Pillar 3 Disclosure 2011 Pillar 3 Disclosure 4 Forward-looking statements 4 Basis of disclosure 5 Background 7 Scope of application 8 Governance 9 Capital 15 Credit risk Organisation 15 Credit approval 15 Risk appetite 15 Credit risk measurement 16 Credit risk mitigation 16 Basel II credit risk-weighted assets measurements 18 Credit risk by advanced IRB approach 19 Credit risk by standardised approach 36 45 Counterparty credit risk 48 Securitisation 57 Market risk 60 Operational risk 62 Additional disclosures Significant subsidiaries 62 Past due and impaired assets 70 Non-trading book equity risk 73 Interest rate risk 74 Sensitivity of net interest income 75 Appendix 1 Glossary of acronyms and key terms RBS Group Pillar 3 Disclosure 2011 1 Pillar 3 Disclosure continued Charts Chart 1: Minimum capital requirement structure 5 Chart 2: Governance structure for model review and approval 17 Chart 3: Regulatory Group hierarchy 62 Tables Table 1: Group RWAs and minimum capital requirement by risk type 9 Table 2: Composition of regulatory capital 10 Table 3: Capital instruments 11 Table 4: Incorporation of credit risk mitigants within IRB risk parameters 17 Table 5: Credit RWAs and minimum capital requirement 18 Table 6: Credit RWAs and minimum capital requirement by advanced IRB exposure class 19 Table 7: Advanced IRB gross average exposure at default 20 Table 8: Advanced IRB gross exposure at default by geographic area 21 Table 9: Advanced IRB gross exposure at default by industry sector 22 Table 10: Advanced IRB gross exposure at default by residual maturity 23 Table 11: Master grading scale mapping to asset quality bands 24 Table 12: Central governments and central banks by asset quality band 25 Table 13: Institutions by asset quality band 26 Table 14: Corporates by asset quality band 27 Table 15: Retail SMEs by asset quality band 28 Table 16: Retail secured by real estate collateral by asset quality band 29 Table 17: Qualifying revolving retail exposures by asset quality band 30 Table 18: Other retail exposures by asset quality band 31 Table 19: Equities by asset quality band 32 Table 20: Advanced IRB exposure covered by guarantees and credit derivatives 33 Table 21: Expected loss and impairment charge 34 Table 22: Predicted probability of default, actual default rates and EAD outcomes versus predictions 34 Table 23: Loss outcomes versus predictions 35 Table 24: RWAs and capital requirement by standardised exposure class 36 Table 25: Standardised gross exposure by exposure class 37 Table 26: Standardised gross exposure by geographic area 38 Table 27: Standardised gross exposure by industry sector 39 Table 28: Standardised gross exposure by residual maturity 41 Table 29: Credit quality steps mapping to external credit gradings 41 Table 30: Standardised portfolio exposure for customer credit risk and counterparty credit risk by credit quality steps 42 Table 31: Standardised exposures covered by eligible financial collateral 44 Table 32: Standardised exposures covered by guarantees and credit derivatives 44 Table 33: Counterparty credit risk capital requirement 45 Table 34: Counterparty credit risk exposure 45 Table 35: Counterparty credit risk exposure at default by method 45 Table 36: Netting and collateralisation impact on counterparty credit risk 46 Table 37: Credit derivative transactions 47 Table 38: Exposures securitised, by transaction and exposure type 52 Table 39: New securitisation activity during the year 53 Table 40: Impaired and past due exposures securitised, by exposure type and losses 53 Table 41: Securitisation positions, retained or purchased, by exposure type on and off-balance sheet 54 Table 42: Securitisation positions, retained or purchased, by risk-weightings 54 Table 43: Re-securitisation positions, retained or purchased, by risk-weightings 56 Table 44: Exposures to securitisations of revolving assets 56 Table 45: Total trading book outstanding exposures securitised and subject to a market risk capital requirement 56 Table 46: Market risk minimum capital requirement 58 Table 47: Operational risk minimum capital requirement 61 Table 48: Significant subsidiaries minimum capital requirement 62 Table 49: Significant subsidiaries RWAs 63 Table 50: Significant subsidiaries credit risk minimum capital requirement 63 Table 51: Significant subsidiaries credit risk advanced IRB minimum capital requirement 64 RBS Group Pillar 3 Disclosure 2011 2 Pillar 3 Disclosure continued Tables continued Table 52: Significant subsidiaries credit risk standardised minimum capital requirement 65 Table 53: Significant subsidiaries counterparty credit risk and concentration requirement 65 Table 54: Significant subsidiaries market risk trading book and other business 66 Table 55: Significant subsidiaries capital resources 67 Table 56: Past due exposures, impaired exposures and provisions by industry sector 71 Table 57: Past due exposures, impaired exposures and provisions by geographic area 72 Table 58: Loan impairment provisions movement 72 Table 59: Non-trading book equity at balance sheet value 73 Table 60: Net realised and unrealised gains from non-trading book equity 73 Table 61: IRRBB VaR for retail and commercial banking activities at a 99% confidence level 75 Table 62: IRRBB VaR by currency 75 Table 63: Sensitivity of net interest income 75 Table 64: Sensitivity of net interest income by currency 75 RBS Group Pillar 3 Disclosure 2011 3 Forward-looking statements This document contains certain forward-looking statements could be materially different from actual results, are within the meaning of the Private Securities Litigation Reform dependent on key model characteristics and assumptions Act of 1995 with respect to the financial condition, results of and are subject to various limitations. For further risks and operations and business of The Royal Bank of Scotland uncertainties faced by the Group that may impact the Group plc (‘the Group’). Generally, words such as ‘may’, statements set out in this document, refer to the Group’s ‘could’, ‘will’, ‘expect’, ‘intend’, ‘estimate’, ‘anticipate’, Annual Report and Accounts for the year ended 31 ‘believe’, ‘plan’, ‘seek’, ‘continue’, ‘project’, ‘should’, December 2011 and any other interim or update information ‘probability’, ‘risk’, ‘value-at-risk’, ‘target’, ‘goal’, ‘objective’, published by the Group, including information furnished to the ‘endeavour’, ‘outlook’, ‘optimistic’ and ‘prospects’ or similar Securities and Exchange Commission on Form 6-K. expressions or variations on such expressions identify forward-looking statements. Any forward-looking statements set out herein speak only as at the date of this document. Except as required by the Any forward-looking statements set out herein represent the Financial Services Authority (FSA), the London Stock Group’s expectations or beliefs concerning future events and Exchange or other applicable law or regulation, the Group involve known and unknown risks and uncertainty that could does not have any obligation to update or revise publicly any cause actual results, performance or events to differ forward-looking statements, whether as a result of new materially from those expressed or implied in such information, further events or circumstances or otherwise, statements. For example, certain of the market risk and expressly disclaims any obligation to do so. disclosures, some of which are only estimates and, therefore, Basis of disclosure The Pillar 3 disclosures being made by the Group are • It is not always possible to aggregate the disclosures designed to comply with the FSA Handbook (BIPRU 11). across the different Basel II approaches to obtain a They should be read in conjunction with the Group’s 2011 Group view. This is particularly important for the credit Annual Report and Accounts, approved on 22 February risk disclosures. 2012. The information is not required to be and therefore has not There are important differences between the accounting and been subject to external audit. Capital Requirements Directives (CRD) disclosures, which can be summarised as follows: Whilst the Group has participated in discussions at the British Bankers’ Association and other trade bodies, it is possible • The Basel II disclosures represent a regulatory, rather that disclosures made by other banks, especially outside the than an accounting basis of consolidation. Various UK, are not directly comparable. businesses (for example insurance) are included in the latter, but not in the former. Therefore, these disclosures The Group has not omitted disclosures on the grounds that may not be comparable to other external disclosures the information may be proprietary or confidential. made by the Group. Disclosures in relation to remuneration are included on pages • The definition of exposure differs between Basel II and 272 to 295 of the Group’s 2011 Annual Report and Accounts. accounting. The Basel II definition used in the Pillar 3 disclosures is exposure at default rather than the balance sheet or drawn balance plus mark-to-market, as used in the Group’s financial reporting. RBS Group Pillar 3 Disclosure 2011 4 Background The Basel II framework was implemented in the European Banks are required to disclose all their material risks as part Union (EU) through the CRD. of the Pillar 3 framework. Some of these requirements have already been satisfied within the Group’s 2011 Annual Report The framework is based on three Pillars: and Accounts, available on the Group's website. The 2011 Annual Report and Accounts include a range of risk factors • Pillar