.
Hence, the bank wants to hedge the interest rate risk (Annual
report, 2008). Nevertheless, according to IFRS rules, the
interest rate risk cannot be hedged because it increased the
volatility in accounting policies. The European Union is yet to
take the interpretation of IAS 39. The IAS 39 is related to the
recognition and measurement of the financial instrument. The
European union do not accept the interpretation of IAS 39 is
due to have some relaxation. Nevertheless, the bank of
Scotland did not take advantage of relaxation. The bank
recognises the financial instrument based on IAS39 (Annual
report. (2010). The bank has accepted some newly revised IFRS
rules. One is IAS 32, which is related to offsetting financial

assets and financial liabilities. The amendment of IFRS 10, IFRS

12 and IAS 27 related to the investment entities. IFRS 3 did not
permit to amortise the Goodwill rather it require to assess
impairment. Therefore, the bank assesses the goodwill every
year to determine the impairment of goodwill. The IASB has
made some amendment I IFRS rule from 2010 to 2013. These
amendments did not have material influence to the reporting of
the bank. However, IFRS issue some amendment in 31
December 2014 that would affect the bank in 2015 reported in
Annual report, 2014.

Conclusion and Recombination

The experience of the global financial crisis 2007-2009,

informed that the existing pillar 3 framework become failure to
inform the market regarding the material risk of the banking
system. The Basel committee then reviewed the circumstances
and developed the revised pillar 3 (Stadler and Nobes, 2014).
Financial institutions are continuously facing new revised set of
standards and interpretation under international financial
reporting standards (IFRS). There is continuous minor or major
change in the amendments of IFRS. These amendments are
affecting various aspects of reporting. The amendments come
to the disclosure a requirements, recognition, and
measurements of elements. These amendments have also
influence on the information systems and the regulatory
capitals of the banks (Reiland, 2014). The amount of the credit
risk is declining over the years. It indicates that overall credit
risk of the bank is downsizing over the years. There is a finding
of the bank that there is strong correlation between the
macroeconomic performance and the credit risk. We have
found that at the time of global financial crisis, the credit risk of
the bank is highest. After the global financial crisis, the overall

credit risk of the bank is declining. It indicates the bank is

performing better in terms of managing the credit risk. It has
been found that as the market risk of the bank is decreasing,
the minimum regulatory capital for the market risk is also
declining over the years. Therefore, the efficiency of market
risk management is also increasing over time. Operational risk
of the bank has increased after 2010 and 2011. In the year
2012, a major cyber attack has been taken place. For this
reason, the operational risk of the bank is highest in the year.
However, after 2012 the operational risk of the bank is
declining. The reason behind it is that the bank has developed
a modern transformation system to mitigate the operational
risk. We recommend the bank to increase the disclosure.
Moreover, we recommend the bank to disclose segment wise
information reporting.

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