FORM 20-F

(Mark one)o
REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or (g) OF THE SECURITIES EXCHANGE ACT OF 1934
   
ORxANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934
  
For the fiscal year ended                                      ��                        31 December 20072009
   
ORo
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
ORo
SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from     to  
  
Commission file number 
1 - 9266
 
NATIONAL WESTMINSTER BANK Plc
ENGLAND
135 Bishopsgate, London, EC2M 3UR, England
 
Miller McLean, Group General Counsel andAileen Taylor, Deputy Group Secretary, Tel: +44 (0) 131 523 2333,626 4099, Fax: +44 (0) 131 626 3081,
PO Box 1000, Gogarburn, Edinburgh EH12 1HQ
 
Securities registered or to be registered pursuant to Section 12 (b)12(b) of the Act.
 Title of each className of each exchange on which registered
-Non-Cumulative Dollar Preference Shares of $25 each, Series B (redeemed in January 2007)New York Stock Exchange
-American Depositary Shares, each representing one Non-Cumulative
Dollar Preference Share of $25 each, Series B (redeemed in January 2007)New York Stock Exchange
-Non-Cumulative Dollar Preference Shares of $25 each, Series CNew York Stock Exchange
-American Depositary Shares, each representing one Non-Cumulative 
 Dollar Preference Share of $25 each, Series CNew York Stock Exchange
 
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, 2007,2009, the close of the period covered by the annual report.
-£1 Ordinary shares1,678,176,5581,678,177,493
-Non-Cumulative Dollar Preference Shares of $25 each, Series C12,000,000
-9% Non-Cumulative Preference Shares of £1 each, Series A140,000,000
 
 
Indicate by check mark if the registrant is a well knownwell-known seasoned filer,issuer, as defined in Rule 405 of the Securities Act .
  o
 YES
x
 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 YESo 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 oAccelerated filer       o
Non accelerated filer  x
 
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

U.S. GAAP o  International Financial Reporting Standards as issued by the International Accounting Standards Board  x  Other o

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 YESx NO
 
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
 
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.
 o YESo NO
     
As a wholly-owned subsidiary of The Royal Bank of Scotland plc, which in turn is a wholly-owned direct subsidiary of The Royal Bank of Scotland Group plc, a public company with limited liability incorporated in Great Britain and which has its registered office in Scotland, National Westminster Bank Plc meets the conditions set forth in General Instruction I(1)(a) and (b) of Form 10-K, as applied to reports on Form 20-F, and is therefore filing its Form 20-F with a reduced disclosure format.

 
NATIONAL WESTMINSTER BANK Plc

ANNUAL REPORT ON FORM 20-F
FOR THE YEAR ENDED 31 DECEMBER 20072009
CONTENTS
 
Item
Item Caption
Page
    
  
Presentation of Information 
1
 PART I  
 1
Identity of Directors, Senior Management and Advisers 
*
 2
Offer Statistics and Expected Timetable 
*
 3
Key Information 
3
  
Selected financial data  
*
  
Capitalisation and indebtedness 
*
  
Reasons for the offer and use of proceeds 
*
  
Risk factors 
6
 4
Information on the Bank 
9
  
History and development of the Bank 
9
  
Business overview 
9
  
Organisational structure 
10
  
Property, plants and equipment
10
 4A Unresolved Staff Comments *
 5
Operating and Financial Review and Prospects 
11
  
Operating results 
11
  
Liquidity and capital resources 
32, 110
  
Research and development, patents, licences etc 
*
  
Trend information 
*
  
Off balance sheet arrangements 
*
  
Contractual obligations 
*
 6
Directors, Senior Management and Employees 
33
  
Directors and senior management 
*
  
Compensation 
*
  
Board practices 
33
  
Employees 
65
  
Share ownership 
34
 
7 
Major Shareholders and Related Party Transactions 
*
  
Major shareholders 
*
  
Related party transactions 
*
  
Interests of experts and counsel 
*
 8
Financial Information 
36
  
Consolidated statements and other financial information 
36
  
Significant changes 
38
ItemItem CaptionPage
   
 Presentation of Information1
PART I  
1Identity of Directors, Senior Management and Advisers*
2Offer Statistics and Expected Timetable*
3Key Information3
 
   Selected financial data
*
 
   Capitalisation and indebtedness
*
 
   Reasons for the offer and use of proceeds
*
 
   Risk factors
6
4Information on the Bank19
 
   History and development of the Bank
19
    Business overview19
    Organisational structure20
 
   Property, plants and equipment
20
4AUnresolved Staff Comments*
5Operating and Financial Review and Prospects21
 
   Operating results
21
 
   Liquidity and capital resources
61
 
   Research and development, patents, licences etc
*
 
   Trend information
*
    Off balance sheet arrangements*
    Contractual obligations*
6Directors, Senior Management and Employees62
 
   Directors and senior management
*
    Compensation*
    Board practices62
 
   Employees
64
    Share ownership64
7Major Shareholders and Related Party Transactions*
    Major shareholders*
    Related party transactions*
    Interests of experts and counsel*
8Financial Information66
    Consolidated statements and other financial information66
    Significant changes66
9The Offer and Listing67
    Offer and listing details67
    Plan of distribution*
    Markets67
    Selling shareholders*
    Dilution*
    Expenses of the issue*
10Additional Information69
    Share capital*
    Memorandum and articles of association69
    Material contracts73
    Exchange controls73
    Taxation73
    Dividends and paying agents*
    Statement of experts*
    Documents on display*
    Subsidiary information*

* Not required because this Form 20-F is filed as an Annual Report, not applicable to National Westminster Bank Plc, is omitted on the basis of General Instruction I to Form 10-K or otherwise not included herein.

*Not required because this Form 20-F is filed as an Annual Report, not applicable to National Westminster Bank Plc, is omitted on the basis of General Instruction I to Form 10-K or otherwise not included herein.

i
 

Table
ItemItem CaptionPage
   
11Quantitative and Qualitative Disclosure about Market Risk76
12Description of Securities other than Equity Securities76
PART II  
13Defaults, Dividend Arrearages and Delinquencies*
14Material Modifications to the Rights of Security Holders and Use of Proceeds*
15Controls and Procedures77
16Reserved*
16AA  Audit Committee financial expert*
 B  Code of ethics*
 C  Principal Accountant Fees and services62, 102
 D  Exemptions from the Listing Standards for Audit Committee*
 E  Purchases of Equity Securities by the Issuer and Affiliated Purchases*
 F  Change in Registrant’s Certifying Accountant*
 G  Corporate Governance78
PART III  
17Financial Statements*
18Financial Statements79
19Exhibits 
 Signature 
   
* Not required because this Form 20-F is filed as an Annual Report, not applicable to National Westminster Bank Plc, is omitted on the basis of ContentsGeneral Instruction I to Form 10-K or otherwise not included herein.

 
 9
The Offer and Listing
39
  
Offer and listing details
39
  Plan of distribution*
  
Markets
40
  Selling shareholders*
  Dilution*
  Expenses of the issue*
 10
Additional Information
41
  Share capital*
  
Memorandum and articles of association
41
  
Material contracts
41
  
Exchange controls
41
  
Taxation
41
  Dividends and paying agents*
  Statement of experts*
  Documents on display*
  Subsidiary information*
 11
Quantitative and Qualitative Disclosure about Market Risk
44
 12Description of Securities other than Equity Securities*
 PART II  
 13Defaults, Dividend Arrearages and Delinquencies*
 14Material Modifications to the Rights of Security Holders and Use of Proceeds*
 15
Controls and Procedures
45
 16Reserved*
 16AA   Audit Committee financial expert*
  B   Code of ethics*
  
C   Principal Accountant Fees and services
33, 68
  D   Exemptions from the Listing Standards for Audit Committee*
  E   Purchases of Equity Securities by the Issuer and Affiliated Purchases*
 PART III  
 17Financial Statements*
 18
Financial Statements
46
 19
Exhibits
119
  
Signature
120
*Not required because this Form 20-F is filed as an Annual Report, not applicable to National Westminster Bank Plc, is omitted on the basis of General Instruction I to Form 10-K or otherwise not included herein.

 
PRESENTATION OF INFORMATION

In this report,document, the term 'NatWest', 'Bank' or ‘Company’‘company’ means National Westminster Bank Plc and 'NatWest Group' means the Bank and its subsidiary undertakings.

National Westminster Bank Plc is a wholly-owned direct subsidiary of The Royal Bank of Scotland plc, which in turn is a wholly-owned direct subsidiary of The Royal Bank of Scotland Group plc.plc (“the ultimate holding company”). For the purpose of this report, the term 'RBS Group' means The Royal Bank of Scotland Group plc and its subsidiary undertakings, including the Bank, and the term the ‘Royal Bank’ refers to The Royal Bank of Scotland plc.

The Bank 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 UK domestic transactions of NatWest Group. Foreign activities comprise NatWest 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 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 yields, spreads and margins of NatWest 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 NatWest 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 on-tradingnon-trading based on their predominant activity. Although this method may result in some non-trading activity being classified as trading, and vice versa, NatWest Group believes that any resulting misclassification is not material.

International Financial Reporting Standards
As required by the Companies Act 1985 and Article 4 of the European Union IAS Regulation, the consolidated financial statements of NatWest GroupThe accounts are prepared on a going concern basis and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the International Financial Reporting Interpretations Committee of the IASB (together ‘IFRS’) as adopted by the European Union. It also complies withUnion (EU) (together IFRS). The EU has not adopted the IFRS as issued by the IASB. On implementationcomplete text of IFRS on 1 January 2005, NatWest Group took advantage of the option in IFRS 1 ‘First-time Adoption of International Financial Reporting Standards’ to implement IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the Standard’s hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 32 ‘Financial Instruments: Disclosure and Presentation’  from 1 January 2005 without restating its 2004 income statement and balance sheet. The date of transition to IFRS for NatWest Group and39 as issued by the date of its opening IFRS balance sheet is 1 January 2004.

NatWestIASB: the Group’s published 2004 financial statements wereare prepared in accordance with then current UK generally accepted accounting principles (“UK GAAP” or “previous GAAP”) comprising standardsIFRS as issued by the UK Accounting Standards Board, pronouncements of the Urgent Issues Task Force, relevant Statements of Recommended Accounting Practice and provisions of the Companies Act 1985.
NatWest Group is no longer required to include reconciliations of shareholders’ equity and net income under IFRS and US GAAP in its filings with the Securities and Exchange Commission in the US.IASB.

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’, ‘could’, ‘intend’, ‘plan’, ‘probability’, ‘risk’, ‘Value-at-Risk (“VaR”)’, ‘target’, ‘goal’, ‘objective’, ‘may’, ‘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 toto: the RBS Group’s restructuring plans; the RBS Group’s and the NatWest Group’s capitalisation, portfolios, capital ratios, liquidity, risk weighted assets, return on equity, cost income ratios, leverage and loan deposit ratios, funding and risk profile; future financial performance; the level and extent of future impairments and write-downs; the protection provided by the APS; and the potential exposures to various types of market risks, such as interest rate risk, foreign exchange rate risk and commodity and equity price risk. SuchThese statements are based on current plans, estimates and projections, and are subject to inherent risks, uncertainties and uncertainties.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 of the 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: the extentfull nationalisation of the RBS Group or other resolution procedures under the Banking Act 2009; the global economy and nature of future developmentsinstability in the creditglobal financial markets, including the sub-prime market, and their impact on the financial industry in general and on the RBS Group and the NatWest Group in particular; general economic conditionsthe financial stability of other financial institutions, and the RBS Group and the NatWest Group’s counterparties and borrowers; the ability of the RBS Group to complete restructurings on a timely basis, or at all, including the disposal of certain non-core assets and assets and businesses required as part of the EC State Aid restructuring plan; organisational restructuring; the ability to access sufficient funding to meet liquidity needs; cancellation or failure to renew governmental support schemes; the extent of future write-downs and impairment charges caused by depressed asset valuations; the inability to hedge certain risks economically; the value and effectiveness of any credit protection purchased by the RBS Group and the NatWest Group; unanticipated turbulence in interest rates, foreign currency exchange rates, credit spreads, bond prices, commodity prices and equity prices; changes in the UKcredit ratings of the RBS Group or the NatWest Group; ineffective management of capital or changes to capital adequacy or liquidity requirements; changes to the valuation of financial instruments recorded at fair value; competition and consolidation in other countries in whichthe banking sector; HM Treasury exercising influence over the operations of the RBS Group; the ability of the RBS or the NatWest Group has significant business activitiesto attract or investments, including the United States;retain senior management or other key employees; regulatory change or a change in UK Government policy; changes to the monetary and interest rate policies of the Bank of England, the Board of Governors of the Federal Reserve System and other G-7G7 central banks; inflation; deflation; unanticipated fluctuationsimpairment of goodwill; pension fund shortfall; litigation and regulatory investigations; general operational risks; insurance claims; reputational risk; general geopolitical and economic conditions in interest rates, foreign currency exchange rates, commodity pricesthe UK and equity prices;in other countries in which the RBS Group and the NatWest Group has significant business activities or investments, including the United States; the ability of the RBS Group to achieve revenue benefits and cost savings from the integration of certain of RBS Holdings N.V.’s businesses and assets; changes in UK and foreign laws, regulations, accounting standards and taxes;taxes, including changes in competitionregulatory capital regulations and pricing environments; natural and other disasters; the inability to hedge certain risks economically; the adequacy of loss reserves; acquisitions or restructurings; technological changes; changes in consumer spending and saving habits;liquidity requirements; and the success of the RBS Group and the NatWest Group in managing the risks involved in the foregoing.

The forward-looking statements contained in this report speak only as of the date of this report, and the NatWest 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.

For a further discussion onof certain risks faced by the RBS Group and the NatWest Group, see Risk Factorsfactors on page 6.


ITEM 3. KEY INFORMATION

The Company has omitted portions of this item on the basis of General Instruction I(2)(a) to Form 10-K.

As discussed on page 1, the consolidated financial statements of NatWest Group are prepared in accordance with International Financial Reporting Standards. NatWest Group took advantage of the option in IFRS 1 to implement IAS 32 and IAS 39 from 1 January 2005 without restating its 2004 income statement and balance sheet. The implementation of IAS 32 and IAS 39 on 1 January 2005 had a significant effect on NatWest Group's balance sheet. Therefore the information set out below for 2007, 2006 and 2005 are not directly comparable to 2004.
SELECTED FINANCIAL DATA

NatWest Group’s accounts are prepared in accordance with IFRS as issued by the IASB. Selected data under IFRS for each of the fourfive years ended 31 December 20072009 are presented below. Selected data under UK GAAP for each of the two years ended 31 December 2004 are presented on page 4.

The dollar financial information included below has been translated for convenienceconverted from sterling at thea rate of £1.00 to US$1.9843,1.6167, being the Noon Buying Rate on 31 December 2007.2009.
                 2005 
  2009  2009  2008  2007  2006  Discontinued*  Continuing 
Summary consolidated income statement  $m   £m   £m   £m   £m   £m   £m 
Net interest income  5,168   3,197   5,397   5,091   4,449   212   4,249 
Non-interest income  9,825   6,077   2,307   3,263   4,877   9   4,180 
Total income  14,993   9,274   7,704   8,354   9,326   221   8,429 
Operating expenses  (6,476)  (4,006)  (5,202)  (4,420)  (5,018)  (70)  (4,413)
Profit before impairment  8,517   5,268   2,502   3,934   4,308   151   4,016 
Impairment  6,692   (4,139)  (1,362)  (849)  (852)  (4)  (752)
Operating profit before tax  1,825   1,129   1,140   3,085   3,456   147   3,264 
Tax  8   5   (599)  (768)  (831)  (44)  (904)
Profit from continuing operations  1,833   1,134   541   2,317   2,625   103   2,360 
Profit from discontinued operations, net of tax  -   -   -   -   -       103 
Profit for the year  1,833   1,134   541   2,317   2,625       2,463 
                             
Profit attributable to:  -                         
Minority interests  - -   -   93   89   39       17 
Ordinary shareholders  1,833   1,134   448   2,228   2,586       2,446 

Amounts in accordance with IFRS* NatWest Group transferred its home mortgage finance business, National Westminster Home Loans Limited, to the Royal Bank on 31 December 2005 at neither a profit nor a loss.


  2009  2009  2008  2007  2006  2005 
Summary consolidated balance sheet  $m   £m   £m   £m   £m   £m 
Loans and advances  481,183   297,633   264,501   260,425   243,974   215,938 
Debt securities and equity shares  57,805   35,755   37,122   39,047   33,701   30,338 
Derivatives and settlement balances  14,620   9,043   13,012   6,275   6,320   6,907 
Other assets  13,414   8,297   6,584   6,535   6,666   7,420 
Total assets  567,022   350,728   321,219   312,282   290,661   260,603 
                         
Shareholders’ equity  22,955   14,199   12,135   10,788   10,173   9,440 
Minority interests  2,073   1,282   1,323   1,314   1,012   744 
Subordinated liabilities  14,549   8,999   10,099   5,932   5,641   6,648 
Deposits  467,058   288,896   254,017   250,380   227,477   203,925 
Derivatives, settlement balances and short positions  34,368   21,258   21,157   18,206   26,617   24,231 
Other liabilities  26,019   16,094   22,488   25,662   19,741   15,615 
Total liabilities and equity  567,022   350,728   321,219   312,282   290,661   260,603 

         2005  2004 
  2007   2006  Discontinued*  Continuing  Discontinued*  Continuing 
Summary consolidated income statement 
$m
  
£m
  
£m
  £m  £m  £m  £m 
                           
Net interest income  10,102   5,091   4,449   212   4,249   265   4,118 
Non-interest income  6,475   3,263   4,877   9   4,180   13   3,627 
Total income  16,577   8,354   9,326   221   8,429   278   7,745 
Operating expenses  8,771   4,420   5,018   70   4,413   53   4,115 
Profit before impairment losses  7,806   3,934   4,308   151   4,016   225   3,630 
Impairment losses  1,684   849   852   4   752   (5)  630 
Operating profit before tax  6,122   3,085   3,456   147   3,264   230   3,000 
Tax  1,524   768   831   44   904   69   797 
Operating profit after tax  4,598   2,317   2,625   103   2,360   161   2,203 
Discontinued operations  -   -   -       103       161 
Profit for the year  4,598   2,317   2,625       2,463       2,364 
Minority interests  177   89   39       17       12 
Preference dividends  -   -   -       -       36 
Profit attributable to ordinary shareholders  4,421   2,228   2,586       2,446       2,316 
                             
Ordinary dividends  3,671   1,850   1,500       350       2,300 
 
*NatWest Group transferred its home mortgage finance business, National Westminster Home Loans Limited, to the Royal Bank on 31 December 2005 at neither a profit nor a loss.
3

  2007   2006   2005   2004 
Summary consolidated balance sheet $m   
£m
   £m   £m   £m 
                    
Loans and advances 516,761   260,425   243,974   215,938   161,661 
Debt securities and equity shares 73,471   37,026   33,426   29,568   23,764 
Derivatives and settlement balances 12,451   6,275   6,320   6,907   4,904 
Other assets 16,978   8,556   6,941   8,190   6,892 
Total assets 619,661   312,282   290,661   260,603   197,221 
                    
Shareholders' equity 21,407   10,788   10,173   9,440   8,009 
Minority interests 2,607   1,314   1,012   744   408 
Subordinated liabilities 11,771   5,932   5,641   6,648   5,808 
Deposits 496,829   250,380   227,477   203,925   149,992 
Derivatives, settlement balances and short positions 36,126   18,206   26,617   24,231   22,775 
Other liabilities 50,921   25,662   19,741   15,615   10,229 
Total liabilities and equity 619,661   312,282   290,661   260,603   197,221 
 
Other financial data 2009  2008  2007  2006  2005 
Return on average total assets (1)
  0.33%  0.14%  0.71%  0.94%  0.99%
Return on average ordinary shareholders’ equity (2)
  9.0%  3.9%  21.9%  26.1%  29.6%
Average owners’ equity as a percentage of average total assets  3.6%  3.5%  3.2%  3.6%  3.3%
Risk asset ratio — Tier 1  10.1%  10.1%  9.8%  9.9%  10.1%
Risk asset ratio — Total  13.4%  14.5%  13.2%  12.9%  14.1%
Ratio of earnings to combined fixed charges and preference share dividends (3)
                    
— including interest on deposits  1.34   1.16   1.43   1.64   1.84 
— excluding interest on deposits  1.70   1.51   2.50   3.09   4.02 
Ratio of earnings to fixed charges only (3)
                    
— including interest on deposits  1.34   1.16   1.43   1.64   1.84 
— excluding interest on deposits  1.70   1.51   2.50   3.09   4.02 
Financial data based upon IFRS:2007 2006 2005 2004 
         
Return on average total assets (1)
0.71%  0.94%  0.99%  1.21% 
Return on average ordinary shareholders' equity (2)
21.9%  26.1%  29.6%  30.7% 
            
Average shareholders' equity as a percentage of average total assets3.2%  3.6%    3.3%    4.2% 
Risk asset ratio           
Tier 1
9.8%    9.9%  10.1%  
    n/a(4)
 
Total
13.2%  12.9%   14.1%   
    n/a(4)
 
Ratio of earnings to combined fixed charges and preference share dividends (3)
           
Including interest on deposits
1.43
  1.64  1.84     2.11 
Excluding interest on deposits
2.50  3.09   4.02      5.62 
Ratio of earnings to fixed charges only (3)
          
Including interest on deposits
1.43  
1.64
   1.84     2.14 
Excluding interest on deposits
2.50  
3.09
    4.02      5.92 

Notes:
(1)Return on average total assets represents profit attributable to ordinary shareholders as a percentage of average total assets.
(2)Return on average ordinary shareholders'shareholders’ equity represents profit attributable to ordinary shareholders expressed as a percentage of average ordinary shareholders'shareholders’ equity.
(3)For this purpose, earnings consist of income before taxestax and minority interests, plus fixed charges less the unremittedunremited income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).
(4)Upon adoption of IFRS by listed banks in the UK on 1 January 2005, the Financial Services Authority changed its regulatory requirements such that the measurement of capital adequacy was based on IFRS subject to a number of prudential filters. The Risk Asset Ratios as at 31 December 2007, 2006 and 2005 have been presented in compliance with these revised FSA requirements.

Amounts in accordance with UK GAAP

  2004  2003  
Summary consolidated profit and loss account  £m   £m  
          
Net interest income  4,360   4,032  
Non-interest income  3,641   3,226  
Total income  8,001   7,258  
Operating expenses  3,893   3,579  
Profit before provisions  4,108   3,679  
Provisions for bad and doubtful debts  625   549  
Amounts written off fixed asset investments  -   1  
Profit on ordinary activities before tax  3,483   3,129  
Tax on profit on ordinary activities  955   946  
Profit on ordinary activities after tax  2,528   2,183  
Minority interests (including non-equity)  12   (1) 
Preference dividends - non-equity  36   39  
Profit attributable to ordinary shareholders  2,480   2,145  
          
Ordinary dividends  2,300   2,257  

  2004  2003  
Summary consolidated balance sheet - UK GAAP  £m   £m  
          
Loans and advances to banks (net of provisions)  27,674   35,412  
Loans and advances to customers (net of provisions)  131,353   102,572  
Debt securities and equity shares  23,707   22,799  
Intangible fixed assets  766   273  
Other assets  12,765   11,817  
Total assets  196,265   172,873  
        
          
Called up share capital  2,102   2,126  
Share premium account  1,286   1,286  
Other reserves  451   417  
Profit and loss account  5,299   5,209  
Shareholders' funds  9,138   9,038  
Minority interests  408   3  
Subordinated liabilities  5,808   5,743  
Deposits by banks  23,082   17,558  
Customer accounts  126,119   116,569  
Debt securities in issue  3,255   2,112  
Other liabilities  28,455   21,850  
Total liabilities  196,265   172,873  

Financial data based upon UK GAAP: 2004
 
2003
 
      
Return on average total assets (1)
  1.30%  1.21% 
Return on average ordinary shareholders' equity (2)
  28.8%  25.6% 
Average shareholders' equity as a percentage of average total assets  
   4.8%
 
 
   5.0%
 
Risk asset ratio       
Tier 1
     8.0%     9.2% 
Total
  11.6%   13.3% 
Ratio of earnings to combined fixed charges and preference share
dividends (3)
       
Including interest on deposits
  2.20   2.52   
Excluding interest on deposits
  6.10   6.92  
Ratio of earnings to fixed charges only (3)
       
Including interest on deposits
  2.23  2.57  
Excluding interest on deposits
  6.44  7.48  

Notes:
(1)Return on average total assets represents profit attributable to ordinary shareholders as a percentage of average total assets.
(2)Return on average ordinary shareholders' equity represents profit attributable to ordinary shareholders expressed as a percentage of average ordinary shareholders' equity.
(3)For this purpose, earnings consist of income before taxes and minority interests, plus fixed charges less the unremitted income of associated undertakings (share of profits less dividends received). Fixed charges consist of total interest expense, including or excluding interest on deposits and debt securities in issue, as appropriate, and the proportion of rental expense deemed representative of the interest factor (one third of total rental expenses).


Exchange rates

Except as stated, the following tables show, for the dates or periods indicated, the Noon Buying Rate in New York for cable transfers in sterling as certified for customs purposes by the Federal Reserve Bank of New York (the 'Noon Buying Rate'):York.
 
              March  February  January  December  November  October 
US dollars per £1 May April March February January December  2010  2010  2010  2009  2009  2009 
 2008 2008 2008 2008 2008 2007 
Noon buying rate             
             
Noon Buying Rate                  
High 1.9818 1.9994 2.0311 1.9923 1.9895 2.0658   1.5296   1.5968   1.6370   1.6641   1.6795   1.6610 
Low 1.9451 1.9627 1.9823 1.9405 1.9515 1.9774   1.4884   1.5201   1.5912   1.5892   1.6383   1.5878 
             

     2009  2008  2007  2006  2005 
Noon Buying Rate                  
Period end rate      1.6167   1.4619   1.9843   1.9586   1.7188 
Average rate for the period (1)
      1.5707   1.8424   2.0073   1.8582   1.8147 
                         
Consolidation rate (2)
                        
Period end rate      1.6222   1.4604   2.0043   1.9651   1.7214 
Average rate for the period      1.5657   1.8528   2.0015   1.8436   1.8198 

    
US dollars per £131 December 
 2007 2006 2005 2004 2003 
Noon buying rate          
Year end rate1.9843  1.9586  1.7188  1.9160  1.7842 
Average rate for the year (1)2.0073  1.8582  1.8147  1.8356  1.6450 
               
Consolidation rate (2)
              
Year end rate2.0043  1.9651  1.7214  1.9346  1.7857 
Average rate for the year2.0015  1.8436  1.8198  1.8325  1.6354 
               

Notes:

(1)The average of the Noon Buying Rates on the last business day of each month during the year.period.
(2)The rates used by NatWest Group for translating US dollars into sterling in the preparation of its consolidated financial statements.
(3)
On 23 June 2008,April 2010, the Noon Buying Rate was £1.00 = $1.9609.US$1.5363.
 
Financial review

RISK FACTORSRisk factors
Most of the risk factors facing RBS Group also apply to NatWest Group and are discussed in this section. References in this section to “the company” refer to the ultimate holding company.

Set out below are certain risk factors which could affect NatWestthe RBS Group’s future results and cause them to be materially different from expected results. NatWestThe RBS Group’s results are also affected by competition and other factors. The factors discussed in this report should not be regarded as a complete and comprehensive statement of all potential risks and uncertainties.

Risks relating to the company
The company and its United Kingdom bank subsidiaries may face the risk of full nationalisation or other resolution procedures under the Banking Act 2009.
Under the provisions of the Banking Act 2009, substantial powers have been granted to HM Treasury and the Bank of England as part of the special resolution regime to stabilise banks that are in financial difficulties (the “SRR”), which includes certain consultation and consent rights granted to the FSA (the FSA, together with HM Treasury and the Bank of England, the “Authorities”). The SRR confers powers on the Bank of England: (i) to transfer to the private sector all or part of the business of a United Kingdom incorporated institution with permission to accept deposits pursuant to Part IV of the Financial Services and Markets Act 2000 (FSMA) (a “relevant entity”) or its securities of such relevant entity; (ii) to transfer all or part of the business of the relevant entity to a “bridge bank” established by the Bank of England and also confers a power on HM Treasury to transfer into temporary public ownership (nationalise) the relevant entity or its United Kingdom incorporated holding company. The Banking Act also provides for two new insolvency and administration procedures for relevant entities.

The purpose of the stabilisation options is to address the situation where all or part of the business of a relevant entity has encountered, or is likely to encounter, financial difficulties. Accordingly, the stabilisation options may only be exercised if the FSA is satisfied that (i) a relevant entity such as the company's United Kingdom banking subsidiaries, including the Royal Bank and NatWest, Group'sis failing, or is likely to fail, to satisfy the threshold conditions set out in Schedule 6 to the FSMA; and (ii) having regard to timing and other relevant circumstances, it is not reasonably likely that (ignoring the stabilisation options) action will be taken that will enable the relevant entity to satisfy those threshold conditions. The threshold conditions are conditions which an FSA-authorised institution must satisfy in order to retain its FSA authorisation. They are relatively wide-ranging and deal with most aspects of a relevant entity’s business, including, but not limited to, minimum capital resource requirements. It is therefore possible that the FSA may trigger one of the stabilisation options before an application for an insolvency or administration order could be made.

The stabilisation options may be exercised by means of powers to transfer property, rights or liabilities of a relevant entity and shares and other securities issued by a relevant entity. HM Treasury may also take the parent company of a relevant entity (such as the company) into temporary public ownership provided that certain conditions set out in Section 82 of the Banking Act are met. Temporary public ownership is effected by way of a share transfer order and can be actioned irrespective of the financial condition of the parent company.
If HM Treasury makes the decision to take the company into temporary public ownership, it may take various actions in relation to any securities issued by the company or its subsidiaries (the “Securities”) without the consent of holders of the Securities, including (among other things):

(i)transferring its Securities free from any contractual or legislative restrictions on transfer;

(ii)transferring its Securities free from any trust, liability or encumbrance;
(iii)extinguishing any rights to acquire Securities;

(iv)delisting the Securities;

(v)converting its Securities into another form or class (including, for example, into equity Securities); or

(vi)disapplying any termination or acceleration rights or events of default under the terms of its Securities which would be triggered by the transfer.

Where HM Treasury has made a share transfer order in respect of securities issued by the holding company of a relevant entity, HM Treasury may make an order providing for the property, rights or liabilities of the holding company or of any relevant entity in the holding company group to be transferred and where such property is held on trust, removing or altering the terms of such trust.

Accordingly, there can be no assurance that the taking of any such actions would not adversely affect the rights of holders of its Securities and/or adversely affect the price or value of their investment or that the ability of the company to satisfy its obligations under contracts related to its Securities would be unaffected. In such circumstances, such holders may have a claim for compensation under one of the compensation schemes currently existing under, or contemplated by, the Banking Act if any action is taken in respect of its Securities (for the purposes of determining an amount of compensation, an independent valuer must disregard actual or potential financial assistance provided by the Bank of England or HM Treasury). There can be no assurance that holders of its Securities would thereby recover compensation promptly and/or equal to any loss actually incurred.

If the company was taken into temporary public ownership and a partial transfer of its or any relevant entity’s business was effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity was effected, the transfer may directly affect the company and/or its RBS Group companies by creating, modifying or cancelling their contractual arrangements with a view to ensuring the provision of such services and facilities as are required to enable the bridge bank or private sector purchaser to operate the transferred business (or any part of it) effectively. For example, the transfer may (among other things) (i) require the company or RBS Group companies to support and co-operate with the bridge bank or private sector purchaser; (ii) cancel or modify contracts or arrangements between the company or the transferred business and a RBS Group company; or (iii) impose additional obligations on the company under new or existing contracts. There can be no assurance that the taking of any such actions would not adversely affect the ability of the company to satisfy its obligations under the issued Securities or related contracts.
6
Financial review
If the company was taken into temporary public ownership and a partial transfer of its or any relevant entity’s business was effected, or if a relevant entity were made subject to the SRR and a partial transfer of its business to another entity was effected, the nature and mix of the assets and liabilities not transferred may adversely affect the company's financial condition and increase the risk that the company may eventually become subject to administration or insolvency proceedings pursuant to the Banking Act.

While the main provisions of the Banking (Special Provisions) Act 2008 were in force, which conferred certain transfer powers on HM Treasury, the United Kingdom Government took action under that Act in respect of a number of United Kingdom financial institutions, including, in extreme circumstances, full and part nationalisation. There have been concerns in the market in the past year regarding the risks of such nationalisation in relation to the company and other United Kingdom banks. If economic conditions in the United Kingdom or globally were to deteriorate, or the events described in the following risk factors occur to such an extent that they have a materially adverse impact on the financial condition, perceived or actual credit quality, results of operations or business of any of the relevant entities in the RBS Group, the United Kingdom Government may decide to take similar action in relation to the company under the Banking Act. Given the extent of the Authorities’ powers under the Banking Act, it is difficult to predict what effect such actions might have on the RBS Group and any Securities issued by the company or RBS Group companies. However, potential impacts may include full nationalisation of the company, the total loss of value in Securities issued by the company and the inability of the company to perform its obligations under the Securities.

If the relevant stabilisation option was effected in respect of the company or the stabilisation options were effected in respect of a relevant entity or its business within the RBS Group, HM Treasury would be required to make certain compensation orders, which will depend on the stabilisation power adopted. For example, in the event that the Bank of England were to transfer some of the business of a relevant entity to a bridge bank, HM Treasury would have to make a resolution fund order including a third party compensation order pursuant to the Banking Act (Third Party Compensation Arrangements for Partial Property Transfers) Regulations 2009. However, there can be no assurance that compensation would be assessed to be payable or that holders of its Securities would recover any compensation promptly and/or equal to any loss actually incurred.
The RBS Group’s businesses, earnings areand financial condition have been and will continue to be affected by general businessthe global economy and geopolitical conditionsinstability in the global financial markets.
The performance of NatWestthe RBS Group ishas been and will continue to be influenced by the economic conditions of the countries in which it operates, particularly the United Kingdom, the United States and other countries throughout Europe, the Middle East and Asia. The outlook for the global economy over the near to medium term remains challenging, particularly in the United Kingdom, the United States and other European economies. In addition, the global financial system has yet to fully overcome the difficulties which first manifested themselves in August 2007 and financial markets conditions have not yet fully normalised. These conditions led to severe dislocation of financial markets around the world and unprecedented levels of illiquidity in 2008 and 2009, resulting in the development of significant problems at a number of the world’s largest corporate institutions operating across a wide range of industry sectors, many of whom are the RBS Group’s customers and counterparties in the ordinary course of its business. In response to this economic instability and illiquidity in the market, a number of governments, including the United Kingdom Government, the governments of the other EU member states and the United States Government, have intervened in order to inject liquidity and capital into the financial system, and, in some cases, to prevent the failure of these institutions.

Despite such measures, the volatility and disruption of the capital and credit markets have continued, with many forecasts predicting only modest levels of GDP growth over the course of 2010. Similar conditions are likely to exist in a number of the RBS Group’s key markets, including those in the United States and Europe, particularly Ireland. These conditions have exerted, and may continue to exert, downward pressure on asset prices and on availability and cost of credit for financial institutions, including the company, and will continue to impact the credit quality of the RBS Group’s customers and counterparties. Such conditions, alone or in combination with regulatory changes or actions of other market participants, may cause the RBS Group to incur losses or to experience further reductions in business activity, increased funding costs and funding pressures, lower share prices, decreased asset values, additional write-downs and impairment charges and lower profitability.
The performance of the RBS Group may be affected by economic conditions particularlyimpacting euro-zone member states. For example, the financial problems experienced by the government of Greece may lead to Greece issuing significant volumes of debt, which may in the UK, USturn reduce demand for debt issued by financial institutions and Europe. Downturns in these economiescorporate borrowers. This could result in a general reduction in business activity and a consequent loss of income for NatWest Group. It could also cause a higher incidence of credit losses and losses in NatWest Group's trading portfolios. Geopolitical conditions can also affect NatWest Group’s earnings. Terrorist acts and threats and the response of Governments in the UK, US and elsewhere to them couldadversely affect the levelRBS Group’s access to the debt capital markets and may increase the RBS Group’s funding costs, having a negative impact on the RBS Group’s earnings and financial condition. In addition, euro-zone countries in which the RBS Group operates may be required to provide financial assistance to Greece, which may in turn have a negative impact on the financial condition of those EU member states. Should the economic activity. NatWest Group's business is alsoconditions facing Greece be replicated in other euro-zone member states, the risks above would be exacerbated.
In addition, the RBS Group will continue to be exposed to the risk of loss if major corporate borrowers or counterparty financial institutions fail or are otherwise unable to meet their obligations. The RBS Group currently experiences certain business interruptionsector and country concentration risk, primarily focused in the United States, the United Kingdom and the rest of Europe and relating to personal and banking and financial institution exposures. The RBS Group’s performance may also be affected by future recovery rates on assets and the historical assumptions underlying asset recovery rates, which (as has already occurred in certain instances) may no longer be accurate given the unprecedented market disruption and general economic slowdown followinginstability. The precise nature of all the outbreakrisks and uncertainties the RBS Group faces as a result of current economic conditions cannot be predicted and many of these risks are outside the control of the RBS Group.

The RBS Group was required to obtain State aid approval, for the aid given to the RBS Group by HM Treasury and for the RBS Group’s State aid restructuring plan, from the European Commission. The RBS Group is subject to a pandemic.variety of risks as a result of implementing the State aid restructuring plan. The State aid restructuring plan includes a prohibition on the making of discretionary dividend or coupon payments on existing hybrid capital instruments (including preference shares and B shares) for a two-year period commencing no later than 30 April 2010, which may impair the RBS Group’s ability to raise new Tier 1 capital through the issuance of ordinary shares and other Securities.
The RBS Group was required to obtain State aid approval for the aid given to the RBS Group by HM Treasury as part of the First Placing and Open Offer undertaken by the company in December 2008, the issuance of £25.5 billion of B shares in the capital of the company which are, subject to certain terms and conditions, convertible into ordinary shares in the share capital of the company to HM Treasury, a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B shares if certain conditions are met and the RBS Group’s participation in the Asset Protection Scheme (the “APS”) (the “State aid”).
 
7
Financial review continued

As a result of the First Placing and Open Offer (approved as part of the European Commission’s approval of a package of measures to the banking industry in the United Kingdom in October 2008), the RBS Group was required to cooperate with HM Treasury to submit a forward plan to the European Commission. This plan was submitted and detailed discussions took place between HM Treasury, the RBS Group and the European Commission. The plan submitted not only had regard to the First Placing and Open Offer, but also the issuance of B shares to HM Treasury, the commitment by HM Treasury to subscribe for additional B shares if certain conditions were met and the RBS Group’s participation in the APS. As part of its review, the European Commission was required to assess the State aid and to consider whether the RBS Group’s long-term viability would be assured, that the RBS Group makes a sufficient contribution to the costs of its restructuring and that measures are taken to limit any distortions of competition arising from the State aid provided to the RBS Group by the United Kingdom Government. The RBS Group, together with HM Treasury, agreed in principle with the European Competition Commissioner the terms of the State aid and the terms of a restructuring plan (the “State aid restructuring plan”). On 14 December 2009, the European Commission formally approved the RBS Group’s participation in the APS, the issuance of £25.5 billion of B shares to HM Treasury, a contingent commitment by HM Treasury to subscribe for up to an additional £8 billion of B shares and the State aid restructuring plan. The prohibition on the making of discretionary dividend (including preference shares and B shares) or coupon payments on existing hybrid capital instruments for a two-year period commencing no later than 30 April 2010 will prevent the company from paying dividends on its ordinary and preference shares and coupons on other Tier 1 securities for the same duration, and it may impair the RBS Group’s ability to raise new Tier 1 capital through the issuance of ordinary shares and other securities.

It is possible a third party could challenge the approval decision in the European Courts (within specified time limits). The RBS Group does not believe that any such challenge would be likely to succeed but, if it were to succeed, the European Commission would need to reconsider its decision, which might result in an adverse outcome for the RBS Group, including a prohibition or amendment to some or all of the terms of the State aid. The European Commission could also impose conditions that are more disadvantageous, potentially materially so, to the RBS Group than those in the State aid restructuring plan.

The RBS Group is subject to a variety of risks as a result of implementing the State aid restructuring plan. There is no assurance that the price that the RBS Group receives for any assets sold pursuant to the State aid restructuring plan will be at a level the RBS Group considers adequate or which it could obtain in circumstances in which the RBS Group was not required to sell such assets in order to implement the State aid restructuring plan or if such sale were not subject to the restrictions (including in relation to potential purchasers of the United Kingdom branch divestment) contained in the terms thereof. Further, should the RBS Group fail to complete any of the required disposals within the agreed timeframes for such disposals, under the terms of the State aid clearance, a divestiture trustee can be empowered to conduct the disposals, with the mandate to complete the disposal at no minimum price.

Furthermore, if the RBS Group is unable to comply with the terms of the State aid approval it could constitute a misuse of aid. In circumstances where the European Commission doubts that the RBS Group is complying with the terms of the State aid approval, it may open a formal investigation. At the conclusion of this investigation, if the European Commission decides that there has been misuse of aid, it can issue a decision requiring HM Treasury to recover the misused aid which could have a material adverse impact on the RBS Group.

In implementing the State aid restructuring plan, the RBS Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the RBS Group’s business arising from implementing the State aid restructuring plan) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals. Further, the loss of such revenues and related income may extend the time period over which the RBS Group may pay any amounts owed to HM Treasury under the APS or otherwise. The implementation of the State aid restructuring plan may also result in disruption to the retained business and give rise to significant strain on management, employee, operational and financial resources, impacting customers and giving rise to separation costs which could be substantial.

The implementation of the State aid restructuring plan may result in the emergence of one or more new viable competitors or a material strengthening of one or more of the RBS Group’s competitors in the RBS Group’s markets. The effect of this on the RBS Group’s future competitive position, revenues and margins is uncertain and there could be an adverse effect on the RBS Group’s operations and financial condition and its business generally.

If any or all of the risks described above, or any other currently unforeseen risks, materialise, there could be a materially negative impact on the RBS Group’s business, operations, financial condition, capital position and competitive position.

The RBS Group’s ability to implement its strategic plan depends on the success of the RBS Group’s refocus on its core strengths and the balance sheet reduction programme arising out of its previously announced non-core restructuring plan and the State aid restructuring plan.
In light of the changed global economic outlook, the RBS Group has embarked on a financial and core business restructuring which is focused on achieving appropriate risk-adjusted returns under these changed circumstances, reducing reliance on wholesale funding and lowering exposure to capital intensive businesses. A key part of this restructuring is the programme announced in February 2009 to run-down and sell the RBS Group’s non-core assets and the continued review of the RBS Group’s portfolio to identify further disposals of certain non-core assets. Assets identified for this purpose and allocated to the RBS Group's Non-Core division totalled £252 billion, excluding derivatives, as at 31 December 2008. At 31 December 2009, this total had reduced to £187 billion, excluding the RBS Group's interest in RBS Sempra Commodities LLP, which was transferred to the Non-Core division during 2009. This balance sheet reduction programme will continue alongside the disposals under the State aid restructuring plan approved by the European Commission.
8
Financial review

Because the ability to dispose of assets and the price achieved for such disposals will be dependent on prevailing economic and market conditions, which may remain challenging, there is no assurance that the RBS Group will be able to sell or run-down (as applicable) those businesses it is seeking to exit either on favourable economic terms to the RBS Group or at all. Furthermore, where transactions are entered into for the purpose of selling non-core assets and businesses, they may be subject to conditions precedent, including government and regulatory approvals and completion mechanics that in certain cases may entail consent from customers. There is no assurance that such conditions precedent will be satisfied, or consents and approvals obtained, in a timely manner or at all. There is consequently a risk that the RBS Group may fail to complete such disposals by any agreed longstop date. Furthermore, in the context of implementing the State aid restructuring plan, the RBS Group is subject to certain timing and other restrictions which may result in the sale of assets at prices below those which the RBS Group would have otherwise agreed had the RBS Group not been required to sell such assets as part of the State aid restructuring plan or if such sale were not subject to the restrictions contained in the terms of the State aid conditions.

In addition, the RBS Group may be liable for any deterioration in businesses being sold between the announcement of the disposal and its completion. In certain cases, the period between the announcement of a transaction and its completion may be lengthy and may span many months. Other risks that may arise out of the disposal of the RBS Group’s assets include ongoing liabilities up to completion of the relevant transaction in respect of the assets and businesses disposed of, commercial and other risks associated with meeting covenants to the buyer during the period up to completion, the risk of employee and customer attrition in the period up to completion, substantive indemnity obligations in favour of the buyer, the risk of liability for breach of warranty, the need to continue to provide transitional service arrangements for potentially lengthy periods following completion of the relevant transaction to the businesses being transferred and redundancy and other transaction costs. Further, the RBS Group may be required to enter into covenants agreeing not to compete in certain markets for specific periods of time. In addition, as a result of the disposals, the RBS Group will lose existing customers, deposits and other assets (both directly through the sale and potentially through the impact on the rest of the RBS Group’s business arising from implementing the restructuring plans) and the potential for realising additional associated revenues and margins that it otherwise might have achieved in the absence of such disposals.

Any of the above factors, either in the context of State aid-related or non-core or other asset disposals, could affect the RBS Group's ability to implement its strategic plan and have a material adverse effect on the RBS Group's business, results of operations, financial condition, capital ratios and liquidity and could result in a loss of value in the Securities.
The extensive organisational restructuring may adversely affect the RBS Group’s business, results of operations and financial condition.
As part of its refocus on core strengths and its disposal programme, the RBS Group has undertaken and continues to undertake extensive organisational restructuring involving the allocation of assets identified as non-core assets to a separate Non-Core Division, and the run-down and sale of those assets over a period of time. In addition, to comply with State aid clearance, the RBS Group agreed to undertake a series of measures to be implemented over a four-year period from December 2009, which include disposing of RBS Insurance (subject to potentially maintaining a minority interest until the end of 2014). The company will also divest by the end of 2013 Global Merchant Services, subject to the company retaining up to 20 per cent. of each business within Global Merchant Services if required by the purchaser, and its interest in RBS Sempra Commodities, as well as divesting the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the direct small and medium-sized enterprise (“SME”) customers and certain mid-corporate customers across the United Kingdom. On 16 February 2010, the company announced that RBS Sempra Commodities had agreed to sell its Metals, Oil and European Energy business lines, subject to certain conditions including regulatory approvals. The RBS Group and its joint venture partner, Sempra Energy, are continuing to consider ownership alternatives for the remaining North American Power and Gas businesses of RBS Sempra Commodities.

In order to implement the restructurings referred to above, various businesses and divisions within the RBS Group will be re-organised, transferred or sold, or potentially merged with other businesses and divisions within the RBS Group. As part of this process, personnel may be reallocated, where permissible, across the RBS Group, new technology may be implemented, and new policies and procedures may be established in order to accommodate the new shape of the RBS Group. As a result, the RBS Group may experience a high degree of business interruption, significant restructuring charges, delays in implementation, and significant strain on management, employee, operational and financial resources. Any of the above factors could affect the RBS Group’s ability to achieve its strategic objectives and have a material adverse effect on its business, results of operations and financial condition or could result in a loss of value in the Securities.

Lack of liquidity is a risk to the RBS Group’s business and its ability to access sources of liquidity has been, and will continue to be, constrained.
Liquidity risk is the risk that a bank will be unable to meet its obligations, including funding commitments, as they fall due. This risk is inherent in banking operations and can be heightened by a number of enterprise specific factors, including an over-reliance on a particular source of funding (including, for example, short-term and overnight funding), changes in credit ratings or market-wide phenomena such as market dislocation and major disasters. During the course of 2008 and 2009, credit markets worldwide experienced a severe reduction in liquidity and term-funding. During this time, perception of counterparty risk between banks also increased significantly. This increase in perceived counterparty risk also led to reductions in inter-bank lending, and hence, in common with many other banking groups, the RBS Group’s access to traditional sources of liquidity has been, and may continue to be, restricted.
9

Financial review continued

The RBS Group’s liquidity management focuses on maintaining a diverse and appropriate funding strategy for its assets, controlling the mismatch of maturities and carefully monitoring its undrawn commitments and contingent liabilities. However, the RBS Group’s ability to access sources of liquidity (for example, through the issue or sale of financial and other instruments or through the use of term loans) during the recent period of liquidity stress has been constrained to the point where it, like other banks, has had to rely on shorter term and overnight funding with a consequent reduction in overall liquidity, and to increase its recourse to liquidity schemes provided by central banks. While during the course of 2009 money market conditions improved, with the RBS Group seeing a material reduction of funding from central banks and the issuance of non-government guaranteed term debt, further tightening of credit markets could have a negative impact on the RBS Group. The RBS Group, in line with other financial institutions, may need to seek funds from alternative sources, potentially at higher costs of funding than has previously been the case.

In addition, there is also a risk that corporate and institutional counterparties with credit exposures may look to reduce all credit exposures to banks, given current risk aversion trends. It is possible that credit market dislocation becomes so severe that overnight funding from non-government sources ceases to be available.

Like many banking groups, the RBS Group relies on customer deposits to meet a considerable portion of its funding. Furthermore, as part of its ongoing strategy to improve its liquidity position, the RBS Group is actively seeking to increase the proportion of its funding represented by customer deposits. However, such deposits are subject to fluctuation due to certain factors outside the RBS Group’s control, such as a loss of confidence, increasing competitive pressures or the encouraged or mandated repatriation of deposits by foreign wholesale or central bank depositors, which could result in a significant outflow of deposits within a short period of time. There is currently heavy competition among United Kingdom banks for retail customer deposits, which has increased the cost of procuring new deposits and impacted the RBS Group’s ability to grow its deposit base. An inability to grow, or any material decrease in, the RBS Group’s deposits could, particularly if accompanied by one of the other factors described above, have a negative impact on the RBS Group’s ability to satisfy its liquidity needs unless corresponding actions were taken to improve the liquidity profile of other deposits or to reduce assets. In particular, the liquidity position of the RBS Group may be negatively impacted if it is unable to achieve the run-off and sale of non-core and other assets as expected. Any significant delay in those plans may require the RBS Group to consider disposal of other assets not previously identified for disposal to achieve its funded balance sheet target level.

The governments of some of the countries in which the RBS Group operates have taken steps to guarantee the liabilities of the banks and branches operating in their respective jurisdiction. Whilst in some instances the operations of the RBS Group are covered by government guarantees alongside other local banks, in other countries this may not necessarily always be the case. This may place the RBS Group’s subsidiaries operating in those countries, such as Ulster Bank Ireland Ltd, which did not participate in such government guarantee schemes, at a competitive disadvantage to the other local banks and therefore may require the RBS Group to provide additional funding and liquidity support to these operations.

There can be no assurance that these measures, alongside other available measures, will succeed in improving the funding and liquidity in the markets in which the RBS Group operates, or that these measures, combined with any increased cost of any funding currently available in the market, will not lead to a further increase in the RBS Group’s overall cost of funding, which could have an adverse impact on the RBS Group’s financial condition and results of operations or result in a loss of value in the Securities.

Governmental support schemes may be subject to cancellation, change or withdrawal or may fail to be renewed, which may have a negative impact on the availability of funding in the markets in which the RBS Group operates.
Governmental support schemes may be subject to cancellation, change or withdrawal (on a general or individual basis, subject to relevant contracts) or may fail to be renewed, based on changing economic and political conditions in the jurisdiction of the relevant scheme. To the extent government support schemes are cancelled, changed or withdrawn in a manner which diminishes their effectiveness, or to the extent such schemes fail to generate additional liquidity or other support in the relevant markets in which such schemes operate, the RBS Group, in common with other banking groups, may continue to face limited access to, have insufficient access to, or incur higher costs associated with, funding alternatives, which could have a material adverse impact on the RBS Group’s business, financial condition, results of operations and prospects or result in a loss of value in the Securities.

The financial performance of NatWestthe RBS Group ishas been and will be affected by borrower credit quality
quality.
Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of NatWestthe RBS Group’s businesses. AdverseWhilst some economies stabilised over the course of 2009, the RBS Group may continue to see adverse changes in the credit quality of NatWest Group’sits borrowers and counterparties, for example, as a result of their inability to refinance their indebtedness, with increasing delinquencies, defaults and insolvencies across a range of sectors (such as the personal and banking and financial institution sectors) and in a number of geographies (such as the United Kingdom, the United States, the Middle East and the rest of Europe, particularly Ireland). This trend has led and may lead to further and accelerated impairment charges, higher costs, additional write-downs and losses for the RBS Group or result in a general deteriorationloss of value in UK,the Securities.
10

Financial review

The actual or global economic conditions,perceived failure or arising from systemic risksworsening credit of the RBS Group’s counterparties has adversely affected and could continue to adversely affect the RBS Group.
The RBS Group’s ability to engage in routine funding transactions has been and will continue to be adversely affected by the actual or perceived failure or worsening credit of its counterparties, including other financial institutions and corporate borrowers. The RBS Group has exposure to many different industries and counterparties and routinely executes transactions with counterparties in the financial systems,industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds and other institutional clients. As a result, defaults by, or even the perceived creditworthiness of or concerns about, one or more corporate borrowers, financial services institutions or the financial services industry generally, have led to market-wide liquidity problems, losses and defaults and could lead to further losses or defaults, by the RBS Group or by other institutions. Many of these transactions expose the RBS Group to credit risk in the event of default of the RBS Group’s counterparty or client and the RBS Group does have significant exposures to certain individual counterparties (including counterparties in certain weakened sectors and markets). In addition, the RBS Group’s credit risk is exacerbated when the collateral it holds cannot be realised or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure that is due to the RBS Group, which is most likely to occur during periods of illiquidity and depressed asset valuations, such as those recently experienced. Any such losses could have a material adverse effect on the RBS Group’s results of operations and financial condition or result in a loss of value in the Securities.

The RBS Group’s earnings and financial condition have been, and its future earnings and financial condition may continue to be, affected by depressed asset valuations resulting from poor market conditions.
Financial markets continue to be subject to significant stress conditions, where steep falls in perceived or actual asset values have been accompanied by a severe reduction in market liquidity, as exemplified by recent events affecting asset-backed collateralised debt obligations, residential mortgage-backed securities and the leveraged loan market. In dislocated markets, hedging and other risk management strategies have proven not to be as effective as they are in normal market conditions due in part to the decreasing credit quality of hedge counterparties, including monoline and other insurance companies and credit derivative product companies. Severe market events have resulted in the RBS Group recording large write-downs on its credit market exposures in 2007, 2008 and 2009. Any deterioration in economic and financial market conditions could lead to further impairment charges and write-downs. Moreover, market volatility and illiquidity (and the assumptions, judgements and estimates in relation to such matters that may change over time and may ultimately not turn out to be accurate) make it difficult to value certain of the RBS Group’s exposures. Valuations in future periods, reflecting, among other things, then-prevailing market conditions and changes in the credit ratings of certain of the RBS Group’s assets, may result in significant changes in the fair values of the RBS Group’s exposures, even in respect of exposures, such as credit market exposures, for which the RBS Group has previously recorded write-downs. In addition, the value ultimately realised by the RBS Group may be materially different from the current or estimated fair value. Any of these factors could require the RBS Group to recognise further significant write-downs or realise increased impairment charges, any of which may adversely affect its capital position, its financial condition and its results of operations or result in a loss of value in the recoverabilitySecurities.

The value or effectiveness of any credit protection that the RBS Group has purchased from monoline and other insurers and other market counterparties (including credit derivative product companies) depends on the value of NatWest Group’sthe underlying assets and require an increase in the provision for impairment lossesfinancial condition of the insurers and such counterparties.
The RBS Group has credit exposure arising from over-the-counter derivative contracts, mainly credit default swaps (“CDSs”), which are carried at fair value. The fair value of these CDSs, as well as the RBS Group’s exposure to the risk of default by the underlying counterparties, depends on the valuation and the perceived credit risk of the instrument against which protection has been bought. Since 2007, monoline and other provisions.insurers and other market counterparties (including credit derivative product companies) have been adversely affected by their exposure to residential mortgage linked and corporate credit products, whether synthetic or otherwise, and their actual and perceived creditworthiness has deteriorated rapidly, which may continue. If the financial condition of these counterparties or their actual or perceived creditworthiness deteriorates further, the RBS Group may record further credit valuation adjustments on the credit protection bought from these counterparties under the CDSs in addition to those already recorded and such adjustments may have a material adverse impact on the RBS Group’s financial condition and results of operations.

Changes in interest rates, foreign exchange rates, credit spreads, bond, equity and commodity prices and other market factors have significantly affected and will continue to affect NatWestthe RBS Group’s businessbusiness.
TheSome of the most significant market risks NatWestthe RBS Group faces are interest rate, foreign exchange, credit spread, bond, equity and bond and equitycommodity price risks. Changes in interest rate levels, yield curves and spreads may affect the interest rate margin realised between lending and borrowing costs.costs, the effect of which may be heightened during periods of liquidity stress, such as those experienced in the past year. Changes in currency rates, particularly in the sterling-dollarsterling-US dollar and sterling-euro exchange rates, affect the value of assets, liabilities, income and liabilitiesexpenses denominated in foreign currencies and affectthe reported earnings reported by NatWest Group’s non-UKof the company’s non-United Kingdom subsidiaries mainly(principally Citizens and RBS Greenwich Capital and Ulster Bank,Securities Inc.) and may affect income from foreign exchange dealing. The performance of financial markets may affect bond, equity and commodity prices and, therefore, cause changes in the value of NatWestthe RBS Group’s investment and trading portfolios. NatWestThis has been the case during the period since August 2007, with market disruptions and volatility resulting in significant reductions in the value of such portfolios. While the RBS Group has implemented risk management methods to mitigate and control these and other market risks to which NatWest Groupit is exposed. However,exposed, it is difficult, particularly in the current environment, to predict with accuracy changes in economic or market conditions and to anticipate the effects that such changes could have on NatWestthe RBS Group’s financial performance and business operations.
 

Financial review continued
NatWest
The RBS Group’s borrowing costs and its access to the debt capital markets depend significantly on its and the United Kingdom Government’s credit ratings
On 22 April 2008, Moody’s rating service announced that it was placingratings.
The company and other RBS Group members have been subject to a number of downgrades in the recent past. Any future reductions in the long-term or short-term credit ratings of the Bank under review for possible downgrade. A reduction incompany or one of its principal subsidiaries (particularly the long-term credit ratings mayRoyal Bank) would further increase its borrowing costs, require the RBS Group to replace funding lost due to the downgrade, which may include the loss of customer deposits, and may also limit the RBS Group’s access to the capital and money markets and trigger additional collateral requirements in derivativederivatives contracts and other secured funding arrangements. Furthermore, given the extent of the United Kingdom Government ownership and support provided to the RBS Group through HM Treasury’s guarantee scheme (announced by the United Kingdom Government on 8 October 2008) (the “Credit Guarantee Scheme”), any downgrade in the United Kingdom Government’s credit ratings could adversely affect the RBS Group’s own credit ratings and may have the effects noted above. All credit rating agencies have reaffirmed the United Kingdom Government’s AAA rating, although S&P changed its outlook to “negative” on 21 May 2009. Fitch reaffirmed the United Kingdom Government’s stable outlook on 31 July 2009 and Moody’s reiterated the United Kingdom Government’s stable outlook on 26 October 2009. Credit ratings of the company, the Royal Bank, ABN AMRO Holding N.V. (which was renamed “RBS Holdings N.V.” on 1 April 2010) (“ABN AMRO”), The Royal Bank of Scotland N.V. (which was renamed from “ABN AMRO Bank N.V.” on 6 February 2010), Ulster Bank and Citizens are also important to NatWestthe RBS Group when competing in certain markets, such as longer-term over-the-counter derivatives. Therefore,As a result, any further reductions in the NatWest Group’scompany’s long-term or short-term credit ratings or those of its principal subsidiaries could adversely affect itsthe RBS Group’s access to liquidity and competitive position, increase its funding costs and hence, negativelyhave a negative impact its earnings.on the RBS Group’s earnings and financial condition or result in a loss of value in the Securities.

NatWestThe RBS Group’s business performance could be adversely affected if its capital resources areis not managed effectively or if there are changes to capital adequacy and liquidity requirements.
NatWestEffective management of the RBS Group’s capital is critical to its ability to operate its businesses, to grow organically and to take advantagepursue its strategy of strategic opportunities. NatWestreturning to standalone strength. The RBS Group is required by regulators in the UKUnited Kingdom, the United States and in other jurisdictions in which it undertakes regulated activities, to maintain adequate capital resources. NatWestThe maintenance of adequate capital is also necessary for the RBS Group’s financial flexibility in the face of continuing turbulence and uncertainty in the global economy. Accordingly, the purpose of the issuance of the £25.5 billion of B shares, the grant of the Contingent Subscription and the previous placing and open offers was to allow the RBS Group mitigatesto strengthen its capital position. The FSA’s recent liquidity policy statement articulates that firms must hold sufficient eligible securities to survive a liquidity stress and this will result in banks holding a greater amount of government securities, to ensure that these institutions have adequate liquidity in times of financial stress.

In addition, on 17 December 2009, the Basel Committee on Banking Supervision (the “Basel Committee”) proposed a number of fundamental reforms to the regulatory capital framework in its consultative document entitled "Strengthening the resilience of the banking sector". If the proposals made by the Basel Committee are implemented, this could result in the RBS Group being subject to significantly higher capital requirements. The proposals include: (a) the build-up of a counter-cyclical capital buffer in excess of the regulatory minimum capital requirement, which is large enough to enable the RBS Group to remain above the minimum capital requirement in the face of losses expected to be incurred in a feasibly severe downturn; (b) an increase in the capital requirements for counterparty risk exposures arising from derivatives, repo-style transactions and securities financing transactions; (c) the imposition of a leverage ratio as a supplementary measure to the existing Basel II risk-based measure; (d) the phasing out of hybrid capital instruments as Tier 1 capital and the requirement that the predominant form of Tier 1 capital must be common shares and retained earnings; and (e) the imposition of global minimum liquidity standards that include a requirement to hold a stock of unencumbered high quality liquid assets sufficient to cover cumulative net cash outflows over a 30-day period under a prescribed stress scenario. The proposed reforms are subject to a consultative process and an impact assessment and are not likely to be implemented before the end of 2012. The Basel Committee will also consider appropriate transition and grandfathering arrangements.

These and other future changes to capital adequacy and liquidity requirements in the jurisdictions in which it operates may require the RBS Group to raise additional Tier 1, Core Tier 1 and Tier 2 capital by careful managementway of further issuances of securities, including in the form of ordinary shares or B shares and could result in existing Tier 1 and Tier 2 securities issued by the RBS Group ceasing to count towards the RBS Group’s regulatory capital, either at the same level as present or at all. The requirement to raise additional Core Tier 1 capital could have a number of negative consequences for the company and its shareholders, including impairing the company’s ability to pay dividends on or make other distributions in respect of ordinary shares and diluting the ownership of existing shareholders of the company. If the RBS Group is unable to raise the requisite Tier 1 and Tier 2 capital, it may be required to further reduce the amount of its risk-weighted assets and engage in the disposition of core and other non-core businesses, which may not occur on a timely basis or achieve prices which would otherwise be attractive to the RBS Group. In addition, pursuant to the State aid approval, should the RBS Group’s Core Tier 1 capital ratio decline to below 5 per cent. at any time before 31 December 2014, or should the RBS Group fall short of its funded balance sheet target level (after adjustments) for 31 December 2013 by £30 billion or more, the RBS Group will be required to reduce its risk-weighted assets by a further £60 billion in excess of its plan through further disposals of identifiable businesses and their associated assets. As provided in the Acquisition and Contingent Capital Agreement, the RBS Group would also be subject to restrictions on payments on its hybrid capital instruments should its Core Tier 1 ratio fall below 6 per cent. or if it would fall below 6 per cent. as a result of such payment.
12
Financial review
Any change that limits the RBS Group’s ability to manage effectively its balance sheet and capital resources through capital raising activities, disciplined capital allocationgoing forward (including, for example, reductions in profits and the hedgingretained earnings as a result of capital currency exposures.
Liquidity risk is inherentwrite-downs or otherwise, increases in NatWest Group’s operations
Liquidity risk is the risk that NatWest Group will be unable to meet its obligations as they fall due. This risk is inherent in banking operations and can be heightened by a number of enterprise specific factors such as an over reliance on a particular source of funding, changes in credit ratings or by marketwide phenomena such as market dislocation and major disasters. NatWest Group’s liquidity management focuses on maintaining a diverse and appropriate funding strategy for itsrisk-weighted assets, in controlling the mis-match of maturities and from carefully monitoring its undrawn commitments and contingent liabilities.
NatWest Group’s future earnings could be affected by market illiquidity
Financial markets are sometimes subject to significant stress conditions where steep falls in perceived or actual asset values are accompanied by severe reduction in market liquidity, such as recent eventsdelays in the US sub-prime residential mortgage market. In dislocated markets, hedgingdisposal of certain assets or the inability to syndicate loans as a result of market conditions, a growth in unfunded pension exposures or otherwise) or to access funding sources, could have a material adverse impact on its financial condition and other risk management strategies may not be as effective as they are in normal market conditions. Severe market events are difficult to foresee and, if they occur, couldregulatory capital position or result in NatWesta loss of value in the Securities.

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.
Under IFRS, the RBS Group incurring significant losses. In 2007, NatWest Group recorded significant write-downs on its trading portfolios. As market conditions changerecognises at fair value: (i) financial instruments classified as “held-for-trading” or “designated as at fair value through profit or loss”; (ii) financial assets classified as “available-for-sale”; and (iii) derivatives. Generally, to establish the fair value of NatWestthese instruments, the RBS Group relies on quoted market prices or, where the market for a financial instrument is not sufficiently active, internal valuation models that utilise observable market data. In certain circumstances, the data for individual financial instruments or classes of financial instruments utilised by such valuation models may not be available or may become unavailable due to changes in market conditions, as has been the case during the recent financial crisis. In such circumstances, the RBS Group’s internal valuation models require the RBS Group to make assumptions, judgements and estimates to establish fair value. In common with other financial institutions, these internal valuation models are complex, and the assumptions, judgements and estimates the RBS Group is required to make often relate to matters that are inherently uncertain, such as expected cash flows, the ability of borrowers to service debt, residential and commercial property price appreciation and depreciation, and relative levels of defaults and deficiencies. Such assumptions, judgements and estimates may need to be updated to reflect changing facts, trends and market conditions. The resulting change in the fair values of the financial instruments has had and could fall further. Furthermore,continue to have a material adverse effect on the RBS Group’s earnings and financial condition. Also, recent market volatility and illiquidity hashave challenged the factual bases of certain underlying assumptions and have made it difficult to value certain of NatWestthe RBS Group’s financial instruments. Valuations in future periods, reflecting prevailing market conditions, may result in further significant changes in the fair values of these instruments. instruments, which could have a negative effect on the RBS Group’s results of operations and financial condition or result in a loss of value in the Securities.

The RBS Group operates in markets that are highly competitive and consolidating. If the RBS Group is unable to perform effectively, its business and results of operations will be adversely affected.
Recent consolidation among banking institutions in the United Kingdom, the United States and throughout Europe is changing the competitive landscape for banks and other financial institutions. If financial markets continue to be volatile, more banks may be forced to consolidate. This consolidation, in combination with the introduction of new entrants into the United States and United Kingdom markets from other European and Asian countries, could increase competitive pressures on the RBS Group.

In addition, certain competitors may have access to lower cost funding and/or be able to offer retail deposits on more favourable terms than the value ultimately realised by NatWestRBS Group will dependand may have stronger multi-channel and more efficient operations as a result of greater historical investments. Furthermore, the RBS Group’s competitors may be better able to attract and retain clients and talent, which may have a negative impact on the market priceRBS Group’s relative performance and future prospects.

Furthermore, increased government ownership of, and involvement in, banks generally may have an impact on the competitive landscape in the major markets in which the RBS Group operates. Although, at that timepresent, it is difficult to predict what the effects of this increased government ownership and involvement will be or how they will differ from jurisdiction to jurisdiction, such involvement may be materially lower than current fair value. Any of these factors could require NatWestcause the RBS Group to recognise further write-downsexperience stronger competition for corporate, institutional and retail clients and greater pressure on profit margins. Future disposals and restructurings by the RBS Group and the compensation structure and restrictions imposed on the RBS Group may also have an impact on its ability to compete effectively. Since the markets in which maythe RBS Group operates are expected to remain highly competitive in all areas, these and other changes to the competitive landscape could adversely affect NatWestthe RBS Group’s future results.business, margins, profitability and financial condition or result in a loss of value in the Securities.
 
 
Financial review continued

As a condition to HM Treasury support, the company has agreed to certain undertakings which may serve to limit the RBS Group’s operations.
Under the terms of the First Placing and Open Offer, the company provided certain undertakings aimed at ensuring that the subscription by HM Treasury of the relevant ordinary shares and preference shares and the RBS Group’s participation in the Credit Guarantee Scheme offered by HM Treasury as part of its support for the United Kingdom banking industry are compatible with the common market under EU law. These undertakings include (i) supporting certain initiatives in relation to mortgage lending and lending to SMEs until 2011, (ii) regulating management remuneration and (iii) regulating the rate of growth of the RBS Group’s balance sheet. Under the terms of the placing and open offer undertaken by the company in April 2009, the RBS Group’s undertakings in relation to mortgage lending and lending to SMEs were extended to larger commercial and industrial companies in the United Kingdom. Pursuant to these arrangements the company agreed to make available to creditworthy borrowers on commercial terms, £16 billion above the amount the company had budgeted to lend to United Kingdom businesses and £9 billion above the amount the company had budgeted to lend to United Kingdom homeowners in the year commencing 1 March 2009. In relation to the 2009 commitment period, which ended on 28 February 2010, the RBS Group’s net mortgage lending to UK homeowners was £12.7 billion above the amount it had originally budgeted to lend. In relation to its business lending commitment, the RBS Group achieved £60 billion of gross new lending to businesses, including £39 billion to SMEs but, in the economic environment prevailing at the time, many customers were strongly focused on reducing their borrowings and repayments consequently increased. Moreover, the withdrawal of foreign lenders was less pronounced than anticipated, there was a sharp increase in capital market issuance and demand continued to be weak. As a result, the RBS Group’s net lending did not reach the £16 billion targeted.
In March 2010, the company agreed with the United Kingdom government certain adjustments to the lending commitments for the 2010 commitment period (the 12 month period commencing 1 March 2010), to reflect expected economic circumstances over the period. As part of the amended lending commitments, the company has committed, among other things, to make available gross new facilities, drawn or undrawn, of £50 billion to UK businesses in the period 1 March 2010 to 28 February 2011. In addition, the company has agreed with the United Kingdom government to make available £8 billion of net mortgage lending in the 2010 commitment period. This is a decrease of £1 billion on the net mortgage lending target that previously applied to the 2010 commitment period which ends on 28 February 2011, to reflect that the mortgage lending commitment for the 2009 commitment period was increased from £9 billion to £10 billion.
The RBS Group has also agreed to certain other commitments, which are material for the structure of the RBS Group and its operations, under the State aid restructuring plan approved by the European Commission in relation to State aid.
In addition, the RBS Group, together with HM Treasury, has agreed with the European Commission a prohibition on the making of discretionary dividends (including on preference shares and B shares) or coupon payments on existing hybrid capital instruments for a two-year period from a date commencing no later than 30 April 2010 (which the RBS Group has subsequently announced shall be 30 April 2010). It is possible that the RBS Group may, in future, be subject to further restrictions on payments on such hybrid capital instruments, whether as a result of undertakings given to regulatory bodies, changes to capital requirements such as the proposals published by the Basel Committee on 17 December 2009 or otherwise. The RBS Group has also agreed to certain other undertakings in the Acquisition and Contingent Capital Agreement.
The undertakings described above may serve to limit the RBS Group’s operations.

The RBS Group could fail to attract or retain senior management, which may include members of the Board or other key employees, and it may suffer if it does not maintain good employee relations.
The RBS Group’s ability to implement its strategy depends on the ability and experience of its senior management, which may include directors, and other key employees. The loss of the services of certain key employees, particularly to competitors, could have a negative impact on the RBS Group’s business. The RBS Group’s future success will also depend on its ability to attract, retain and remunerate highly skilled and qualified personnel competitively with its peers. This cannot be guaranteed, particularly in light of heightened regulatory oversight of banks and heightened scrutiny of, and (in some cases) restrictions placed upon, management compensation arrangements, in particular those in receipt of Government funding (such as the company). The RBS Group has made a commitment to comply with the FSA Remuneration Code. These rules came into force on 1 January 2010 and are in line with the agreement reached by the G-20, setting global standards for the implementation of the Financial Stability Board’s remuneration principles. The RBS Group agreed that it will be at the leading edge of implementing the G-20 principles and granted UK Financial Investments Limited (“UKFI”) consent rights over the shape and size of its aggregate bonus pool for the 2009 performance year. The level of the 2009 bonus pool and the deferral and claw-back provisions implemented by the RBS Group may impair the ability of the RBS Group to attract and retain suitably qualified personnel in various parts of the RBS Group’s businesses.
14

Financial review


The RBS Group is also altering certain of the pension benefits it offers to staff. Some employees continue to participate in defined benefit arrangements. The following two changes have been made to the main defined benefit pension plans: (i) a yearly limit on the amount of any salary increase that will count for pension purposes; and (ii) a reduction in the severance lump sum for those who take an immediate undiscounted pension for redundancy. In addition to the effects of such measures on the RBS Group’s ability to retain senior management and other key employees, the marketplace for skilled personnel is becoming more competitive, which means the cost of hiring, training and retaining skilled personnel may continue to increase. The failure to attract or retain a sufficient number of appropriately skilled personnel could place the RBS Group at a significant competitive disadvantage and prevent the RBS Group from successfully implementing its strategy, which could have a material adverse effect on the RBS Group’s financial condition and results of operations or result in a loss of value in the Securities.

In addition, certain of the RBS Group’s employees in the United Kingdom, continental Europe and other jurisdictions in which the RBS Group operates are represented by employee representative bodies, including trade unions. Engagement with its employees and such bodies is important to the RBS Group and a breakdown of these relationships could adversely affect the RBS Group’s business, reputation and results. As the RBS Group implements cost-saving initiatives and disposes of, or runs-down, certain assets or businesses (including as part of its expected restructuring plans), it faces increased risk in this regard and there can be no assurance that the RBS Group will be able to maintain good relations with its employees or employee representative bodies in respect of all matters. As a result, the RBS Group may experience strikes or other industrial action from time to time, which could have a material adverse effect on its business and results of operations and could cause damage to its reputation.
Each of the RBS Group’s businesses is subject to substantial regulation and oversight. Any significant regulatory developments could have an effect on how the RBS Group conducts its business and on its results of operations and financial condition.
The RBS Group is subject to financial services laws, regulations, corporate governance requirements, administrative actions and policies in each location in which it operates. All of these are subject to change, particularly in the current market environment, where there have been unprecedented levels of government intervention and changes to the regulations governing financial institutions, including recent nationalisations in the United States, the United Kingdom and other European countries. As a result of these and other ongoing and possible future changes in the financial services regulatory landscape (including requirements imposed by virtue of the RBS Group’s participation in government or regulator-led initiatives), the RBS Group expects to face greater regulation in the United Kingdom, the United States and other countries in which it operates, including throughout the rest of Europe. Compliance with such regulations may increase the RBS Group’s capital requirements and costs and have an adverse impact on how the RBS Group conducts its business, on the products and services it offers, on the value of its assets and on its results of operations and financial condition, or result in a loss of value in the Securities.

Other areas where governmental policies and regulatory changes could have an adverse impact include, but are not limited to:

•  the monetary, interest rate, capital adequacy, liquidity, balance sheet leverage and other policies of central banks and regulatory authorities;

•  general changes in government or regulatory policy or changes in regulatory regimes that may significantly influence investor decisions in particular markets in which the RBS Group operates, increase the costs of doing business in those markets or result in a reduction in the credit ratings of the company or one of its subsidiaries;

•  changes to financial reporting standards;

•  changes in regulatory requirements relating to capital and liquidity, such as limitations on the use of deferred tax assets in calculating Core Tier 1 and/or Tier 1 capital, or prudential rules relating to the capital adequacy framework;

•  other general changes in the regulatory requirements, such as the imposition of onerous compliance obligations, restrictions on business growth or pricing, new levies or fees, requirements in relation to the structure and organisation of the RBS Group and requirements to operate in a way that prioritises objectives other than shareholder value creation;

•  changes in competition and pricing environments;

•  further developments in financial reporting, corporate governance, corporate structure, conduct of business and employee compensation;

•  differentiation among financial institutions by governments with respect to the extension of guarantees to bank customer deposits and the terms attaching to such guarantees, including requirements for the entire RBS Group to accept exposure to the risk of any individual member of the RBS Group, or even third party participants in guarantee schemes, failing;

•  implementation of, or costs related to, local customer or depositor compensation or reimbursement schemes;

•  transferability and convertibility of currency risk;

•  expropriation, nationalisation and confiscation of assets;

•  changes in legislation relating to foreign ownership; and

•  other unfavourable political, military or diplomatic developments producing social instability or legal uncertainty which, in turn, may affect demand for the RBS Group’s products and services.
15
Financial reviewcontinued

The RBS Group’s results have been and could be further adversely affected in the event of goodwill impairment.
The RBS Group capitalises goodwill, which is calculated as the excess of the cost of an acquisition over the net fair value of the identifiable assets, liabilities and contingent liabilities acquired. Acquired goodwill is recognised initially at cost and subsequently at cost less any accumulated impairment losses. As required by IFRS, the RBS Group tests goodwill for impairment annually or more frequently, at external reporting dates, when events or circumstances indicate that it might be impaired. An impairment test involves comparing the recoverable amount (the higher of value in use and fair value less cost to sell) of an individual cash generating unit with its carrying value. The value in use and fair value of the RBS Group’s cash generating units are affected by market conditions and the performance of the economies in which the RBS Group operates. Where the RBS Group is required to recognise a goodwill impairment, it is recorded in the RBS Group’s income statement, although it has no effect on the RBS Group’s regulatory capital position.
The RBS Group may be required to make further contributions to its pension schemes if the value of pension fund assets is not sufficient to cover potential obligations.
The RBS Group maintains a number of defined benefit pension schemes for past and a number of current employees. Pensions risk is the risk that the liabilities of the RBS Group’s various defined benefit pension schemes which are long term in nature will exceed the schemes’ assets, as a result of which the RBS Group is required or chooses to make additional contributions to the schemes. The schemes’ assets comprise investment portfolios that are held to meet projected liabilities to the scheme members. Risk arises from the schemes because the value of these asset portfolios and returns from them may be less than expected and because there may be greater than expected increases in the estimated value of the schemes’ liabilities. In these circumstances, the RBS Group could be obliged, or may choose, to make additional contributions to the schemes, and during recent periods, the RBS Group has voluntarily made such contributions. Given the current economic and financial market difficulties and the prospect that they may continue over the near and medium term, the RBS Group may experience increasing pension deficits or be required or elect to make further contributions to its pension schemes and such deficits and contributions could be significant and have a negative impact on the RBS Group’s capital position, results of operations or financial condition or result in a loss of value in the Securities. The next funding valuation of the RBS Group’s major defined benefit pension plan, The Royal Bank of Scotland Group Pension Fund, will take place with an effective date of 31 March 2010.

The RBS Group is and may be subject to litigation and regulatory investigations that may impact its business.
The RBS Group’s operations are diverse and complex, and it operates in legal and regulatory environments that expose it to potentially significant litigation, regulatory investigation and other regulatory risk. As a result, the RBS Group is, and may in the future be, involved in various disputes, legal proceedings and regulatory investigations in the United Kingdom, the EU, the United States and other jurisdictions, including class action litigation, anti-money laundering investigations and review by the European Commission under State aid rules. Furthermore, the RBS Group, like many other financial institutions, has come under greater regulatory scrutiny over the last year and expects that environment to continue for the foreseeable future, particularly as it relates to compliance with new and existing corporate governance, employee compensation, conduct of business, anti-money laundering and anti-terrorism laws and regulations, as well as the provisions of applicable sanctions programmes. Disputes, legal proceedings and regulatory investigations are subject to many uncertainties, and their outcomes are often difficult to predict, particularly in the earlier stages of a case or investigation. Adverse regulatory action or adverse judgments in litigation could result in restrictions or limitations on the RBS Group’s operations or result in a material adverse effect on the RBS Group’s reputation or results of operations or result in a loss of value in the Securities. For details about certain litigation and regulatory investigations in which the Group is involved, see Note 28 on the financial statements.

Operational risks are inherent in NatWestthe RBS Group’s businessoperations.
NatWestThe RBS Group’s businessesoperations are dependent on the ability to process a very large number of transactions efficiently and accurately. Operationalaccurately while complying with applicable laws and regulations where it does business. The RBS Group has complex and geographically diverse operations and operational risk and losses can result from internal and external fraud, errors by employees or third parties, failure to document transactions properly or to obtain proper authorisation, failure to comply with applicable regulatory requirements and Conductconduct of Businessbusiness rules (including those arising out of anti-money laundering and anti-terrorism legislation, as well as the provisions of applicable sanctions programmes), equipment failures, natural disasters, or the inadequacy or failure of external systems for example, NatWestand controls, including those of the RBS Group’s suppliers or counterparties. Although NatWestthe RBS Group has implemented risk controls and loss mitigation actions, and substantial resources are devoted to developing efficient procedures to identify and rectify weaknesses in existing procedures and to train staff, training, it is onlynot possible to be reasonably, but not absolutely, certain that such proceduresactions have been or will be effective in controlling each of the operational risks faced by NatWestthe RBS Group. Any weakness in
 
Each
16

Financial review
these systems or controls, or any breaches or alleged breaches of NatWest Group’s businesses is subject to substantial regulation and regulatory oversight. Any significant regulatory developmentsapplicable laws or regulations, could have an effecta materially negative impact on how NatWest Group conducts itsthe RBS Group’s business, reputation and on NatWest Group’s results of operations
NatWest Group is subject and the price of any Securities. Notwithstanding anything contained in this risk factor, it should not be taken as implying that the company will be unable to financial services laws, regulations, administrative actions and policies in each location in which NatWest Group operates. This supervision and regulation, in particular incomply with its obligations as a company with securities admitted to the UK, if changed could materially affect NatWest Group’s business, the products and services offered or the value of assets. In the normal course of business NatWest Group and its subsidiaries co-operate with regulatory authorities in various jurisdictions in their enquiries or investigations into alleged or possible breaches of regulations. NatWest Group has co-operated fully with various regulatory reviewsOfficial List of the operation of retail banking and consumer credit industries inUnited Kingdom Listing Authority nor that it, or its relevant subsidiaries, will be unable to comply with its or their obligations as supervised firms regulated by the UK and elsewhere. FSA.

The outcome of these reviews is outside the Group’s control and it is not possible to predict the effect, if any, on the Group’s operations of future changes in regulatory actions and policies.
Future growth in NatWest Group’s earnings and shareholder value depends on strategic decisions regarding organic growth and potential acquisitions
NatWest Group devotes substantial management and planning resources to the development of strategic plans for organic growth and identification of possible acquisitions, supported by substantial expenditure to generate growth in customer business. If these strategic plans do not meet with success, NatWest Group’s earnings could grow more slowly or decline.
The risk of litigation is inherent in NatWest Group’s operations
In the ordinary course of NatWest Group’s business, legal actions, claims against and by NatWest Group and arbitrations arise; the outcome of such legal proceedings could affect the financial performance of NatWest Group.
NatWestRBS Group is exposed to the risk of changes in tax legislation and its interpretation and to increases in the rate of corporate and other taxes in the jurisdictions in which it operatesoperates.
NatWestThe RBS Group’s activities are subject to tax at various rates around the world computed in accordance with local legislation and practice. Action by governments to increase tax rates or to impose additional taxes or to restrict the tax reliefs currently available to the RBS Group would reduce the profitability of NatWest Group.RBS Group’s profitability. Revisions to tax legislation or to its interpretation might also affect NatWest Group'sthe RBS Group’s results in the future.

HM Treasury (or UKFI on its behalf) may be able to exercise a significant degree of influence over the RBS Group.
UKFI manages HM Treasury’s shareholder relationship with the company. Although HM Treasury has indicated that it intends to respect the commercial decisions of the RBS Group and that the RBS Group will continue to have its own independent board of directors and management team determining its own strategy, should its current intentions change, HM Treasury's position as a majority shareholder (and UKFI’s position as manager of this shareholding) means that HM Treasury or UKFI may be able to exercise a significant degree of influence over, among other things, the election of directors and the appointment of senior management. In addition, as the provider of the APS, HM Treasury has a range of rights that other shareholders do not have. These include rights under the terms of the APS over the RBS Group's remuneration policy and practice. The manner in which HM Treasury or UKFI exercises HM Treasury’s rights as majority shareholder or in which HM Treasury exercises its rights under the APS could give rise to conflict between the interests of HM Treasury and the interests of other shareholders. The Board has a duty to promote the success of the company for the benefit of its members as a whole.
The RBS Group’s operations have inherent reputational risk.
Reputational risk, meaning the risk to earnings and capital from negative public opinion, is inherent in the RBS Group’s business. Negative public opinion can result from the actual or perceived manner in which the RBS Group conducts its business activities, from the RBS Group’s financial performance, from the level of direct and indirect government support or from actual or perceived practices in the banking and financial industry. Negative public opinion may adversely affect the RBS Group’s ability to keep and attract customers and, in particular, corporate and retail depositors. The RBS Group cannot ensure that it will be successful in avoiding damage to its business from reputational risk.

In the United Kingdom and in other jurisdictions, the RBS Group is responsible for contributing to compensation schemes in respect of banks and other authorised financial services firms that are unable to meet their obligations to customers.
In the United Kingdom, the Financial Services Compensation Scheme (the “Compensation Scheme”) was established under the FSMA and is the United Kingdom’s statutory fund of last resort for customers of authorised financial services firms. The Compensation Scheme can pay compensation to customers if a firm is unable, or likely to be unable, to pay claims against it and may be required to make payments either in connection with the exercise of a stabilisation power or in exercise of the bank insolvency procedures under the Banking Act. The Compensation Scheme is funded by levies on firms authorised by the FSA, including the RBS Group. In the event that the Compensation Scheme raises funds from the authorised firms, raises those funds more frequently or significantly increases the levies to be paid by such firms, the associated costs to the RBS Group may have a material impact on its results of operations and financial condition. As at 31 December 2009, the RBS Group has a provision of £135 million for its share of Compensation Scheme management expenses levies for the 2009/10 and 2010/11 Compensation Scheme years.

In addition, to the extent that other jurisdictions where the RBS Group operates have introduced or plan to introduce similar compensation, contributory or reimbursement schemes (such as in the United States with the Federal Deposit Insurance Corporation), the RBS Group may make further provisions and may incur additional costs and liabilities, which may negatively impact its financial condition and results of operations or result in a loss of value in the Securities.
17

Financial review continued


The RBS Group’s business and earnings may be affected by geopolitical conditions.
The performance of the RBS Group is significantly influenced by the geopolitical and economic conditions prevailing at any given time in the countries in which it operates, particularly the United Kingdom, the United States and other countries in Europe and Asia. For example, the RBS Group has a presence in countries where businesses could be exposed to the risk of business interruption and economic slowdown following the outbreak of a pandemic, or the risk of sovereign default following the assumption by governments of the obligations of private sector institutions. Similarly, the RBS Group faces the heightened risk of trade barriers, exchange controls and other measures taken by sovereign governments which may impact a borrower’s ability to repay. Terrorist acts and threats and the response to them of governments in any of these countries could also adversely affect levels of economic activity and have an adverse effect upon the RBS Group’s business.

The restructuring proposals for ABN AMRO are complex and may not realise the anticipated benefits for the Group.
The restructuring plan in place for the integration and separation of ABN AMRO (called The Royal Bank of Scotland N.V. with effect from 6 February 2010) into and among the businesses and operations of the Consortium Members (as defined below) is complex, involving substantial reorganisation of ABN AMRO’s operations and legal structure. The restructuring plan is being implemented and significant elements have been completed within the planned timescales and the integration of the Group’s businesses continues. As part of this reorganisation, on 6 February 2010, the majority of the businesses of ABN AMRO acquired by the Dutch State were legally demerged from the ABN AMRO businesses acquired by the Group and were transferred into a newly established company, ABN AMRO Bank N.V. (formerly named ABN AMRO II N.V.). This company was transferred to ABN AMRO Group N.V., a company wholly owned by the Dutch State, on 1 April 2010. Certain assets and liabilities of ABN AMRO acquired by the Dutch State were not part of the transfer which occurred on 1 April 2010 and remain within ABN AMRO (now The Royal Bank of Scotland N.V.). These will be transferred to the Dutch State as soon as possible. In addition, certain assets within ABN AMRO (The Royal Bank of Scotland N.V.) continue to be under shared ownership by the Consortium Members.

The RBS Group may not realise the benefits of the acquisition or the restructuring when expected or to the extent projected. The occurrence of any of these events, including as a result of staff losses or performance issues, or as a result of further disposals or restructurings by the RBS Group, may have a negative impact on the RBS Group’s financial condition and results of operations. It is not expected that the Dutch State’s acquisition of Fortis Bank Nederland’s shares in RFS Holdings B.V. will materially affect the integration benefits envisaged by the RBS Group.

The recoverability and regulatory capital treatment of certain deferred tax assets recognised by the RBS Group depends on the RBS Group's ability to generate sufficient future taxable profits and there being no adverse changes to tax legislation, regulatory requirements or accounting standards.
In accordance with IFRS, the RBS Group has recognised deferred tax assets on losses available to relieve future profits from tax only to the extent that it is probable that they will be recovered. The deferred tax assets are quantified on the basis of current tax legislation and accounting standards and are subject to change in respect of the future rates of tax or the rules for computing taxable profits and allowable losses. Failure to generate sufficient future taxable profits or changes in tax legislation or accounting standards may reduce the recoverable amount of the recognised deferred tax assets.

There is currently no restriction in respect of deferred tax assets recognised by the RBS Group for regulatory purposes. Changes in regulatory rules may restrict the amount of deferred tax assets that can be recognised and such changes could lead to a reduction in the RBS Group’s Core Tier 1 capital ratio. In particular, on 17 December 2009, the Basel Committee published a consultative document setting out certain proposed changes to capital requirements (see risk factor above headed “The RBS Group’s business performance could be adversely affected if its capital is not managed effectively or if there are changes to capital adequacy and liquidity requirements”). Those proposals included a requirement that deferred tax assets which rely on future profitability of the RBS Group to be realised should be deducted from the common equity component of Tier 1 and therefore not count towards Tier 1 capital.
The Royal Bank has entered into a credit derivative and a financial guarantee contract with The Royal Bank of Scotland N.V. which may adversely affect the Issuer Group’s results
The Royal Bank has also entered into a credit derivative and a financial guarantee contract with The Royal Bank of Scotland N.V., which is a subsidiary undertaking of the ultimate holding company, under which it has sold credit protection over the exposures held by The Royal Bank of Scotland N.V. and its subsidiaries that are subject to the APS. These agreements may adversely affect the Issuer Group's results as: (a) they cover 100% of losses on these assets whilst the APS provides 90% protection if losses on the whole APS portfolio exceed the first loss; and (b) the basis of valuation of the APS and the financial guarantee contract are asymmetrical: the one measured at fair value and the other at the higher of cost less amortisation and the amount determined in accordance with IAS 37 “Provisions, Contingent Liabilities and Contingent Assets”.
18
 

ITEM 4. INFORMATION ON THE BANK

The Company has omitted portions of this item on the basis of General Instruction I(2)(a) and (d) to Form 10-K.

HISTORY AND DEVELOPMENT OF THE BANK

National Westminster Bank Plc is a public limited company registered in England and Wales No. 929027. The registered office and principal office of the Bank is 135 Bishopsgate, London, EC2M 3UR (telephone 020-7085-5000). The Bank's website address is www.NatWest.com.www.natwest.com.

NatWest Group is a diversified financial services group engaged in a wide range of banking, financial and finance-related activities in the UK and internationally. NatWest Group's operations are principally centred in the UK.

National Westminster Bank Plc is a major UK clearing bank. The Bank was incorporated in England in 1968 and was formed from the merger of National Provincial Bank Limited and Westminster Bank Limited, which had themselves been formed through a series of mergers involving banks with origins dating back to the 17thcentury.

National Westminster Bank Plc was acquired by The Royal Bank of Scotland Group plc on 6 March 2000 and was its wholly-owned direct subsidiary until 31 January 2003 when ownership of the entire issued ordinary share capital was transferred to the Royal Bank.

Following placing and open offers in December 2008 and April 2009, HM Treasury owned approximately 70.3% of the enlarged ordinary share capital of The Royal Bank of Scotland Group.

In December 2009, The Royal Bank of Scotland Group issued £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 one capital.

Following the issuance of B shares, HM Treasury’s holding of ordinary shares of The Royal Bank of Scotland Group remained at 70.3% although its economic interest rose to 84.4%.

HM Treasury has agreed not to convert its B shares into ordinary shares to the extent that its holding of ordinary shares following the conversion would represent more than 75% of the ultimate holding company’s issued ordinary share capital.


BUSINESS OVERVIEW

Since being acquired by The Royal Bank of Scotland Group plc in 2000, NatWest Group has operated and been managed as a member of the overall RBS Group. As part of the integration of NatWest Group into the RBS Group a number of businesses and assets have been transferred between NatWest Group and the Royal Bank to bring together similar operations and functions. In the RBS Group, all new large corporate relationships are domiciled in the Royal Bank. In the retail banking division in the UK, RBS Group has retained and promotes both the NatWest and the Royal Bank brands, which compete with each other.

A central ManufacturingBusiness Services function (formerly Manufacturing) provides services to entities in the RBS Group. Allocations of manufacturingBusiness Services costs are made on appropriate bases to individual legal entities, including NatWest.

At 31 December 2007,2009, NatWest Group had total assets of £312.3£350.7 billion and shareholders' equity of £10.8£14.2 billion.

The RBSFollowing a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. A Non-Core division has been created comprising those lines of business, portfolios and individual assets that the Group operates on an integrated basis throughintends to run off or sell. Furthermore, Business Services (formerly Group Manufacturing) is no longer reported as a divisional structure. Theseparate division and its costs are now allocated to the customer-facing divisions relevant to NatWest Group for the year ended December 31, 2007 were Corporate Markets (comprising Globalalong with certain central costs. UK Retail & Commercial Banking & Markets andhas been split into three segments (UK Retail, UK Corporate Banking), Retail Markets (comprising Retail and Wealth Management),Wealth). Ulster Bank and Manufacturing.
On 28 February 2008, the RBS Group announced changes to its organisational structure which are aimed at recognising the RBS Group’s presence in over 50 countries and facilitating the integration and operationhas become a specific segment. The remaining elements of its expanded footprint. Following the acquisition of ABN AMRO in October 2007, the RBS Group’s new organisational structure incorporates those ABN AMRO businesses to be retained by the RBS Group but excludes the ABN AMRO businesses to be acquired by Fortis and Santander. This new organisational structure is expected to give the RBS Group the appropriate framework for managing the enlarged RBS Group in a way that fully capitalises on the enhanced range of attractive growth opportunities now available to it. The RBS Group’s organisational structure as of 28 February 2008 comprises the following divisions: Global Markets (comprising Global Banking & Markets and Global Transaction Services), Regional Markets (comprising UK Retail and Commercial Banking, US Retail and Commercial Banking, Europe & Middle East Retail and& Commercial Banking and Asia Retail and& Commercial Banking RBS Insurance, Group Manufacturingassets form part of Non-Core. The segment measure is now operating Profit/(loss) before tax which differs from Contribution used previously. Comparative data have been restated accordingly.

UK Retail offers a comprehensive range of banking products and related financial services to the Centre. Allpersonal market. It serves customers through the NatWest network of these activities are relevantbranches and ATMs in the United Kingdom, and also through telephone and internet channels.

UK Corporate is a 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.

Wealth provides private banking and investment services in the UK through Coutts & Company, offshore banking through NatWest Group with the exception of those conductedOffshore and international private banking through RBS InsuranceCoutts.

Global Banking & Markets (GBM) is a banking partner to major corporations and ABN AMROfinancial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its subsidiaries.customers. The division is organised
 
919
along six principal business lines: money markets; rates flow trading; currencies and commodities; equities; credit markets and portfolio management & origination.

TableGlobal Transaction Services offers global payments, cash and liquidity management, and trade finance and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States as well as Global Merchant Services, the Group’s United Kingdom and international merchant acquiring business.

Ulster Bank is the leading retail and commercial bank in Northern Ireland and the third largest banking group on the island of ContentsIreland. It provides a comprehensive range of financial services through both its Retail Markets division which has a network of branches and operates in the personal and bancassurance sectors, and its Corporate Markets division provides services to SME business customers, corporates and institutional markets.

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.

Central Functions comprises group and corporate functions, such as treasury, funding and 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 retail and corporate business in the UK and Ireland that the Group has concluded are no longer strategic.

Business divestments
To comply with European Commission State Aid (EC State Aid) requirements the RBS Group has agreed a series of restructuring measures to be implemented over a four year period. This will supplement the measures in the strategic plan previously announced by the RBS Group. These include divesting fully RBS Insurance, Global Merchant Services and RBS Sempra Commodities, as well as divesting the RBS branch-based business in England & Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.
Recent Developments
On 25 March 2010, the RBS Group announced its intention to launch (i) an offer to exchange certain subordinated debt securities issued by Group members for new senior debt and (ii) tender offers in respect of certain preference shares, preferred securities and perpetual securities issued by Group members. The RBS Group announced the offers on 6 April 2010 and will seek shareholder approvals as required in coordination with the annual general meeting of The Royal Bank of Scotland Group plc scheduled to take place on 28 April 2010.

In January 2010, the FSA informed the RBS Group that it intended to commence an investigation into certain aspects of the handling of customer complaints. On 25 March 2010 FSA formally notified the RBS Group of the appointment of investigators in respect of aspects of complaint handling relating to RBS and NatWest retail bank products and services. The company and its subsidiaries intend to co-operate fully with this investigation.
 
In March 2010, the ultimate holding company converted 935,228 non-cumulative dollar preference shares in the ultimate holding company into ordinary shares resulting in approximately 1.6 billion ordinary shares being issued.  This increase in the ultimate holding company's issued ordinary share capital resulted in HMT's holding in the ultimate holding company's ordinary shares reducing to approximately 68.4%.

In the UK, the OFT has been investigating RBS Group for alleged conduct in breach of Article 101 of the Treaty on the Functioning of the European Union and/or the Chapter 1 prohibition of the Competition Act 1998 relating to the provision of loan products to professional services firms. RBS Group co-operated fully with the OFT's investigation.  On 30 March 2010 the OFT announced that it has arrived at an early resolution agreement with RBS Group by which RBS Group will pay a (discounted) fine of £28.59 million and admit a breach in competition law relating to the provision of loan products to professional services firms.

Brendan Nelson has been appointed as a non-executive director with effect from 1 April 2010. Brendan will succeed Archie Hunter as Chairman of the Group Audit Committee with effect from the conclusion of the Group's Annual General Meeting on 28 April 2010.

Legal separation of ABN AMRO Bank N.V. occurred on 1 April 2010, with the shares in that entity being transferred by RBS Holdings N.V. to a holding company called ABN AMRO Group N.V., which is owned by the Dutch State. Certain assets within RBS Holdings N.V. continue to be shared by the Consortium Members. RBS Holdings N.V. is a fully operational bank within the Group and is independently rated and licensed and regulated by the Dutch Central Bank.

Following the legal separation, RBS Holdings N.V. has one direct subsidiary, The Royal Bank of Scotland N.V. (‘RBS N.V.’), a fully operational bank within the RBS Group. RBS N.V. is independently rated and regulated by the Dutch Central Bank.

ORGANISATIONAL STRUCTURE

The company is a wholly-owned direct subsidiary of theThe Royal Bank. The ultimate holding company is The Royal Bank of Scotland Group plc which is incorporated in Great Britain and has its registered office at 36 St Andrew Square, Edinburgh EH2 2YB. The principal subsidiary undertakings of NatWest Group and their activities are detailed in Note 15 to the Consolidated Financial Statements.

The ownership of National Westminster Home Loans Limited, a home mortgage finance business, was transferred to the Royal Bank on 31 December 2005.
 
DESCRIPTION OF PROPERTY AND EQUIPMENT

NatWest Group operates from a number of locations worldwide, principally in the UK. At 31 December 2007,2009, NatWest had 1,629 retail branches in the UK. Ulster Bank including First Active had a network of 282 branches and business centres in Northern Ireland and the Republic of Ireland. A substantial majority of the UK branches are owned by NatWest and its subsidiaries or are held under leases with unexpired terms of over 50 years. NatWest Group’s properties include its principal office in London at 135 Bishopsgate.

Total capital expenditure on premises (excluding investment properties), computers and other equipment for the year ended 31 December 2009 was £209 million (2008 - £347 million; 2007 was- £222 million (2006-£305 million; 2005 – £201 million).
 
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The Companycompany has omitted portions of this item on the basis of General Instruction I(2)(a) to Form 10-K. For a discussion of critical accounting policies that are considered by the directors to be the most important to the portrayal of its financial condition, see pages 5387 to 63.94. In addition, for a discussion of accounting developments, see page 63.95.

OPERATING RESULTS

As discussed on page 1, the consolidated financial statements of NatWest Group are prepared in accordance with International Financial Reporting Standards.

Overview of results

The following table summarises NatWest Group's results for each of the three years ended 31 December 2007:2009:

Consolidated income statement    Discontinued*
 
Continuing
 
2007 2006 2005 2005
 
 2009  2008  2007 
£m £m £m £m
 
  £m   £m   £m 
                    
Net interest income5,091  4,449 212 4,249   3,197   5,397   5,091 
                     
Fees and commissions receivable4,226  3,928 43 3,663   4,079   4,367   4,226 
Fees and commissions payable
(1,036
) (960) (34) (926)  (1,241)  (1,178)  (1,036)
(Loss)/Income from trading activities(360) 1,458 - 808 
Income/(loss) from trading activities  1,454   (963)  (360)
Gain on redemption of own debt  381   -   - 
Other operating income433  451 - 635   1,404   81   433 
            
Non-interest income3,263  4,877 9 4,180   6,077   2,307   3,263 
                     
Total income8,354  9,326 221 8,429   9,274   7,704   8,354 
                     
Administrative expenses         
- staff costs1,567  1,754 - 1,477 
- premises and equipment267  266 - 114 
- other2,322  2,741 70 2,440 
Administrative Expenses            
Staff costs – excluding curtailment gains  (1,749)  (1,402)  (1,567)
– pension schemes curtailment gains  544   -   - 
Premises and equipment  (407)  (331)  (267)
Other administrative expenses  (2,147)  (2,516)  (2,322)
Depreciation and amortisation264  257 - 382   (247)  (237)  (264)
Write-down of goodwill and other intangible assets  -   (716)  - 
            
Operating expenses4,420  5,018 70 4,413   (4,006)  (5,202)  (4,420)
                     
Profit before impairment losses3,934  
4,308
 
151
 
4,016
   5,268   2,502   3,934 
Impairment losses849  852 4 752   (4,139)  (1,362)  (849)
            
Operating profit before tax3,085  3,456 147 3,264   1,129   1,140   3,085 
Tax768  831 44 904 
Operating profit after tax
2,317
  2,625  103  2,360 
Discontinued operations-  -    103 
Tax credit/(charge)  5   (599)  (768)
            
Profit for the year2,317  2,625    2,463   1,134   541   2,317 
         

* NatWest Group transferred its home mortgage finance business, National Westminster Home Loans Limited, to the Royal Bank on 31 December 2005 at neither a profit nor a loss.
20072009 compared with 20062008

Profit
Profit before tax was down 11%,£1,129 million compared with £1,140 million in 2008. The results reflect an improvement in income from £3,456trading activities and lower operating expenses offset by a significant increase in impairment losses, reflecting the continuing deterioration in economic conditions.

Total income
Total income was up 20% to £9,274 million, to £3,085 million,benefiting from favourable trading conditions, principally as a result of reduced profits in the UK Retail and Global Banking & Markets partially offset(GBM) divisions.

Net interest income
Net interest income decreased by 41% to £3,197 million primarily reflecting the pressure on liability margins, with rates on many deposit products at floors in the low interest rate environment and strong growthcompetition, particularly for longer term deposits and the build up of the Group’s liquidity portfolio.

Non-interest income
Non-interest income increased to £6,077 million from £2,307 million in 2008 largely reflecting the sharp improvement in income from trading activities, as improved asset valuations led to lower credit market losses and GBM benefited from the restructuring of its business to focus on core customer franchises. The Group also recorded a gain of £381 million on a liability management exercise to redeem a number of upper Tier 2 securities.

21
Other operating income increased to £1,404 million from £81 million in 2008 largely reflecting a substantial increase in dividend income and profit on sale subsidiaries and associates.

Operating expenses
Operating expenses decreased to £4,006 million from £5,202 million. Integration and restructuring costs were £150 million compared with £42 million in 2008. Other operating expenses were £3,856 million compared with £5,160 million in 2008.

Cost:income ratio
The Group’s cost:income ratio was 43.2% compared with 67.5% in 2008.

Impairment losses
Impairment losses were £4,139 million compared with £1,362 million in 2008, with Core bank impairments rising by £1,309 million and Non-Core by £1,468 million. In the Core business, the biggest increases were in UK Retail, MarketsUK Corporate and Ulster Bank.Bank, reflecting the difficult economic environment. Non-Core impairment losses increased substantially, particularly across the corporate and property sectors.

Capital and capital ratios
During the year the Bank issued 935 new ordinary shares of £1 each to the parent company at £1 million per share. Capital ratios at 31 December 2009 were 8.7% (Core Tier 1), 10.1% (Tier 1) and 13.4% (Total).

Balance sheet
Total assets were £350.7 billion at 31 December 2009, 9% higher than total assets of £321.2 billion at 31 December 2008.

Lending to customers, excluding reverse repurchase agreements and stock borrowing, decreased in 2009 by 20% or £38.6 billion to £154.5 billion. Customer deposits, excluding repurchase agreements and stock lending, increased by 8% or £14.2 billion to £190.5 billion.

2008 compared with 2007

Profit
Profit before tax was £1,140 million compared with £3,085 million in 2007. The results have been adversely affected by difficult trading conditions, particularly in the credit markets, and write-down of goodwill and other assets of £716 million.

Total income
Total income was down by £9728% or £650 million 10%, to £8,354£7,704 million, mainly reflectingprincipally due to the adverse impact of the developments in global credit markets in the second half of 2007.slower market conditions.

Net interest income increased by £306 million, 6% to £5,397 million.

Non-interest income fell by 29% to £2,307 million from £3,263 million. Within non-interest income, fees and commissions receivable increased by 3% to £4,367 million and fees and commissions payable increased by 14% to £5,091 million and represents 61% of total income (2006 – 48%).

Non-interest income fell by 33% to £3,263 million and represents 39% of total income (2006 – 52%).£1,178 million. The decrease in non-interest income was due primarily to a fall in incomeloss from trading activities was £963 million compared with a loss of £360 million in Global Banking & Markets which more than offset growth2007. Other operating income decreased to £81 million from £433 million in fees and commissions.2007.

Operating expenses
Operating expenses fellrose by 12%18% to £4,420 million primarily reflecting the effect of lower income in Global Banking & Markets. £5,202 million. Integration and restructuring costs which primarily relate to the integration of First Active, were £43£42 million compared with £67£43 million in 2006.2007. Write down of goodwill and other intangible assets was £716 million. Other operating expenses were £4,444 million compared with £4,377 million in 2007.

Cost:income ratio
TheNatWest Group’s cost:income ratio was 52.9%67.5% compared with 53.8%52.9% in 2006.2007.

Impairment losses
Impairment losses were £849£1,362 million, compared with £852£849 million in 2006.2007.

Taxation
The effective tax rate for 2008 was 52.5% compared with 24.9% in 2007.

Dividends
Ordinary dividends totalling £1,850£1,000 million (2006(2007 – £1,500£1,850 million) were paid to the parent company during the year.

Balance sheetSheet
Total assets were £321.2 billion at 31 December 2008, 3% higher than total assets of £312.3 billion at 31 December 2007, 7% higher than total assets of £290.7 billion at 31 December 2006.2007. Lending to customers, excluding repurchase agreements and stock borrowing (‘reverse repos’), increased by 6%11% or £10.5£19.7 billion to £173.4£193.1 billion. Customer deposits, excluding repurchase agreements and stock lending grew by 13% or £19.9 billion to £175.3 billion.
Capital ratios at 31 December 2007 were 9.8% (tier 1) and 13.2% (total).
2006 compared with 2005

Profit
Operating profit before tax was up 1%, from £3,411 million to £3,456 million. The Group transferred its home mortgage business, National Westminster Home Loans Limited to the Royal Bank on 31 December 2005 and the results of this entity have been classified as ‘Discontinued’ in 2005. Profit before tax from continuing operations increased by £192 million, 6%, reflecting organic income growth.

Total income
The Group achieved strong organic growth in income during 2006. Total income was up 8% or £676 million to £9,326 million. Total income from continuing operations was up £897 million, 11%. This growth was reflected across all divisions and was particularly strong in UK Corporate Banking, Retail, Wealth Management and Ulster Bank.
Net interest income was flat at £4,449 million. Net interest income from continuing operations rose by 5%, £200 million and represents 48% of total income (2005 - 50%). Average loans and advances to customers and average customer deposits grew by 11% and 14% respectively.

Non-interest income increased 16% to £4,877 million. Non-interest income from continuing operations was up 17%, £697 million and represents 52% of total income (2005 - 50%). Within non-interest income, fees and commissions receivable increased by 6% to £3,928 million and fees and commissions payable were stable at £960 million. Income from trading activities increased by 80% to £1,458 million while other operating income decreased by 29% to £451 million.

Operating expenses
Operating expenses rose by 12% to £5,018 million. Operating expenses from continuing operations increased by 14% to support business expansion. Integration costs which relate to the integration of First Active were £67 million compared with £163 million in 2005.

Cost: income ratio
The Group’s cost: income ratio was 53.8% compared with 52.4% for continuing operations in 2005.

Impairment losses
Impairment losses were £852 million compared with £756 million in 2005, an increase of 13%. Higher provisions in Retail Banking in respect of unsecured personal loans and credit cards and in Ulster Bank due to growth in lending were partially offset by lower impairment losses in Global Banking & Markets where credit conditions have remained benign.
Dividends
Ordinary dividends totalling £1,500 million (2005 - £350 million) were paid to the holding company during the year.
BALANCE SHEET
Total assets were £290.7 billion at 31 December 2006, 12% higher than total assets of £260.6 billion at 31 December 2005.
Lending to customers, excluding repurchase agreements and stock borrowing (“reverse repos”), increased by 12% or £18.1 billion to £162.9 billion. Customer deposits, excluding repurchase agreements and stock lending (“repos”(‘repos’), grew by 13%1% or £18.2£1.2 billion to £155.4£176.4 billion.
Capital ratios at 31 December 2006 were 9.9% (tier 1) and 12.9% (total).



Analysis of results
Net interest income

2007 2006
 
2005
 
£m
 
£m
 
£m
 
 2009  2008  2007 
        £m   £m   £m 
Interest receivable12,178  9,825  8,492   6,451   12,373   12,178 
Interest payable(7,087) (5,376) (4,031)  (3,254)  (6,976)  (7,087)
Net interest income5,091  4,449  4,461   3,197   5,397   5,091 
                    
         %  %  % 
Gross yield on interest-earning assets of banking business6.13  5.77  5.73 
Cost of interest-bearing liabilities of banking business(4.20) (3.65) (3.22)
Interest spread of banking business1.93  2.12  2.51 
Gross yield on interest-earning assets of the banking business  2.82   5.65   6.13 
Cost of interest-bearing liabilities of the banking business  (1.68)  (3.73)  (4.20)
Interest spread of the banking business  1.14   1.92   1.93 
Benefit from interest-free funds0.63  0.49  0.50   0.26   0.54   0.63 
Net interest margin of banking business2.56  2.61  3.01 
Net interest margin of the banking business  1.40   2.46   2.56 

The following table gives average interest rates, yields and margins.

Yields, spreads and margins of the banking business %  %  % 
Gross yield (1)
         
Group  2.82   5.65   6.13 
UK  2.77   5.72   6.46 
Overseas  2.94   5.45   5.05 
Interest spread (2)
            
Group  1.14   1.92   1.93 
UK  1.15   2.06   2.21 
Overseas  1.07   1.45   1.01 
Net interest margin (3)
            
Group  1.40   2.46   2.56 
UK  1.36   2.48   2.82 
Overseas  1.50   2.40   1.71 
The Royal Bank of Scotland plc base rate (average)  0.64   4.67   5.51 
London inter-bank three month offered rates (average):            
Sterling  1.21   5.51   6.00 
Eurodollar  0.69   2.92   5.29 
Euro  1.21   4.63   4.28 
 2007 2006
 
2005
 
%
 
%
 
% 
Yields, spreads and margins of the banking business:        
Gross yield (1)        
  Group6.13  5.77  5.73 
  UK6.46  6.12  6.11 
  Overseas5.05  4.67  4.55 
         
Interest spread (2)        
  Group1.93  2.12  2.51 
  UK2.21  2.52  2.89 
  Overseas1.01  0.84  1.32 
        
Net interest margin (3)        
  Group2.56  2.61  3.01 
  UK2.82  2.88  3.32 
  Overseas1.71  1.78  2.03 
         
The Bank's base rate5.51  4.64  4.65 
London inter-bank three month offered rate:        
  Sterling6.00  4.85  4.76 
  Eurodollar5.29  5.20  3.56 
  Euro4.28  3.08  2.18 

Notes:
Notes:
(1)Gross yield is the interest rate earned on average interest-earning assets of the banking business.
(2)Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities of the banking business.
(3)Net interest margin is net interest income of the banking business as a percentage of average interest-earning assets of the banking business.



Average balance sheetssheet and related interest rates

The following table shows average balances and interest rates for 2007, 2006 and 2005.
  
2009
  
2008
 
  Average balance  Interest  Rate  Average balance  Interest  Rate 
   £m   £m  %   £m   £m  % 
Assets                      
Loans and advances to banks                      
– UK  73,448   1,236   1.68   45,844   1,784   3.89 
– Overseas  6,543   131   2.00   8,095   341   4.21 
Loans and advances to customers                        
– UK  93,968   3,394   3.61   113,633   7,343   6.46 
– Overseas  51,654   1,591   3.08   48,145   2,720   5.65 
Debt securities                        
– UK  1,569   52   3.31   1,932   98   5.07 
– Overseas  1,958   47   2.40   1,485   87   5.86 
Total interest-earning assets                        
– banking business (2, 3)
  229,140   6,451   2.82   219,134   12,373   5.65 
– trading business (4)
  77,788           71,961         
Total interest-earning assets  306,928           291,095         
Non-interest-earning assets (2, 3)
  38,590           35,824         
Total assets  345,518           326,919         
Percentage of assets applicable to overseas operations  42.3%          44.2%        
Liabilities and owners’ equity                        
Deposits by banks                        
– UK  13,885   511   3.68   7,511   287   3.82 
– Overseas  21,832   326   1.49   13,763   533   3.87 
Customer accounts: demand deposits                        
– UK  58,198   272   0.47   56,691   1,299   2.29 
– Overseas  3,287   46   1.40   4,840   114   2.36 
Customer accounts: savings deposits                        
– UK  44,714   713   1.59   32,307   1,338   4.14 
– Overseas  1,977   48   2.43   875   51   5.83 
Customer accounts: other time deposits                        
– UK  25,144   422   1.68   37,274   1,690   4.53 
– Overseas  8,008   181   2.26   7,545   342   4.53 
Debt securities in issue                        
– UK  903   36   3.99   2,559   163   6.37 
– Overseas  10,810   249   2.30   16,665   699   4.19 
Subordinated liabilities                        
– UK  7,885   436   5.53   7,511   487   6.48 
– Overseas  567   18   3.17   323   22   6.81 
Internal funding of trading business                        
– UK  (1,400)  (4)  0.29   (1,077)  (49)  4.55 
– Overseas  -   -   -   -   -   - 
Total interest-bearing liabilities                        
– banking business (2, 3)
  195,810   3,254   1.66   186,787   6,976   3.73 
– trading business (4)
  78,449           73,400         
Total interest-bearing liabilities  274,259           260,187         
Non-interest-bearing liabilities:                        
Demand deposits                        
– UK  20,004           14,419         
– Overseas  7,012           5,288         
Other liabilities (3, 4)
  31,642           35,497         
Shareholders’ equity  12,601           11,528         
Total liabilities and owners’ equity  345,518           326,919         
Percentage of liabilities applicable to overseas operations  40.7%          44.5%        
 
  
 2007
  
 2006
  
 2005
 
   Average
balance
   
Interest
    Average
rate
   Average
balance
   
Interest
   Average
rate
  
Average
balance
  Interest  
Average
rate
 
ASSETS £m  £m   %  £m  £m  %  £m  £m  % 
Loans and advances to banks                           
UK
  44,039   2,357   5.35   27,400   1,159   4.23   18,461   762   4.13 
Overseas
  6,760   229   3.39   7,334   244   3.33   7,127   234   3.28 
Loans and advances to customers (1)                                    
UK
  105,914   7,362   6.95   101,499   6,737   6.64   93,135   6,066   6.51 
Overseas
  38,521   2,060   5.35   31,326   1,573   5.02   26,977   1,332   4.94 
Debt securities                                    
UK
  1,814   86   4.74   803   39   4.86   769   35   4.55 
Overseas
  1,752   84   4.79   1,836   73   3.98   1,689   63   3.73 
Total interest-earning assets - Banking business
  198,800   12,178   6.13   170,198   9,825   5.77   148,158   8,492   5.73 
Total interest-earning assets -Trading business (2)
  84,615           72,166           68,521         
Total interest-earning assets  283,415           242,364           216,679         
Non-interest-earning assets  30,400           33,194           30,077         
Total assets  313,815           275,558           246,756         
                                     
Percentage of assets applicable to overseas operations  45.5%          45.2%          46.7%         
                                     
LIABILITIES AND SHAREHOLDERS' EQUITY                                    
Deposits by banks                                    
UK
  9,307   525   5.64   7,526   373   4.96   4,669   183   3.92 
Overseas
  11,433   520   4.55   12,427   491   3.95   11,251   374   3.32 
Customer accounts
                                    
- demand deposits
                                    
UK
  55,561   1,791   3.22   54,313   1,451   2.67   46,585   1,156   2.48 
Overseas
  6,868   181   2.64   3,524   83   2.36   4,361   86   1.97 
                                     
- savings deposits
                                    
UK
  25,308   1,137   4.49   20,970   759   3.62   17,733   517   2.92 
Overseas
  1,969   81   4.11   1,518   50   3.29   1,078   26   2.41 
                                     
- other time deposits
                                    
UK
  32,919   1,639   4.98   26,673   1,206   4.52   21,531   921   4.28 
Overseas
  6,387   290   4.54   5,827   221   3.79   7,125   244   3.42 
Debt securities in issue                                    
UK
  3,637   216   5.94   2,704   139   5.14   1,650   75   4.55 
Overseas
  11,789   467   3.96   6,880   300   4.36   3,692   146   3.95 
Loan capital                                    
UK
  4,433   262   5.91   5,016   288   5.74   5,440   290   5.33 
Overseas
  456   30   6.58   430   27   6.28   488   28   5.74 
Internal funding of trading business  (1,207)  (52)  4.31   (382)  (12)  3.14   (509)  (15)  2.95 
Total interest-bearing liabilities - Banking business  168,860   7,087   4.20   147,426   5,376   3.65   125,094   4,031   3.22 
Total interest-bearing liabilities - Trading business(2)
  85,382           72,027           67,726         
Total interest-bearing liabilities  254,242           219,453           192,820         
Non-interest bearing liabilities                                    
Demand deposits
                                    
UK
  13,711           15,258           13,855         
Overseas
  4,713           3,741           3,154         
Other liabilities
  30,964           27,195           28,670         
Shareholders' funds  10,185           9,911           8,257         
Total liabilities and shareholders' equity  313,815           275,558           246,756         
                                     
Percentage of liabilities applicable to overseas operations  47.7%          43.6%          45.3%        

Notes:

(1)
(1)The analysis into UK and Overseas has been compiled on the basis of location of office.
(2) Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities.

(2)Interest income and interest expense do not include interest on financial assets and liabilities designated as at fair value through profit or loss.

(3)Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities.
Average balance sheet and related interest
  
2007
 
  Average balance  Interest  Rate 
   £m   £m  % 
Assets           
Loans and advances to banks           
– UK  44,039   2,357   5.35 
– Overseas  6,760   229   3.39 
Loans and advances to customers            
– UK  105,914   7,362   6.95 
– Overseas  38,521   2,060   5.35 
Debt securities            
– UK  1,814   86   4.74 
– Overseas  1,752   84   4.79 
Total interest-earning assets            
– banking business (2)
  198,800   12,178   6.13 
– trading business (3)
  84,615         
Total interest-earning assets  283,415         
Non-interest-earning assets (2)
  30,400         
Total assets  313,815         
Percentage of assets applicable to overseas operations  45.5%        
Liabilities and owners’ equity            
Deposits by banks            
– UK  9,307   525   5.64 
– Overseas  11,433   520   4.55 
Customer accounts: demand deposits            
– UK  55,561   1,791   3.22 
– Overseas  6,868   181   2.64 
Customer accounts: savings deposits            
– UK  25,308   1,137   4.49 
– Overseas  1,969   81   4.11 
Customer accounts: other time deposits            
– UK  32,919   1,639   4.98 
– Overseas  6,387   290   4.54 
Debt securities in issue            
– UK  3,637   216   5.94 
– Overseas  11,789   467   3.96 
Subordinated liabilities            
– UK  4,433   262   5.91 
– Overseas  456   30   6.58 
Internal funding of trading business            
– UK  (1,207)  (52)  4.31 
– Overseas  -   -   - 
Total interest-bearing liabilities            
– banking business (2)
  168,860   7,087   4.20 
– trading business (3)
  85,382         
Total interest-bearing liabilities  254,242         
Non-interest-bearing liabilities:            
Demand deposits            
– UK  13,711         
– Overseas  4,713         
Other liabilities (2, 3)
  30,964         
Shareholders’ equity  10,185         
Total liabilities and owners’ equity  313,815         
Percentage of liabilities applicable to overseas operations  47.7%        
Notes:
(1)The analysis into UK and Overseas has been compiled on the basis of location of office.
(2)Interest income and interest expense do not include interest on financial assets and liabilities designated as at fair value through profit or loss.
(3)Interest receivable and interest payable on trading assets and liabilities are included in income from trading activities.
25

ChangesAnalysis 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 yearperiod 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.
 
 2007 compared with 2006 2006 compared with 2005  
2009 over 2008
  
2008 over 2007
 
 Increase/(decrease) due to changes in: Increase/(decrease) due to changes in:  Increase/(decrease) due to changes in:  Increase/(decrease) due to changes in: 
 Average Average Net Average Average Net  Average volume  Average rate  Net change  Average volume  Average rate  Net change 
 volume rate change volume rate change   £m   £m   £m   £m   £m   £m 
 £m £m £m £m £m £m 
INTEREST-EARNING ASSETS              
Interest-earning assets                        
Loans and advances to banks                                      
UK
 834 364 1,198  378 19 397   761   (1,309)  (548)  93   (666)  (573)
Overseas
 (19) 4 (15) 7 3 10   (56)  (154)  (210)  50   62   112 
Loans and advances to customers                                      
UK
 301 324 625  549 122 671   (1,113)  (2,836)  (3,949)  518   (537)  (19)
Overseas
 379  108 487  219 22 241   186   (1,315)  (1,129)  539   121   660 
Debt securities                                      
UK
 48 (1) 47  2 2 4   (16)  (30)  (46)  6   6   12 
Overseas
 (3) 14 11  6 4 10   22   (62)  (40)  (14)  17   3 
Total interest receivable of banking business              
Total interest receivable of the banking business                        
UK
 1,183 687 1,870  929 143 1,072   (368)  (4,175)  (4,543)  617   (1,197)  (580)
Overseas
 357 126 483  232 29 261   152   (1,531)  (1,379)  575   200   775 
 1,540 813 2,353  1,161 172 1,333   (216)  (5,706)  (5,922)  1,192   (997)  195 
              
INTEREST-BEARING LIABILITIES              
Interest-bearing liabilities                        
Deposits by banks                                      
UK
 (96) 
(56
) (152) (133) (57)  (190)   (235)  11   (224)  89   149   238 
Overseas
 41 (70) (29) (42)  (75)  (117)  (219)  426   207   (97)  84   (13)
Customer accounts              
- demand deposits
              
Customer accounts: demand deposits                        
UK
 (34) (306) (340) (202)  (93)  (295)  (34)  1,061   1,027   (36)  528   492 
Overseas
 (87) (11) (98) 18 (15)  3   30   38   68   49   18   67 
- savings deposits
              
Customer accounts: savings deposits                        
UK
 (175) (203) (378) (105)  (137)  (242)  (393)  1,018   625   (295)  94   (201)
Overseas
 (17) (14) (31) (13)  (11)  (24)  (39)  42   3   56   (26)  30 
- other time deposits
              
Customer accounts: other time deposits                        
UK
 (302) (131) (433) (231)  (54)  (285)  432   836   1,268   (206)  155   (51)
Overseas
 (23) (46) (69) 48 (25)  23   (20)  181   161   (53)  1   (52)
Debt securities in issue                                       
UK
 (53) (24) (77) (53)  (11)  (64)  81   46   127   68   (15)  53 
Overseas
 (197)  30 (167) (137)  (17)  (154)  197   253   450   (203)  (29)  (232)
Loan capital              
Subordinated liabilities                        
UK
 34 (8) 26  23 (21)  2   (23)  74   51   (198)  (27)  (225)
Overseas
 (2) (1) (3) 4 (3)  1   (11)  15   4   9   (1)  8 
Internal funding of trading business 34  6 40  (4) 1 (3)                         
Total interest payable of banking business              
UK
 (592) (722) (1,314) (705)  (372)  (1,077)  11   (56)  (45)  (6)  3   (3)
Overseas
 (285) (112) (397) (122)  (146)  (268)   -   -   -   -   -   - 
 (877) (834) (1,711) (827)  (518)  (1,345) 
Total interest payable of the banking business                        
UK  (161)  2,990   2,829   (584)  887   303 
Overseas  (62)  955   893   (239)  47   (192)
                (223)  3,945   3,722   (823)  934   111 
Movement in net interest income                                      
UK
 591 (35) 556  224 (229)  (5)  (529)  (1,185)  (1,714)  33   (310)  (277)
Overseas
 72 14 86  110 (117)  (7)   90   (576)  (486)  336   247   583 
 663 (21)  642  334 (346)  (12)   (439)  (1,761)  (2,200)  369   (63)  306 
 

1526
 
Overview of balance sheet
Summary consolidated balance sheet

  2009  2008 
   £m   £m 
         
Assets        
Cash and balances at central banks  1,805   1,285 
Loans and advances to banks  133,230   66,234 
Loans and advances to customers  164,403   198,267 
Debt securities and equity shares  35,755   37,122 
Other assets  15,535   18,311 
Total assets  350,728   321,219 
         
Liabilities        
Deposits by banks  61,433   53,633 
Customer accounts  227,463   200,384 
Debt securities in issue  11,470   17,212 
Other liabilities  25,882   26,433 
Subordinated liabilities  8,999   10,099 
Minority interests  1,282   1,323 
Shareholders’ equity  14,199   12,135 
Total liabilities and equity  350,728   321,219 
  2007 2006 
  £m £m 
Assets      
Cash and balances at central banks 1,363  1,525 
Treasury and other eligible bills 2,021  275 
Loans and advances to banks 71,449  61,563 
Loans and advances to customers 188,976  182,411 
Debt securities and equity shares 37,026  33,426 
Other assets 11,447  11,461 
Total assets 312,282  290,661 
       
Liabilities      
Deposits by banks 44,861  46,258 
Customer accounts 205,519  181,219 
Debt securities in issue 20,923  14,335 
Other liabilities 22,945  32,023 
Subordinated liabilities 5,932  5,641 
Minority interests 1,314  1,012 
Shareholders' equity 10,788  10,173 
Total liabilities 312,282  290,661 

 
Analysis of repurchase agreements

 2009  2008 
2007 2006   £m   £m 
£m £m         
Reverse repurchase agreements and stock borrowing             
     
Loans and advances to banks8,487  10,793   7,287   3,882 
Loans and advances to customers15,557  19,459   9,916   5,202 
24,044  30,252   17,203   9,084 
             
Repurchase agreements and stock lending             
     
Deposits by banks13,139  20,386   10,591   12,027 
Customer accounts30,239  25,806   36,922   23,985 
43,378  46,192   47,513   36,012 



 

Overview -– summary consolidated balance sheet

Total assets of £312.3£350.7 billion at 31 December 20072009 were up £21.6£29.5 billion, 7%9%, compared with 31 December 2006.

Treasury2008, principally reflecting higher lending to banks partially offset by substantial repayments of customer loans and other eligible bills increased by £1.7 billionadvances as corporate customer demand fell and corporates looked to £2.0 billion, due to trading activity.deleverage their balance sheets.

Loans and advances to banks increased by £9.9£67.0 billion, 16%101%, to £71.4 billion. Excluding£133.2 billion reflecting higher reverse repurchase agreements and stock borrowing ("(‘reverse repos"repos’), down £2.3up £3.4 billion, 21%88% to £8.5£7.3 billion and higher bank placings, were up by £12.2£63.6 billion, 24%102%, to £62.9£125.9 billion.

Loans and advances to customers increased by £6.6were down £33.9 billion, 4%17%, to £189.0at £164.4 billion. Within this, reverse repos decreasedincreased by 20%91%, £3.9£4.7 billion to £15.6£9.9 billion. Excluding reverse repos, lending rosedeclined by £10.5£38.6 billion, 6%20% to £173.4£154.5 billion.

Debt securities increaseddecreased by £3.6£1.2 billion, 11%3%, to £35.9£34.8 billion principally due to increasedlower holdings in Global Banking & Markets. and Non-Core.

Settlement balances fell by £0.9were up £0.5 billion, 24%11%, to £2.7 billion.£4.6 billion as a result of increased customer activity.

Movements in the value of derivatives,derivative assets, down £4.4 billion, 50%, to £4.5 billion, and liabilities, primarilydown £3.8 billion, 47%, to £4.3 billion, reflect changesthe easing of market volatility, the strengthening of sterling and significant tightening in credit spreads in the continuing low interest rates and growth in trading volumes.

Prepayments, accrued income and other assets increased by £0.2 billion, 9% to £2.4 billion.rate environment.

Deposits by banks fellincreased by £1.4£7.8 billion, 3%15% to £44.9 billion.  Higher inter-bank deposits, up £5.8£61.4 billion 22% at £31.8 billion were more than offset bydue to a decrease in repurchase agreements and stock lending ("repos"(‘repos’), down £7.2£1.4 billion, 36%12%, to £13.1£10.6 billion and increased inter-bank deposits, up £9.2 billion, 22% to £50.8 billion.

Customer accounts were up £24.3£27.1 billion, 13%14%, to £205.5£227.5 billion.  Within this, repos increased £4.4£12.9 billion, 17%54% to £30.2£36.9 billion. Excluding repos, deposits roseincreased by £19.9£14.2 billion, 13%8%, to £175.3 billion reflecting organic growth.£190.6 billion.

Debt securities in issue increased by £6.6were down £5.7 billion, 46%,33% to £20.9 billion.£11.5 billion mainly as a result of movements in exchange rates, together with reductions in Global Banking & Markets and Non-Core.

Settlement balances and short positions were down £9.3up £3.9 billion, 38%29%, to £15.0 billion.

Accruals, deferred income and other liabilities decreased £0.7£16.9 billion 17% to £3.4 billion.as a result of increased customer activity.

Subordinated liabilities increased by £0.3were down £1.1 billion, 5%,11% to £5.9 billion. The£9.0 billion, reflecting the issue of £0.6 billion dated loan capital and £0.1of £1.0 billion movement in exchange rates wasmore than offset by the redemption of £0.3£0.7 billion undated loan capital and £0.1£0.9 billion non-cumulative preference shares.dated loan capital, together with the effect of exchange rate movements and other adjustments, £0.5 billion.

Shareholders’ equity increased by £0.6£2.1 billion, 6%17%, to £10.8£14.2 billion. The issue of ordinary shares to the parent company raised £0.9 billion in addition to capital contributions of £0.8 billion. Exchange rate and movements of £0.7 billion were partly offset by the attributable profit for the year, of £2.2 billion and movements in currency translation, £0.3 billion were partially offset by the payment of an ordinary dividend to the parent company of £1.9£1.1 billion.



Description of assets and liabilities

Assets

Loan portfolio

NatWest Group’s loan portfolio consists of loans (including overdraft facilities) and finance leases and instalment credit.

Overdraft facilities provide the customer with a demand deposit account and demand credit facility combined in a single checking (current) account. An overdraft is effected whenever a customer’s drawings on a demand deposit account exceed the credit balance of the account, the balance of which may alternate between debit and credit. While overdrafts are contractually repayable on demand, unless a fixed term has been agreed, in practice customers will from time to time make deposits into the account thereby reducing indebtedness or increasing a credit balance in accordance with their requirements. Borrowing limits on the overdraft facility are established and full repayment is normally only required if the customer fails to honour the conditions on which the limit was granted or their financial position has so deteriorated such that it is necessary to take protective action. Overdraft facilities are usually reviewed at least annually. Interest is generally calculated on the daily outstanding balance by reference to NatWest Group’s base rate and is typically charged monthly.

Analysis of loans to customers by geographical area and type of customer - IFRS

The following table analyses loans and advances to customers before provisions by remaining maturity, geographical area and type of customer. Overdrafts are included within the ‘within 1 year’ category.

   After           
   1 but   IFRS       
 Within within After 2007 
IFRS
 IFRS IFRS 
 1 year 5 years 5 years Total 
2006
 2005 2004  
Within
1 year
  
After 1
but within
5 years
  
After
5 years
  
2009
Total
  2008  2007  2006  2005 
 £m £m £m £m £m £m £m   £m   £m   £m   £m   £m   £m   £m   £m 
UK                                                
Central and local government  2,044 – 14  2,058 2,118 1,668 128   1,841   9   -   1,850   2,054   2,058   2,118   1,668 
Manufacturing  4,177 450 556 5,183 5,050 5,380 2,742   2,931   233   915   4,079   4,702   5,183   5,050   5,380 
Construction  4,138 825 754 5,717 4,817 4,273 2,811   2,836   482   721   4,039   5,672   5,717   4,817   4,273 
Finance  33,066 1,131 471 34,668 37,606 34,827 1,597   1,563   284   2,973   4,820   38,703   34,668   37,606   34,827 
Service industries and business activities  12,587 4,452 5,757 22,796 20,199 19,703 13,876   10,147   1,569   8,488   20,204   22,197   22,796   20,199   19,703 
Agriculture, forestry and fishing  589 381 688 1,658 1,962 1,849 1,739   723   229   1,060   2,012   2,102   1,658   1,962   1,849 
Property  8,347 4,743 5,802 18,892 15,023 10,699 8,581   7,702   3,716   7,246   18,664   21,064   18,892   15,023   10,699 
Individuals - home mortgages
  1,438 343 1,784 3,565 3,449 2,746 29,434 
Individuals - other
  13,783 803 1,363 15,949 15,527 14,652 14,051 
Individuals — home mortgages  1,429   1,306   2,468   5,203   4,003   3,565   3,449   2,746 
— other  10,024   2,678   3,183   15,885   16,912   15,949   15,527   14,652 
Finance leases and instalment credit  22 170 125 317  308 320 356   201   4   50   255   273   317   308   320 
Accrued interest  462 13 3 478 377 202 -   6,119   -   3   6,122   330   478   377   202 
Total domestic  80,653 13,311 17,317 111,281 106,436 96,319 75,315   45,516   10,510   27,107   83,133   118,012   111,281   106,436   96,319 
Overseas residents  6,063 4,900 6,090 17,053 13,803 12,449 11,413   7,656   8,978   6,580   23,214   18,824   17,053   13,803   12,449 
Total UK offices  86,716 18,211 23,407 128,334 120,239 108,768 86,728   53,172   19,488   33,687   106,347   136,836   128,334   120,239   108,768 
                                                
Overseas                                                
United States  16,411 131 2,443 18,985 29,232 23,939 24,662 
US  10,169   76   776   11,021   7,019   18,985   29,232   23,939 
Rest of the World  16,301 6,359 21,335 43,995 34,999 29,264 22,223   20,623   8,399   23,678   52,700   57,336   43,995   34,999   29,264 
Total overseas offices  32,712 6,490 23,778 62,980 64,231 53,203 46,885 
                
Loans and advances to customers - gross  
119,428
 24,701 47,185  191,314 184,470 161,971 133,613 
Total Overseas offices  30,792   8,475   24,454   63,721   64,355   62,980   64,231   53,203 
Loans and advances to customers — gross  83,964   27,963   58,141   170,068   201,191   191,314   184,470   161,971 
Loan impairment provisions          (2,338)  (2,059) (2,028) (1,934)              (5,665)  (2,924)  (2,338)  (2,059)  (2,028)
Loans and advances to customers - net          188,976 182,411 159,943 131,679 
Loans and advances to customers — net              164,403   198,267   188,976   182,411   159,943 
                                                
Fixed rate  18,938 7,100 11,225  37,263 46,548 31,823 40,861   20,712   4,896   10,804   36,412   35,353   37,263   46,548   31,823 
Variable rate  100,490 17,601 35,960  154,051 137,922 130,148 92,752   63,252   23,067   47,337   133,656   165,838   154,051   137,922   130,148 
Loans and advances to customers - gross  119,428 24,701 47,185  191,314 184,470 161,971 133,613 
Loans and advances to customers — gross  83,964   27,963   58,141   170,068   201,191   191,314   184,470   161,971 

For further information regarding NatWest Group's operations by geographical area, see Note 3734 to the Consolidated Financial Statements.
 


Loan impairment provisions

Provisioning policy

NatWest Group’s approach to managing credit risk is discussed in note 29the Risk, capital and liquidity management section on pages 37 to 60 to the Consolidated Financial Statements and its accounting policy for impairment of financial assets is set out on page 56.91.

Loan impairment provisions - IFRS

For a discussion of the factors considered in determining the amount of the provisions, see ‘Provision analysis’ and ‘Provision methodology’ on page 104.

The following table shows the elements of loan impairment provisions.

 
IFRS
2007
 
IFRS
2006
 
IFRS
2005
 
IFRS
2004
  2009  2008  2007  2006  2005 
 £m £m £m £m   £m   £m   £m   £m   £m 
Provisions at beginning of year         
Provisions at the beginning of the year                    
Domestic
 1,748  1,680  1,654  1,358   2,271   1,986   1,748   1,680   1,654 
Foreign
 313  351  471  547   655   354   313   351   471 
 2,061  2,031  2,125  1,905 
              2,926   2,340   2,061   2,031   2,125 
Currency translation and other adjustments                                
Domestic
  14  -  7  -   5   1   14   -   7 
Foreign
  27  (7) (9) (27)  (3)  134   27   (7)  (9)
 41  (7) (2) (27)  2   135   41   (7)  (2)
            
Acquisition/(disposal) of subsidiaries            
(Disposals)/acquisitions of businesses                    
Domestic
 
-
  -  (23) -   -   -   -   -   (23)
Foreign
 
-
  -  16  35   -   (70)  -   -   16 
 -  -  (7) 35 
              -   (70)  -   -   (7)
Amounts written-off                                
Domestic
  (537) (681) (639) (425)  (1,144)  (744)  (537)  (681)  (639)
Foreign
  (80) (120) (179) (170)  (27)  (48)  (80)  (120)  (179)
 (617) (801) (818) (595)  (1,171)  (792)  (617)  (801)  (818)
            
Recoveries of amounts written-off in previous years                                
Domestic
  67  50  44  41   45   46   67   50   44 
Foreign
  27  21  12  4   3   16   27   21   12 
 94  71  56  45 
              48   62   94   71   56 
Transfers to immediate parent company                                
Domestic -  (30) -  (48)  -   -   -   (30)  - 
Foreign -  12  -  -   -   -   -   12   - 
 -  (18) -  (48)  -   -   -   (18)  - 
            
Charge to income statement            
Charged to income statement (1)
                    
Domestic
  769  787  704  470   2,653   1,060   769   787   704 
Foreign
  79  65  49  155   1,462   291   79   65   49 
 848  852  753  625   4,115   1,351   848   852   753 
            
Discount unwind            
Unwind of discount                    
Domestic
  (75) (58) (67)     (124)  (78)  (75)  (58)  (67)
Foreign
 (12) (9) (9)     (122)  (22)  (12)  (9)  (9)
 (87) (67) (76)     (246)  (100)  (87)  (67)  (76)
Provisions at end of year            
Provisions at the end of the year (2)
                    
Domestic
  1,986  1,748  1,680  1,396   3,706   2,271   1,986   1,748   1,680 
Foreign
  354  313  351  544   1,968   655   354   313   351 
  2,340  2,061  2,031  1,940   5,674   2,926   2,340   2,061   2,031 
                                
Gross loans and advances to customers                                
Domestic  111,281  106,436  96,319  75,315   83,133   122,120   111,281   106,436   96,319 
Foreign  80,033  78,034  65,652  58,298   86,935   79,071   80,033   78,034   65,652 
  191,314  184,470  161,971  133,613   170,068   201,191   191,314   184,470   161,971 
            
Closing customer provisions as a % of gross loans and advances to customers            
Closing customer provisions as a % of gross loans and advances to customers (3)
                    
Domestic  1.78% 1.64% 1.74% 1.85%  4.46%  1.86%  1.78%  1.64%  1.74%
Foreign  0.44% 0.40% 0.53% 0.92%  2.26%  0.83%  0.44%  0.40%  0.53%
 1.22% 1.12% 1.25% 1.45%
            
Total  3.33%  1.45%  1.22%  1.12%  1.25%
Customer charge to income statement as a % of gross loans and advances to customers                                
Domestic  0.69%  0.74% 0.73% 0.62%  3.19%  0.87%  0.69%  0.74%  0.73%
Foreign  0.10%  0.08% 0.07% 0.27%  1.67%  0.37%  0.10%  0.08%  0.07%
  0.44%  0.46% 0.46% 0.47%
Total  2.42%  0.67%  0.44%  0.46%  0.46%


Notes:
(1)Includes charge against loans and advances to banks of £7 million (2008 to 2004 – nil)
(2)Includes closing provisions against loans and advances to banks of £9 million (2008 - £2 million; 2007 — £2 million; 2006 — £2 million; 2005 — £3 million).
(3)Closing customer provisions exclude closing provisions against loans and advances to banks.

The following table presentsshows additional information within respect toof the loan impairment provisions.

  
IFRS
2007
 
IFRS
2006
 
IFRS
2005
 
IFRS
2004
 
  £m £m £m £m 
          
Loans and advances to customers (gross)  191,314  184,470  161,971  133,613 
             
Loan impairment provisions at end of year:            
Customers  2,338  2,059  2,028    
Banks  2  2  3    
Specific provisions - customers          1,651 
Specific provisions - banks          6 
General provision          283 
   2,340  2,061  2,031  1,940 
             
Average loans and advances to customers (gross)  187,700  170,905  162,733  117,249 
             
As a % of average loans and advances to customers during the year:            
             
Total customer provisions charged to income statement  0.45% 0.50% 0.46% 0.53%
             
Amounts written-off (net of recoveries) - customers  0.28% 0.43% 0.47% 0.47%
  2009  2008  2007  2006  2005 
   £m   £m   £m   £m   £m 
Loan impairment provisions at end of year:                    
– customers  5,665   2,924   2,338   2,059   2,028 
– banks  9   2   2   2   3 
   5,674   2,926   2,340   2,061   2,031 
Average loans and advances to customers (gross)  139,948   158,225   187,700   170,905   162,733 
                     
As a % of average loans and advances to customers during the year:                    
Total customer provisions charged to income statement  2.94%  0.85%  0.45%  0.50%  0.46%
                     
Amounts written-off (net of recoveries) – customers  0.80%  0.46%  0.28%  0.43%  0.47%

 
Analysis of closing customer loan impairment provisions - IFRS

The following table analyses customer loan impairment provisions by geographical area and type of domestic customer.

 IFRS IFRS IFRS IFRS 
 2007 2006 2005 2004 
   % of   % of   % of   % of 
   loans to   loans to   loans to   loans to 
 Closing total Closing total Closing total Closing total  2009  2008  2007  2006  2005 
 provision  loans provision loans provision loans provision loans  Closing provision  % of loans to total loans  Closing provision  % of loans to total loans  Closing provision  % of loans to total loans  Closing provision  % of loans to total loans  Closing provision  % of loans to total loans 
 £m % £m % £m % £m %   £m  %   £m  %   £m  %   £m  %   £m  % 
Domestic                                                     
Central and local government 
-
  1.1  - 1.1 - 1.0 - 0.1   -   1.2   -   1.3   -   1.1   -   1.1   -   1.0 
Manufacturing  56 2.7  53 2.7 70 3.3 80 2.1   103   2.6   59   2.9   56   2.7   53   2.7   70   3.3 
Construction  59  3.0  45 2.6 48 2.7 50 2.1   233   2.6   155   3.5   59   3.0   45   2.6   48   2.7 
Finance  4  18.1  6 20.4 17 21.5 16 1.2   10   1.1   6   1.2   4   18.1   6   20.4   17   21.5 
Service industries and business activities  369  11.8  364 11.0 411 12.2 299 10.4   464   12.8   348   13.8   369   11.8   364   11.0   411   12.2 
Agriculture, forestry and fishing
  17  0.9  18 1.1 20 1.1 17 1.3   16   1.3   16   1.3   17   0.9   18   1.1   20   1.1 
Property  50  9.9  39 8.1 38 6.6 27 6.4   620   12.0   178   13.1   50   9.9   39   8.1   38   6.6 
Individuals                  
- home mortgages
  4  1.9  6 1.9 3 1.7 9 22.0 
- other
  1,244  8.3  1,077 8.4 921 9.1 716 10.5 
Individuals — home mortgages  5   3.3   5   2.5   4   1.9   6   1.9   3   1.7 
— other  1,598   10.2   1,304   10.6   1,244   8.3   1,077   8.4   921   9.1 
Finance leases and instalment credit
  13  0.2  13 0.2 - 0.2 45 0.3   10   0.2   11   0.2   13   0.2   13   0.2   -   0.2 
Accrued interest  -  0.3  - 0.2 - 0.1       -   0.2   -   0.2   -   0.3   -   0.2   -   0.1 
Total domestic  1,816  58.2  1,621 57.7 1,528 59.5 1,259 56.4   3,059   47.5   2,082   50.6   1,816   58.2   1,621   57.7   1,528   59.5 
Foreign  265  41.8  242 42.3 298 40.5 392 43.6   1,746   52.5   562   49.4   265   41.8   242   42.3   298   40.5 
Impaired book  2,081   100.0  1,863  100.0  1,826  100.0     100.0 
Latent book provision 257    196   202       
Specific              1,651   
General                  283    
Impaired book provisions  4,805   100.0   2,644   100.0   2,081   100.0   1,863   100.0   1,826   100.0 
Latent book provisions  860       280       257       196       202     
Total provisions  2,338    2,059    2,028     1,934      5,665       2,924       2,338       2,059       2,028     


2031
Analysis of Contents

Write-offs - IFRS

write-offs
The following table analyses amounts written-off by geographical area and type of domestic customer:customer.
  2009  2008  2007  2006  2005 
  £m   £m   £m   £m   £m 
Domestic                   
Manufacturing  32   23   15   22   26 
Construction  130   40   13   13   13 
Finance  3   4   1   12   4 
Service industries and business activities  212   178   102   114   82 
Agriculture, forestry and fishing  3   3   2   4   3 
Property  46   15   5   5   7 
Individuals — home mortgages  -   -   -   -   1 
 — others  719   481   399   511   503 
Total domestic  1,145   744   537   681   639 
Foreign  26   48   80   120   179 
Total write-offs (1)
  1,171   792   617   801   818 
Note:
(1)
Includes £3 million written-off in respect of loans and advances to banks in 2005.

  IFRS IFRS IFRS IFRS 
  2007 2006 2005 2004 
  £m £m £m £m 
Domestic         
Manufacturing 15  22  26  25 
Construction 13  13  13  9 
Finance 1
 
 12  4  1 
Service industries and business activities
 102
 
 114  82  79 
Agriculture, forestry and fishing 2
 
 4  3  3 
Property 5  5  7  12 
Individuals - home mortgages
 
-
  -  1  - 
 - others 399
 
 511  503  296 
Total domestic 537  681  639  425 
Foreign 80  120  179  170 
Total write-offs 617  801  818  595 

* includes £3 million written-off in respectAnalysis of loans and advances to banks in 2005recoveries
Recoveries - IFRS

The following table analyses recoveries of amounts written-offwritten-off by geographical area and type of domestic customer:customer.

 IFRS IFRS IFRS IFRS 
 2007 2006 2005 2004  2009  2008  2007  2006  2005 
 £m £m £m £m   £m   £m   £m   £m   £m 
Domestic                                
Manufacturing -  -  1  -   -   1   -   -   1 
Service industries and business activities 6  1  2  2   3   6   6   1   2 
Individuals - others
 61  49  41  39 
Individuals — others  41   39   61   49   41 
Total domestic 67  50  44  41   44   46   67   50   44 
Foreign 27  21  12  4   4   16   27   21   12 
Total recoveries 94  71  56  45   48   62   94   71   56 

2132

Risk elements in lending and potential problem loans - IFRS
NatWest Group’s loan control and review procedures do not include the classification of loans as non-accrual, accruing past due, restructured and potential problem loans, as defined by the SEC in the US. The following table shows the estimated amount of loans that would be reported using the SEC’s classifications. The figures are stated before deducting the value of security held or related provisions.

IFRS require interest to be recognised on a financial asset (or a group of financial assets) after impairment at the rate of interest used to discount recoveries when measuring the impairment loss. Thus, interest on impaired financial assets is credited to profit or loss as the discount on expected recoveries unwinds. Despite this, such assets are not considered performing. All loans that have an impairment provision are classified as non-accrual. This is a change from past practice in 2004 and earlier years where certain loans with provisions were classified as past due 90 days or potential problem loans (and interest accrued on them).
  2009  2008  2007  2006  2005 
   £m   £m   £m   £m   £m 
Loans accounted for on a non-accrual basis (2):   ��                
Domestic  6,453   3,960   2,744   2,517   2,700 
Foreign  6,462   2,112   555   467   487 
Total  12,915   6,072   3,299   2,984   3,187 
Accruing loans which are contractually overdue                    
90 days or more as to principal or interest (3):                    
Domestic  1,236   656   50   71   2 
Foreign  434   344   39   24   7 
Total  1,670   1,000   89   95   9 
Total risk elements in lending  14,585   7,072   3,388   3,079   3,196 
                     
Potential problem loans (4)                    
Domestic  141   121   16   31   11 
Foreign  9   6   1   6   5 
Total potential problem loans  150   127   17   37   16 
Closing provisions for impairment as a % of total risk elements in lending  39%  41%  69%  67%  63%
Closing provisions for impairment as a % of total risk elements in lending and potential problem loans  39%  41%  69%  66%  63%
Risk elements in lending as a % of gross lending to customers excluding reverse repos  9.10%  3.61%  1.93%  1.87%  2.18%

  IFRS IFRS IFRS IFRS 
  2007 2006 2005 2004 
  
£m
 
£m
 
£m
 
£m
 
Loans accounted for on a non-accrual basis (2):
 
 
       
Domestic
 2,744  2,517  2,700  1,966 
Foreign
 555  467  487  565 
Total
 3,299  2,984  3,187  2,531 
Accruing loans which are contractually past due            
90 days or more as to principal or interest (3):
            
Domestic
 50  71  2  342 
Foreign
 39  24  7  60 
Total
 89  95  9  402 
Loans not included above which are classified as            
'troubled debt restructurings' by the SEC: -  -  -  - 
             
Total risk elements in lending 3,388  3,079  3,196  2,933 
             
Potential problem loans (4)
            
Domestic 16  31  11  13 
Foreign 1  6  5  83 
Total
 17  37  16  96 
             
Closing provisions for impairment as a % of total risk elements in lending 69% 67% 63% 66%
             
Closing provisions for impairment as a % of total risk elements in lending
and potential problem loans
 69% 66% 63% 64%
             
Risk elements in lending as a % of gross lending to customers excluding reverse repos 1.93% 1.87% 2.18% 2.53%
             
Notes:
(1)For the analysis above, ‘Domestic’ consists of the United Kingdom domestic transactions of NatWest Group. ‘Foreign’ comprises NatWest Group’s transactions conducted through offices outside the UK and through those offices in the UK specifically organised to service international banking transactions.
 
Notes:
(1)   For the analysis above, 'Domestic' consists of the United Kingdom domestic transactions of NatWest Group. 'Foreign' comprises NatWest Group’s transactions conducted through offices outside the UK and through those offices in the UK specifically organised to service international banking transactions.
(2)   All loans against which an impairment provision is held are reported in the non-accrual category.
(3)   Loans where an impairment event has taken place but no impairment recognised. This category is used for fully-collateralised non-revolving credit facilities.
(4)   Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully-collateralised advances and revolving credit facilities where identification as 90 days overdue is not feasible.
(2)All loans against which an impairment provision is held are reported in the non-accrual category.
 
(3)Loans where an impairment event has taken place but no impairment recognised. This category is used for fully collateralised non-revolving credit facilities.
(4)Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully collateralised advances and revolving credit facilities where identification as 90 days overdue is not feasible.

  2009  2008  2007  2006  2005 
   £m   £m   £m   £m   £m 
Gross income not recognised but which would have been recognised under the original terms of non-accrual and restructured loans:                    
Domestic  310   243   200   225   99 
Foreign  153   108   10   24   21 
   463   351   210   249   120 
Interest on non-accrual and restructured loans included in net interest income:                    
Domestic  124   78   75   68   67 
Foreign  122   22   12   9   9 
   246   100   87   77   76 

2233

 
  IFRS IFRS IFRS IFRS 
  2007 2006 2005 2004 
  
£m
 
£m
 
£m
 
£m
 
Gross income not recognised but which would have been recognised under the original terms of non-accrual and restructured loans            
Domestic
 200  225  99  130 
Foreign
 10  24  21  31 
  210  249  120  161 
             
Interest on non-accrual and restructured loans included in net interest income            
Domestic
 75  68  67  41 
Foreign
 12
 
 9  9  - 
  87  77  76  41 

Cross border outstandings in excess of 0.75% of total assets

Cross border outstandings consist of loans to banks and customers (including instalment credit and finance lease receivables), acceptances and other monetary assets, including non-local currency claims of overseas offices on local residents. NatWest Group monitors the geographical breakdown of outstandings based on the country of domicile of the borrower or guarantor of ultimate risk.

At 31 December 2009, 2008 and 2007, 2006, and 2005, NatWest Group had no cross border outstandings in excess of 0.75% of total assets (including acceptances).


Debt Securities
The following table categorisesanalyses by issuer the Group'sNatWest Group’s available-for-sale debt securities by remaining maturity and the related yield (based on weighted averages) as of 31 December 2007.
.
 
 Within 1 year  After 1 but within 5 years  After 5 but within 10 years  Total  
Within 1 year
  
After 1 but
within 5 years
  
After 5 but
within 10 years
  
After 10 years
  
Total
 
 Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield  Amount  Yield 
Issued by  £m  %   £m  %   £m  %   £m  % 
UK government  -   -   1,320   2.5   -   -   1,320   2.5 
Other government  150   4.0   790   3.8   -   -   940   3.8 
2009  £m  %   £m  %   £m  %   £m  %   £m  % 
Other central and local government  1,023   1.5   529   3.3   7   3.1   -   -   1,559   2.1 
Bank and building society  245   4.6   571   4.4   15   3.8   831   4.5   135   2.2   238   2.1   2   4.7   -   -   375   2.1 
Mortgage-backed securities (1)  -   -   -   -   124   6.4   124   6.4   4   2.9   52   2.8   -   -   72   0.7   128   1.6 
Corporate  1   7.5   13   5.7   -   -   14   5.9   -   -   19   2.7   6   3.9   -   -   25   3.0 
Other  553   5.1   -   -   -   -   553   5.1 
Total fair value  949   4.8   2,694   3.3   139   6.1   3,782   3.8   1,162   1.6   838   2.9   15   3.6   72   0.7   2,087   2.1 
 
Note:
Notes:
(1) Excludes securities issued by US federal agencies and government sponsored entities.
(1)Includes securities issued by US federal agencies and government sponsored entities.
 
2334
 
Liabilities

Analysis of deposits - IFRS

Analysis of deposits by— product type and geographical area - IFRS

analysis
The following table shows the distribution of the NatWest Group'sGroup’s deposits by product type and geographical area.

  IFRS IFRS IFRS 
  2007 2006 2005 
  £m £m £m 
UK         
Domestic:         
Demand deposits - interest-free
  34,467  31,738  23,825 
Demand deposits - interest-bearing
  65,142  68,350  54,048 
Time deposits - savings
  20,856
 
 19,219  17,234 
Time deposits - other
  33,612  23,412  25,011 
Overseas residents:         
Demand deposits - interest-free
  263  604  329 
Demand deposits - interest-bearing
  7,928  7,121  4,326 
Time deposits - savings
  441  5,557  892 
Time deposits - other
  3,360  3,182  873 
Total UK offices  166,069  159,183  126,538 
          
Overseas         
Demand deposits - interest-free
  5,577  4,441  3,629 
                             - interest-bearing
  5,216  10,254  9,244 
Time deposits - savings
  1,269  2,578  1,097 
                        - other
  72,249  51,021  63,417 
Total overseas offices (see below)
  84,311  68,294  77,387 
Total deposits  250,380  227,477  203,925 
          
Held for trading  32,596  15,435  16,961 
Fair value through profit or loss  1,661
 
 1,448  1,339 
Amortised cost  216,123  210,594  185,625 
Total deposits  250,380  227,477  203,925 
          
Overseas offices         
United States  54,316  49,743  43,432 
Rest of the World  29,995  18,551  33,955 
Total overseas offices
  84,311  68,294  77,387 
  2009  2008  2007 
   £m   £m   £m 
UK Domestic:            
Demand deposits – interest-free  33,210   30,625   34,467 
  – interest-bearing
  79,560   54,615   65,142 
Time deposits – savings  44,796   40,118   20,856 
– other
  24,098   26,599   33,612 
Overseas residents:            
Demand deposits – interest-free  3,658   1,663   263 
  – interest-bearing
  3,566   3,592   7,928 
Time deposits – savings  5,083   7,380   441 
– other
  765   1,687   3,360 
Total UK offices  194,736   166,279   166,069 
Overseas            
Demand deposits – interest-free  8,502   4,999   5,577 
– interest-bearing  3,891   3,628   5,216 
Time deposits – savings  1,425   1,275   1,269 
– other
  80,342   77,836   72,249 
Total overseas offices  94,160   87,738   84,311 
Total deposits  288,896   254,017   250,380 
             
Held-for-trading  34,648   43,170   32,596 
Designated as at fair value through profit or loss  2,435   2,291   1,661 
Amortised cost  251,813   208,556   216,123 
Total deposits  288,896   254,017   250,380 
             
Overseas            
US  51,171   42,312   54,316 
Rest of the World  42,989   45,426   29,995 
Total overseas offices  94,160   87,738   84,311 

2435
 
Short-termShort term borrowings - IFRS
  2009  2008  2007 
   £m   £m   £m 
Commercial paper            
Outstanding at year end  1,702   4,780   5,564 
Maximum outstanding at any month end during the year  3,913   10,775   7,335 
Approximate average amount during the year  2,164   8,391   5,554 
Approximate weighted average interest rate during the year  1.0%  1.8%  4.5%
Approximate weighted average interest rate at year end  0.5%  2.8%  4.8%
             
Other short term borrowings            
Outstanding at year end  56,053   52,878   55,947 
Maximum outstanding at any month end during the year  70,452   102,820   73,848 
Approximate average amount during the year  57,608   81,571   65,385 
Approximate weighted average interest rate during the year  0.3%  1.9%  5.0%
Approximate weighted average interest rate at year end  0.1%  0.4%  3.7%

The following table shows details of NatWest Group's short-term borrowings.

  IFRS IFRS IFRS 
  2007 2006 2005 
  £m £m £m 
Commercial paper:         
Outstanding at 31 December
  5,564  1,442  2,343 
Maximum amount outstanding at any month-end during the year
  7,335   2,423  3,326 
Approximate average amount outstanding during the year
  5,554   1,834  2,863 
Approximate weighted average interest rate during the year
  4.5%   5.0%  3.0%
Approximate weighted average interest rate at 31 December
  4.8%   5.3%  4.4%
          
Other short-term borrowings:         
Outstanding at 31 December
  55,947  49,208  37,513 
Maximum amount outstanding at any month-end during the year
  73,848   54,401  44,172 
Approximate average amount outstanding during the year
  65,385   46,650  37,147 
Approximate weighted average interest rate during the year
  5.0%   5.3%  3.9%
Approximate weighted average interest rate at 31 December
  3.7%   5.2%  4.1%

Average interest rates during the year are computed by dividing total interest expense by the average amount borrowed. Average interest rates at year end are average rates for a single day and as such may reflect one-day market distortions which may not be indicative of generally prevailing rates. Original maturities of commercial paper are not in excess of one year. 'Other‘Other short-term borrowings'borrowings’ consist principally of borrowings in the money markets included within 'Deposits‘Deposits by banks'banks’ and 'Customer accounts'‘Customer accounts’ in the Consolidated Financial Statements,financial statements, and generally have original maturities of one year or less.

Certificates of deposit and other time deposits - IFRS

The following table shows details of NatWest Group'sthe Group’s certificates of deposit issued and other time deposits over £50,000 (or$100,000 or equivalent by remaining maturity.
  
Within
3 months
  
Over 3 months but within
6 months
  
Over 6 months but within
12 months
  
Over
12 months
  
2009
Total
 
   £m   £m   £m   £m   £m 
UK based companies and branches                    
Certificates of deposit  366   96   55   -   517 
Other time deposits  17,298   959   1,099   3,542   22,898 
                     
Overseas based companies and branches                 ��  
Certificates of deposit  338   19   37   20   414 
Other time deposits  14,718   1,995   2,581   4,144   23,438 
   32,720   3,069   3,772   7,706   47,267 
36
Financial review continued
Risk, capital and liquidity management
On pages 37 to 60 of the equivalentFinancial review, certain information has been audited and is part of $100,000the Group’s financial statements as permitted by IFRS 7. Other disclosures are unaudited and labelled with an asterisk (*).

Risk, capital and liquidity management are conducted on an overall basis within the RBS Group. Therefore the discussion on risk, capital and liquidity management on pages 37 to 60 refers principally to policies and procedures in the RBS Group that also apply to the Group. Data is also provided for currenciesthe Bank and its subsidiaries (“the Group”), and the Bank.
Risk, capital and liquidity governance*
Risk, capital and liquidity management strategies are owned and set by the RBS Group’s Board of Directors, and implemented by executive management led by the Group Chief Executive. There are a number of committees and executives that support the execution of the business plan and strategy, as set out below. Representation by and interaction between the individual risk disciplines is a key feature of this governance structure, with the aim of promoting cross-risk linkages.

Note:
For key changes to the risk, capital and liquidity governance structure, refer to the table overleaf.

* unaudited
37
Financial review
Risk, capital and liquidity management
Risk, capital and liquidity governance* continued
The role and remit of these committees is as follows:
CommitteeFocusMembership
Group Audit Committee
(GAC)
Financial reporting and the application of accountingpolicies as part of the internal control and riskassessment process. From a historical perspective,GAC monitors the identification, evaluation andmanagement of all significant risks throughoutthe Group.
Independent non-executive directors
Board Risk Committee
(BRC)
A new committee, formed to provide oversight and adviceto the Group Board in relation to current and potential futurerisk exposures of the Group and future risk strategy. Reportsto the Group Board, identifying any matters within its remit inrespect of which it considers an action or improvementis needed, and making recommendations as to thesteps to be taken. Provides quantitative and qualitativeadvice to the Remuneration Committee upon theGroup Remuneration Policy and the implications forrisk management.
At least three independent non-executive
directors, one of whom is the Chairman
of the Group Audit Committee
Executive Credit Group
(ECG)
Formed to replace the Advances Committee and theGroup Credit Committee, the ECG decides on requestsfor the extension of existing or new credit limits on behalfof the Board of Directors which exceed the delegatedauthorities of individuals throughout the Group asdetermined by the credit approval grid. The Head ofRestructuring and Risk or the Group Chief Credit Officermust be present along with at least one other memberto ensure the meeting is quorate.
Group Chief Executive
Head of Restructuring and Risk
Group Chief Risk Officer
Group Chief Credit Officer
Chief Executive Officer from each division
Group Finance Director
Executive Committee
(ExCo)
A newly formed committee responsible for managingGroup wide issues and those operational issues materialto the broader Group.
Group Chief Executive
Business and function heads, as determined by the Group Chief Executive/Board
Head of Restructuring and Risk
Group Finance Director
Group Risk Committee
(GRC)
Recommends limits and approves processes and majorpolicies to ensure the effective management of allmaterial risks across the Group.
Head of Restructuring and Risk
Group Chief Risk Officer
Group Head of each risk function
Group Head of Country Risk
Global Head of Risk Architecture
Deputy Group Finance Director
Chief Operating Officer, RBS Risk Management
Chief Executive and Chief Risk Officer
from each division
Group Asset and Liability
Management Committee
(GALCO)
Identifies, manages and controls the Groupbalance sheet risks.
Group Finance Director
Deputy Group Finance Director
Head of Restructuring and Risk
Chief Executive from each division
Group Chief Accountant
Group Treasurer and Deputy Group Treasurer
Chief Financial Officer, ABN AMRO
Director, Group Corporate Finance
Director, Group Financial Planning & Analysis
Head of Balance Sheet Management, Group Treasury
Executive Risk Forum
(ERF)
Acts on all strategic risk and control matters across theGroup including, but not limited to, credit risk, marketrisk, operational risk, compliance and regulatory risk,enterprise risk, treasury and liquidity risk, reputationalrisk, insurance risk and country risk.
Group Chief Executive
Head of Restructuring and Risk
Group Chief Risk Officer
Group Finance Director
Chief Executive Officer from each division
Note:
These committees are supported at a divisional level by a risk governance structure embedded in the businesses.
* unaudited
38
Financial reviewcontinued

Risk, capital and liquidity governance* continued
Management responsibilities

All employees have a role to play in the day-to-day management of capital, liquidity and risk which is set and managed by specialist staff in:

Risk Management: credit risk, market risk, operational risk, regulatory risk, reputational risk, insurance risk and country risk, together with risk analytics; and

Group Treasury: balance sheet, capital management, intra-group exposure, funding, liquidity and hedging policies.

Independence underpins the approach to risk management, which is reinforced throughout the RBS Group by appropriate reporting lines. Risk Management and Group Treasury functions are independent of the revenue generating business. As part of the move toward greater functional independence, the divisional Chief Risk Officers have a direct reporting line to the Head of Restructuring and Risk as well as to their divisional CEOs.

Group Internal Audit supports the GAC in providing an independent assessment of the design, adequacy and effectiveness of the internal controls relating to risk management.

Risk appetite
Risk appetite is an expression of the maximum level of risk that the RBS Group is prepared to accept in order to deliver its business objectives. Risk and capital management across the RBS Group is based on the risk appetite set by the Board, who ultimately approve annual plans for each division and regularly reviews and monitors the RBS Group’s performance in relation to risk.

Risk appetite is defined in both quantitative and qualitative terms as follows:

Quantitative: encompassing stress testing, risk concentration, VaR, liquidity and credit related metrics; and

Qualitative: ensuring that the RBS Group applies the correct principles, policies and procedures.

Different techniques are used to ensure that the RBS Group’s risk appetite is achieved. The Board Risk Committee considers and recommends for approval by the NatWest Group Board, the RBS Group’s risk appetite framework and tolerance for current and future strategy, taking into account the RBS Group’s capital adequacy and the external risk environment. The ERF is responsible for ensuring that the implementation of strategy and operations are in line with the risk appetite determined by the Board. This is reinforced through policy and limit frameworks ensuring that all staff within the RBS Group make appropriate risk and reward trade-offs within pre-agreed boundaries.

The annual business planning and performance management processes and associated activities together ensure that the expression of risk appetite remains appropriate. Both GRC and GALCO support this work.
Remuneration responsibilities
In August 2009, the Financial Services Authority (FSA) published its Code of Remuneration Practices (the Code). The Code requires the RBS Group to establish, implement and maintain remuneration policies, procedures and practices that promote and are consistent with effective risk management.

The Risk Management function provides input to the Remuneration Committee on the remuneration policy for the RBS Group. Each division is allocated risk objectives as part of the strategic plan and achievement of these objectives is evaluated as part of the annual performance management process.

During 2009, Risk Management provided formal independent 360° feedback for key individuals, reviewing their capability and performance in relation to managing risk. Individuals selected perform roles of significant influence and their activities have, or could have, a material impact on the RBS Group’s risk profile.

An annual report on the risk performance of each division, including both qualitative and quantitative information, is provided to the Remuneration Committee to allow consideration of adjustments relating to the compensation for the performance year.




* unaudited
39

Financial review
Risk, capital and liquidity management
Capital*
All disclosures in this section (page 40) are unaudited and are labelled with an asterisk (*).
Capital resources
It is the RBS Group’s policy to maintain a strong capital base and to utilise it efficiently throughout its activities to optimise the return to shareholders, while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the RBS Group has regard to the supervisory requirements of the FSA. The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (RWAs) (the assets and off-balance sheet exposures are “weighted” to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than sterling) at8% with a Tier 1 component of not less than 4%. At 31 December 2007,2009, the Group’s total RAR was 13.4% (2008 – 14.5%) and the Tier 1 RAR was 10.1% (2008 – 10.1%).
As part of the annual planning and budgeting cycle, each division is allocated capital based upon RWAs and associated regulatory deductions. The budgeting process considers risk appetite, available capital resources, stress testing results and business strategy. The budget is agreed by time remaining until maturity:the Board and allocated to divisions to manage their allocated RWAs.
Group Treasury and GALCO monitor available capital and its utilisation across divisions. GALCO makes the necessary decisions around reallocation of budget and changes in RWA allocations.
Risk coverage
The main risks facing the NatWest Group are shown below.
Risk type
Definition
Features
Credit risk
(including country
and political risks)
The risk arising from the possibility that the Group will incur losses owing to the failure of customers to meet their financial obligations to the Group.  
Loss characteristics vary materially across portfolios.
Significant correlation between losses and the macroeconomic environment.
Concentration risk - potential for large material losses.
The risk arising from country events.
Country risks correlated with macroeconomic developments.
Country vulnerabilities changing structurally in the aftermath of the financial crisis.
Funding and liquidity risk
The risk of being unable to meet obligations as they fall due.Potential to disrupt the business model and stop normal functions of the Group.
Market risk
The risk that the value of an asset or liability may change as a result of a change in market risk factors.
Potential for large, material losses.
Significantly correlated with equity risk and the macroeconomic environment.
Potential for losses due to stress events.
Operational risk
The risk of financial, customer or reputational loss resulting from inadequate or failed internal processes or systems; from improper behaviour; or from external events.
Frequent small losses.
Infrequent material losses.
Regulatory risk
The risks arising from regulatory changes and enforcement.
Risk of regulatory changes.
Compliance with regulations.
Potential for fines and/or restrictions in business activities.
Other risk
The risks arising from reputation risk.
Additional regulation can be introduced as a result of  other risk losses.
Failure to meet expectations of stakeholders.
Pension risk is the risk that the Group may have to make additional contributions to its defined benefit pension schemes.
Pension risk arises because of the uncertainty of future investment returns and the projected value of schemes’ liabilities.
* unaudited
40
Financial review continued
Credit risk
Credit risk is the risk arising from the possibility that the RBS Group will incur losses owing to the failure of customers to meet their financial obligations. The quantum and nature of credit risk assumed in the RBS Group’s different businesses varies considerably, while the overall credit risk outcome usually exhibits a high degree of correlation to the macroeconomic environment. Certain disclosures in this section (pages 41 to 46) are unaudited and are labelled with an asterisk (*).
Principles for credit risk management
The key principles for credit risk management in the RBS Group are as follows:
●
A credit risk assessment of the customer and credit facilities is undertaken prior to approval of credit exposure. Typically, this includes both quantitative and qualitative elements including: the purpose of the credit and sources of repayment; compliance with affordability tests; repayment history; ability to repay; sensitivity to economic and market developments; and risk-adjusted return based on credit risk measures appropriate to the customer and facility type;
●
Credit risk authority is specifically granted in writing to individuals involved in the approval of credit extensions. In exercising credit authority, individuals are required to act independently of business considerations and must declare any conflicts of interest;
●
Credit exposures, once approved, are monitored, managed and reviewed periodically against approved limits. Lower quality exposures are subject to more frequent analysis and assessment;
●
Credit risk management works with business functions on the ongoing management of the credit portfolio, including decisions on mitigating actions taken against individual exposures or broader portfolios;
●
Customers with emerging credit problems are identified early and classified accordingly. Remedial actions are implemented promptly and are intended to restore the customer to a satisfactory status and minimise any potential loss to the RBS Group; and
●
Stress testing of portfolios is undertaken to assess the potential credit impact of non-systemic scenarios and wider macroeconomic events on the RBS Group’s income and capital.
Credit risk organisation
The credit risk function is organised within a divisionally aligned structure to ensure appropriate proximity to the businesses it covers and to develop and provide the specialisation required to manage the associated credit risk. The function comprises a number of activities: credit approval; transaction/customer assessment; policy formulation and development (in the context of the RBS Group-wide policy framework); portfolio reporting; and quantitative portfolio analytics.
In addition to the activities undertaken within divisional functions, an RBS Group-wide credit risk function sets the overall framework and highest level credit risk policy standards; produces RBS Group-wide credit risk portfolio reporting and analysis; and approves credit transactions which exceed divisional credit authority.
The Group Risk Committee (GRC) considers detailed reports of credit risk performance such as monthly risk portfolio performance trend information. The Group Credit Risk Policy Committee, a subcommittee of the GRC, approves material new credit risk policy standards.
For wholesale credit portfolios, an updated RBS Group-wide credit approval and authority framework was introduced in early 2009, replacing the previous structure of credit committees. The authority held by an individual in respect of a particular extension of credit is determined by an RBS Group-wide credit approval grid which links total credit limit amount for a customer group with customer credit quality (expressed as a credit grade) and the individual’s credit experience and expertise (which determines the authority level assigned to them). The Executive Credit Group (ECG) considers credit decisions which exceed the delegated authorities of individuals throughout the Group.
Global Restructuring Group (GRG)
GRG manages problem and potential problem exposures in the RBS Group’s wholesale credit portfolios. Its primary function is to work closely with the RBS Group’s customer facing businesses to support the proactive management of any problem lending. This may include assisting with the restructuring of a customer’s business and/or renegotiation of credit.
GRG reports to the Head of Restructuring and Risk and is structured with specialist teams focused on: large corporate cases (higher value, multiple lenders); small and medium-size business cases (lower value, bilateral relationships); and recovery/litigations.
Originating business units liaise with GRG upon the emergence of a potentially negative event or trend that may impact a borrower’s ability to service its debt. This may be a significant deterioration in some aspect of the borrower’s activity, such as trading, where a breach of covenant is likely or where a borrower has missed or is expected to miss a material contractual payment to the RBS Group or another creditor.
On transfer of a relationship to GRG a strategy is devised to:
●
Work with the borrower to facilitate changes that will maximise the potential for turnaround of their situation and return them to profitability;
●
Define the RBS Group’s role in the turnaround situation and assess the risk/return dimension of the RBS Group’s participation;
●
Return customers to the originating business unit in a sound and stable condition or, if such recovery cannot be achieved, avoid additional losses and maximise recoveries; and
●
Ensure key lessons learned are fed back into origination policies and procedures.
Retail collections and recoveries
There are collections and recoveries functions in each of the consumer businesses. Their role is to provide support and assistance to customers who are currently experiencing difficulties meeting their financial obligations. Where possible, the aim of the collections and recoveries teams is to return the customer to a satisfactory position by working with them to restructure their finances. If this is not possible, the team has the objective of reducing the loss to the RBS Group.
41
Financial review
Risk, capital and liquidity management

    Over 3 Over 6     
  Within but within but within Over 2007 
  3 months 6 months 12 months 12 months Total 
  £m £m £m £m £m 
UK based companies and branches                
Certificates of deposit
   2,295   689   350   5   3,339 
Other time deposits
   11,579   633   217   533   12,962 
                 
Overseas based companies and branches                
Certificates of deposit
   534   35  –   1,138   1,707 
Other time deposits
   7,330   630  
 197
   821   8,978 
Total   21,738  1,987   764   2,497   26,986 
                 
Credit risk continued
Retail collections and recoveries continued
The ongoing investment in collections and recoveries operations has continued in 2009. Investment has increased staffing levels in all collections and recoveries functions, enhanced staff training to improve efficiency and effectiveness as well as upgraded technology and infrastructure.
 
In the UK and Ireland, the RBS Group has introduced new forbearance policies for customers in financial difficulty based on various government sponsored schemes, customer affordability and prospects. In the US there has been an increase in agreed loan modification programmes, including those sponsored by the US government.
Credit risk framework
The approach taken to managing credit risk varies significantly between wholesale portfolios (loans, and other products giving rise to credit risk, to all but the smaller corporate customers, to financial institutions and to government entities) and retail portfolios (secured and unsecured loans and related products to individuals and small businesses).
Wholesale portfolios
Wholesale risk limits are aggregated at the counterparty level to determine the level of credit approval required and to facilitate consolidated credit risk management.
The credit approval process has two stages, assessment and decision. Credit applications for corporate customers are prepared by relationship managers in the units originating the credit exposures or by the relationship management team with lead responsibility for a counterparty where a customer has relationships with different divisions and business units across the RBS Group. This includes the assignment of risk parameter estimates (probability of default, loss given default and exposure at default) using approved models.
Credit approval authority is discharged by way of a framework of individual delegated authorities that requires at least two individuals to approve each credit decision, one from the business and one from the credit risk management function. Both parties must hold sufficient delegated authority under the RBS Group-wide authority grid. The level of authority granted to an individual is dependent on their experience and expertise with only a small number of senior executives holding the highest authority provided under the framework.
Daily monitoring of individual counterparty limits is undertaken. For certain counterparties, early warning indicators are also in place to detect deteriorating trends of concern in limit utilisation or account performance. A framework is also in place to monitor changes in credit quality at the portfolio level.
As a minimum, credit relationships are reviewed and re-approved annually. The renewal process addresses: borrower performance, including reconfirmation or adjustment of risk parameter estimates; the adequacy of security; and compliance with terms and conditions.
Retail portfolios
Retail business operations require a large volume of small scale credit decisions, typically involving an application for a new product or a change in facilities on an existing product. The majority of these decisions are based upon automated strategies utilising best practice credit and behaviour scoring techniques. Scores and strategies are typically segmented by product, brand and other significant drivers of credit risk. These data driven strategies utilise a wide range of credit information relating to a customer including, where appropriate, information across a customer’s holdings.
A small number of credit decisions are subject to additional manual underwriting by authorised approvers in specialist units. These include higher value more complex small business transactions and some residential mortgage applications.
Divisional risk management committees focus on portfolio level decisions which drive credit quality, changes to policy and strategy, and the setting of credit scorecard cut-offs. The divisional risk management committees are also responsible for reviewing ongoing performance of the business and, if necessary, making or recommending adjustments to risk appetite.
Credit risk measurement
Credit risk models are used throughout the RBS Group to support the quantitative risk assessment element of the credit approval process, ongoing credit risk management, monitoring and reporting and portfolio analytics. Credit risk models used by the RBS Group can be divided into three categories.
Probability of default/customer credit grade (PD)
These models assess the probability that a customer will fail to make full and timely repayment of their obligations. The probability of a customer failing to do so is measured over a one year period through the economic cycle, although certain retail scorecards use longer periods for business management purposes.
●
Wholesale businesses: each counterparty is assigned an internal credit grade which is in turn assigned to a default probability range. There are a number of different credit grading models in use across the RBS Group, each of which considers risk characteristics particular to a type of customer. The credit grading models score a combination of quantitative inputs, (for example, recent financial performance) and qualitative inputs (for example, management performance or sector outlook). Scores are then mapped to grades within each model. Grades are calibrated centrally to default probabilities. Obligor grades can, under certain circumstances, be cascaded to other borrowing entities within the obligor group where there is sufficient dependence on the graded entity. The credit grades for sovereign and central bank entities are assigned by a specialist country risk analysis team using a sovereign grading model. This team is independent of the origination function and is comprised of economists. Certain grading models also cover customers or transactions categorised as specialised lending (for example, certain types of investment property and asset finance such as shipping).
●
Retail businesses: each customer account is separately scored using models based on the most material drivers of default. In general, scorecards are statistically derived using customer data. Customers are assigned a score which, in turn, is mapped to a probability of default. The probability of default is used within the credit approval and ongoing credit risk management, monitoring and the probabilities of default are used to group customer risk pools. Pools are then assigned a weighted average of default using regulatory default definitions.
42
Financial review continued
Credit risk continued
Credit risk measurement continued
Exposure at default (EAD)
Facility usage models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. For revolving and variable draw down type products which are not fully drawn, the EAD will typically be higher than the current utilisation. The methodologies used in EAD modelling provide an estimate of potential exposure and recognise that customers may make more use of their existing credit facilities as they approach default.
Counterparty credit risk exposure measurement models calculate the market driven credit risk exposure for products where the exposure is not based solely upon principal and interest due. These models are most commonly used for derivative and other traded instruments where the amount of credit risk exposure may be dependent upon one or more underlying market variables such as interest or foreign exchange rates. These models drive internal credit risk activities such as limit and excess management.
Loss given default (LGD)
These models estimate the economic loss that may be experienced – the amount that cannot be recovered – by the RBS Group on a credit facility in the event of default. The RBS Group’s LGD models take into account both borrower and facility characteristics for unsecured or partially unsecured facilities, as well as the quality of any risk mitigation that may be in place for secured facilities, plus the cost of collections and a time discount factor for the delay in cash recovery.
Credit risk mitigation
The RBS Group employs a number of structures and techniques to mitigate credit risk:
●
Netting of debtor and creditor balances is utilised in accordance with relevant regulatory and internal policies and requires a formal agreement with the customer to net the balances and a legal right of set-off;
●
Under market standard documentation, net exposure on over-the-counter (OTC) derivative and secured financing transactions is further mitigated by the exchange of financial collateral;
●
The RBS Group enhances its position as a lender in a range of transactions, from retail mortgage lending to large wholesale financing, by structuring a security interest in a physical or financial asset;
●
Credit derivatives, including credit default swaps, credit linked debt instruments and securitisation structures are used to mitigate credit risk; and
●
Guarantees and similar instruments (for example, credit insurance) from related and third parties are used in the management of credit portfolios, typically to mitigate credit concentrations in relation to an individual obligor, a borrower group or a collection of related borrowers.
The use and approach to credit risk mitigation varies by product type, customer and business strategy. Minimum standards applied across the RBS Group cover:
●
General requirements, including acceptable credit risk mitigation types and any conditions or restrictions applicable to those mitigants;
●
The maximum loan-to-value (LTV) percentages, minimum haircuts or other volatility adjustments applicable to each type of mitigant including, where appropriate, adjustments for currency mismatch, obsolescence and any time sensitivities on asset values;
●
The means by which legal certainty is to be established, including required documentation and all necessary steps required to establish legal rights;
●
Acceptable methodologies for the initial and any subsequent valuations of collateral and the frequency with which they are to be revalued (for example, daily in the trading book);
●
Actions to be taken in the event the current value of mitigation falls below required levels;
●
Management of the risk of correlation between changes in the credit risk of the customer and the value of credit risk mitigation, for example, any situations where customer default materially impacts the value of a mitigant and applying a haircut or recovery value adjustment which reflects the potential correlation risk;
●
Management of concentration risks, for example, setting thresholds and controls on the acceptability of credit risk mitigants and on lines of business that are characterised by a specific collateral type or structure; and
●
Collateral management to ensure that credit risk mitigation is legally effective and enforceable.
Credit concentration risk*
The RBS Group defines four key areas of concentration in credit risk that are monitored, reported and managed at both the RBS Group and divisional levels. These are single name, industry/sector, country and product/class. Frameworks to address single name, industry/sector and country concentrations are established and continue to be enhanced and embedded into business processes across the RBS Group. Aspects of the product/asset class framework are in place whilst others will be developed during the course of 2010.
Under the RBS Group’s credit approval framework, the required approval level is linked to the size of exposure with exposures above a certain level requiring the highest level of approval, held by a very small number of executives. In addition, the RBS Group’s single name concentration framework includes specific approval requirements; additional reporting and monitoring; and the requirement to develop plans to address and reduce excess exposures.
*unaudited
43

Financial review
Risk, capital and liquidity management

Credit risk continued
Credit concentration risk* continued
The RBS Group has also developed a more robust approach and framework for managing sector concentrations, a major outcome of which is the regular review of the most material concentrations at the Executive Risk Forum (ERF). These reviews include an assessment of the RBS Group’s franchise in a particular sector, an analysis of the outlook (including downside outcomes), identification of key vulnerabilities and stress/scenario tests. Reviews conclude with specific sector caps and other portfolio strategies to align the RBS Group’s exposure profile with its appetite.
Country risk*
Country risk arises from sovereign events (for example, default or restructuring); economic events (for example, contagion of sovereign default to other parts of the economy, cyclical economic shock); political events (for example, convertibility restrictions and expropriation or nationalisation); and natural disaster or conflict. Losses are broadly defined and include credit, market, liquidity, operational and franchise risk-related losses.
Risk elements and impairments
All the disclosures in this section (pages 44 to 46) are audited. The RBS Group classifies impaired assets as either risk elements in lending (REIL) or potential problem loans (PPL). REIL represents non-accrual loans, loans that are accruing but are past due 90 days and restructured loans. PPL represents impaired assets which are not included in REIL, but where information about possible credit problems cause management to have serious doubts about the future ability of the borrower to comply with loan repayment terms.
Both REIL and PPL are reported gross and take no account of the value of any security held which could reduce the eventual loss should it occur, nor of any provision marked. Therefore impaired assets which are highly collateralised, such as mortgages, will have a low coverage ratio of provisions held against the reported impaired balance.
The analyses of risk elements in lending and impairments as discussed below, form a key part of the data provided to senior management on the credit performance of the RBS Group’s portfolios.
The table below sets out NatWest Group’s loans that are classified as REIL and PPL.

  NatWest Group 
  
2009
£m
  
2008
£m
 
Loans accounted for on a non-accrual basis (1)
  12,915   6,072 
Accruing loans which are contractually overdue 90 days or more as to principal interest (2)
  1,670   1,000 
Total REIL 
  14,585   7,072 
PPL (3) 
  150   127 
Total REIL and PPL 
  14,735   7,199 
  
REIL and PPL as % of customer loans and advances – gross (4) 
  9.20%   3.67% 
  
The sub-categories of REIL and PPL are calculated as described in notes 1 to 4 below.
Notes:
(1)All loans against which an impairment provision is held are reported in the non-accrual category.
(2)
Loans where an impairment event has taken place but no impairment recognised. This category is used for fully collateralised, non-revolving credit facilities.
(3)
Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully collateralised advances and revolving credit facilities where identification as at 90 days overdue is not feasible.
(4)
Gross of provisions and excluding reverse repurchase agreements.
Impairment loss provision methodology
Provisions for impairment losses are assessed under three categories:
●
Individually assessed provisions: provisions required for individually significant impaired assets which are assessed on a case by case basis, taking into account the financial condition of the counterparty and any guarantee and other collateral held after being stressed for downside risk. This incorporates an estimate of the discounted value of any recoveries and realisation of security or collateral. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off;
●
Collectively assessed provisions: provisions on impaired credits below an agreed threshold which are assessed on a portfolio basis, to reflect the homogeneous nature of the assets, such as credit cards or personal loans. The provision is determined from a quantitative review of the relevant portfolio, taking account of the level of arrears, security and average loss experience over the recovery period; and

●
Latent loss provisions: provisions held against the impairments in the portfolio that have been incurred as a result of events before the balance sheet date but which have not been identified at the balance sheet date. The RBS Group has developed methodologies to estimate latent loss provisions that reflect:
-Historical loss experience adjusted, where appropriate, in the light of current economic and credit conditions; and
-The period (emergence period) between an impairment event occurring and a loan being identified and reported as impaired.
Recoverable cash flows are estimated using two parameters: loss given default (LGD) – this is the estimate loss amount, expressed as a percentage, that will be incurred if the borrower defaults; and the probability that the borrower will default (PD).
*unaudited
44
Financial review continued
Credit risk continued
Impairment loss provision methodology continued
Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as a coupon period and repayment terms, and the duration of the administrative process required to report and identify an impaired loan as such. Emergence periods vary across different portfolios from two to 225 days. They are based on actual experience within the particular portfolio and are reviewed regularly.
The RBS Group’s retail business segment their performing loan books into homogenous portfolios such as mortgages, credit cards or unsecured loans, to reflect their different credit characteristics. Latent provisions are computed by applying portfolio-level LGDs, PDs and emergence periods. The wholesale calculation is based on similar principles but there is no segmentation into portfolios: PDs and LGDs are calculated on an individual basis.
Provision analysis
The RBS Group’s consumer portfolios, which consist of high volume, small value credits, have highly efficient, largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods. Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements.
Provisions are assessed on a case by case basis by experienced specialists with input from professional valuers and accountants. The RBS Group operates a transparent provisions governance framework, setting thresholds to trigger enhanced oversight and challenge.
Impairment charge
The following table shows total impairment losses charged to the income statement.

  NatWest Group 
  2009  2008 
   £m   £m 
New impairment losses 
  4,187   1,424 
less: recoveries of amounts previously written-off 
  (48)   (62) 
Charge to income statement 
  4,139   1,362 
  
Comprising: 
        
Loan impairment losses 
  4,115   1,351 
Impairment losses on available-for-sale securities 
  24   11 
Charge to income statement 
  4,139   1,362 
Analysis of loan impairment charge
  NatWest Group 
  2009  2008 
   £m   £m 
Latent loss 
  588   22 
Collectively assessed 
  1,605   899 
Individually assessed (1) 
  1,915   430 
Charge to income statement (1, 2) 
  4,108   1,351 
  
Charge as a % of customer loans and advances – gross (3) 
  2.57%  0.69%
Notes: 
(1)Excludes loan impairment charge against loans and advances to banks of £7 million (2008 – nil) 
(2)Excludes impairment of available-for-sale securities of £24 million (2008 – £11 million) 
(3)Gross of provisions and excluding reverse repurchase agreements. 

Analysis of loan impairment provisions on loans to customers

  NatWest Group 
  2009  2008 
   £m   £m 
Latent loss 
  860   280 
Collectively assessed 
  2,616   2,009 
Individually assessed (1) 
  2,189   635 
   5,665   2,924 
  
Total provision as a % of customer loans and advances – gross (2) 
  3.54%  1.49%
Notes:
(1)Excludes provisions of £9 million relating to loans and advances to banks (2008 – £2 million).
(2)Gross of provisions and excluding reverse repurchase agreements.
45

Financial review
Risk, capital and liquidity management

Credit risk continued
Provisions coverage
The NatWest Group’s provision coverage ratios are shown in the table below.

  NatWest Group 
  2009  2008 
   %   % 
Total provision expressed as a: 
        
% of REIL 
  39   41 
% of REIL and PPL 
  39   41 

The coverage ratio of closing provisions to REIL and PPL decreased from 41% to 39% during 2009. The lower coverage ratio reflects amounts written-off and the changing mix from unsecured to secured exposures.
Movement in loan impairment provisions
The following table shows the movement in the provision for impairment losses for loans and advances.

  NatWest Group 
  Individually  Collectively     Total    
  assessed  assessed  Latent  2009  2008 
   £m   £m   £m   £m   £m 
At 1 January 
  637   2,009   280   2,926   2,340 
Currency translation and other adjustments 
  25   (15)   (8)   2   65 
Amounts written-off 
  (237)   (934)   —   (1,171)   (792) 
Recoveries of amounts previously written-off 
  3   45   —   48   62 
Charged to the income statement (1) 
  1,922   1,605   588   4,115   1,351 
Unwind of discount 
  (152)   (94)   —   (246)   (100) 
At 31 December (2) 
  2,198   2,616   860   5,674   2,926 
Notes:
(1)Includes charge relating to loans and advances to banks of £7 million (2008 – nil).
(2)Includes closing provisions relating to loans and advances to banks of £9 million (2008 – £2 million).
46

Financial review continued
Balance sheet analysis
All the disclosures in this section (pages 47 to 51) are audited. The following tables provide an analysis of the credit quality and distribution of financial assets by the RBS Group’s internal credit quality gradings, geography and industry sector.
Credit quality

  NatWest Group 
  Cash and                         
  balances  Loans and  Loans and        Other          
  at central  advances  advances to  Settlement     financial     Contingent    
  banks  to banks (1)  
 customers
  balances  Derivatives  instruments  Commitments  liabilities  Total 
2009   £m   £m   £m   £m   £m   £m   £m   £m   £m 
AQ1 
  1,791   12,687   15,238   863   719   26   7,472   1,140   39,936 
AQ2 
  —   7   1,406   40   103   —   787   201   2,544 
AQ3 
  —   412   2,548   204   50   —   2,048   433   5,695 
AQ4 
  14   39   17,110   555   199   —   7,905   956   26,778 
AQ5 
  —   12   32,656   114   390   7   12,612   833   46,624 
AQ6 
  —   3   32,442   —   293   —   10,494   494   43,726 
AQ7 
  —   14   18,586   —   125   —   8,906   297   27,928 
AQ8 
  —   5   9,665   —   51   —   4,961   52   14,734 
AQ9 
  —   —   4,149   —   22   —   1,352   26   5,549 
AQ10 
  —   36   2,535   —   89   —   1,059   64   3,783 
Balances with Group companies —   117,861   14,295   —   2,429   —   —   239   134,824 
Accruing past due 
  —   36   6,532   2,797   —   —   —   —   9,365 
Non-accrual 
  —   9   12,906   —   —   —   —   —   12,915 
Impairment provision 
  —   (9)   (5,665)   —   —   —   —   —   (5,674) 
   1,805   131,112   164,403   4,573   4,470   33   57,596   4,735   368,727 
  
  
2008                                     
AQ1 
  1,283   8,742   11,712   866   669   32   10,232   1,208   34,744 
AQ2 
  2   250   1,669   3   49   —   1,583   448   4,004 
AQ3 
  —   687   3,376   46   86   —   2,465   734   7,394 
AQ4 
  —   191   30,875   35   796   —   9,948   843   42,688 
AQ5 
  —   39   34,809   30   668   —   19,981   891   56,418 
AQ6 
  —   21   31,257   118   704   —   6,635   671   39,406 
AQ7 
  —   11   20,141   —   154   —   8,779   315   29,400 
AQ8 
  —   1   9,189   —   40   —   6,810   96   16,136 
AQ9 
  —   —   3,979   —   29   —   1,427   24   5,459 
AQ10 
  —   —   1,992   —   45   —   226   33   2,296 
Balances with Group companies —   54,185   40,970   —   5,655   —   10   —   100,820 
Accruing past due 
  —   —   5,152   3,019   —   —   —   —   8,171 
Non-accrual 
  —   2   6,070   —   —   —   —   —   6,072 
Impairment provision 
  —   (2)   (2,924)   —   —   —   —   —   (2,926) 
   1,285   64,127   198,267   4,117   8,895   32   68,096   5,263   350,082 
  

Note:
(1)Excluding items in the course of collection of £2,118 million (2008 – £2,107 million).
47
Financial review
Risk, capital and liquidity management

Balance sheet analysis continued
Credit quality continued

  Bank 
  Cash and                   
  balances  Loans and  Loans and             
  at central  advances  advances to        Contingent    
  banks  to banks(1)   customers  Derivatives  Commitments  liabilities  Total 
2009   £m   £m   £m   £m   £m   £m   £m 
AQ1 
  906   830   4,843   221   5,491   889   13,180 
AQ2 
  —   —   507   93   677   179   1,456 
AQ3 
  —   374   1,423   40   1,637   350   3,824 
AQ4 
  —   38   5,797   184   4,765   570   11,354 
AQ5 
  —   5   19,012   338   10,705   638   30,698 
AQ6 
  —   2   16,827   255   9,172   376   26,632 
AQ7 
  —   —   10,229   106   8,185   120   18,640 
AQ8 
  —   —   6,122   32   4,702   22   10,878 
AQ9 
  —   —   1,898   15   1,284   20   3,217 
AQ10 
  —   33   2,155   57   586   19   2,850 
Balances with Group companies —   78,269   14,710   1,559   41   —   94,579 
Accruing past due 
  —   —   3,775   —   —   —   3,775 
Non-accrual 
  —   8   4,362   —   —   —   4,370 
Impairment provision 
  —   (8)   (3,104)   —   —   —   (3,112) 
   906   79,551   88,556   2,900   47,245   3,183   222,341 
  
  
2008                             
AQ1 
  838   491   6,170   455   4,281   1,026   13,261 
AQ2 
  —   162   1,166   47   1,346   407   3,128 
AQ3 
  —   680   1,327   75   1,752   522   4,356 
AQ4 
  —   186   7,865   419   5,948   610   15,028 
AQ5 
  —   24   18,015   594   16,141   664   35,438 
AQ6 
  —   —   18,554   419   4,186   379   23,538 
AQ7 
  —   7   12,586   105   7,673   175   20,546 
AQ8 
  —   —   6,086   39   5,962   40   12,127 
AQ9 
  —   —   2,691   29   1,289   19   4,028 
AQ10 
  —   —   1,923   44   160   30   2,157 
Balances with Group companies —   19,574   45,062   2,671   37   —   67,344 
Accruing past due 
  —   —   2,216   —   —   —   2,216 
Non-accrual 
  —   —   3,135   —   —   —   3,135 
Impairment provision 
  —   —   (2,103)   —   —   —   (2,103) 
   838   21,124   124,693   4,897   48,775   3,872   204,199 
Note:
(1)Excluding items in the course of collection of £1,881 million (2008 – £2,022 million).
48

Financial review continued

Balance sheet analysis continued
Debt securities
The tables below analyse debt securities by external ratings, mapped onto the Standard & Poor’s rating scale.
  NatWest Group 
        Bank and  Asset          
  UK and US  Other  building  backed          
  government  government  society  securities  Corporate  Other  Total 
2009   £m   £m   £m   £m   £m   £m   £m 
AAA 
  12,190   1,642   507   14,493   615   —   29,447 
BBB– and above 
  —   190   353   428   1,088   —   2,059 
Non-investment grade 
  —   23   5   610   408   —   1,046 
Unrated 
  —   5   —   15   59   —   79 
   12,190   1,860   865   15,546   2,170   —   32,631 
Balances with Group companies —   —   —   2,158   —   —   2,158 
   12,190   1,860   865   17,704   2,170   —   34,789 
  
  
2008                             
AAA 
  9,530   1,295   247   19,900   36   —   31,008 
BBB– and above 
  —   111   492   447   3,539   —   4,589 
Non-investment grade 
  —   —   8   151   183   —   342 
Unrated 
  —   —   28   9   15   2   54 
   9,530   1,406   775   20,507   3,773   2   35,993 
  
  
                  Bank 
                  Bank and  Asset     
                  building  backed     
                  society  securities  Total 
2009                   £m   £m   £m 
BBB– and above 
                  —   5   5 
Balances with Group companies                 2,158   —   2,158 
                   2,158   5   2,163 
  
  
  
                  Bank 
                      Asset     
                  Other  backed     
                  government
 
 securities  Total 
2008                   £m   £m   £m 
BBB– and above 
                  34   7   41 
49

Financial review
Risk, capital and liquidity management

Balance sheet analysis continued
Industry risk – geographical analysis
The tables below analyse financial assets by location of office and by industry type.
  NatWest Group 
  Loans and                
  advances                
  to banks              Netting 
  and customers  Securities  Derivatives   
Other (1)
  Total  
offset(2)
 
2009   £m   £m   £m   £m   £m   £m 
UK 
  207,448   3,103   2,946   —   213,497   9,785 
US 
  35,565   30,828   269   4,546   71,208   1,369 
Europe 
  55,472   1,513   1,221   60   58,266   — 
Rest of the World 
  4,822   335   34   —   5,191   — 
   303,307   35,779   4,470   4,606   348,162   11,154 
  
  
Central and local government 
  1,935   8,954   3   164   11,056   1,258 
Manufacturing 
  7,217   191   154   —   7,562   1,743 
Construction 
  6,710   71   50   —   6,831   973 
Finance 
  154,808   25,024   3,301   4,436   187,569   1,619 
Service industry and business activities 34,632   1,310   477   —   36,419   4,787 
Agriculture, forestry and fishing 
  3,067   2   9   —   3,078   15 
Property 
  42,160   68   468   —   42,696   758 
Individuals: 
                        
Home mortgages 
  26,393   —   8   —   26,401   — 
Other 
  19,932   —   —   6   19,938   1 
Finance leases and instalment credit 271   —   —   —   271   — 
Interest accruals 
  6,182   159   —   —   6,341   — 
   303,307   35,779   4,470   4,606   348,162   11,154 
  
  
2008                         
UK 
  179,589   2,562   4,955   —   187,106   10,153 
US 
  23,083   32,788   1,589   4,028   61,488   1,612 
Europe 
  60,326   1,770   2,323   116   64,535   — 
Rest of the World 
  4,429   9   28   5   4,471   — 
   267,427   37,129   8,895   4,149   317,600   11,765 
  
  
Central and local government 
  2,380   8,339   —   35   10,754   1,284 
Manufacturing 
  8,271   59   411   —   8,741   1,891 
Construction 
  9,758   60   114   —   9,932   1,079 
Finance 
  116,193   27,790   6,695   4,113   154,791   1,835 
Service industry and business activities 36,352   659   773   1   37,785   5,068 
Agriculture, forestry and fishing 
  3,318   1   12   —   3,331   15 
Property 
  40,605   30   862   —   41,497   593 
Individuals: 
                        
Home mortgages 
  27,265   —   9   —   27,274   — 
Other 
  22,451   —   19   —   22,470   — 
Finance leases and instalment credit 286   —   —   —   286   — 
Interest accruals 
  548   191   —   —   739   — 
   267,427   37,129   8,895   4,149   317,600   11,765 
Notes:
(1)Includes settlement balances of £4,573 million (2008 – £4,117 million).
(2)This column shows the amount by which the NatWest Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the NatWest Group a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the NatWest Group holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The NatWest Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
50
Financial review continued

Balance sheet analysis continued
Industry risk – geographical analysis continued

  Bank 
  Loans and             
  advances             
  to banks        
 
  Netting 
  and customers  Securities  Derivatives  Total  
offset(1)
 
2009   £m   £m   £m   £m   £m 
UK 
  171,848   2,176   2,900   176,924   9,785 
US 
  1   —   —   1   — 
Europe 
  1,251   —   —   1,251   — 
   173,100   2,176   2,900   178,176   9,785 
  
  
Central and local government 
  1,850   —   3   1,853   1,258 
Manufacturing 
  5,193   —   154   5,347   1,743 
Construction 
  4,404   —   50   4,454   973 
Finance 
  91,721   2,176   1,732   95,629   250 
Service industry and business activities 
  25,186   —   476   25,662   4,787 
Agriculture, forestry and fishing 
  1,854   —   9   1,863   15 
Property 
  23,218   —   468   23,686   758 
Individuals: 
                    
Home mortgages 
  16   —   8   24   — 
Other 
  13,517   —   —   13,517   1 
Finance leases and instalment credit 
  46   —   —   46   — 
Interest accruals 
  6,095   —   —   6,095   — 
   173,100   2,176   2,900   178,176   9,785 
  
  
2008                     
UK 
  148,442   47   4,897   153,386   10,153 
US 
  38   —   —   38   — 
Europe 
  1,462   —   —   1,462   — 
   149,942   47   4,897   154,886   10,153 
  
  
Central and local government 
  2,281   —   —   2,281   1,284 
Manufacturing 
  5,859   —   376   6,235   1,891 
Construction 
  5,187   —   54   5,241   1,079 
Finance 
  69,688   47   3,259   72,994   223 
Service industries and business activities 
  26,236   —   625   26,861   5,068 
Agriculture, forestry and fishing 
  1,911   —   11   1,922   15 
Property 
  23,718   —   563   24,281   593 
Individuals: 
                    
Home mortgages 
  19   —   9   28   — 
Other 
  14,661   —   —   14,661   — 
Finance leases and instalment credit 
  26   —   —   26   — 
Interest accruals 
  356   —   —   356   — 
   149,942   47   4,897   154,886   10,153 
Note:
(1)This column shows the amount by which the Bank’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Bank a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Bank holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Bank obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
51
Financial review
Risk, capital and liquidity management
Funding and liquidity risk
All the disclosures in this section (pages 52 to 56) are audited unless indicated otherwise with an asterisk (*).
The RBS Group’s liquidity policy is designed to ensure that the RBS Group can at all times meet its obligations as they fall due.
Liquidity management within the RBS Group addresses the overall balance sheet structure and the control, within prudent limits, of risk arising from the mismatch of maturities across the balance sheet and from exposure to undrawn commitments and other contingent obligations.
Following a difficult first quarter of 2009, most indicators of stress in financial markets are close to or better than in late 2008. Liquidity conditions in money and debt markets have improved significantly since the beginning of the second quarter of 2009. Contributing to the improvement has been a combination of ongoing central bank and other official liquidity support schemes, guarantee schemes and rate cuts. Signs of underlying macroeconomic trends such as stabilisation of the UK economy also helped to sustain a recovery in debt markets.
Liquidity risk framework and governance
The RBS Group has an approved risk appetite supported by explicit targets and metrics to control the size and extent of both short-term and long-term liquidity risk. These metrics are reviewed by the Board and Group Asset and Liability Management Committee (GALCO) on a regular basis. The RBS Group uses stress tests to refine and update the risk appetite in light of changing conditions.
The GALCO, chaired by the Group Finance Director, has the responsibility to set RBS Group policy and ensure that it is cascaded and communicated to the business divisions. Group Treasury is the functional area with responsibility for monitoring and control of the RBS Group's funding and liquidity positions.
Group Treasury is supported by a governance process that includes a Liquidity Risk Forum comprising functional areas across the organisation that are responsible for liquidity management, including monitoring through divisional and regional asset and liability committees.
The RBS Group uses funds transfer pricing to ensure the costs of liquidity as well as funding are integrated into the business decision making process.
The RBS Group continues to improve and augment funding and liquidity risk management practices in light of experience of the market over the last two years and of emerging regulatory and industry standards such as the FSA policy statement on strengthening liquidity standards.
Structural management
The RBS Group regularly evaluates its structural liquidity risk and applies a variety of balance sheet management and term funding strategies to maintain this risk within its policy parameters. The degree of maturity mismatch within the overall long-term structure of the RBS Group’s assets and liabilities are managed within internal policy guidelines aimed at ensuring term asset commitments are funded on an economic basis over their life. In managing its overall term structure, the RBS Group analyses and takes into account the effect of retail and corporate customer behaviour on actual asset and liability maturities where they differ materially from the underlying contractual maturities.
The RBS Group targets diversification in its funding sources to reduce funding risk. A key source of funds for the RBS Group is its core customer deposits gathered by its retail banking, private client, corporate and Small and Medium Enterprises (SME) franchises. The RBS Group’s multi-brand offering and strong client focus is a key part of the funding strategy and continues to benefit the RBS Group’s funding position.
The RBS Group also accesses the wholesale funding market to provide additional flexibility in funding sources. The RBS Group has actively sought to manage its liquidity position through improving the duration of short-term wholesale funding, continued diversification of wholesale debt investors and depositors, supplemented by long-term issuance, government guaranteed debt, and a programme of ensuring that assets held are eligible as collateral to access using central bank liquidity schemes.
Cash flow management
The short-term maturity structure of the RBS Group’s assets and liabilities is managed daily to ensure that all material or potential cash flow, undrawn commitments and other contingent obligations can be met. The primary focus of the daily management activity is to ensure access to sufficient liquidity to meet cash flow obligations within key time horizons, including out to one month ahead and FSA target horizons such as 90 days.
Potential sources of liquidity include cash inflows from maturing assets, new borrowings or the sale of various debt securities held. Short-term liquidity risk is generally managed on a consolidated basis with liquidity mismatch limits in place for subsidiaries and non-UK branches which have material local treasury activities, thereby assuring that the daily maintenance of the RBS Group’s overall liquidity risk position is not compromised.
Volume management
The RBS Group also actively monitors and manages future business volumes to assess funding and liquidity requirements and ensure that the RBS Group operates within risk appetite and metrics set by the Board. This includes management of undrawn commitments, conduits and liquidity facilities within acceptable levels.
 

Amounts in accordance with UK GAAP

Analysis of loans and advances to customers by geographical area and type of customer - UK GAAP
 
The following table analyses loans and advances to customers before provisions by remaining maturity, geographical area and type of customer.

  
UK GAAP
2004
 
UK GAAP
2003
 
  £m £m 
UK     
Central and local government  128  127 
Manufacturing  2,742  2,896 
Construction  2,811  2,356 
Finance  1,278  742 
Service industries and business activities  13,855  12,680 
Agriculture, forestry and fishing  1,739  1,731 
Property  8,581  6,964 
Individuals - home mortgages
  29,434  24,545 
Individuals - other
  14,051  12,760 
Finance leases and instalment credit  356  1,961 
Total domestic  74,975  66,762 
Overseas residents  11,413  13,263 
Total UK offices  86,388  80,025 
        
Overseas       
United States  24,676  12,034 
Rest of the World  22,223  12,411 
Total overseas offices  46,899  24,445 
        
Loans and advances to customers - gross  133,287  104,470 
Provisions for bad and doubtful debts  (1,934) (1,898)
Loans and advances to customers - net  131,353  102,572 
        
Fixed rate  40,761  25,573 
Variable rate  92,526  78,897 
Gross loans and advances to customers - by maturity  133,287  104,470 
        
Financial review continued
 
Funding and liquidity risk continued
Liquidity reserves
The RBS Group has built up a diversified stock of highly marketable liquid assets including highly rated central government debt that can be used as a buffer against unforeseen impacts on cash flow or in stressed environments. The make-up of this portfolio of assets is sub-divided into tiers on the basis of asset liquidity, with haircuts applied to ensure that realistic liquidation values are used in key metrics. This portfolio includes a centrally held buffer against severe liquidity stresses and locally held buffers to meet self sufficiency needs.
Stress testing
The RBS Group performs stress tests to simulate how events may impact its funding and liquidity capabilities. Such tests assist in the planning of the overall balance sheet structure, help define suitable limits for control of the risk arising from the mismatch of maturities across the balance sheet and from undrawn commitments and other contingent obligations, and feed into the risk appetite and contingency funding plan. The form and content of stress tests are updated where required as market conditions evolve. These stresses include the following scenarios:
●
Idiosyncratic stress: an unforeseen, name-specific, liquidity stress, with the initial short-term period of stress lasting for at least two weeks;
●
Market stress: an unforeseen, market-wide liquidity stress of three months duration;
●
Idiosyncratic and market stress: a combination of idiosyncratic and market stress;
●
Rating downgrade: one and two notch long-term credit rating downgrade scenarios; and
●
Daily market lockout: no access to unsecured funding and no funding rollovers are possible.
Contingency planning
Contingency funding plans have been developed which incorporate early warning indicators to monitor market conditions. The RBS Group reviews its contingency funding plans in the light of evolving market conditions and stress test results. The contingency funding plans cover: the available sources of contingent funding to supplement cash flow shortages; the lead times to obtain such funding; the roles and responsibilities of those involved in the contingency plans; the communication and escalation requirements when early warning indicators signal deteriorating market conditions; and the ability and circumstances within which the RBS Group accesses central bank liquidity.
Monitoring
Liquidity risk is constantly monitored to evaluate the RBS Group’s position having regard to its risk appetite and key metrics. Daily, weekly and monthly monitoring and control processes are in place, which allow management to take appropriate action. Actions taken to improve the liquidity risk include a focus on improving the loan to deposit ratio, issuing longer-term wholesale funding, both guaranteed and unguaranteed, and the size of the conduit commitments. Metrics include, but are not limited to:
Wholesale funding > one year: As the wholesale funding markets have improved over the course of 2009, the RBS Group is better able to manage both its short and longer-term funding requirements and has significantly reduced its reliance on central bank funding.
Loan to deposit ratio: The RBS Group monitors the loan to deposit ratio as a key metric.
Undrawn commitments: The RBS Group has been actively managing down the amount of undrawn commitments that it is exposed to.
Liquidity reserves: The total stock of liquid assets has increased during 2009.
Funding profile
The contractual maturity of on balance sheet assets and liabilities, shown in the tables overleaf, highlight the maturity transformation which underpins the role of banks to lend longer-term but funded predominantly by short-term liabilities such as customer deposits. This is achieved through the diversified funding franchise of the RBS Group across an extensive retail, wealth and SME customer base, and across a wide geographic network. In practice, the behaviour profile of many assets and liabilities exhibit greater stability and longer maturity than the contractual maturity. The RBS Group models the behavioural maturity of liabilities so that it can target a diversified and stable funding base.
 

Provision for bad and doubtful debts - - UK GAAP
 
Financial review
Risk, capital and liquidity management

Funding and liquidity risk continued
Funding profile continued
The following table showsbelow analyses the elementscontractual undiscounted cash flows receivable and payable up to a period of provisions for badtwenty years including future receipts and doubtful debts under UK GAAP:payments of interest of the on balance sheets by contractual maturity.

  UK GAAP UK GAAP 
  2004 2003 
  £m £m 
Provisions at beginning of year       
Domestic
  1,358  1,559 
Foreign
  547  543 
   1,905  2,102 
        
Currency translation and other adjustments       
Domestic
  -  - 
Foreign
  (27) - 
Acquisition/(disposal) of subsidiaries       
Domestic
  -  (156)
Foreign
  35  4 
Amounts written-off       
Domestic
  (425) (467)
Foreign
  (170) (139)
Recoveries of amounts written-off in previous years       
Domestic
  41  8 
Foreign
  4  4 
Transfers to immediate parent company       
Domestic  (48) - 
Foreign  -  - 
Charge to profit and loss account       
Domestic
  470  414 
Foreign
  155  135 
Provisions at end of year       
Domestic
  1,396  1,358 
Foreign
  544  547 
   1,940  1,905 
        
Gross loans and advances to customers       
Domestic  74,975  66,762 
Foreign  58,312  37,708 
   133,287  104,470 
        
Closing customer provisions as a % of gross loans
and advances to customers
       
Domestic  1.86% 2.03%
Foreign  0.93% 1.45%
   1.46% 1.82%
        
Customer charge against profit as a % of gross loans
and advances to customers
       
Domestic  0.63% 0.62%
Foreign  0.27% 0.36%
   0.47% 0.53%
        
  NatWest Group 
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2009   £m   £m   £m   £m   £m   £m 
Assets by contractual maturity                         
Cash and balances at central banks 
  1,800   —   —   —   —   — 
Loans and advances to banks 
  106,931   3,365   2,695   452   5   — 
Debt securities 
  2,808   420   689   407   33   35 
Settlement balances 
  4,573   —   —   —   —   — 
Other financial assets 
  —   7   —   17   9   — 
Total maturing assets 
  116,112   3,792   3,384   876   47   35 
Loans and advances to customers 
  41,259   21,161   26,155   20,262   28,766   37,996 
Total assets 
  157,371   24,953   29,539   21,138   28,813   38,031 
  
Liabilities by contractual maturity                         
Deposits by banks 
  39,886   2,031   1,103   499   224   5 
Debt securities in issue 
  3,605   1,354   444   408   —   — 
Subordinated liabilities 
  1,946   588   1,160   1,393   4,621   732 
Settlement balances and other liabilities 
  3,744   —   —   —   1   4 
Total maturing liabilities 
  49,181   3,973   2,707   2,300   4,846   741 
Customer accounts 
  203,751   3,094   2,465   1,836   108   20 
Total liabilities 
  252,932   7,067   5,172   4,136   4,954   761 
  
  
Maturity gap   66,931   (181)   667   (1,424)   (4,799)   (706) 
Cumulative maturity gap   66,931   66,750   67,427   66,003   61,204   60,498 
  
Guarantees and commitments notional amount                         
Guarantees (1) 
  2,450   —   —   —   —   — 
Commitments (2) 
  57,199   —   —   —   —   — 
  
  
2008                         
Assets by contractual maturity                         
Cash and balances at central banks 
  1,283   —   —   —   2   — 
Loans and advances to banks 
  48,352   4,334   1,436   684   182   8 
Debt securities 
  525   549   2,017   470   406   61 
Settlement balances 
  4,117   —   —   —   —   — 
Other financial assets 
  2   —   —   10   20   — 
Total maturing assets 
  54,279   4,883   3,453   1,164   610   69 
Loans and advances to customers 
  76,398   22,619   30,507   23,987   36,861   39,120 
Total assets 
  130,677   27,502   33,960   25,151   37,471   39,189 
  
Liabilities by contractual maturity                         
Deposits by banks 
  25,194   3,198   2,046   509   319   4 
Debt securities in issue 
  8,482   3,131   1,185   1,105   445   742 
Subordinated liabilities 
  227   1,536   2,257   824   3,869   2,468 
Settlement balances and other liabilities 
  2,382   —   —   —   4   — 
Total maturing liabilities 
  36,285   7,865   5,488   2,438   4,637   3,214 
Customer accounts 
  171,888   4,319   2,498   1,540   153   24 
Total liabilities 
  208,173   12,184   7,986   3,978   4,790   3,238 
  
  
Maturity gap   17,994   (2,982)   (2,035)   (1,274)   (4,027)   (3,145) 
Cumulative maturity gap   17,994   15,012   12,977   11,703   7,676   4,531 
 
Notes:
(1) The NatWest Group is only called upon to satisfy a guarantee when the guaranteed party fails to meet its obligations. The NatWest Group expects most guarantees it provides to expire unused.
(2)The NatWest Group has given commitments to provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. The NatWest Group does not expect all facilities to be drawn, and some may lapse before drawdown.
 

 
The following table presents additional information with respect to provisions for bad and doubtful debts.Financial review continued

  UK GAAP UK GAAP 
  2004 2003 
  
£m
 
£m
 
      
Loans and advances to customers (gross)  133,287  104,470 
        
Provisions at end of year:       
    Specific provisions - customers  1,651  1,528 
    Specific provisions - banks  6  7 
    General provision  283  370 
   1,940  1,905 
Customer provision at end of year as a % of loans and advances to customers at end of year:       
    Specific provisions  1.24% 1.46%
    General provision  0.21% 0.36%
   1.45% 1.82%
        
Average loans and advances to customers (gross)  116,917  106,967 
        
As a % of average loans and advances to customers
during the year:
       
Total customer provisions charged to profit and loss  0.53% 0.51%
        
    Amounts written-off (net of recoveries) - customers  0.47% 0.56%
Funding and liquidity risk continued


Analysis of closing customer provisions for bad and doubtful debts -UK GAAP

Other contractual cash obligations
The following table analyses customer provisions for bad and doubtful debtsbelow summarises the NatWest Group’s other contractual cash obligations by geographical area and type of domestic customer.

  UK GAAP UK GAAP 
  2004 2003 
    % of 
 
 % of 
    loans to 
 
 loans to 
  Closing total Closing total 
  provision loans provision loans 
  £m %  £m  % 
Domestic             
Central and local government  -  0.1  -  0.1 
Manufacturing  80  2.1  84  2.8 
Construction  50  2.1  46  2.2 
Finance  16  1.0  14  0.7 
Service industries and business activities  299  10.4  326  12.1 
Agriculture, forestry and fishing  
  17  1.3  16  1.7 
Property  27  6.4  29  6.7 
Individuals             
- home mortgages
  9  22.1  13  23.5 
- other
  716  10.5  548  12.2 
Finance leases and instalment credit  45  0.3  
45
  
1.9
 
Total domestic  1,259  56.3  1,121  63.9 
Foreign  392  43.7  407  36.1 
Specific provisions  1,651  100.0  1,528  100.0 
General provision  283    370   
Total provisions  1,934    1,898   
              
payment date.
 
  NatWest Group 
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2009   £m   £m   £m   £m   £m   £m 
Operating leases 
  30   85   213   180   333   533 
Contractual obligations to purchase goods or services 
  3   13   5   —   —   — 
   33   98   218   180   333   533 
  
2008                         
Operating leases 
  29   85   217   193   368   570 
Contractual obligations to purchase goods or services  9   25   7   —   —   — 
   38   110   224   193   368   570 
  
          Bank             
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2009   £m   £m   £m   £m   £m   £m 
Operating leases 
  21   61   153   128   238   394 
  
2008                         
Operating leases 
  21   59   151   135   269   432 
Undrawn formal facilities, credit lines and other commitments to lend were £57,199 million (2008 – £67,387 million) for the NatWest Group and £46,930 million (2008 – £48,148 million) for the Bank. While NatWest Group has given commitments to provide these funds, some facilities may be subject to certain conditions being met by the counterparty. NatWest Group does not expect all facilities to be drawn, and some may lapse before drawdown.
The tables above show the timing of cash inflows and outflows to settle financial assets and liabilities. They have been prepared on the following basis:
Financial assets have been reflected in the time band of the latest date on which they could be repaid unless earlier repayment can be demanded by the reporting entity; financial liabilities are included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If the repayment of a financial asset or liability is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the latest date on which it can repay regardless of early repayment whereas the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period whatever the level of the index at the year end. The settlement date of debt securities in issue issued by certain securitisation vehicles consolidated by the NatWest Group depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date. As the repayment of assets and liabilities are linked, the repayment of assets in securitisations are shown on the earliest date that the asset can be prepaid as this is the basis used for liabilities.
Assets and liabilities with a contractual maturity of greater than 20 years – the principal amounts of financial assets and liabilities that are repayable after 20 years or where the counterparty has no right to repayment of the principal are excluded from the table as are interest payments after 20 years.
Held-for-trading assets and liabilities – held-for-trading assets and liabilities amounting to £60.0 billion (assets) and £54.0 billion (liabilities) (2008 – £55.7 billion assets, £63.8 billion liabilities) have been excluded from the table in view of their short term nature.
This contractual analysis highlights the maturity transformation of the balance sheet that is fundamental to the structure of banking. In practice, this is not a reflection of the actual behaviour of assets or liabilities. In particular the customer funding of the balance sheet exhibits much greater stability and maturity than the tables indicate. This is because the funding franchise of the NatWest Group is diversified across an extensive retail network.
 

 
Write-offs - UK GAAP
Financial review
Risk, capital and liquidity management
 
Funding and liquidity risk continued
Wholesale funding breakdown
The following table analyses amounts written-offbelow shows the composition of wholesale funding of the NatWest Group. 
  NatWest Group 
  Less than 1 year  1 to 5 years  More than 5 years  Total 
   £m  %   £m  %   £m  %   £m  % 
Deposits by banks (1) 
  39,867   17.5   10,708   61.0   267   1.6   50,842   19.4 
Debt securities in issue:                                 
– Commercial paper   1,701   0.7   —   —   —   —   1,701   0.6 
– Certificates of deposits   919   0.4   11   0.1   —   —   930   0.4 
– Medium term notes and other bonds   1,358   0.6   1,333   7.5   2,294   13.7   4,985   1.9 
– Securitisations   —   —   —   —   3,854   23.1   3,854   1.5 
   3,978   1.7   1,344   7.6   6,148   36.8   11,470   4.4 
Subordinated debt   937   0.4   443   2.5   7,619   45.6   8,999   3.5 
  
Total wholesale funding   44,782   19.6   12,495   71.1   14,034   84.0   71,311   27.3 
Customer deposits (1) 
  182,799   80.4   5,070   28.9   2,672   16.0   190,541   72.7 
   227,581   100.0   17,565   100.0   16,706   100.0   261,852   100.0 
Note:
(1)Excluding repurchase agreements and stock lending.
Outlook for 2010*
Whilst there have been improvements in the state of the global economy over the course of 2009, the outlook for 2010 remains uncertain. In line with meeting the objectives of the strategic plan, the RBS Group is actively focusing on closing the customer funding gap, continuing to exit non-core businesses and focusing on reducing undrawn and contingent commitments. This will reduce the absolute need for wholesale funding. In addition, the RBS Group will continue to make progress in terming out its remaining wholesale funding. The RBS Group will continue to reduce reliance on government supported schemes and the state of the markets and economies in which it operates. These strategies will ensure that the RBS Group will be more resilient to any further disruptions in the market and will be better placed to take advantage of favourable trading conditions as they return.
Regulatory environment*
The RBS Group operates in multiple jurisdictions across the globe and is subject to a number of regulatory regimes. The RBS Group’s lead regulator is the UK FSA. The liquidity framework applied by geographical areathe FSA is the Sterling Stock regime. In line with the FSA policy statement PS09/16, the RBS Group will be subject to a new liquidity risk regulatory framework in the future. The RBS Group has been working towards this new framework and type of domestic customer:will meet the requirements as they come into force.
 
Market risk
  UK GAAP  UK GAAP 
  2004  2003 
  £m  £m 
Domestic        
Manufacturing  25   57 
Construction  9   16 
Finance  1   30 
Service industries and business activities  79   150 
Agriculture, forestry and fishing  3   3 
Property  12   5 
Individuals - others
  296   169 
Finance leases and instalment credit  -   37 
Total domestic  425   467 
Foreign  170   139 
Total write-offs  595   606 
         
All the disclosures in this section (pages 56 to 60) are audited.
 
Market risk arises from changes in interest rates, foreign currency, credit spread, equity prices and risk related factors such as market volatilities. The RBS Group manages market risk centrally within its trading and non-trading portfolios through a comprehensive market risk management framework. This framework includes limits based on, but not limited to, VaR, scenario analysis, position and sensitivity analyses.

Recoveries - UK GAAPMeasurement
At the RBS Group level, the risk appetite is expressed in the form of a combination of VaR, sensitivity and scenario limits. VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels. For internal risk management purposes, the RBS Group’s VaR assumes a time horizon of one trading day and in June 2009, the RBS Group changed its VaR confidence level from 95% to 99% as it considers this provides greater clarity in respect of more severe potential economic outcomes. The RBS Group’s VAR model is based on a historical simulation model utilising data from the previous two years’ trading results.
The RBS Group continued to update and enhance its market risk management framework during 2009. In addition to the move to a VaR based on a 99% confidence level, the RBS Group has improved and strengthened its market risk limit framework, increasing the transparency of market risk taken across the RBS Group’s businesses in both the trading and non-trading portfolios.
 
The following table analyses recoveries of amounts written-off by geographical areaRBS Group’s market risk appetite is defined within this limit framework which is cascaded down through legal entity, division, business and type of domestic customer:ultimately trader level market risk limits.
 
  UK GAAP  UK GAAP 
  2004  2003 
  £m  £m 
Domestic        
Service industries and business activities  2   1 
Individuals - others
  39   6 
Finance leases and instalment credit  -   1 
Total domestic  41   8 
Foreign  4   4 
Total recoveries  45   12 
         
* unaudited
 
 
Risk elements in lending and potential problem loans - UK GAAP
  UK GAAP  UK GAAP 
  2004  2003 
  £m  £m 
Loans accounted for on a non-accrual basis (3):
        
Domestic  1,966   1,950 
Foreign  565   537 
Total  2,531   2,487 
Accruing loans which are contractually past due        
90 days or more as to principal or interest (4):
        
Domestic  342   276 
Foreign  60   48 
Total  402   324 
Loans not included above which are classified as        
'troubled debt restructurings' by the SEC:        
Domestic  -   16 
         
Total risk elements in lending  2,933   2,827 
         
Potential problem loans (5)
        
Domestic  13   276 
Foreign  83   50 
Total  96   326 
         
Closing provisions for bad and doubtful debts as a % of total risk elements in lending  66%  67%
         
Closing provisions for bad and doubtful debts as a % of total risk elements in lending and potential problem loans  64%  60%
         
Risk elements in lending as a % of gross loans and advances to customers excluding reverse repos  2.54%  2.96%
         
Financial reviewcontinued
 
Notes:
Market risk continued
Measurement continued
The VaR disclosure is broken down into trading and non-trading, where trading VaR relates to the main trading activities of the RBS Group and non-trading reflects the VaR associated with reclassified assets, money market business and the management of internal funds flow within the RBS Group’s businesses.
As part of the strategic review, the designation of assets between Core and Non-Core divisions was completed during 2009. As the Non-Core division was not established until conclusion of the strategic review in the first quarter of 2009, constitution of the average, maximum and minimum VaR for Core and Non-Core has been prepared on a best efforts basis as these measures require daily data.
The Group calculates VaR using historical simulation models but does not make any assumption about the nature or type of underlying loss distribution other than implied by history. The methodology uses the previous 500 trading days of market data and calculates both general market risk (the risk due to movement in general market benchmarks) and idiosyncratic market risk (the risk due to movements in the value of securities by reference to specific issuers). The Group VaR should be interpreted in light of the limitations of the methodology used as follows:
(1)  
•
ForHistorical simulation VaR may not provide the analysis above, ‘Domestic’ consistsbest estimate of future market movements. It can only provide a prediction of the UK domestic transactions of NatWest Group. ‘Foreign’ comprises NatWest Group’s transactions conducted through offices outside the UK and through those officesfuture based on events that occurred in the UK specifically organised to service international banking transactions.time series horizon. Therefore, events that are more severe than those in the historical data series cannot be predicted;
(2)  
•
VaR that uses a 99% confidence level does not reflect the extent of potential losses beyond that percentile;
•
VaR that uses a one-day time horizon will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day; and
•
The classificationGroup computes the VaR of a loan as non-accrual, past due 90 days or troubled debt restructuring does not necessarily indicate thattrading portfolios at the principalclose of business. Positions may change substantially during the course of the loan is uncollectable in whole or in part. Collection depends in each case on the individual circumstances of the loan, including the adequacy of any collateral securing the loantrading day and therefore classification of a loan as non-accrual, past due 90 days or troubled debt restructuring does not always require that a provisionintra-day profit and losses will be made against such a loan. In accordance with NatWest Group’s provisioning policy for bad and doubtful debts, it is considered that adequate provisions for the above risk elements in lending have been made.
(3)  NatWest Group’s UK banking subsidiary undertakings account for loans on a non-accrual basis from the point in time at which the collectability of interest is in significant doubt.
(4)  Overdrafts generally have no fixed repayment schedule and consequently are not included in this category.
(5)  Loans that are current as to the payment of principal and interest but in respect of which management has serious doubts about the ability of the borrower to comply with contractual repayment terms. Substantial security is held in respect of these loans and appropriate provisions have already been made in accordance with NatWest Group’s provisioning policy for bad and doubtful debts.incurred.
 

A ‘Risks not in VaR’ framework has been developed to address those market risks not adequately captured by the market standard VaR methodology. Where risks are not included in the model, various non-VaR controls (for example, position monitoring, sensitivity limits, triggers or stress limits) are in place.
These limitations mean that the Group cannot guarantee that losses will not exceed the VaR.
Traded portfolios
The primary focus of the RBS Group’s trading activities is client facilitation. The RBS Group also undertakes activities within the Core division of the wholesale bank, built around clients in chosen markets, including:
•
Market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes.
•
Arbitrage – entering into offsetting positions in different, but closely related markets in order to profit from market imperfections.
•
Proprietary activity – taking positions in financial instruments as principal in order to take advantage of anticipated market conditions.
Financial instruments held in the RBS Group’s trading portfolios include, but are not limited to: debt securities, loans, deposits, equities, securities sale and repurchase agreements and derivative financial instruments (futures, forwards, swaps and options).
The RBS Group participates in exchange traded and over-the-counter (OTC) derivatives markets. The RBS Group buys and sells financial instruments that are traded or cleared on an exchange, including interest rate swaps, futures and options. Holders of exchange traded instruments provide daily margins with cash or other security at the exchange, to which the holders look for ultimate settlement.
The RBS Group also buys and sells financial instruments that are traded OTC, rather than on a recognised exchange. These instruments range from commoditised transactions in derivative markets, to trades where the specific terms are tailored to the requirements of the RBS Group’s customers. In many cases, industry standard documentation is used, most commonly in the form of a master agreement, with individual transaction confirmations.
Assets and liabilities in the trading book are measured at their fair value. Fair value is the amount at which the instrument could be exchanged in a current transaction between willing parties. The fair values are determined following IAS 39 guidance, which requires banks to use quoted market prices or valuation techniques (models) that make the maximum use of observable inputs. When marking to market using a model, the valuation methodologies are reviewed and approved by the market risk function at RBS Group level. Group Risk provides an independent evaluation of the model for transactions deemed by the Group Model Product Review Committee (GMPRC) to be large, complex and/or innovative. Any profits or losses on the revaluation of positions are recognised in the daily profit and loss.
3057
Financial review
Table of ContentsRisk, capital and liquidity management
 
Market risk continued
The VaR for the NatWest Group’s trading and non-trading portfolios segregated by type of market risk exposure, including idiosyncratic risk, is presented in the table below.

  UK GAAP  UK GAAP 
  2004  2003 
   £m   £m 
G Gross income not recognised but which would have been recognised under the original terms of non-accrual and restructured loans        
Domestic  130   134 
Foreign  31   31 
   161   165 
         
Interest on non-accrual and restructured loans included in net interest income        
Domestic  41   43 
         
  2009(99%ile)  2008(99%ile) 
  Average  Period end  Maximum  Minimum  Average  Period end  Maximum  Minimum 
Trading 
  £m   £m   £m   £m   £m   £m   £m   £m 
Interest rate   17.6   15.8   25.3   9.8   12.8   20.5   34.7   4.7 
Credit spread   47.4   73.4   76.5   12.2   25.3   13.7   43.7   10.6 
Currency   0.8   —   9.7   0.1   0.8   2.2   2.4   0.1 
Equity   0.5   2.1   2.9   —   0.2   0.1   0.9   — 
Commodity   —   —   0.4   —   0.1   —   0.4   — 
Diversification       (19.2)               (7.0)         
   49.7   73.2   79.7   24.4   30.5   29.5   47.7   16.0 
  
  
 2009(99%ile)
  2008(99%ile)
  Average  Period end  Maximum  Minimum  Average  Period end  Maximum  Minimum 
Non-trading   £m   £m   £m   £m   £m   £m   £m   £m 
Interest rate   2.4   2.5   5.2   1.0   1.9   2.0   3.2   0.8 
Credit spread   34.5   58.0   59.3   4.2   0.6   4.3   4.4   — 
Currency   —   —   0.1   —   —   0.1   1.0   — 
Diversification       (1.6)               (1.4)         
   34.9   58.9   60.4   5.0   2.2   5.0   5.3   0.8 
 
Non-trading data above reflects the VaR associated with reclassified assets, money market business and the management of internal funds from within the NatWest Group’s businesses.
Back-testing, stress testing and sensitivity analysis
The RBS Group undertakes a programme of daily back-testing, which compares the actual profit or loss realised in trading activity to the VaR estimation. The results of the back-testing process are one of the methods by which the RBS Group monitors the ongoing suitability of its VaR model.
The RBS Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from exceptional, but plausible market events. Stress testing measures the impact of abnormal changes in market rates and prices on the fair value of the RBS Group’s trading portfolios. The RBS Group calculates historical stress tests and hypothetical stress tests.
Historical stress tests calculate the loss that would be generated if the market movements that occurred during historical market events were repeated. Hypothetical stress tests calculate the loss that would be generated if a specific set of adverse market movements were to occur.
Stress testing is also undertaken at key trading strategy level, for those strategies where the associated market risks are not adequately captured by VaR. Stress test exposures are discussed with senior management and are reported to GRC, ERF and the Board. Breaches in the RBS Group’s market risk stress testing limits are monitored and reported.
In addition to VaR and stress testing, the RBS Group calculates a wide range of sensitivity and position risk measures, for example interest rate ladders or option revaluation matrices. These measures provide valuable additional controls, often at individual desk or strategy level.
Model validation governance
Pricing models are developed and owned by the front office. Where pricing models are used as the basis of books and records valuations, they are all subject to independent review and sign-off. Models are assessed by GMPRC as having either immaterial or material model risk (valuation uncertainty arising from choice of modelling assumptions), the assessment being made on the basis of expert judgement.
Those models assessed by the GMPRC as having material model risk are prioritised for independent quantitative review. Independent quantitative review aims to quantify model risk (i.e. the impact of missing risk factors in the front office model or the possibility that we may be mismarking these products relative to other market participants who may be using an alternative model) by comparing model outputs against alternative independently developed models. The results of independent quantitative review are used by market risk to inform risk limits and by finance to inform reserves. Governance over this process is provided by GMPRC, a forum which brings together front office quantitative analysts, market risk, finance and QuaRC (Quantitative Research Centre, RBS Group Risk’s independent quantitative model review function). Risk (market risk, incremental default risk, counterparty credit risk) models are developed both within business units and by RBS Group functions. Risk models are also subject to independent review and sign-off. Meetings are held with the FSA every quarter to discuss the traded market risk, including changes in models, management, back testing results, other risks not included in the VaR framework and other model performance statistics.
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Financial reviewcontinued
Market risk continued
Risk control
All divisions that are exposed to market risk in the course of their business are required to comply with the requirements of the RBS Group’s Market Risk Policy Standards (MRPS). The main risk management tools are delegated authorities, hard limits and discussion triggers, independent model valuation, a robust and efficient risk system and timely and accurate management information.
Limits form part of the dealing authorities and constitute one of the cornerstones of the market risk management framework. Upon notification of a limit breach, the appropriate body must take one of the following actions:
•
Instructions can be given to reduce positions so as to bring the RBS Group within the agreed limits;
•
A temporary increase in the limit can be granted to pursue an agreed short-term strategy; and
•
A permanent increase in the limit can be granted if consistent with the strategy and supported by the business and Risk Management.
Non-traded portfolios
Risks in non-traded portfolios mainly arise in retail and commercial banking assets and liabilities and financial investments designated as available-for-sale and held-to-maturity.
Group Treasury is responsible for setting and monitoring the adequacy and effectiveness of management, using a framework that identifies, measures, monitors and controls the underlying risk. GALCO approves the RBS Group’s non-traded market risk appetite, expressed as statistical and non-statistical risk limits, which are delegated to the businesses responsible.
Various banking regulators review non-trading market risk as part of their regulatory oversight. As home country regulator, the FSA has responsibility for reviewing non-trading market risk at an RBS Group consolidated level.
The RBS Group is exposed to the following non-traded risks:
Interest Rate Risk in the Banking Book (IRRBB) represents exposures to instruments whose values vary with the level or volatility of interest rates. These instruments include, but are not limited to, loans, debt securities, equity shares, deposits, certificates of deposits, loan capital and derivatives. Hedging instruments used to mitigate these risks include related derivatives such as options, futures, forwards and swaps. Interest rate risk arises from the RBS Group’s non-trading activities in four principal forms:
•
Re-pricing risk – arises from differences in the re-pricing terms of the RBS Group’s assets and liabilities;
•
Optionality – arises where a customer has an option to exit a deal early;
•
Basis risk – arises, for example, where liabilities, the interest on which is linked to LIBOR, is used to fund assets bearing interest linked to the base rate; and
Yield curve risk – arises as a result of non-parallel changes in the yield curve.
It is the RBS Group’s policy to minimise the sensitivity to changes in interest rates in its retail and commercial businesses and, where interest rate risk is retained, to ensure that appropriate resources, measures and limits are applied.
Non-trading interest rate risk is calculated in each business on the basis of establishing the re-pricing behaviour of each asset, liability and off-balance sheet product. For many retail and commercial products, the actual interest rate re-pricing characteristics differ from the contractual re-pricing. In most cases, the re-pricing maturity is determined by the market interest rate that most closely fits the historical behaviour of the product interest rate. For non-interest bearing current accounts, the repricing maturity is determined by the stability of the portfolio. The repricing maturities used are approved by Group Treasury and divisional asset and liability committees at least annually. Key conventions are reviewed annually by GALCO.
Non-trading interest rate exposures are controlled by limiting re-pricing mismatches in the individual business balance sheets. Potential exposures to interest rate movements in the medium to long-term are measured and controlled using a version of the same VaR methodology that is used for the RBS Group’s trading portfolios. Net accrual income exposures are measured and controlled in terms of sensitivity over time to movements in interest rates.
Risk is managed within VaR limits approved by GALCO, through the execution of cash and derivative instruments. Execution of the hedging is carried out by the relevant division through the RBS Group’s treasury functions. The residual risk position is reported to divisional asset and liability committees, GALCO and the Board.
Foreign Exchange Risk in the Banking Book (FXRBB) represents exposures to changes in the values of current holdings and future cash flows denominated in other currencies. Hedging instruments used to mitigate these risks include foreign currency options, currency swaps, futures, forwards and deposits. Foreign exchange risk results from the RBS Group’s investments in overseas subsidiaries, associates and branches in three principal forms:
•
Structural foreign currency exposures that arise from net investment in overseas subsidiaries, associates and branches;
•
Transactional/commercial foreign currency exposures that arise from mismatches in the currency balance sheet; and
•
Foreign currency profit streams.
Equity Risk in the Banking Book (ERBB) is defined as the potential variation in the RBS Group’s non-trading income and reserves arising from changes in equity prices/income. This risk may crystallise during the course of normal business activities or in stressed market conditions. Equity positions in the RBS Group’s banking book are retained to achieve strategic objectives, support venture capital transactions or in respect of customer restructuring arrangements.
59
Financial review
Risk, capital and liquidity management
Market risk continued
Non-traded portfolios continued
The commercial decision to invest in equity holdings, including customer restructurings, is taken by authorised persons with delegated authority under the RBS Group credit approval framework. Investments or disposal of a strategic nature are referred to the Group Acquisitions and Disposal Committee (ADCo), Group Executive Committee (ExCo) and where appropriate the Board for approval; those involving the purchase or sale by the RBS Group of subsidiary companies also require Board approval, after consideration by ExCo and ADCo.
Structural interest rate risk
Non-trading interest rate VaR for the NatWest Group’s retail and commercial banking activities at a 99% confidence level was £45.9 million at 31 December 2009 (2008 – £70.1 million). During 2009, the maximum VaR was £75.4 million (2008 – £70.1 million), the minimum was £45.9 million (2008 – £36.2 million) and the average was £61.5 million (2008 – £44.5 million).
Currency risk
The RBS Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding. The RBS Group’s policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in foreign subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the RBS Group’s or the subsidiary’s regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by the Group Asset and Liability Committee. Foreign exchange differences arising on the translation of foreign operations are recognised directly in equity, together with the effective portion of foreign exchange differences arising on hedging instruments.
Equity classification of foreign currency denominated preference share issuances means that these shares are recorded on the balance sheet at historic cost. Consequently, these share issuances have the effect of increasing the NatWest Group’s structural foreign currency position.
The table below sets out NatWest Group’s structural foreign currency exposures.
 NatWest Group 
 2009  2008 
  Net     Other  Structural  Net     Structured 
  investments  Net  related  foreign  investments  Related  foreign 
  in foreign  investment  currency  currency  in foreign  currency  currency 
  operations  hedges  borrowings  exposures  operations  borrowings  exposures 
   £m   £m   £m   £m   £m   £m   £m 
US dollar   2,465   (227)   —   2,238   4,884   (1,348)   3,536 
Euro   4,870   (470)   (1,334)   3,066   3,973   (1,624)   2,349 
Swiss franc   937   —   —   937   912   —   912 
Other non-sterling   9   (9)   —   —   8   (8)   — 
   8,281   (706)   (1,334)   6,241   9,777   (2,980)   6,797 
Retranslation gains and losses on NatWest Group’s net investments in operations together with those on instruments that qualify and are effective as accounting hedges are recognised in equity. Gains and losses on retranslating related currency borrowings that are not accounting hedges are recorded in profit or loss. Changes in foreign currency exchange rates affect equity in proportion to the structural foreign currency exposure.
At 31 December 2009, a 5% strengthening of foreign currencies would result in a gain of £380 million in equity and a loss of £70 million in profit or loss, while a 5% weakening of foreign currencies would result in a loss of £360 million in equity and a gain of £60 million in profit or loss. At 31 December 2008, NatWest Group had no net investment hedge relationships.
These movements offset retranslation effects on the NatWest Group's foreign currency denominated risk weighted assets, reducing the sensitivity of Tier 1 capital ratio to movements in foreign currency exchange rates.
Equity risk
Equity positions are measured at fair value. Fair value calculations are based on available market prices wherever possible. In the event that market prices are not available, fair value is based on appropriate valuation techniques or management estimates.
The types, nature and amounts of exchange-traded exposures, private equity exposures, and other exposures vary significantly. Such exposures may take the form of listed and unlisted equity shares, linked equity fund investments, private equity and venture capital investments, preference shares classified as equity and Federal Home Loan Stock.
60
LIQUIDITY AND CAPITAL RESOURCESRESOURCES

In the management of capital resources, NatWest Group is governed by RBS Group’s policy which is to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, NatWest Group has regard to the supervisory requirements of the Financial Services Authority (“FSA”). The FSA uses Risk Asset Ratio (“RAR”) as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a tier 1 component of not less than 4%. At 31 December 2007,2009, NatWest Group's total RAR was 9.8%13.4% and the tier 1 RAR was 13.2%10.1%.

Upon the adoption of IFRS by listed banks in the UK on 1 January 2005, the FSA changed its regulatory requirements such that the measurement of capital adequacy was based on IFRS subject to a number of prudential filters. The data set out below have been presented in compliance with these revised FSA requirements.

 2007 - IFRS 2006 - IFRS
 
2005 - IFRS
 
 2009  2008  2007 
 £m
 
£m
 
£m   £m   £m   £m 
Capital base                   
Tier 1 capital
 12,014  11,300  10,359   12,926   11,988   12,014 
Tier 2 capital 5,493  5,335  6,043   4,514   5,475   5,493 
Total 17,507  16,635  16,402 
Less investments in insurance subsidiaries, associated undertakings and
other supervisory deductions
 (1,354) (1,932) 
(1,911
)
  17,440   17,463   17,507 
Less: investments in insurance subsidiaries, associated undertakings and other supervisory deductions  (291)  (290)  (1,354)
Total capital 16,153  14,703  14,491   17,149   17,173   16,153 
Risk-weighted assets            
Credit risk  108,300   97,900     
Counterparty risk  2,600   2,600     
Market risk  3,100   3,300     
Operational risk  14,200   15,000     
           128,200   118,800     
Risk-weighted assets         
Banking book:                     
On-balance sheet
 108,600  96,800  88,600           108,600 
Off-balance sheet
 
9,600
  10,700  9,300           9,600 
Trading book 4,500  6,600  4,600           4,500 
 122,700  114,100  102,500           122,700 
         
Risk asset ratios          %  %  % 
Tier 1 9.8%  9.9% 10.1%  10.1   10.1   9.8 
Total 13.2% 12.9% 14.1%  13.4   14.5   13.2 
         

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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

The CompanyBank has omitted portions of this item on the basis of General Instruction I(2)(c) to Form 10-K.

BOARD PRACTICESBoard Practices

The CompanyBank is committed to high standards of corporate governance, business integrity and professionalism in all its activities.

Under the US Sarbanes-Oxley Act of 2002 (the “Act”), specific standards of corporate governance and business and financial disclosuredisclosures apply to companies with securities registered in the US. NatWest GroupThe Bank complies with all currently applicable sections of the Act.

Board of directors

The Board is the principal decision makingmain decision-making forum for the Company.Bank. It has overall responsibility for leadingmanagement of the business and controllingaffairs of the CompanyGroup, the establishment of Group strategy and capital raising and allocation, and is accountable to shareholders for financial and operational performance. The Board approvesconsiders strategic issues and ensures the Group strategymanages risk effectively through approving and monitors performance.monitoring the Group’s risk appetite, considering Group stress scenarios and agreed mitigants and identifying longer term strategic threats to the Group’s business operations. The Board has adopted a formal schedule of matters detailing key aspects of the Company’sBank’s affairs reserved to it for its decision. This schedule is reviewed annually.

The roles of the Chairman and Group Chief Executive are distinct and separate, with a clear division of responsibilities. The Chairman leads the Board and ensures the effective engagement and contribution of all non-executiveexecutive and executivenon-executive directors. The Group Chief Executive has responsibility for all Group businesses and acts in accordance with the authority delegated by the Board. Responsibility for the development of policy and strategy and operational management is delegated to the Group Chief Executive and other executive directors.

All directors participate in discussing strategy, performance and the financial and risk management of the Company.Bank. Meetings of the Board are structured to allow open discussion.

At the beginning of the year, a number of Board meetings are scheduled. For 2009, ten Board meetings were scheduled. The NatWest Board met six times during 2007 and wasdirectors were supplied with comprehensive papers in advance of each Board meeting covering the Group’s principal business activities. The Group Chief Executive provides a written report on business activities at each Board meeting. Members of executive management attend and make regular presentations at meetings of the Board. The Chairman and the non-executives meet at least once per year without executives present.
 
The Board is aware of the other commitments of its directors and ishas established procedures for ensuring that the Board’s powers for authorising directors’ conflicts of interest are being operated effectively. With effect from 1 October 2008, the Companies Act 2006 introduced a statutory duty on directors to avoid conflicts of interest. Since that date, the Board has considered, and where appropriate authorised, any actual or potential conflicts of interests that directors may have. The Walker review recommends that the Chairman should be expected to commit a proportion of his time, probably not less than two thirds, to the business. In November 2009, Philip Hampton joined the Board of Anglo American plc as a non-executive director. This appointment was fully disclosed to the Board and it was satisfied that these do not conflict with their duties as non-executive directors of the company.there were no issues in relation to his time commitment to RBS. Philip Hampton has confirmed that RBS remains his priority.

Board Committees

In order to provide effective oversight and leadership, the Board has established a number of Board Committees with particular responsibilities. The Committee chairmanship and membership are reviewed on a regular basis.

In accordance with the recommendations of the Walker review, the Bank has established a Board Risk Committee to advise the Board on risk issues.

Audit Committee

All members of the Audit Committee are independent non-executive directors. The Audit Committee holds at least fivesix scheduled meetings each year. In 2009, the Audit Committee held four additional meetings. The Audit Committee is responsible for assisting the Board in carrying out its responsibilities relating to accounting policies, internal control and financial reporting.

An Audit Committee meeting is held immediately prior to submission of the interim and annual financial statements to the Board and the quarterly Interim Management Statements. This core programme is supplemented by additional meetings as required, four being added in 2007.required. Audit Committee meetings are attended by relevant executive directors, the internal and external auditors and finance and risk management executives. At least twice per annum the Audit Committee meets privately with the external auditors. TheSince 2000, the Audit Committee alsohas undertaken an annual programme of visits to the Group's business divisions and certaincontrol functions. The object of the programme is to allow the Audit Committee to gain a better understanding of the Group functions under aand an invitation to attend is extended to all non-executive directors. The programme set atof future visits is considered annually and the beginning ofnorm is for two to three visits to be undertaken each year. The Group Audit Committee undertook three visits in 2009.

The Audit Committee is responsible for:
·  •assisting the Board in discharging its responsibilities and in making all relevant disclosures in relation to the financial affairs of the Group;
·  reviewing accounting and financial reporting and regulatory compliance;
·  reviewing the Group’s systems of internal control; and
·  monitoring the Group’s processes for internal audit, risk management and external audit.

The Audit Committee has adopted a policy on the engagement of the external auditors to supply audit and non-audit services, which takes into account relevant legislation regarding the provision of such services by an external audit firm. The Audit Committee reviews the policy annually and prospectively approves the provision of audit services and certain non-audit services by the external auditors. The Audit Committee approves all other permitted non-audit services on a case by case basis before their commencement. In addition, the Audit Committee reviews and monitors the independence and objectivity of the external auditors when it approves non-audit work to be carried out by them, taking into consideration relevant legislation and ethical guidance.

Information on the audit and non-audit services carried out by the external auditors is detailed in Note 4 to the Group’s accounts.
Group;
 
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Table• reviewing accounting and financial reporting and regulatory compliance;
• reviewing the Group’s systems of Contentsinternal control; and
•monitoring the Group’s processes for internal audit and external audit.
The Committee dedicated a significant proportion of time and attention during 2009 to the consideration and approval of the Group’s accession to the Asset Protection Scheme (“the Scheme”). A specific meeting, which was attended by the majority of the Group Board, was held to consider the Scheme and its impact on the Group.

In response to the economic crisis the Group Audit Committee formally commissioned an independent report on risk reporting within the organisation. As a result, the format and content of risk reporting has undergone significant development during 2009.

As far as it can determine, the Group Audit Committee received all the information and material it required to allow it to meet its obligations in respect of the 2009 financial statements.

During 2009, the Group Audit Committee regularly reviewed the work of the Group’s risk management and internal audit functions. Additional sessions of the Group Audit Committee were held in 2009 that focused solely on risk and audit issues.

The Audit Committee undertakes an annual evaluation to assess the independence and objectivity of the external auditors and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The resultsoutcomes of this evaluation are reportedconsidered by the Board together with the Group Audit Committee’s recommendation on the re-appointment of the external auditors or whether to commence an audit tender process. The annual evaluation is carried out following completion of the Board. annual accounts and audit.

Deloitte LLP have been the Bank’s auditors since March 2000. The external auditors are required to rotate the lead audit partner responsible for the audit every five years. The current lead audit partner has completed his fifth year and accordingly, a new audit partner will lead the audits for the year ending 31 December 2010. There are no contractual obligations restricting the Bank’s choice of external auditor.

The Audit Committee is responsible for making recommendations to the Board, for it to submit the Audit Committee’s recommendations to shareholders for their approval at the Annual General Meeting in relation to the appointment, re-appointmentreappointment and removal of the external auditors. The Board has endorsed the Audit Committee’s recommendation that shareholders be requested to approve the reappointment of Deloitte & ToucheLLP as external auditors at the Annual General Meeting in April 2008.2010.

Remuneration Committee

The Remuneration Committee is comprised of independent non-executive directors. The Remuneration Committee holds at least four scheduled meetings each year. The Remuneration Committee held an additional 16 meetings in 2009. The Remuneration Committee is responsible for assisting the Board in discharging its responsibilities and making all relevant disclosures in relation to the formulation and reviewoverview of the Group’s policy on remuneration, as well as considering executive remuneration policy. The Remuneration Committee makesand, as required, making recommendations to the Group Board onin respect of the remuneration arrangements forof the executive directors anddirectors. It is also responsible for setting the Chairman. The membersremuneration arrangements of the RemunerationExecutive Committee compriseand Management Committee and any employees falling within the definition of principle 8 of the FSA Code on Remuneration.

Board Risk Committee
The Board Risk Committee is comprised of at least three independent non-executive directors, together withone of whom is the Chairman of the Board. No directorAudit Committee. A minimum of six meetings will be held each year. The Board Risk Committee is involvedresponsible for providing oversight and advice to the Board in decisions regarding hisrelation to current and potential future risk exposures of
the Group and future risk strategy, promoting a risk awareness culture within the Group, reporting to the Board, as well as identifying any matters within its remit in respect of which it considers that action or her own remuneration.improvement is needed and making recommendations as to the steps to be taken.

Nominations Committee

The Nominations Committee comprises independent non-executive directors, under the chairmanship of the Chairman of the Board. The Nominations Committee meets as required.

The Nominations Committee is responsible for assisting the Board in the formal selection and appointment of directors. Itdirectors having regard to the overall balance of skills, knowledge and experience on the Board. The committee engages with external consultants, considers potential candidates and recommends appointments of new directors to the Board. The appointments are based on merit against objective criteria, including the time available of the potential director and the commitment which will be required of the potential director.

required. In addition, the Nominations Committee considers succession planning for the Chairman, Group Chief Executive and non-executive directors.
Corporate responsibility The Nominations Committee takes into account the knowledge, mix of skills, experience and networks of contacts which are anticipated to be needed on the Board in the future. The Chairman, Group Chief Executive and non-executive directors meet to consider executive succession planning. No director is involved in decisions regarding his or her own succession.

Business excellence requires that
63
Group Corporate Sustainability Committee
The Group Corporate Sustainability Committee is chaired by the Senior Independent Director and attended by the Group Chairman and members of the Group executive and senior management. It reports into the Board and is responsible for setting and reviewing the Group’s overall sustainability strategy, values and policies. It receives reports from the Environment Working Group and other relevant internal programmes.

Sustainability sits at the heart of how the Group is being re-shaped and RBS Group meets changing customer, shareholder, investor, employee and supplier expectations. The RBS Group believes thatmaintains a strong commitment to meeting high standards of environmental, social and ethical responsibilityresponsibility.

Corporate sustainability issues are governed by the Group Corporate Sustainability Committee (GCSC), which was established in 2009. The GCSC is keysupported by the executive-led Environment Working Group which has representatives from across the Group and reports to the way it doesGCSC. The Environment Working Group monitors environmental risk, commercial opportunities, operational impacts and communications and engagement.

The Microfinance Advisory Board comprises senior members from a range of stakeholder groups and provides independent oversight and support for the Microfinance and Supporting Enterprise programmes across the Group’s international business.

Further detailsThroughout the development of ’MoneySense’, RBS has continuously sought independent counsel. This has now been formalised through the formation of the RBS Group’s corporate responsibility policies will be contained inMoneySense Advisory Board which draws on the 2007 Corporate Responsibility Report.skills of independent, impartial experts, to provide strategic input to the MoneySense programme.

EMPLOYEES
Details of employee numbers are shown in note 3 on page 6598 within Item 18 'Consolidated Financial Statements'.

SHARE OWNERSHIP

The Bank is a wholly-owned direct subsidiary of The Royal Bank of Scotland plc, which in turn is a wholly ownedwholly-owned direct subsidiary of The Royal Bank of Scotland Group plc.

No director had an interest in NatWest Group’s preference shares or loan notes during the year.
 
3464
 
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

The CompanyBank has omitted this item on the basis of General Instruction I(2)(c) to Form 10-K.
 
3565
 
ITEM 8. FINANCIAL INFORMATION

CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION

The Consolidated Financial Statements are included in Item 18 of this Annual Report.

Legal proceedings
Litigation

As a participant in the financial services industry, NatWest Group operates in a legal and regulatory environment that exposes it to potentially significant litigation risks. As a result, NatWest Groupthe Bank and other members of the RBSNatWest Group are involved in various disputes and legal proceedings in the United Kingdom, the United States and other jurisdictions, including litigation. Such cases are subject to many uncertainties, and their outcome is often difficult to predict, particularly in the earlier stages of a case. Currently, NatWest Group is involved in litigation arising out of its operations.

Other than as set out in this section,Note 28 on the financial statements, so far as the BankNatWest Group is aware, neither the Bank nor any member of the RBS Group is or has been engaged in noror has pending or threatened any governmental, legal or arbitration proceedings which may have or have had in the recent past (covering the 12 months immediately preceding the date of this document) a significant effect on NatWestthe Group’s financial position or profitability.

United Kingdom

In common with other banks in the United Kingdom, the Royal Bank and the Bank have received claims and complaints from a large number of customers relating to the legal status and enforceability of current and historic contractual terms in personal current account agreements relating to unarranged overdraft and unpaid item charges (‘‘Relevant Charges’’) and seeking repayment of Relevant Charges that had been applied to their accounts in the past. The claims and complaints are based primarily on the common law penalty doctrine and the Unfair Terms in Consumer Contracts Regulations 1999 (the ‘‘Regulations’’). Because of the High Court test case referred to below, most existing and new claims in the County Courts are currently stayed and there is currently an FSA waiver of the complaints handling process and a standstill of Financial Ombudsman Service decisions.
On 27 July 2007, following discussions between the OFT, the Financial Ombudsman Service, the Financial Services Authority and major UK banks (including the Bank), the OFT issued proceedings in a test case against the banks which was intended to determine certain preliminary issues concerning the legal status and enforceability of contractual terms relating to Relevant Charges.

The judgement on these preliminary issues was handed down on 24 April 2008. The judgement primarily addressed the contractual terms relating to Relevant Charges in personal current account (excluding basic bank account) agreements in force in early 2008 (‘‘Current Terms’’) and not contractual terms in historic personal current account agreements. The judgement held that the Current Terms used by the Royal Bank and the Bank (i) are not unenforceable as penalties, but (ii) are not exempt from assessment for fairness under the Regulations. The RBS Group is considering whether to appeal any of the rulings contained in the judgement.

A High Court hearing has been arranged for 22 May 2008 at which the OFT, the RBS Group and the other test case banks are expected to make submissions to the Court in relation to whether they wish to appeal the judgement, the implications of the judgement in the test case and arrangements for any remaining issues relevant to the customer claims and complaints to be determined in the test case in due course.

The issues relating to the legal status and enforceability of the Relevant Charges are complex. The RBS Group maintains that its Relevant Charges are fair and enforceable and believes that it has a number of substantive and credible defences. The RBS Group cannot, however, at this stage predict with any certainty if, or for how long, the stays, waiver and standstill referred to above will remain in place. Nor can it at this stage predict with any certainty the timing or substance of the final outcome of the customer claims and complaints, any appeals against the judgement handed down on 24 April 2008 and any further stages of the test case. It is unable reliably to estimate the liability, if any, that may arise as a result of or in connection with these matters or its effect on NatWest Group’s consolidated net assets, operating results or cash flows in any particular period.
Update
On 23 May 2008, a case management hearing was held at which the Judge granted the banks (including the Royal Bank and the Bank) leave to appeal the Judge's decision that the banks' current terms are not exempt from an assessment for fairness under the Regulations. The banks and the OFT agreed that the case should move forward as quickly as possible. It is expected that this appeal will be heard during autumn 2008.
United States

Proceedings, including consolidated class actions on behalf of former Enron securities holders, have been brought in the United States against a large number of defendants, including the RBS Group, following the collapse of Enron. The claims against the RBS Group could be significant; the class plaintiff’s position is that each defendant is responsible for an entire aggregate damage amount less settlements—they have not quantified claimed damages against the RBS Group in particular. The RBS Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously. Recent decisions by the US Supreme Court and the US federal court for the Fifth Circuit provide further support for the RBS Group’s position. The RBS Group is unable reliably to estimate the liability, if any, that might arise or its effect on the RBS Group’s consolidated net assets, its operating results or cash flows in any particular period.

Investigations

NatWest Group’s businesses and earnings can be affected by the fiscal or other policies and other actions of various governmental and regulatory authorities in the United Kingdom, the European Union, the United States and elsewhere. There is continuing political and regulatory scrutiny of the operation of the retail banking and consumer credit industries in the United Kingdom and elsewhere. The nature and impact of future changes in policies and regulatory action are not predictable and are beyond NatWest Group’s control but could have an adverse impact on NatWest Group’s businesses and earnings.

European Union

In the European Union, these regulatory actions included an inquiry into retail banking in all of the then 25 member states by the European Commission’s Directorate General for Competition. The inquiry examined retail banking in Europe generally. On 31 January 2007, the European Commission announced that barriers to competition in certain areas of retail banking, payment cards and payment systems in the European Union had been identified. The European Commission indicated that it will use its powers to address these barriers and will encourage national competition authorities to enforce European and national competition laws where appropriate.

In 2007 the European Commission issued a judgement that MasterCard’s current multilateral interchange fee (‘‘MIF’’) arrangement for cross border payment card transactions with MasterCard and Maestro branded consumer credit and debit cards in the European Union are in breach of competition law. MasterCard is required by the decision to withdraw the relevant cross border MIFs by June 2008. RBS Group is waiting for MasterCard to report to member banks with its proposals for removing the cross border MIF for credit and debit card transactions. RBS Group also understands that MasterCard is intending to appeal the decision. Visa’s MIFs were temporarily allowed in 2002 by the European Commission up to 31 December 2007. On 27 March 2008, the European Commission opened a formal inquiry into Visa’s current MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit card charges in the European Union. There is no deadline for the closure of the inquiry.

United Kingdom

In the United Kingdom, in September 2005, the Office of Fair Trading (‘‘OFT’’) received a supercomplaint from the Citizens Advice Bureau relating to payment protection insurance (‘‘PPI’’). As a result, the OFT commenced a market study on PPI in April 2006. In October 2006, the OFT announced the outcome of the market study and, on 7 February 2007, following a period of consultation, the OFT referred the PPI market to the Competition Commission (‘‘CC’’) for an in-depth inquiry. This inquiry could continue for up to two years. Also, in October 2006, the Financial Services Authority published the outcome of its broad industry thematic review of PPI sales practices in which it concluded that some institutions fail to treat customers fairly.

In January 2006, the OFT commenced a review of the undertakings given following the conclusion of the CC inquiry in 2002 into the supply of banking services to small and medium enterprises (‘‘SMEs’’). On 21 December 2007, the CC published its decision to lift the temporary price controls imposed in 2003 on the United Kingdom’s four largest banks servicing SMEs (including RBS) and to retain certain behavioural undertakings.

The OFT has carried out investigations into Visa and MasterCard credit card interchange rates. The decision by the OFT in the MasterCard interchange case was set aside by the Competition Appeals Tribunal in June 2006. The OFT’s investigations in the Visa interchange case and a second MasterCard interchange case are ongoing. The outcome is not known, but these investigations may have an impact on the consumer credit industry in general and, therefore, on the RBS Group’s business in this sector. On 9 February 2007, the OFT announced that it was expanding its investigation into interchange rates to include debit cards.

On 29 March 2007, the OFT announced that, following an initial review into bank current account charges, it had decided to conduct an in-depth study of UK retail bank pricing and a formal investigation into the fairness of bank current account charges. The findings of the OFT’s study and investigation are expected to be published later this year. Given the stage of the investigation, the Company cannot estimate the impact of any adverse outcome of the investigation upon it, if any. However, the Company is cooperating fully with the OFT to achieve resolution of the matters under investigation.

On 26 January 2007, the FSA issued a Statement of Good Practice relating to Mortgage Exit Administration Fees. On 1 March 2007, the RBS Group adopted a policy of charging all customers the fee applicable at the time the customers took out the mortgage or, if later, varied their mortgage. The Company believes that it is currently in compliance with the Statement of Good Practice and will continue to monitor its performance against those standards.
On 15 May 2007, the CC published its final report into the supply of personal current account banking services in Northern Ireland. The Northern Ireland PCA Banking Market Investigation Order 2008 implementing the remedies (including, inter alia, measures designed to make switching current accounts between banks easier for depositors and requiring the provision of aggregate fees and other information to customers) set out in the report came into force on 22 February 2008. NatWest Group owns Ulster Bank, which is active in the Northern Ireland current account market. The Company has responded to the remedies mandated by the Order and believes that it is currently in compliance with its obligations. The Company will continue to monitor its performance against those requirements.
United States
The New York State Attorney General has issued subpoenas to a wide array of participants in the sub-prime mortgage industry including mortgage originators, appraisers, due diligence firms, investment banks and rating agencies, focusing on the information underwriters obtained as part of the due diligence process from the independent due diligence firms and whether that information is adequately disclosed to investors. RBS Greenwich Capital has produced documents requested by the New York State Attorney General principally related to sub-prime loans that were pooled into one securitisation transaction.

In addition to the above, certain of RBS Group’s subsidiaries have received requests for information from various US governmental agencies and self-regulatory organisations including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. In particular, during March 2008 RBS Group was advised by the SEC that it had commenced a non-public, formal investigation relating to RBS Group’s US sub-prime securities exposure and US residential mortgage exposures. The company and its subsidiaries are co-operating with these various requests for information and investigations.

SIGNIFICANT CHANGES

Post balance sheet events

There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.


On 25 March 2010, the RBS Group announced its intention to launch (i) an offer to exchange certain subordinated debt securities issued by Group members for new senior debt and (ii) tender offers in respect of certain preference shares, preferred securities and perpetual securities issued by Group members. The RBS Group expects to announce the offers in early April and will seek shareholder approvals as required in coordination with the annual general meeting of The Royal Bank of Scotland Group plc scheduled to take place on 28 April 2010.

On 30 March 2010, the Office of Fair Trading announced that it had arrived at an early resolution agreement with the RBS Group by which the RBS Group will pay a fine of £29 million and admit a breach in competition law relating to the provision of loan products to professional services firms.
 
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ITEM 9. THE OFFER AND LISTING

OFFER AND LISTING DETAILS

Nature of trading market

On 10 April 2000, following the acquisition by The Royal Bank of Scotland Group plc, the Bank's ordinary shares were delisted from the London Stock Exchange and the ordinary shares represented by American Depository Shares were delisted from the New York Stock Exchange. All of the Bank's ordinary share capital is ultimately held by The Royal Bank of Scotland Group plc.

On 9 June 1993 and 8 April 1997, the Bank issued respectively the following12,000,000 Series C ("Series C American Depository Shares ("ADSs"(‘ADSs’), each") representing 12,000,000 non-cumulative dollar preference shares, Series C in connection with a public offering in the United States:States.

10,000,000 Series B ("Series B ADSs") representing 10,000,000 non-cumulative dollar preference shares, Series B; and
12,000,000 Series C ("Series C ADSs") representing 12,000,000 non-cumulative dollar preference shares, Series C.

Each of the respective ADSs represents the right to receive one corresponding preference share, is evidenced by an American Depository Receipt ("ADR") and is listed on the New York Stock Exchange ("NYSE"(“NYSE”) under the ticker symbol “NWPRC”.

The ADRs evidencing the ADSs above were issued pursuant to a Deposit Agreement dated as of 25 September 1991 (which was amended in November 1997), covering both the Series B ADSs and the Series C ADSs, among the Bank, Morgan Guaranty Trust Company of New York as the depository, and all holders from time to time of ADRs issued thereunder. Currently, there is no non-United States trading market for any of the non-cumulative dollar preference shares, although the Series B dollar preference shares, all of which were redeemed in January 2007, were listed on the London Stock Exchange.shares. All of the non-cumulative dollar preference shares are held by the depository, as custodian, in bearer form.

On 4 November 1993, the Bank issued $500 million 7.875% Exchangeable Capital Securities, $25 each, Series A ("Capital Securities") in connection with a public offering in the United States. The Capital Securities were listed on the New York Stock Exchange and all of the Capital Securities were redeemed on 16 January 2006.

 
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The following table shows the high and low sales prices for the Series C ADSs for the period indicated, as reported on the NYSE composite tape:

    
  
Series C
ADSs
 
  $ 
By month   
May 2008High25.44 
 Low25.03 
April 2008High25.25 
 Low24.96 
March 2008High25.35 
 Low24.85 
February 2008High25.75 
 Low25.23 
January 2008High25.45 
 Low24.84 
December 2007High25.40 
 Low24.51 
By quarter   
2008 : First quarterHigh25.75 
 Low24.84 
2007 : Fourth quarterHigh25.65 
 Low24.51 
2007 : Third quarterHigh25.79 
 Low25.15 
2007 : Second quarterHigh25.95 
 Low25.25 
2007 : First quarterHigh25.84 
 Low25.30 
2006 : Fourth quarterHigh26.13 
 Low25.20 
2006 : Third quarterHigh26.05 
 Low25.35 
2006 : Second quarterHigh25.68 
 Low25.20 
2006 : First quarterHigh26.00 
 Low25.46 
    
By year   
2007High25.95 
 Low24.51 
2006High26.13 
 Low25.20 
2005High26.30 
 Low25.42 
2004High26.61 
 Low25.40 
2003High26.83 
 Low26.00 
  Series C
Figures in US$ ADSs
By month  
March 2010High21.43
 Low19.99
February 2010High19.82
 Low18.58
January 2010High19.85
 Low17.60
December 2009High17.78
 Low17.25
November 2009High17.38
 Low15.19
October 2009High16.25
 Low13.25
   
By quarter  
2010: First  quarterHigh21.43
 Low17.60
2009: Fourth quarterHigh17.78
 Low13.25
2009: Third quarterHigh17.67
 Low11.8
2009: Second quarterHigh14.79
 Low7.15
2009: First quarterHigh14.00
 Low3.26
2008: Fourth quarterHigh13.60
 Low5.57
2008: Third quarterHigh22.85
 Low8.20
2008: Second quarterHigh25.44
 Low21.70
2008: First quarterHigh25.75
 Low24.84
   
By year  
2009High25.95
 Low24.51
2008High25.75
 Low5.57
2007High25.95
 Low24.51
2006High26.13
 Low25.20
2005High26.30
 Low25.42


MARKETS

The Series C non-cumulative dollar preference shares and ADSs are listed on the New York Stock Exchange.
 
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ITEM 10. ADDITIONAL INFORMATION

MEMORANDUM AND ARTICLES OF ASSOCIATION

AThe following information is a summary of certain terms of the company’sBank's Memorandum of Association (the “Memorandum”"Memorandum") and Articles of Association (the “Articles”"Articles") as in effect at the date of this annual reportAnnual Report and certain relevant provisions of the Companies Act 1985, as amended2006 (the “Act”“2006 Act”) where appropriate and as relevant to the holders of any class of share is contained in the Company’s Annual Report on Form 20-F for the year ended 31 December 2002, which summary is incorporated by reference into this annual report.share. The following summary description is qualified in its entirety by reference to the terms and provisions of the Memorandum and Articles. The Memorandum and Articles are registered with the Registrar of Companies of England and Wales. Holders of any class of share are encouraged to read the full Memorandum and Articles, which have been filed with the SEC.

Incorporation and registration

The Bank was incorporated and registered in England and Wales under the Companies Act 1948 to 1967 as a limited company on 18 March 1968 under the name National Westminster Bank Limited. On 1 February 1982, it changed its name to its present name and was reregistered under the Companies Act 1948 to 1980 as a public company with limited liability. The Bank is registered under Company No. 929027.

Purpose and objects

The Memorandum provides that the Bank's principal objects are to carry on the business of banking in all its forms. The objects of the Bank are set out in full in paragraph 4 of the Memorandum and in terms of the 2006 Act are now deemed to form part of the Articles.

Directors

At each annual general meeting of the Bank, one third of the directors (or the number nearest to one third) subject to retirement will retire by rotation and be eligible for re-election. The directors to retire will be those who do not wish to stand for re-election and those who have been longest in office since their last appointment or reappointment or, in the case of those who were appointed or reappointed on the same day, will (unless they otherwise agree) be determined by lot.

Directors may be appointed by the Bank by ordinary resolution or by the board. A director appointed by the board holds office only until the next annual general meeting, whereupon he will be eligible for re-election, and is not taken into account in determining the directors who are to retire by rotation at that meeting.

Unless and until otherwise determined by ordinary resolution, the directors (other than alternative directors) shall be not more than twenty five.  There is no stipulation in the Articles regarding a minimum number of directors.

Directors' interests

A director shall not vote at a meeting of the board or a committee of the board on any resolution of the board concerning a matter in which he has an interest (otherwise than by virtue of his interest in shares, debentures or other securities of, or otherwise in or through, the Bank) which (together with any interest of any person connected with him) is, to his knowledge, material unless his interest arises only because the resolution relates to one or more of the following matters:

(i) the giving of any security or indemnity in respect of money lent, or obligations incurred by him or any other person at the request of, or for the benefit of, the Bank or any of its subsidiary undertakings;

(ii) the giving of any security or indemnity to a third party in respect of a debt or obligation of the Bank or any of its subsidiary undertakings for which he has assumed responsibility (in whole or in part) under a guarantee or indemnity or by the giving of security;

(iii) a proposal concerning an offer of shares, debentures or other securities of the Bank, or any of its subsidiary undertakings, for subscription or purchase, in which offer he is, or may be, entitled to participate as a holder of securities or in the underwriting or sub-underwriting of which he is to participate;

(iv) any proposal about any other company if the director, and any person connected with the director under section 252 of the 2006 Act, has a direct or indirect interest of any kind, including holding any position in that company, or being a shareholder of that company. But this does not apply if he knows that he, and any persons connected with him, hold an interest in shares representing 1% or more of any class of equity share capital of the company or the voting rights in the company.

(v) an arrangement for the benefit of the employees of the Bank or any of its subsidiary undertakings which does not award him any privilege or benefit not generally accorded to the employees to whom the arrangement relates; and

(vi) a proposal concerning any insurance which the Bank proposes to purchase and/or maintain for, or for the benefit of, any directors or for persons who include directors of the Bank.

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A director may (or any firm of which he is a partner, employee or member may) act in a professional capacity for the Bank (other than as auditor) and be remunerated for so doing. A director may also be or become a director or other officer of, or be otherwise interested in, any company promoted by the Bank or in which the Bank may be interested and will not be liable to account to the Bank or the members for any benefit received by him.

Under the 2006 Act a director must avoid a situation where he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict, with the company’s interests. The 2006 Act allows directors of public companies, where appropriate, to authorise conflicts and potential conflicts where the articles of association contain a provision to this effect. The 2006 Act also allows the articles of association to contain other provisions for dealing with directors’ conflicts of interest to avoid a breach of duty.

Clause 128.5 of the Articles gives the directors authority to authorise any matter which would or might otherwise constitute or give rise to a breach of the duty of a director under the 2006 Act to avoid a situation in which he has, or can have, a direct or indirect interest that conflicts, or possibly may conflict with the company.

Authorisation of any matter pursuant to Clause 128.5 must be approved in accordance with normal board procedures by directors who have no interest in the matter being considered. In taking the decision, the directors must act in a way they consider, in good faith, will be most likely to promote the company’s success. Any authorisation of a matter may be given on or subject to such conditions or limitations as the directors determine, whether at the time of authorisation or subsequently, including providing for the exclusion of the interested directors from the receipt of information or participation in discussion relating to the matter authorised by the directors and providing that interested directors in receipt of confidential information from a third party are not obliged to disclose such information to the company or use the information in relation to the company’s affairs. Any authorization may be terminated by the directors at any time.

A director is not, except as otherwise agreed by him, accountable to the company for any benefit which he, or a person connected with him, derives from any matter authorised by the directors and any contract, transaction or arrangement relating to such matter is not liable to be avoided on the grounds of such benefit.

Borrowing powers

Subject to the 2006 Act, the directors may exercise all the powers of the Bank to borrow money and to mortgage or charge its undertaking, property and uncalled capital and to issue debentures and other securities, whether outright or as collateral security for any debt, liability or obligation of the Bank, or of any third party.

Classes of shares

The Bank has two general classes of shares, ordinary shares and preference shares, to which the provisions set forth below apply.

Dividends

Ordinary shares
Subject to the provisions of the 2006 Act and any special rights attached to any shares, the holders of the ordinary shares are entitled pari passu amongst themselves, but in proportion to the amounts paid up on the ordinary shares held by them, to share in the profits of the Bank paid out as dividends.

Preference shares
Each preference share confers the right to a non-cumulative preferential dividend payable half-yearly for the sterling preference shares and quarterly for the dollar preference shares. Each preference share confers the right to a preferential dividend (not exceeding a specified amount) payable in the currency of the relevant share. The rate of such dividend and the date of payment thereof, together with the terms and conditions of the dividend are as may be determined by the directors prior to allotment.

The preference shares rank pari passu with each other and any shares expressed to rank, in terms of participation in the profits of the Bank, in some or all respects pari passu therewith and otherwise in priority to dividends payable on the ordinary shares.

Dividends will be declared and paid in full on the preference shares if, in the opinion of the directors of the Bank, the Bank has sufficient distributable profits to cover full payment of dividends on the preference shares (including all dividends accrued on any cumulative preference shares) and all dividends payable at that time on any other shares which rank equally in sharing in profits.

If, in the opinion of the directors, insufficient profits of the Bank are available to cover the payment in full of dividends, dividends will be declared by the directors pro rata on the preference shares to the extent of the available distributable profits.

If any dividend is not payable for the reasons described above, or if payment of any dividend would cause a breach of the UK Financial Services Authority's capital adequacy requirements applicable to the Bank or its subsidiaries, none of that dividend will be declared or paid.

If the whole or part of any dividend on any non-cumulative preference share is not paid for any of the reasons, the directors will, as far as the law allows, allot and issue extra non-cumulative preference shares to the holders of those shares. The condition is that there must be an amount in the Bank's profit and loss account, or in any of the Bank's reserves (including any share premium account and capital redemption reserve), which can be used for paying up the full nominal value of extra non-cumulative preference share.
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The extra shares will be credited as fully paid and in the same currency, have the same rights and restrictions, and rank pari passu with the shares on which the dividend could not be paid in cash. The total nominal value of the extra shares to be allotted will be decided by the directors on allotment. The extra shares will be allotted and issued when the unpaid dividend was due to be paid.

If the Bank does not have sufficient authorised share capital, or the directors do not have the requisite authority to allot the extra shares under section 551 of the 2006 Act, the directors must call a general meeting. The directors will propose resolutions to increase the authorised share capital, or to grant the necessary authority to allot the extra shares.

If the dividend payable on any series of preference shares on the most recent payment date is not paid in full, or if a sum is not set aside to provide for such payment in full, (or, if applicable, extra shares have not been allotted), no dividends may be declared on any other share capital of the Bank that ranks equally with, or behind the preference shares and no sum may be set aside for the payment of a dividend on any other share capital, unless, on the date of declaration, an amount equal to the dividend payable in respect of the then current dividend period for such series of preference shares is set aside for payment in full on the next dividend payment date.

If any dividend payable on the preference shares is not paid in full or if a sum is not set aside to provide for such payment in full, the Bank may not redeem or purchase or otherwise acquire any other share capital of the Bank that ranks equally with, or behind the preference shares and may not set aside any sum nor establish any sinking fund for its redemption, purchase or other such acquisition, until such time as dividends have been declared and paid in full in respect of successive dividend periods together aggregating not less than twelve months.

Voting rights

General
Subject to any rights or restrictions as to voting attaching to any shares or class of shares, on a show of hands every member who is present in person or by proxy at a general meeting shall have one vote and on a poll every member present in person or by proxy shall have one vote for each share held by him. No member shall be entitled to vote at a general meeting or at a separate meeting of the holders of shares in the capital of the Bank, either in person or by proxy, in respect of any share held by him unless all moneys presently payable by him in respect of that share have been paid.

The quorum required for a meeting of members is not less than two members present in person or by proxy and entitled to vote. If a meeting was called by shareholders and adjourned because of the lack of a quorum, it will be dissolved. Any other meeting will be adjourned for one week, reconvening at the same time and in the same place. If there is still no quorum at the adjourned meeting, the shareholders personally present and entitled to vote will be quorum.

Preference shares
The holders of preference shares are not entitled to receive notice of, attend, or vote at any general meeting unless the dividend for that series of preference share has not been paid in full for the dividend period immediately prior to the notice convening the relevant general meeting or the business of the meeting includes the consideration of a resolution for the winding up of the Bank or the sale of the whole of the business of the Bank or any resolution directly affecting any of the special rights or privileges attached to any of the classes of preference shares or other circumstances have arisen which the directors had set out before a series of preference shares was first allotted.

Distribution of assets on liquidation

Ordinary shares
On a winding-up of the Bank, the liquidator may, with the authority of an extraordinary resolution and any other sanction required by the Insolvency Act 1986 and subject to the rights attaching to any class of shares after payment of all liabilities, including the payment to holders of preference shares, divide amongst the members according to the number of ordinary shares held by them in specie the whole or any part of the assets of the Bank or vest the whole or any part of the assets in trustees upon such trusts for the benefit of the members and may determine the scope and terms of those trusts. No member shall be compelled to accept any assets on which there is a liability.

Preference shares
In the event of a return of capital on a winding-up or otherwise, the holders of cumulative preference shares are entitled to receive out of the surplus assets of the Bank available for distribution amongst the members in priority to the holders of the ordinary shares, the amount paid up or credited as paid up on such shares together with any premium paid on issue and the arrears of any dividends including the amount of any dividend due for payment after the date of commencement of any winding-up or liquidation.

Redemption

Unless the directors determine, prior to allotment of any particular series of preference shares, that some or all of such series shall be non-redeemable, the preference shares will be redeemable at the option of the Bank on any date (a 'Redemption Date') which (subject to certain exceptions described in the terms of such shares) falls no earlier than such date (if any) as may be fixed by the directors, prior to allotment of such shares. On redemption, there shall be paid on each preference share the aggregate of its nominal amount together with any premium paid on issue, where applicable a redemption premium and accruals of dividend.

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If the Bank is only going to redeem some of a series of preference shares, it will arrange for a draw to decide which shares to redeem. This will be drawn at the registered office of the Bank, or at any other place which the directors decide on. The auditors of the Bank must be present at the draw.

Purchase

Subject to the 2006 Act, the Bank may, by special resolution, reduce its share capital, any capital redemption reserve and any share premium account and may also, subject to the 2006 Act, the requirements of the London Stock Exchange and the rights attached to any class of shares, purchase its own shares (including redeemable shares). The shares can be purchased upon such terms and conditions as the directors shall determine and can be bought back through the market, by tender or by private arrangement.

Conversion rights

If any preference shares are issued which can be converted into ordinary shares, or into any other class of shares which rank equally with, or behind, existing preference shares these are called 'convertible preference shares'.

The directors can decide to redeem any convertible preference shares at their nominal value. The redemption must be made out of the proceeds of a fresh issue of ordinary shares or any other shares which they can be converted into. When the convertible preference shares become due to be converted they will give their holders the right and obligation to subscribe for the number of ordinary shares, or other shares, set by the terms of the convertible preference shares. The new shares will be subscribed for at the premium (if any) which is equal to the redemption money, less the nominal amount of the new shares. Each holder of convertible preference shares will be treated as authorising and instructing the company secretary, or anybody else the directors decide on, to subscribe for the shares in this way.

Changes in share capital and variation of rights

Subject to the provisions of the 2006 Act and without prejudice to any rights attached to any existing shares or class of shares, any share may be issued with such rights or restrictions as the Bank may by ordinary resolution determine or, subject to and in default of such determination, as the board shall determine. Subject to the provisions of the 2006 Act, the Bank may issue shares which are, or at the option of the Bank or the holder are liable, to be redeemed. Subject to the provisions of the 2006 Act and the Articles, unissued shares are at the disposal of the board.

The Bank may by ordinary resolution: increase its share capital; consolidate and divide all or any of its share capital into shares of larger amount than its existing shares; subject to the provisions of the 2006 Act, subdivide its shares, or any of them, into shares of smaller amount than is fixed by the Memorandum; or cancel any shares which have not been taken or agreed to be taken by any person and diminish the amount of its share capital by the amount of the shares so cancelled.

Subject to the 2006 Act, the Bank may by special resolution reduce its share capital, capital redemption reserve or share premium account in any way. The capital paid up on the preference shares cannot be reduced unless the holders of such preference shares have approved this by passing an extraordinary resolution at a separate meeting.

Subject to the provisions of the 2006 Act, if at any time the capital of the Bank is divided into different classes of shares, the special rights attached to any class of shares may (unless further conditions are provided by the terms of issue of the shares of that class) be varied or abrogated, whether or not the Bank is being wound up, either with the consent in writing of the holders of three-quarters in nominal value of the issued shares of the class or with the sanction of an extraordinary resolution passed at a separate general meeting of holders of the shares of the class (but not otherwise).

To any such separate general meeting the provision of the Articles relating to general meetings will apply, save that:

(i) at least two people who hold, or who act as proxies for, at least one third of the total nominal value of the existing shares of the class will form a quorum. However, if at any adjourned meeting of such holders, a quorum as defined above is not present, one person who holds shares of the class, or his proxy, will be a quorum; and

(ii) any such holder present in person or by proxy may demand a poll.

The rights attaching to any class of shares having preferential rights are not, unless otherwise expressly provided by the terms of issue thereof, deemed to be varied by the creation or issue of further shares ranking, as regards participation in the profits or assets of the Bank, pari passu therewith, but in no respect in priority thereto.


Disclosure of interests in shares

The 2006 Act gives the Bank the power to require persons who it believes to be, or have been within the previous three years, interested in its shares, to disclose prescribed particulars of those interests. Failure to supply the information or supplying a statement which is materially false may lead to the board imposing restrictions upon the relevant shares.
The restrictions available are the suspension of voting or other rights conferred by membership in relation to meetings of the Bank in respect of the relevant shares and, additionally, in the case of a shareholding representing at least 0.25 per cent. of the class of shares concerned, the withholding of payment of dividends on, and the restriction of transfers of, the relevant shares.

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Limitations on rights to own shares

There are no limitations imposed by English Law or the Memorandum and Articles on the right of non-residents or foreign persons to hold or vote the Bank's shares other than the limitations that would generally apply to all of the Bank's shareholders.

Members resident abroad

Members with registered addresses outside the United Kingdom are not entitled to receive notices from the Bank unless they have given the Bank an address within the United Kingdom at which such notices may be served.

Certain other UK law provisions

Pre-emptive rights
As the Bank is a public company incorporated in Great Britain and registered in England and Wales, in general, holders of ordinary shares have automatic pre-emptive rights pursuant to section 561 of the 2006 Act.

Lien and forfeiture
The Bank will have a first and paramount lien (enforceable by sale) on every partly paid share (including dividends payable on such a share) for all moneys payable to the Bank in respect of that share. The board may call any moneys unpaid on shares and may forfeit shares on which calls payable are not duly paid. The forfeiture shall include all dividends payable in respect of the forfeited shares, which have not been paid before the forfeiture.

Untraced shareholders
The Bank shall be entitled to sell, at the best price reasonably obtainable, the shares of a member or the shares to which a person is entitled by transmission if:

(i) during a period of 12 years prior to the date of advertising its intention to sell such shares at least three cash dividends in respect of such shares have become payable but all dividends or other moneys payable remain unclaimed;

(ii) as soon as practicable after the expiry of the period referred to in sub-paragraph (i) above, the Bank inserts advertisements in a leading London daily newspaper and one newspaper circulating in the area of the last known address of the member or other person giving notice of its intention to sell the shares;

(iii) during the period referred to in sub-paragraph (i) above and the period of three months following the publication of the advertisements referred to in sub-paragraph (ii) above, the Bank receives no indication of the whereabouts or existence of the member or other person; and

(iv) if the shares are listed on the London Stock Exchange, the Bank gives notice to the London Stock Exchange of its intention to sell the shares prior to publication of the advertisements.

The net proceeds of such sale shall belong to the Bank, which shall be obliged to account to the former member or other person previously entitled to the shares for an amount equal to the proceeds as a creditor of the Bank.

MATERIAL CONTRACTS

The Bank and its subsidiaries are party to various contracts in the ordinary course of business. In the year ended 31 December 2007,2009, there have been no material contracts entered into outside the ordinary course of business.

EXCHANGE CONTROLS

The Bank has been advised that there are currently no UK laws, decrees or regulations which would prevent the import or export of capital, including the availability of cash or cash equivalents for use by the NatWest Group, or the remittance of dividends or other payments to non-UK resident holders of the Bank's non-cumulative dollar preference shares.

There are no restrictions under the Articles of Association of the Bank or under UK law, as currently in effect, which limit the right of non-UK resident owners to hold or, when entitled to vote, freely to vote the Bank's non-cumulative dollar preference shares.

TAXATION FOR US HOLDERS

The following discussion summarises certain US federal and UK tax consequences of the ownership and disposition of non-cumulative dollar preference shares or ADSs by a beneficial owner of non-cumulative dollar preference shares or ADSs that is for US federal income tax purposes (i) a citizen or resident of the United States, (ii) a corporation, or other entity taxable as a corporation, created or organised under the laws of the United States or any State thereof, or (iii) a trust or an estate the income of which is subject to US federal income tax without regard to its source, andin each case that holds such non-cumulative dollar preference shares or ADSs as capital assets (a "US Holder").

73
This summary does not address the tax consequences to a US Holder (i) that is resident (or, in the case of an individual, ordinarily resident) in the UK for UK tax purposes, (ii) that carries on a trade, profession or vocation in the UK through a branch, agency or permanent establishment in connection with which their non-cumulative dollar preference shares or ADSs are held, used or acquired, or generally, (ii)or (iii) that is a corporation which alone or together with one or more associated companies, controls, directly or indirectly, 10% or more of the voting stock of the Bank.Bank, nor does this summary address the tax consequences to US Holders subject to special rules, such as certain financial institutions, dealers or traders in securities who use a mark-to-market method of tax accounting, persons holding ordinary shares, non-cumulative dollar preference shares or ADSs as part of a hedging transaction, straddle, wash sale, conversion transaction or integrated transaction or persons entering into a constructive sale with respect to such securities, persons whose functional currency for US federal income tax purposes is not the US dollar, entities classified as partnerships for US federal income tax purposes or tax-exempt entities.

The statements and practices set forth below regarding US and UK tax laws (including the US/UK double taxation convention relating to income and capital gains which entered into force on 31 March 2003 (the “Treaty”) and the US/UK double taxation convention relating to estate and gift taxes (the "Estate Tax Treaty")) are based on those laws and practices as in force and as applied in practice on the date of this Report, which are subject to change, possibly with retroactive effect. This summary is not exhaustive of all possible tax considerations and holders are advised to satisfy themselves as to the overall tax consequences, including specifically the consequences under US federal, state, local and other laws, of the acquisition, ownership and disposition of non-cumulative dollar preference shares or ADSs by consulting their own tax advisers.

For the purposes of the Treaty and the Estate Tax Treaty and for purposes of the US Internal Revenue Code of 1986, as amended (the "Code"), US Holders of ADSs will be treated as owners of the non-cumulative dollar preference shares underlying such ADSs.
 
41
Table of ContentsThe following discussion assumes that the Bank is not, and will not become, a passive foreign investment company (PFIC).

 
Preference shares or ADSs

Taxation of dividends

The Bank is not required to withhold UK tax at source from dividend payments it makes or from any amount (including any amounts in respect of accrued dividends) distributed by the Bank on a redemption or winding-up. US Holders who are not resident or ordinarily resident in the UK and who do not carry on a trade, profession or vocation in the UK through a branch, agency or permanent establishment in connection with which their non-cumulative dollar preference shares or ADSs are held, used or acquired will not be subject to UK tax in respect of dividends received.

DistributionsFor U.S. federal income tax purposes distributions will constitute foreign source dividend income to the extent paid out of the Bank’s current or accumulated earnings and profits, as determined forunder US federal income tax purposes. principles. Because the Bank does not maintain calculations of its earnings and profits under US federal income tax principles, it is expected that distributions will be reported to US Holders as dividends. Distributions will not be eligible for the dividends-receiveddividends received deduction generally allowed to corporate US Holders.

Subject to applicable limitations that may vary depending on a holder’s individual circumstances, dividends paid to certain non-corporate US Holders in taxable years beginning before 1 January 2011 will be taxablesubject to U.S. federal income tax at a maximum rate of 15%. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at this favourable rate.

Taxation of capital gains

Subject to the provisions set out in the next paragraph in relation to temporary non-residents, a US Holder that is not resident (or, in the case of an individual, ordinarily resident) in the UK and does not carry on a trade, profession or vocation in the UK through a branch, agency or permanent establishment through which the non-cumulative dollar preference share or ADS is used, held or acquired will not normally be liable for UK tax on gains realized on the disposal of such holder's non-cumulative dollar preference share or ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a branch or agency and such non-cumulative dollar preference share or ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), permanent establishment, branch or agency, in which case such US Holder might, depending on the circumstances, be liable to UK tax on gains realized on the disposal of such holder’s non-cumulative dollar preference share or ADS.

An individual US Holder who has ceased to be resident or ordinarily resident for UK tax purposes in the UK for a period of less than five years of assessment and who disposes of a non-cumulative dollar preference share or ADS during that period may, forin the year of assessment when that individual returns to the UK, be liable to UK taxation on chargeable gains arising during the period of absence, subject to any available exemption or relief.

A US Holder will, upon the sale, exchange or redemption of a non-cumulative dollar preference share or ADS representing preference shares, generally recognise capital gain or loss for US federal income tax purposes (assuming in the case of a redemption, that such US Holder does not own, and is not deemed to own, any ordinary shares of the Bank) in an amount equal to the difference between the amount realised (excluding any declared but unpaid dividends, which will be treated as a dividend for US federal income tax purposes) and the US Holder's tax basis in the non-cumulative dollar preference share or ADS. Gain or loss will generally be US source and will be long-term capital gain or loss if the US Holder held the non-cumulative dollar preference share or ADS for more than one year.

A US Holder who is liable for both UK and US tax on a gain recognised on the disposal of a non-cumulative dollar preference share or ADS will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.

US Holders should consult their tax advisers regarding the US federal income tax treatment of capital gains (which may be taxed at lower rates than ordinary income for certain non-corporate taxpayers) and losses (the deductibility of which is subject to limitations).

Finance (No. 2) Act 2005
If a corporate US Holder is subject to UK corporation tax by reason of carrying on a trade in the UK through a permanent establishment and such US Holder’s non-cumulative dollar preference share or ADS is, or has been, used, held or acquired for the purpose of that permanent establishment, certain provisions introduced by the Finance (No. 2) Act 2005 may apply if the US Holder holds its non-cumulative dollar preference share or ADS for a 'tax avoidance purpose'. If these provisions apply, dividends on the non-cumulative dollar preference share or ADS, as well as certain fair value credits and debits arising in respect of such non-cumulative dollar preference share or ADS, may be brought within the charge to UK corporation tax on income and the UK tax position outlined in the proceeding paragraphs under the sub-heading “Taxation of Capital Gains” in relation to such US Holder will not apply.
42
Estate and gift tax

A non-cumulative dollar preference share or ADS beneficially owned by an individual, whose domicile is determined to be the United States for the purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual's death or on a lifetime transfer of the non-cumulative dollar preference share or ADS, except in certain cases where the non-cumulative dollar preference share or ADS (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where a non-cumulative dollar preference share or ADS is subject both to UK inheritance tax and to US federal estate or gift tax.

74
UK stamp duty and stamp duty reserve tax (“SDRT”)

The following is a summary of the UK stamp duty and SDRT consequences of transferring an ADS evidenced by an ADR in registered form (otherwise than to the custodian on cancellation of the ADS). It does not set out the UK stamp duty or SDRT consequences of transferring, or agreeing to transfer, non-cumulative dollar preference shares or any interest therein or right thereto (other than interests in ADSs evidenced by ADRs) on which investors should consult their own tax advisers.

A transfer of an ADS evidenced by an ADR in registered form executed and retained in the US will not give rise to stamp duty and an agreement to transfer an ADS or ADR in registered form will not give rise to SDRT.

4375
 
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK


Risk management is conducted on an overall basis within the RBS Group. The financial risk management objectives and policies of the RBS Group and information on NatWest Group’s exposure to price, credit, liquidity and cash flow risk are contained in Note 29 on the financial statements, included'Risk, capital and liquidity management' set out in Item 18 of this Annual Report on Form 20-F.5 (pages 37 to 60).


ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
ADR Payment Information
Category (as defined by SEC)
Depositary Actions
Associated Fee
(a) Depositing or substituting the underlying shares
Each person to whom ADRs are issued against deposits of Shares, including deposits and issuances in respect of:
●    Share distributions, stock split, rights, merger
●    Exchange of securities or any other transaction or event or other distribution affecting the ADSs or the Deposited Securities
USD 5.00 for each 100 ADSs (or portion thereof) evidenced by the new ADRs delivered
(b) Receiving or distributing dividends
Distribution of dividendsUSD 0.02 or less per ADS
(c) Selling or exercising rights
Distribution or sale of securities, the fee being in an amount equal to the fee for the execution and delivery of ADSs which would have been charged as a result of the deposit of such securities
USD 5.00 for each 100 ADSs (or portion thereof)
(d) Withdrawing an underlying securityAcceptance of ADRs surrendered for withdrawal of deposited securities
USD 5.00 for each 100 ADSs (or portion thereof) evidenced by the ADRs surrendered
(e) Transferring, splitting or grouping receipts;Transfers, combining or grouping of depositary receipts
USD 2.50 per ADS USD 0.02 per ADS (or portion thereof)not more than once each calendar year and payable at the sole discretion of the depositary by billing Holders or by deducting such charge from one or more cash dividends or other cash distributions
(f) General depositary services, particularly those charged on an annual basis.
●    Other services performed by the depositary in administering the ADRs
●    Provide information about the depositary’s right, if any, to collect fees and charges by offsetting them against dividends received and deposited securities
USD 0.02 per ADS (or portion thereof) not more than once each calendar year and payable at the sole discretion of the depositary by billing Holders or by deducting such charge from one or more cash dividends or other cash distributions
(g) Expenses of the depositary
Expenses incurred on behalf of Holders in connection with
●    Compliance with foreign exchange control regulations or any law or regulation relating to foreign investment
●    The depositary’s or its custodian’s compliance with applicable law, rule or regulation
●    Stock transfer or other taxes and other governmental charges
●    Cable, telex, facsimile transmission/delivery
●    Expenses of the depositary in connection with the conversion of foreign currency into U.S. dollars (which are paid out of such foreign currency)
Any other charge payable by depositary or its agents
Expenses payable at the sole discretion of the depositary by billing Holders or by deducting charges from one or more cash dividends or other cash distributions.
From 1 January 2009 to 26 April 2010, the Bank received no fees from the depositary for continuing annual stock exchange listing fees, standard out-of-pocket maintenance costs for the ADRs, any applicable performance indicators relating to the ADR facility, underwriting fees and legal fees.
4476


ITEM 15. CONTROLS AND PROCEDURESPROCEURES


Disclosure controls and procedures
As required by US regulations, the effectiveness of the Company’s disclosure controls and procedures (as defined in the rules under the US Securities Exchange Act of 1934) have been evaluated. This evaluation has been considered and approved by the Board which has instructed the Group Chief Executive and the Group Finance Director to certify that as at 31 December 2007,2009, the Company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the Company and its consolidated subsidiaries would be made known to them by others within those entities.

Internal Control
Management of NatWest Group is responsible for NatWest Group’s system of internal control that is designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. In devising internal controls, NatWest Group has regard to the nature and extent of the risk, the likelihood of it crystallising and the cost of controls. A system of internal control is designed to manage, but not eliminate, the risk of failure to achieve business objectives and can only provide reasonable, and not absolute, assurance against the risk of material misstatement, fraud or losses.

Management’s report on internal control over financial reporting
Management of NatWest Group is responsible for establishing and maintaining adequate internal control over financial reporting for NatWest Group.

NatWest Group’s internal control over financial reporting is a component of an overall system of internal control. NatWest Group’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the preparation, reliability and fair presentation of financial statements for external purposes in accordance with International Financial Reporting Standards (“IFRS”) and it includes:

·  Policies and procedures that relate to the maintenance of records, that in reasonable detail, fairly and accurately reflect the transactions and disposition of assets.

·  Controls providing reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with IFRS, and that receipts and expenditures are being made only as authorised by management.

·  Controls providing reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use or disposition of assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or because the degree of compliance with policies or procedures may deteriorate.

Management assessed the effectiveness of NatWest Group’s internal control over financial reporting as of 31 December 20072009 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘’Internal Control – Integrated Framework’’.

Based on its assessment, management believes that, as of 31 December 2007,2009, NatWest Group’s internal control over financial reporting is effective.

This annual report does not include an attestation report of the company's registered public accounting firm regarding internal control over financial reporting. Management's report wasThe internal controls over financial reporting were not subject to attestation by the company's registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management's report in this annual report.

Changes in internal controls
There was no change in the Company’s internal control over financial reporting that occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.


4577
 
ITEM 16G: CORPORATE GOVERNANCE

As a foreign issuer with American Depositary Shares (ADS) representing preference shares listed on the New York Stock Exchange (NYSE), the Company must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under the NYSE’s corporate governance listing standards. In addition, the Company must comply with the relevant provisions of the listing standards that relate to the composition, responsibilities and operation of audit committees. These provisions incorporate the relevant rules concerning audit committees of the US Securities Exchange Act of 1934.

The Company has reviewed its corporate governance arrangements and is satisfied that these are consistent with the NYSE’s corporate governance listing practices, with the exception that the Chairman of the Board is Chairman of the Nominations Committee which is permitted by the UK Combined Code (since the Chairman was considered independent on appointment). The Company’s Audit, Nomination and Remuneration Committees are otherwise composed solely of non-executive directors deemed by the Board to be independent. The NYSE’s corporate governance listing standards also require that a compensation committee has direct responsibility to review and approve Natwest Group Chief Executive remuneration. The Board, rather than the Remuneration Committee, reserves the authority to make the final determination of the remuneration of the Natwest Group Chief Executive.

The Natwest Group Audit Committee complies with the provisions of the NYSE’s corporate governance listing standards that relate to the composition, responsibilities and operation of audit committees.
78
ITEM 18. CONSOLIDATED FINANCIAL STATEMENTS

CONTENTS
 Page
Statement of directors' responsibilities
4780
Report of independent registered public accounting firm
48
81
Consolidated income statement for the year ended 31 December 2007
2009
49
82
Balance sheets at 31 December 2007
50
StatementsConsolidated statement of recognisedcomprehensive income and expense for the year ended 31 December 2007
2009
51
83
Balance sheets at 31 December 2009
84
Statements of changes in equity for the year ended 31 December 200985
Cash flow statements for the year ended 31 December 20072009
52
86
Accounting policies
5387
Notes on the accounts
64
96
  1 Net interest income96
  2 Non-interest income96
  3 Operating expenses97
  4 Pension costs98
  5 Auditors’ remuneration102
  6 Tax102
  7 Dividends to preference shareholders102
  8 Ordinary dividends103
  9 (Loss)/profit dealt with in the accounts of the Bank103
  10 Financial instruments103
  11 Financial assets – impaired assets115
  12 Derivatives117
  13 Debt securities119
  14 Equity shares120
  15 Investments in Group undertakings121
  16 Intangible assets122
  17 Property, plant and equipment125
  18 Prepayments, accrued income and other assets127
  19 Settlement balances and short positions127
  20 Accruals, deferred income and other liabilities127
  21 Deferred taxation128
  22 Subordinated liabilities129
  23 Minority interests133
  24 Share capital and reserves133
  25 Leases134
  26 Collateral and securitisations135
  27 Capital resources136
  28 Memorandum items137
  29 Net cash inflow/(outflow) from operating activities142
  30 Analysis of the net investment in business interests and intangible assets142
  31 Interest received and paid143
  32 Analysis of changes in financing during the year143
  33 Analysis of cash and cash equivalents143
  34 Segmental analysis144
  35 Directors’ and key management remuneration149
  36 Transactions with directors and key management150
  37 Related parties151
  38 Ultimate holding company152
  39 Post balance sheet events152
Additional information153

79
Statement of directors’ responsibilities
 
 


46

Statement of directors' responsibilities
The directors are required by Article 4 of the IAS Regulation (European Commission Regulation No 1606/2002) to prepare Group accounts and, as permitted by the Companies Act 1985 have elected to prepare Bank accounts for each financial year in accordance with International Financial Reporting Standards as adopted by the European Union. They are responsible for preparing accounts that present fairly the financial position, financial performance and cash flows of the Group and the Bank. In preparing those accounts, the directors are required to:

The directors are required by Article 4 of the IAS Regulation (European Commission Regulation No 1606/2002) to prepare Group accounts, and as permitted by the Companies Act 2006 have elected to prepare Bank accounts, for each financial year in accordance with International Financial Reporting Standards as adopted by the European Union. They are responsible for preparing accounts that present fairly the financial position, financial performance and cash flows of the Group and the Bank. In preparing those accounts, the directors are required to:
•     
select suitable accounting policies and then apply them consistently;
 
•     make judgements and estimates that are reasonable and prudent;
 
•     state whether applicable accounting standards have been followed, subject to any material departures disclosed and explained in the accounts; and
 
•     prepare the accounts on the going concern basis unless it is inappropriate to presume that the Bankbank will continue in business.

The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Bank and to enable them to ensure that the Annual report and accounts complies with the Companies Act 1985. They are also responsible for safeguarding the assets of the Bank and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.

By order of the Board.
The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the Bank and to enable them to ensure that the Annual Report and Accounts complies with the Companies Act 2006. They are also responsible for safeguarding the assets of the Bank and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities.
By order of the Board
 
 
 
Miller McLean
Secretary
2831 March 20082010

We, the directors listed below, confirm that to the best of our knowledge:
the financial statements, prepared in accordance with International Financial Reporting Standards, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Bank and the undertakings included in the consolidation taken as a whole; and
the Financial review, which is incorporated into the Directors’ report, includes a fair review of the development and performance of the business and the position of the Bank and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face.
 
By order of the Board 
Philip Hampton Stephen Hester Bruce Van Saun
Chairman
Group Chief Executive
Group Finance Director
4731 March 2010
Board of directors
Table of ContentsChairman
Executive directors
Non-executive directors
Philip Hampton Stephen Hester Colin Buchan 
Gordon Pell Sandy Crombie 
Bruce Van Saun Penny Hughes 
Archie Hunter 
Joe MacHale 
John McFarlane 
Arthur ‘Art’ Ryan 
Philip Scott 
80
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM to the members of National Westminster Bank Plc

We have audited the accompanying consolidated balance sheets of National Westminster Bank Plc (a wholly owned subsidiary of The Royal Bank of Scotland Group plc) and its subsidiaries (together the “Group”) for the year ended 31 December 2009 which comprise the accounting policies, the consolidated balance sheets as at 31 December 2009 and 2008, the consolidated income statements, the consolidated statements of  comprehensive income, the consolidated statements of changes in equity and the consolidated cash flow statements for each of the three years in the period ended 31 December 2009, the related Notes 1 to 39 and the information identified as ‘audited’ in the Risk, capital and liquidity management section of the Business review.  These financial statements are the responsibility of the Group’s directors.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Group as at 31 December 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended 31 December 2009, in conformity with International Financial Reporting Standards (“IFRS”) as adopted for use in the European Union and IFRS as issued by the International Accounting Standards Board.



\s\ Deloitte LLP
London, United Kingdom
31 March 2010
81

Report of Independent Registered Accounting Firm Consolidated income statementto the members of National Westminster Bank Plc

We have audited the financial statements of National Westminster Bank Plc ("the Bank") and its subsidiaries (together "the Group") for the year ended 31 December 2007 which comprise the accounting policies, the balance sheets as at 31 December 2007 and 2006, the consolidated income statement, the cash flow statements, the statements of recognised income and expense for each of the three years in the period ended 31 December 2007 and the related Notes 1 to 42. These financial statements have been prepared under the accounting policies set out therein.2009
Respective responsibilities of directors and auditors
The directors' responsibilities for preparing the annual report, and the financial statements in accordance with applicable law and International Financial Reporting Standards (IFRS) as adopted by the European Union are set out in the statement of directors' responsibilities.
Our responsibility is to audit the financial statements in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland).
We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements have been properly prepared in accordance with the Companies Act 1985 and as regards the Group's consolidated financial statements, Article 4 of the IAS Regulation. We also report to you whether in our opinion, the information given in the directors' report is consistent with the financial statements.
In addition we report to you if, in our opinion, the Bank has not kept proper accounting records, we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors' remuneration and other transactions is not disclosed.
We read the other information contained in the Annual Report and Accounts 2007 as described in the contents section and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information outside the Annual Report and Accounts 2007.
Basis of audit opinion
We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board and with the standards of the Public Company Accounting Oversight Board (United States). An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the financial statements and of whether the accounting policies are appropriate to the circumstances of the Bank and the Group, consistently applied and adequately disclosed.

We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion, we also evaluated the overall adequacy of the presentation of information in the financial statements.
The Group is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Group's internal control over financial reporting. Accordingly, we express no such opinion.
UK Opinion
In our opinion:

•  the Group financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union, of the state of the Group's affairs as at 31 December 2007 and of its profit and cash flows for the year then ended;
 
•  the Bank financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union as applied in accordance with the provisions of the Companies Act 1985, of the state of affairs of the Bank as at 31 December 2007;
     2009  2008  2007 
  Note  £m  
£m
  
£m
 
Interest receivable      6,451   12,373   12,178 
Interest payable 
     (3,254)   (6,976)   (7,087) 
Net interest income 
  1   3,197   5,397   5,091 
Fees and commissions receivable 
      4,079   4,367   4,226 
Fees and commissions payable 
      (1,241)   (1,178)   (1,036) 
Income/(loss) from trading activities 
      1,454   (963)   (360) 
Gain on redemption of own debt 
      381   —   — 
Other operating income 
      1,404   81   433 
Non-interest income 
  2   6,077   2,307   3,263 
Total income 
      9,274   7,704   8,354 
Staff costs  – excluding curtailment gains 
      (1,749)   (1,402)   (1,567) 
  – pension schemes curtailment gains 
      544   —   — 
Premises and equipment 
      (407)   (331)   (267) 
Other administrative expenses 
      (2,147)   (2,516)   (2,322) 
Depreciation and amortisation 
      (247)   (237)   (264) 
Write-down of goodwill and other intangible assets 
      —   (716)   — 
Operating expenses 
  3   (4,006)   (5,202)   (4,420) 
Profit before impairment losses 
      5,268   2,502   3,934 
Impairment losses 
  11   (4,139)   (1,362)   (849) 
Operating profit before tax 
      1,129   1,140   3,085 
Tax credit/(charge) 
  6   5   (599)   (768) 
Profit for the year 
      1,134   541   2,317 
  
Profit attributable to: 
                
Minority interests 
  23   —   93   89 
Ordinary shareholders 
      1,134   448   2,228 
��      1,134   541   2,317 
 
•  
the financial statements have been properly prepared in accordance with the Companies Act 1985 and, as regards the Group financial statements, Article 4 of the IAS Regulation; and
The accompanying notes on pages 96 to 152, the accounting policies on pages 87 to 95 and the audited sections of the ‘Financial review: Risk, capital and liquidity management’ on pages 37 to 60 form an integral part of these financial statements.
 
•  the information given in the directors' report is consistent with the financial statements.

Separate opinion in relation to IFRS
As explained in the accounting policies, the Group, in addition to complying with its legal obligation to comply with IFRS as adopted by the European Union, has also complied with IFRS as issued by the International Accounting Standards Board (IASB).
In our opinion the financial statements give a true and fair view, in accordance with IFRS, of the state of the Group's affairs as at 31 December 2007 and of its profit and cash flows for the year then ended.
US opinion
In our opinion, the financial statements present fairly, in all material respects, the financial position of the Group as at 31 December 2007 and 2006 and the results of its operations and its cash flows for each of the three years in the period ended 31 December 2007, in accordance with IFRS as adopted for use in the European Union and IFRS as issued by the IASB.
Deloitte & Touche LLP
Chartered Accountants and Registered Auditors
Edinburgh, United Kingdom
28 March 2008


82
48


Consolidated income statementfor the year ended 31 December 2007


           2005
     2007  2006  Discontinued*  Continuing 
  Note   £m   £m   £m   £m 
Interest receivable     12,178   9,825   203   8,289 
Interest payable     (7,087)  (5,376)  9   (4,040)
Net interest income     5,091   4,449   212   4,249 
Fees and commissions receivable     4,226   3,928   43   3,663 
Fees and commissions payable     (1,036)  (960)  (34)  (926)
(Loss)/income from trading activities  1   (360)  1,458   –    808 
Other operating income      433   451   –    635 
Non-interest income      3,263   4,877   9   4,180 
Total income      8,354   9,326   221   8,429 
Staff costs      1,567   1,754   –    1,477 
Premises and equipment      267   266   –    114 
Other administrative expenses      2,322   2,741   70   2,440 
Depreciation and amortisation      264   257   –    382 
Operating expenses  2   4,420   5,018   70   4,413 
Profit before impairment losses      3,934   4,308   151   4,016 
Impairment losses  11   849   852   4   752 
Operating profit before tax      3,085   3,456   147   3,264 
Tax  5   768   831   44   904 
Operating profit after tax      2,317   2,625   103   2,360 
Discontinued operations      –    –        103 
Profit for the year      2,317   2,625       2,463 
                     
                     
Profit attributable to:                    
Minority interests      89   39       17 
Ordinary shareholders      2,228   2,586       2,446 
       2,317   2,625       2,463 

*  the Group transferred its home mortgage finance business, National Westminster Home Loans Limited, to The Royal Bank of Scotland plc on 31 December 2005 at neither a profit nor a loss.




Balance sheets at 31 December 2007


     Group  Bank 
     2007  2006  2007  2006 
  Note   £m   £m   £m   £m 
Assets                   
Cash and balances at central banks     1,363   1,525   1,006   876 
 Treasury and other eligible bills subject to repurchase agreements  27   1,974   225   –    –  
 Other treasury and other eligible bills      47   50   –    –  
Treasury and other eligible bills  9   2,021   275   –    –  
Loans and advances to banks  9   71,449   61,563   27,296   25,006 
Loans and advances to customers  9   188,976   182,411   115,632   109,496 
 Debt securities subject to repurchase agreements  27   31,970   29,346   –     –   
 Other debt securities      3,946   2,922   31   42 
Debt securities  13   35,916   32,268   31   42 
Equity shares  14   1,110   1,158   18   50 
Investments in Group undertakings  15   –     –     6,052   6,758 
Settlement balances      2,700   3,574   –     –   
Derivatives  12   3,575   2,746   1,588   1,400 
Intangible assets  16   1,244   1,209   375   359 
Property, plant and equipment  17   1,514   1,719   908   1,009 
Prepayments, accrued income and other assets  18   2,414   2,213   879   705 
Total assets      312,282   290,661   153,785   145,701 
                     
Liabilities                    
Deposits by banks  9   44,861   46,258   6,324   6,438 
Customer accounts  9   205,519   181,219   132,248   125,095 
Debt securities in issue  9   20,923   14,335   9   29 
Settlement balances and short positions  19   14,955   24,274   –     –   
Derivatives  12   3,251   2,343   1,352   1,145 
Accruals, deferred income and other liabilities  20   3,417   4,108   1,091   1,231 
Retirement benefit liabilities  3   1,322   1,298   1,124   1,110 
Subordinated liabilities  22   5,932   5,641   4,244   4,583 
Total liabilities      300,180   279,476   146,392   139,631 
                     
 Equity                    
 Minority interests  23   1,314   1,012   –     –   
 Shareholders' equity                    
Called up share capital  24   1,678   1,678   1,678   1,678 
Reserves  25   9,110   8,495   5,715   4,392 
Total equity      12,102   11,185   7,393   6,070 
                     
Total liabilities and equity      312,282   290,661   153,785   145,701 

The accounts were approved by the Board of directors on 28 March 2008 and signed on its behalf by:
 
Sir Tom McKillop
Chairman
Sir Fred Goodwin
Group Chief Executive
Guy Whittaker
Group Finance Director
Financial statements
 
50
TableConsolidated statement of Contentscomprehensive income


Statements of recognised income and expensefor the year ended 31 December 20072009
 
  2009  2008  2007 
  £m  £m  £m 
Profit for the year 
  1,134   541   2,317 
  
Other comprehensive income: 
            
Available-for-sale financial assets 
  43   (51)   2 
Cash flow hedges 
  (42)   (36)   (20) 
Currency translation 
  (795)   1,978   247 
Other comprehensive (loss)/income before tax 
  (794)   1,891   229 
Tax 
  (2)   20   7 
Other comprehensive (loss)/income after tax 
  (796)   1,911   236 
Total comprehensive income for the year 
  338   2,452   2,553 
  
  
Total comprehensive income recognised in the statement of changes in equity is attributable as follows: 
  
Minority interests 
  (41)   105   88 
Ordinary shareholders 
  379   2,347   2,465 
   338   2,452   2,553 
The accompanying notes on pages 96 to 152, the accounting policies on pages 87 to 95 and the audited sections of the ‘Financial review: Risk, capital and liquidity management’ on pages 37 to 60 form an integral part of these financial statements.
83
 

  Group  Bank 
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
Available-for-sale investments                        
Net valuation gains taken direct to equity  87   81   38   40   44   33 
Net profit taken to income on sales  (85)  (55)  (324)  (72)  –    (320)
                         
Cash flow hedges                        
Net (losses)/gains taken direct to equity  –    (2)  –    (9)  13   (39)
Net gains taken to earnings  (20)  (39)  (28)  (13)  (28)  (13)
                         
Exchange differences on translation of foreign operations  247   (491)  180   2   6   (5)
Income/(expense) before tax on items recognised direct in equity  229   (506)  (134)  (52)  35   (344)
Tax on items recognised direct in equity  7   (43)  106   15   (50)  110 
Net income/(expense) recognised direct in equity  236   (549)  (28)  (37)  (15)  (234)
Profit for the year  2,317   2,625   2,463   3,210   1,688   1,774 
Total recognised income and expense for the year  2,553   2,076   2,435   3,173   1,673   1,540 
                         
Attributable to:                        
Equity shareholders  2,465   2,045   2,420   3,173   1,673   1,540 
Minority interests  88   31   15   –    –    –  
   2,553   2,076   2,435   3,173   1,673   1,540 
Balance sheets 

at 31 December 2009

     Group     Bank    
     2009  2008  2009  2008 
  Note  £m  £m
 
 
£m
  
£m
 
Assets 
               
Cash and balances at central banks 
  10   1,805   1,285   906   838 
Loans and advances to banks 
  10   133,230   66,234   81,432   23,146 
Loans and advances to customers 
  10   164,403   198,267   88,556   124,693 
Debt securities subject to repurchase agreements 
  26   30,602   33,817   —   — 
Other debt securities 
      4,187   2,176   2,163   41 
Debt securities 
  13   34,789   35,993   2,163   41 
Equity shares 
  14   966   1,129   13   6 
Investments in Group undertakings 
  15   —   —   6,783   7,339 
Settlement balances 
      4,573   4,117   —   — 
Derivatives 
  12   4,470   8,895   2,900   4,897 
Intangible assets 
  16   748   815   380   401 
Property, plant and equipment 
  17   3,300   1,970   837   883 
Deferred taxation 
  21   568   496   —   400 
Prepayments, accrued income and other assets 
  18   1,876   2,018   1,004   674 
Total assets 
      350,728   321,219   184,974   163,318 
  
Liabilities 
                    
Deposits by banks 
  10   61,433   53,633   21,909   8,536 
Customer accounts 
  10   227,463   200,384   143,025   130,695 
Debt securities in issue 
  10   11,470   17,212   —   15 
Settlement balances and short positions 
  19   16,944   13,091   —   — 
Derivatives 
  12   4,314   8,066   2,506   6,243 
Accruals, deferred income and other liabilities 
  20   3,827   4,032   910   1,407 
Retirement benefit liabilities 
  4   512   1,198   472   982 
Deferred taxation 
  21   285   46   217   — 
Subordinated liabilities 
  22   8,999   10,099   7,105 �� 7,860 
Total liabilities 
      335,247   307,761   176,144   155,738 
  
Minority interests 
  23   1,282   1,323   —   — 
Equity owners 
  24   14,199   12,135   8,830   7,580 
Total equity 
      15,481   13,458   8,830   7,580 
  
Total liabilities and equity 
      350,728   321,219   184,974   163,318 
The accompanying notes on pages 96 to 152, the accounting policies on pages 87 to 95 and the audited sections of the ‘Financial review: Risk, capital and liquidity management’ on pages 37 to 60 form an integral part of these financial statements.
The accounts were approved by the Board of directors on 31 March 2010 and signed on its behalf by:
 
Philip Hampton
Stephen Hester
Bruce Van Saun
Chairman
Group Chief Executive
Group Finance Director
National Westminster Bank Plc
Registration No. 929027
84
Financial statements
51
TableStatements of Contentschanges in equity 


Cash flow statementsfor the year ended 31 December 20072009

     Group  Bank
     2007  2006  2005  2007  2006  2005 
  Note   £m   £m   £m   £m   £m   £m 
Operating activities                           
Operating profit before tax     3,085   3,456   3,411   3,729   1,963   2,315 
                            
Adjustments for:                           
Depreciation and amortisation     264   257   382   177   202   326 
Interest on subordinated liabilities     271   310   304   239   271   283 
Charge for defined benefit pension schemes     132   229   149   83   168   97 
Cash contribution to defined benefit pension schemes   (117)  (135)  (1,007)  (69)  (70)  (976)
Elimination of foreign exchange differences     (464)  1,503   (2,178)  5   143   189 
Other non-cash items     (75)  (289)  (1,007)  (380)  28   (1,070)
Net cash inflow from trading activities     3,096   5,331   54   3,784   2,705   1,164 
Changes in operating assets and liabilities     15,004   2,706   24,173   3,999   1,559   6,010 
Net cash flows from operating activities before tax   18,100   8,037   24,227   7,783   4,264   7,174 
Income taxes paid     (592)  (1,157)  (1,170)  (104)  (588)  (662)
Net cash flows from operating activities  32   17,508   6,880   23,057   7,679   3,676   6,512 
                             
Investing activities                            
Sale and maturity of securities      560   1,489   1,600   19   85   951 
Purchase of securities      (2,215)  (874)  (1,322)  (82)  (60)  (80)
Sale of property, plant and equipment      678   268   333   326   265   302 
Purchase of property, plant and equipment      (328)  (382)  (281)  (135)  (85)  (119)
Net investment in business interests and intangible assets  33   (159)  (92)  (168)  403   (524)  (167)
Net cash flows from investing activities      (1,464)  409   162   531   (319)  887 
                             
Financing activities                            
Issue of subordinated liabilities      634   91   291   –    –    –  
Proceeds of minority interests issued      288   271   463   –    –    –  
Redemption of minority interests      (2)  –    (121)  –    –    –  
Capital contribution      –    188   –    –    188   –  
Repayment of subordinated liabilities      (403)  (719)  (210)  (381)  (590)  (210)
Dividends paid      (1,922)  (1,534)  (365)  (1,850)  (1,500)  (350)
Interest on subordinated liabilities      (274)  (313)  (319)  (244)  (276)  (297)
Net cash flows from financing activities      (1,679)  (2,016)  (261)  (2,475)  (2,178)  (857)
Effects of exchange rate changes on cash and cash equivalents   364   (2,237)  2,621   74   (240)  135 
                             
Net increase in cash and cash equivalents      14,729   3,036   25,579   5,809   939   6,677 
Cash and cash equivalents 1 January      51,460   48,424   22,845   19,527   18,588   11,911 
Cash and cash equivalents 31 December      66,189   51,460   48,424   25,336   19,527   18,588 


 
     Group        Bank    
  2009  2008  2007  2009  2008  2007 
  £m  £m  £m  £m  £m  £m 
Called-up share capital 
                  
At 1 January and 31 December 
  1,678   1,678   1,678   1,678   1,678   1,678 
  
Share premium account 
                        
At 1 January 
  1,291   1,291   1,291   1,291   1,291   1,291 
Ordinary shares issued during the year 
  935   —   —   935   —   — 
At 31 December 
  2,226   1,291   1,291   2,226   1,291   1,291 
  
Available-for-sale reserve 
                        
At 1 January 
  (18)   23   18   —   9   31 
Unrealised gains/(losses) in the year 
  78   (54)   87   7   (13)   40 
Realised (gains)/losses in the year 
  (35)   3   (85)   —   —   (72) 
Taxation 
  (9)   10   3   (2)   4   10 
At 31 December 
  16   (18)   23   5   —   9 
  
Cash flow hedging reserve 
                        
At 1 January 
  30   56   72   (119)   25   42 
Amount recognised in equity during the year 
  (5)   —   —   96   (158)   (9) 
Amount transferred from equity to earnings in the year 
  (37)   (36)   (20)   61   (29)   (13) 
Taxation 
  7   10   4   (45)   43   5 
At 31 December 
  (5)   30   56   (7)   (119)   25 
  
Foreign exchange reserve 
                        
At 1 January 
  1,900   (66)   (314)   (44)   3   1 
Retranslation of net assets 
  (805)   1,966   248   32   (47)   2 
Foreign currency gains on hedges of net assets 
  51   —   —   —   —   — 
At 31 December 
  1,146   1,900   (66)   (12)   (44)   3 
  
Other reserves 
                        
At 1 January 
  614   614   486   614   614   486 
Redemption of preference shares classified as debt 
  —   —   128   —   —   128 
At 31 December 
  614   614   614   614   614   614 
  
Retained earnings 
                        
At 1 January 
  6,640   7,192   6,942   4,160   3,773   2,541 
Profit attributable to ordinary shareholders 
  1,134   448   2,228   (584)   1,387   3,210 
Ordinary dividends paid 
  —   (1,000)   (1,850)   —   (1,000)   (1,850) 
Redemption of preference shares classified as debt 
  —   —   (128)   —   —   (128) 
Capital contribution 
  750   —   —   750   —   — 
At 31 December 
  8,524   6,640   7,192   4,326   4,160   3,773 
  
Shareholders’ equity at 31 December 
  14,199   12,135   10,788   8,830   7,580   7,393 
  
Minority interests 
                        
At 1 January 
  1,323   1,314   1,012   —   —   — 
Currency translation adjustments and other movements 
  (41)   12   (1)   —   —   — 
Profit attributable to minority interests 
  —   93   89   —   —   — 
Dividends paid 
  —   (94)   (72)   —   —   — 
Equity raised 
  —   70   288   —   —   — 
Equity withdrawn and disposals 
  —   (72)   (2)   —   —   — 
At 31 December 
  1,282   1,323   1,314   —   —   — 
  
Total equity at 31 December 
  15,481   13,458   12,102   8,830   7,580   7,393 
  
Total comprehensive income recognised in the statement of changes in equity is attributable as follows: 
                        
Minority interests 
  (41)   105   88   —   —   — 
Ordinary shareholders 
  379   2,347   2,465   (435)   1,187   3,173 
   338   2,452   2,553   (435)   1,187   3,173 
The accompanying notes on pages 96 to 152, the accounting policies on pages 87 to 95 and the audited sections of the ‘Financial review: Risk, capital and liquidity management’ on pages 37 to 60 form an integral part of these financial statements.

 
Cash flow statements 
Accounting policiesfor the year ended 31 December 2009
        Group        Bank    
     2009  2008  2007  2009  2008  2007 
  Note  £m  £m  £m  £m  £m  £m 
Operating activities 
                     
Operating profit/(loss) before tax 
     1,129   1,140   3,085   (692)   1,866   3,729 
  
Adjustments for: 
                           
Depreciation and amortisation 
     247   237   264   156   145   177 
Write-down of goodwill and other intangible assets 
     —   716   —   —   45   — 
Write-down of investment in subsidiaries 
     —   —   —   2,281   —   — 
Interest on subordinated liabilities 
     454   509   271   414   432   239 
Charge for defined benefit pension schemes 
     54   2   132   (29)   (65)   83 
Pension scheme curtailment gains 
     (544)   —   —   (358)   —   — 
Cash contribution to defined benefit pension schemes 
     (213)   (154)   (117)   (124)   (78)   (69) 
Gain on redemption of own debt 
     (381)   —   —   (381)   —   — 
Elimination of foreign exchange differences 
     2,063   (5,850)   (464)   421   (1,002)   5 
Other non-cash items 
     3,272   717   (75)   1,449   68   (380) 
Net cash inflow/(outflow) from trading activities 
     6,081   (2,683)   3,096   3,137   1,411   3,784 
Changes in operating assets and liabilities 
     58,112   (22,841)   15,004   46,091   (7,163)   3,999 
Net cash flows from operating activities before tax 
     64,193   (25,524)   18,100   49,228   (5,752)   7,783 
Income taxes paid 
     (1,092)   (331)   (592)   (554)   (290)   (104) 
Net cash flows from operating activities 
  29   63,101   (25,855)   17,508   48,674   (6,042)   7,679 
  
Investing activities 
                            
Sale and maturity of securities 
      2,253   1,304   560   36   71   19 
Purchase of securities 
      (2,319)   (710)   (2,215)   (2,158)   (69)   (82) 
Sale of property, plant and equipment 
      36   85   678   12   6   326 
Purchase of property, plant and equipment 
      (1,484)   (512)   (328)   (11)   (84)   (135) 
Net investment in business interests and intangible assets 
  30   (31)   23   (159)   (1,924)   (1,000)   403 
Net cash flows from investing activities 
      (1,545)   190   (1,464)   (4,045)   (1,076)   531 
  
Financing activities 
                            
Issue of ordinary shares 
      935   —   —   935   —   — 
Issue of subordinated liabilities 
      1,000   2,749   634   1,000   2,700   — 
Proceeds of minority interests issued 
      —   70   288   —   —   — 
Capital contribution 
      750   —   —   750   —   — 
Repayment of subordinated liabilities 
      (1,250)   —   (403)   (1,052)   —   (381) 
Redemption of minority interests 
      —   (72)   (2)   —   —   — 
Dividends paid 
      —   (1,094)   (1,922)   —   (1,000)   (1,850) 
Interest on subordinated liabilities 
      (536)   (440)   (274)   (495)   (365)   (244) 
Net cash flows from financing activities 
      899   1,213   (1,679)   1,138   1,335   (2,475) 
Effects of exchange rate changes on cash and cash equivalents 
      (3,010)   8,338   364   (500)   1,381   74 
  
Net increase/(decrease) in cash and cash equivalents 
      59,445   (16,114)   14,729   45,267   (4,402)   5,809 
Cash and cash equivalents at 1 January 
      50,075   66,189   51,460   20,934   25,336   19,527 
Cash and cash equivalents at 31 December 
  33   109,520   50,075   66,189   66,201   20,934   25,336 
The accompanying notes on pages 96 to 152, the accounting policies on pages 87 to 95 and the audited sections of the ‘Financial review: Risk, capital and liquidity management’ on pages 37 to 60 form an integral part of these financial statements.
86
Financial statements
 
1. Presentation of accounts
The accounts are prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board ("IASB"), and interpretations issued by the International Financial Reporting Interpretations Committee of the IASB (together "IFRS") as adopted by the European Union ("EU"). The EU has not adopted the complete text of IAS 39 'Financial Instruments Recognition and Measurement'; it has relaxed some of the standard's hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 39 as issued by the IASB. The date of transition to IFRS for the Group and the Bank and the date of their opening IFRS balance sheets was 1 January 2004.

The Group has adopted IFRS 7 'Financial Instruments: Disclosures' for the accounting period beginning 1 January 2007. This has had no effect on the results, cash flows or financial position of the Group or the Bank. However, there are changes to the notes on the accounts and comparative information is presented accordingly.

The Bank is incorporated in the UK and registered in England. The accounts are prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held-for-trading financial assets and financial liabilities, financial assets and financial liabilities that are designated as at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged.
The Bank accounts are presented in accordance with the Companies Act 1985.

2. Basis of consolidation

The consolidated financial statements incorporate the financial statements of the Bank and entities (including certain special purpose entities) that continue to be controlled by the Group (its subsidiaries). Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. Any excess of the cost (the fair value of assets given, liabilities incurred or assumed and equity instruments issued by the Group plus any directly attributable costs) of an acquisition over the fair value of the net assets acquired is recognised as goodwill. The interest of minority shareholders is stated at their share of the fair value of the subsidiary's net assets.

The results of subsidiaries acquired are included in the consolidated income statement from the date control passes to the Group. The results of subsidiaries are included up until the Group ceases to control them through sale or significant change in circumstances.

All intra-group balances, transactions, income and expenses are eliminated on consolidation. The consolidated accounts are prepared using uniform accounting policies.

3. Revenue recognition

Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those at fair value through profit or loss are determined using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable, that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.

Financial assets and financial liabilities held-for-trading or designated as at fair value through profit or loss are recorded at fair value. Changes in fair value are recognised in profit or loss together with dividends and interest receivable and payable.
Commitment and utilisation fees are determined as a percentage of the outstanding facility. If it is unlikely that a specific lending arrangement will be entered into, such fees are taken to profit or loss over the life of the facility otherwise they are deferred and included in the effective interest rate on the advance.
Fees in respect of services are recognised as the right to consideration accrues through the provision of the service to the customer. The arrangements are generally contractual and the cost of providing the service is incurred as the service is rendered. The price is usually fixed and always determinable. The application of this policy to significant fee types is outlined below.
Payment services: Accounting policiesthis comprises income received for payment services including cheques cashed, direct debits, Clearing House Automated Payments (the UK electronic settlement system) and BACS payments (the automated clearing house that processes direct debits and direct credits). These are generally charged on a per transaction basis. The income is earned when the payment or transaction occurs. Charges for payment services are usually debited to the customer's
1. Presentation of accounts
The accounts are prepared on a going concern basis and in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board (IASB) and interpretations issued by the International Financial Reporting Interpretations Committee of the IASB as adopted by the European Union (EU) (together IFRS). The EU has not adopted the complete text of IAS 39 ‘Financial Instruments: Recognition and Measurement’; it has relaxed some of the Standard’s hedging requirements. The Group has not taken advantage of this relaxation and has adopted IAS 39 as issued by the IASB: the Group’s financial statements are prepared in accordance with IFRS as issued by the IASB.
IAS 1 (Revised 2007) ‘Presentation of Financial Statements’ has introduced a number of changes in the format and content of the Group’s financial statements including a statement of changes in equity (showing the components of changes in equity for the period) as a primary financial statement and a statement of comprehensive income immediately following the income statement.
The Group has adopted ‘Improving Disclosures about Financial Instruments (Amendments to IFRS 7 Financial Instruments: Disclosures)’. These amendments expand the disclosures required about fair value measurement and liquidity risk.
As described in Note 34, the NatWest Group has made changes to the operating segments. The changes do not affect the NatWest Group’s results. Comparative data for the operating segments have been restated accordingly. IAS 1 ‘Presentation of Financial Statements’ requires the presentation of a balance sheet as at the beginning of the earliest period when a company applies an accounting policy retrospectively. For the NatWest Group, this balance sheet would be as at 31 December 2007. However, the retrospective accounting for the changes made to the operating segments had no impact on the balance sheet as at 31 December 2007, and therefore that third balance sheet has not been represented in these Consolidated Financial Statements.
The Bank is incorporated in the UK and registered in England. The accounts are prepared on the historical cost basis except that the following assets and liabilities are stated at their fair value: derivative financial instruments, held-for-trading financial assets and financial liabilities, financial assets and financial liabilities that are designated as at fair value through profit or loss, available-for-sale financial assets and investment property. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged.
The Bank accounts are presented in accordance with the Companies Act 2006.
2. Basis of consolidation
The consolidated financial statements incorporate the financial statements of the Bank and entities (including certain special purpose entities) that are controlled by the Group. Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. Any excess of the cost (the fair value of assets given, liabilities incurred or assumed and equity instruments issued by the Group plus any directly attributable costs) of an acquisition over the fair value of the net assets acquired is recognised as goodwill. The interest of minority shareholders is stated at their share of the fair value of the subsidiary’s net assets.
The results of subsidiaries acquired are included in the consolidated income statement from the date control passes until the Group ceases to control them through a sale or significant change in circumstances.
All intra-group balances, transactions, income and expenses are eliminated on consolidation. The consolidated accounts are prepared using uniform accounting policies.
3. Revenue recognition
Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those at fair value through profit or loss are determined using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument’s initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable, that are an integral part of the instrument’s yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.
Financial assets and financial liabilities held-for-trading or designated as at fair value through profit or loss are recorded at fair value. Changes in fair value are recognised in profit or loss together with dividends and interest receivable and payable.
Commitment and utilisation fees are determined as a percentage of the outstanding facility. If it is unlikely that a specific lending arrangement will be entered into, such fees are taken to profit or loss over the life of the facility otherwise they are deferred and included in the effective interest rate on the advance.
Fees in respect of services are recognised as the right to consideration accrues through the provision of the service to the customer. The arrangements are generally contractual and the cost of providing the service is incurred as the service is rendered. The price is usually fixed and always determinable. The application of this policy to significant fee types is outlined below.
Payment services: this comprises income received for payment services including cheques cashed, direct debits, Clearing House Automated Payments (the UK electronic settlement system) and BACS payments (the automated clearing house that processes direct debits and direct credits). These are generally charged on a per transaction basis. The income is earned when the payment or transaction occurs. Charges for payment services are usually debited to the customer’s account monthly or quarterly in arrears. Accruals are raised for services provided but not charged at period end.
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Accounting policies continued
Card related services: fees from credit card business include:
 
Card related services: fees from credit card business include:●
Commission received from retailers for processing credit and debit card transactions: income is accrued to the income statement as the service is performed.
performed;
●
Interchange received: as issuer, the Group receives a fee (interchange) each time a cardholder purchases goods and services. The Group also receives interchange fees from other card issuers for providing cash advances through its branch and Automated Teller Machine networks. These fees are accrued once the transaction has taken place.
53
place; and
Table of Contents●

An annual fee payable by a credit card holder is deferred and taken to profit or loss over the period of the service i.e. 12 months.
Insurance brokerage: this is made up of fees and commissions received from the agency sale of insurance. Commission on the sale of an insurance contract is earned at the inception of the policy as the insurance has been arranged and placed. However, provision is made where commission is refundable in the event of policy cancellation in line with estimated cancellations.
Investment management fees: fees charged for managing investments are recognised as revenue as the services are provided. Incremental costs that are directly attributable to securing an investment management contract are deferred and charged as expense as the related revenue is recognised.
4. Pensions and other post-retirement benefits

The Group provides post-retirement benefits in the form of pensions and healthcare plans to eligible employees.
For defined benefit schemes, scheme liabilities are measured on an actuarial basis using the projected unit credit method and discounted at a rate that reflects the current rate of return on a high quality corporate bond of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. Cumulative actuarial gains or losses that exceed 10 per cent of the greater of the assets or the obligations of the scheme are amortised to the income statement over the expected average remaining lives of participating employees. Past service costs are recognised immediately to the extent that benefits have vested; otherwise they are amortised over the period until the benefits become vested.
Any surplus or deficit of scheme assets over liabilities adjusted for unrecognised actuarial gains and losses and past service costs is recognised in the balance sheet as an asset (surplus) or liability (deficit).
Contributions to defined contribution pension schemes are recognised in the income statement when payable.
5. Intangible assets and goodwill
Intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss over the assets'
Insurance brokerage: this is made up of fees and commissions received from the agency sale of insurance. Commission on the sale of an insurance contract is earned at the inception of the policy, as the insurance has been arranged and placed. However, provision is made where commission is refundable in the event of policy cancellation in line with estimated cancellations.
Investment management fees: fees charged for managing investments are recognised as revenue as the services are provided. Incremental costs that are directly attributable to securing an investment management contract are deferred and charged as expense as the related revenue is recognised.
4. Pensions and other post-retirement benefits
The Group provides post-retirement benefits in the form of pensions and healthcare plans to eligible employees.
For defined benefit schemes, scheme liabilities are measured on an actuarial basis using the projected unit credit method and discounted at a rate that reflects the current rate of return on a high quality corporate bond of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. Cumulative actuarial gains or losses that exceed 10 per cent of the greater of the assets or the obligations of the scheme are amortised to the income statement over the expected average remaining lives of participating employees. Past service costs are recognised immediately to the extent that benefits have vested; otherwise they are amortised over the period until the benefits become vested.
Any surplus or deficit of scheme assets over liabilities adjusted for unrecognised actuarial gains and losses and past service costs is recognised in the balance sheet as an asset (surplus) or liability (deficit).
Contributions to defined contribution pension schemes are recognised in the income statement when payable.
5. Intangible assets and goodwill
Intangible assets that are acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss over the assets’ estimated economic lives using methods that best reflect the pattern of economic benefits and is included in depreciation and amortisation. The estimated useful economic lives are as follows:
Core deposit intangibles6 to 10 years
Other acquired intangibles5 to 10 years
Computer software3 to 5 years
Expenditure on internally generated goodwill and brands is written-off as incurred. Direct costs relating to the development of internal-use computer software are capitalised once technical feasibility and economic viability have been established. These costs include payroll, the costs of materials and services, and directly attributable overheads. Capitalisation of costs ceases when the software is capable of operating as intended. During and after development, accumulated costs are reviewed for impairment against the projected benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred as are all training costs and general overheads. The costs of licences to use computer software that are expected to generate economic benefits beyond one year are also capitalised.
Acquired goodwill, being the excess of the cost of an acquisition over the Group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities of the subsidiary, associate or joint venture acquired, is initially recognised at cost and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisition of subsidiaries and joint ventures is included in the balance sheet category ‘Intangible assets’ and that on associates within their carrying amounts. The gain or loss on the disposal of a subsidiary, associate or joint venture includes the carrying value of any related goodwill.
6. Property, plant and equipment
Items of property, plant and equipment (except investment property –see accounting policy 8) are stated at cost less accumulated depreciation and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately.
Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases) over their estimated useful lives.
The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows:
Freehold and long leasehold buildings50 years
Short leaseholdsunexpired period of the lease
Property adaptation costs10 to 15 years
Computer equipmentup to 5 years
Other equipment4 to 15 years
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Financial statements
7. Impairment of intangible assets and property, plant and equipment
At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent from those of other assets or groups of assets, recoverable amount is determined for the cash-generating unit to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash-generating unit that have not been reflected in the estimation of future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed that which it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
8. Investment property
Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. It is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease. Lease incentives granted are recognised as an integral part of the total rental income.
9. Foreign currencies
The Group’s consolidated financial statements are presented in sterling which is the functional currency of the Bank.
Transactions in foreign currencies are translated into sterling at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into sterling at the rates of exchange ruling at the balance sheet date.
Foreign exchange differences arising on translation are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations. Non-monetary items denominated in foreign currencies that are stated at fair value are translated into sterling at foreign exchange rates ruling at the dates the values were determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example, equity shares which are included in the available-for-sale reserve in equity unless the asset is the hedged item in a fair value hedge.
The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into sterling at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised directly in equity and included in profit or loss on its disposal.
10. Leases
Contracts to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer. Other contracts to lease assets are classified as operating leases.
Finance lease receivables are stated in the balance sheet at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment. Unguaranteed residual values are subject to regular review to identify potential impairment. If there has been a reduction in the estimated unguaranteed residual value, the income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.
Rental income from operating leases is credited to the income statement on a receivable basis over the term of the lease. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see accounting policy 6).
11. Provisions
The Group recognises a provision for a present obligation resulting from a past event when it is more likely than not that it will be required to transfer economic benefits to settle the obligation and the amount of the obligation can be estimated reliably.
Provision is made for restructuring costs, including the costs of redundancy, when the Group has a constructive obligation to restructure. An obligation exists when the Group has a detailed formal plan for the restructuring and has raised a valid expectation in those affected by starting to implement the plan or announcing its main features.
If the Group has a contract that is onerous, it recognises the present obligation under the contract as a provision. An onerous contract is one where the unavoidable costs of meeting the obligations under it exceed the expected economic benefits. When the Group vacates a leasehold property, a provision is recognised for the costs under the lease less any expected economic benefits (such as rental income).
Contingent liabilities are possible obligations arising from past events whose existence will be confirmed only by uncertain future events or present obligations arising from past events that are not recognised because either an outflow of economic benefits is not probable or the amount of the obligation cannot be reliably measured. Contingent liabilities are not recognised but information about them is disclosed unless the possibility of any outflow of economic benefits in settlement is remote.
89
Accounting policies continued
12. Taxation
Provision is made for taxation at current enacted rates on taxable profits, arising in income or in equity, taking into account relief for overseas taxation where appropriate. Deferred taxation is accounted for in full for all temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes, except in relation to overseas earnings where remittance is controlled by the Group, and goodwill.
Deferred tax assets are only recognised to the extent that it is probable that they will be recovered.
13. Financial assets
On initial recognition, financial assets are classified into held-to-maturity investments; available-for-sale financial assets; held-for-trading; designated as at fair value through profit or loss; or loans and receivables.
Held-to-maturity investments – a financial asset may be classified as a held-to-maturity investment only if it has fixed or determinable payments, a fixed maturity and the Group has the positive intention and ability to hold to maturity. Held-to-maturity investments are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see accounting policy 3) less any impairment losses.
Held-for-trading – a financial asset is classified as held-for-trading if it is acquired principally for sale in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial assets are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses on held-for-trading financial assets are recognised in profit or loss as they arise.
Designated as at fair value through profit or loss – financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both, that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.
Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial assets that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
The Group has designated financial assets as at fair value through profit or loss principally where the assets are economically hedged by derivatives and fair value designation eliminates the measurement inconsistency that would arise if the assets were carried at amortised cost or classified as available-for-sale.
Loans and receivables – non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables, except those that are classified as available-for-sale or as held-for-trading, or designated as at fair value through profit or loss. Loans and receivables are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see accounting policy 3) less any impairment losses.
Available-for-sale – financial assets that are not classified as held-to-maturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables, are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of foreign currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see accounting policy 3). Other changes in the fair value of available-for-sale financial assets are reported in a separate component of shareholders’ equity until disposal, when the cumulative gain or loss is recognised in profit or loss.
Reclassifications – held-for-trading and available-for-sale financial assets that meet the definition of loans and receivables (non-derivative financial assets with fixed or determinable payments that are not quoted in an active market) may be reclassified to loans and receivables if the Group has the intention and ability to hold the financial asset for the foreseeable future or until maturity. The Group typically regards the foreseeable future as twelve months from the date of reclassification. Additionally, held-for-trading financial assets that do not meet the definition of loans and receivables may, in rare circumstances, be transferred to available-for-sale financial assets or to held-to-maturity investments. Reclassifications are made at fair value. This fair value becomes the asset’s new cost or amortised cost as appropriate. Gains and losses recognised up to the date of reclassification are not reversed.
Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; issues of equity or financial liabilities measured at amortised cost are recognised on settlement date; all other regular way transactions in financial instruments are recognised on trade date.
Fair value for a net open position in a financial asset that is quoted in an active market is the current bid price times the number of units of the instrument held. Fair values for financial assets not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial assets.
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Financial statements
14. Impairment of financial assets
The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets classified as held-to-maturity, available-for-sale or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
Financial assets carried at amortised cost – if there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivables or as held-to-maturity investments has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition.
Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective assessment of impairment, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of observable data, to reflect current conditions not affecting the period of historical experience.
Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If, in a subsequent period, the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment.
Impaired loans and receivables are written off, i.e. the impairment provision is applied in writing down the loan's carrying value partially or in full, when the Group concludes that there is no longer any realistic prospect of recovery of part or all of the loan. For portfolios that are collectively assessed for impairment, the timing of write off principally reflects historic recovery experience for each portfolio. For loans that are individually assessed for impairment, the timing of write off is determined on a case-by-case basis. Such loans are reviewed regularly and write offs will be prompted by bankruptcy, insolvency, restructuring and similar events. Amounts recovered after a loan has been written off are credited to the loan impairment charge for the period in which they are received.
Financial assets carried at fair value – when a decline in the fair value of a financial asset classified as available-for-sale has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in profit or loss. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on available-for-sale equity instruments are not reversed through profit or loss, but those on available-for-sale debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.
15. Financial liabilities
On initial recognition financial liabilities are classified into held-for-trading; designated as at fair value through profit or loss; or amortised cost.
Held for trading – a financial liability is classified as held-for-trading if it is incurred principally for repurchase in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise.
Designated as at fair value through profit or loss – financial liabilities may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.
Financial liabilities that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial liabilities that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
The principal categories of financial liabilities designated as at fair value through profit or loss are structured liabilities issued by the Group: designation significantly reduces the measurement inconsistency between these liabilities and the related derivatives carried at fair value.
Amortised cost – all other financial liabilities are measured at amortised cost using the effective interest method (see accounting policy 3).
Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument held or issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities.
16. Financial guarantee contracts
Under a financial guarantee contract, the Group, in return for a fee, undertakes to meet a customer’s obligations under the terms of a debt instrument if the customer fails to do so. A financial guarantee is recognised as a liability; initially at fair value and, if not designated as at fair value through profit or loss, subsequently at the higher of its initial value less cumulative amortisation and any provision under the contract measured in accordance with accounting policy 11 Provisions. Amortisation is calculated so as to recognise fees receivable in profit or loss over the period of the guarantee.
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Accounting policies continued
17. Loan commitments
Provision is made for loan commitments, other than those classified as held-for-trading, if it is probable that the facility will be drawn and the resulting loan will be recognised at a value less than the cash advanced. Syndicated loan commitments in excess of the level of lending under the commitment approved for retention by the Group are classified as held-for-trading and measured at fair value.
18. Derecognition
A financial asset is derecognised when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either: (a) transfers the contractual rights to receive the asset’s cash flows; or (b) retains the right to the asset’s cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. If substantially all the risks and rewards have been retained, the asset remains on the balance sheet. If substantially all the risks and rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If it has not retained control, the asset is derecognised. Where the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement.
A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires. On the redemption or settlement of debt securities (including subordinated liabilities) issued by the Group, the Group derecognises the debt instrument and records a gain or loss being the difference between the debt’s carrying amount and the cost of redemption or settlement. The same treatment applies where the debt is exchanged for a new debt issue that has terms substantially different from those of the existing debt. The assessment of whether the terms of the new debt instrument are substantially different takes into account qualitative and quantitative characteristics including a comparison of the discounted present value of the cash flows under the new terms with the discounted present value of the remaining cash flows of the original debt issue.
19. Sale and repurchase transactions
Securities subject to a sale and repurchase agreement under which substantially all the risks and rewards of ownership are retained by the Group continue to be shown on the balance sheet and the sale proceeds recorded as a financial liability. Securities acquired in a reverse sale and repurchase transaction under which the Group is not exposed to substantially all the risks and rewards of ownership are not recognised on the balance sheet and the consideration paid is recorded as a financial asset.
Securities borrowing and lending transactions are usually secured by cash or securities advanced by the borrower. Borrowed securities are not recognised on the balance sheet or lent securities derecognised. Cash collateral received or given is treated as a loan or deposit; collateral in the form of securities is not recognised. However, where securities borrowed are transferred to third parties, a liability for the obligation to return the securities to the stock lending counterparty is recorded.
20. Netting
Financial assets and financial liabilities are offset and the net amount presented in the balance sheet when, and only when, the Group currently has a legally enforceable right to set off the recognised amounts; and it intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. The Group is party to a number of arrangements, including master netting agreements, that give it the right to offset financial assets and financial liabilities but where it does not intend to settle the amounts net or simultaneously and therefore the assets and liabilities concerned are presented gross.
21. Capital instruments
The Group classifies a financial instrument that it issues as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms. An instrument is classified as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.
22. Derivatives and hedging
Derivative financial instruments are initially recognised, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative’s components using appropriate pricing or valuation models.
A derivative embedded in a contract is accounted for as a stand-alone derivative if its economic characteristics are not closely related to the economic characteristics of the host contract; unless the entire contract is measured at fair value with changes in fair value recognised in profit or loss.
Gains and losses arising from changes in the fair value of a derivative are recognised as they arise in profit or loss unless the derivative is the hedging instrument in a qualifying hedge. The Group enters into three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a highly probable forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.
Hedge relationships are formally documented at inception. The documentation identifies the hedged item and the hedging instrument and details the risk that is being hedged and the way in which effectiveness will be assessed at inception and during the period of the hedge. If the hedge is not highly effective in offsetting changes in fair values or cash flows attributable to the hedged risk, consistent with the documented risk management strategy, hedge accounting is discontinued.
92
Financial statements
Fair value hedge – in a fair value hedge, the gain or loss on the hedging instrument is recognised in profit or loss. The gain or loss on the hedged item attributable to the hedged risk is recognised in profit or loss and adjusts the carrying amount of the hedged item. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; or if the hedging instrument expires or is sold, terminated or exercised; or if hedge designation is revoked. If the hedged item is one for which the effective interest rate method is used, any cumulative adjustment is amortised to profit or loss over the life of the hedged item using a recalculated effective interest rate.
Cash flow hedge – in a cash flow hedge, the effective portion of the gain or loss on the hedging instrument is recognised directly in equity and the ineffective portion in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity in the same periods in which the asset or liability affects profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same time as the hedged transaction. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss in equity is recognised in profit or loss when the hedged cash flow occurs or, if the forecast transaction results in the recognition of a financial asset or financial liability, in the same periods during which the asset or liability affects profit or loss. Where a forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss in equity is recognised in profit or loss immediately.
Hedge of net investment in a foreign operation – in the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge is recognised directly in equity. Any ineffective portion is recognised in profit or loss. Non-derivative financial liabilities as well as derivatives may be the hedging instrument in a net investment hedge.
23. Cash and cash equivalents
Cash and cash equivalents comprises cash and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
24. Shares in Group entities
The Bank’s investments in its subsidiaries are stated at cost less any impairment.
Critical accounting policies and key sources of estimation uncertainty
The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. UK company law and IFRS require the directors, in preparing the Group’s financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB’s Framework for the Preparation and Presentation of Financial Statements. The judgements and assumptions involved in the Group’s accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
Loan impairment provisions
The Group’s loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost. A loan is impaired when there is objective evidence that events since the loan was granted have affected expected cash flows from the loan. The impairment loss is the difference between the carrying value of the loan and the present value of estimated future cash flows at the loan’s original effective interest rate.
At 31 December 2009, gross loans and advances to customers totalled £170,068 million (2008 – £201,191 million) and customer loan impairment provisions amounted to £5,665 million (2008 – £2,924 million).
There are two components to the Group’s loan impairment provisions: individual and collective.
Individual component – all impaired loans that exceed specific thresholds are individually assessed for impairment. Individually assessed loans principally comprise the Group’s portfolio of commercial loans to medium and large businesses. Impairment losses are recognised as the difference between the carrying value of the loan and the discounted value of management’s best estimate of future cash repayments and proceeds from any security held. These estimates take into account the customer’s debt capacity and financial flexibility; the level and quality of its earnings; the amount and sources of cash flows; the industry in which the counterparty operates; and the realisable value of any security held. Estimating the quantum and timing of future recoveries involves significant judgement. The size of receipts will depend on the future performance of the borrower and the value of security, both of which will be affected by future economic conditions; additionally, collateral may not be readily marketable. The actual amount of future cash flows and the date they are received may differ from these estimates and consequently actual losses incurred may differ from those recognised in these financial statements.
Collective component – this is made up of two elements: loan impairment provisions for impaired loans that are below individual assessment thresholds (collectively assessed provisions) and for loan losses that have been incurred but have not been separately identified at the balance sheet date (latent loss provisions). Collectively assessed provisions are established on a portfolio basis using a present value methodology taking into account the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends. The most significant factors in establishing these provisions are the expected loss rates and the related average life. These portfolios include credit card receivables and other personal advances including mortgages. The future credit quality of these portfolios is subject to uncertainties that could cause actual credit losses to differ materially from reported loan impairment provisions. These uncertainties include the economic environment, notably interest rates and their effect on customer spending, the unemployment level, payment behaviour and bankruptcy trends. Latent loss provisions are held against estimated
93
Accounting policies continued
impairment losses in the performing portfolio that have yet to be identified as at the balance sheet date. To assess the latent loss within its portfolios, the Group has developed methodologies to estimate the time that an asset can remain impaired within a performing portfolio before it is identified and reported as such.
Pensions
The Group operates a number of defined benefit pension schemes as described in Note 4 on the accounts. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any surplus or deficit in excess of 10% of the greater of scheme assets and scheme liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). In determining the value of scheme liabilities, assumptions are made as to price inflation, dividend growth, pension increases, earnings growth and employees. There is a range of assumptions that could be adopted in valuing the schemes’ liabilities. Different assumptions could significantly alter the amount of the surplus or deficit recognised in the balance sheet and the pension cost charged to the income statement. The assumptions adopted for the Group’s pension schemes are set out in Note 4 on the accounts together with the sensitivity of reported amounts to changes in those assumptions. A pension asset of £10 million and a liability of £512 million were recognised in the balance sheet at 31 December 2009 (2008: asset – nil, liability – £1,198 million).
Fair value – financial instruments
Financial instruments classified as held-for-trading or designated as at fair value through profit or loss and financial assets classified as available-for-sale are recognised in the financial statements at fair value. All derivatives are measured at fair value. Gains or losses arising from changes in the fair value of financial instruments classified as held-for-trading or designated as at fair value through profit or loss are included in the income statement. Unrealised gains and losses on available-for-sale financial assets are recognised directly in equity unless an impairment loss is recognised.
Financial instruments measured at fair value include:
Loans and advances (held-for-trading and designated as at fair value through profit or loss) – principally comprise reverse repurchase agreements (reverse repos) and cash collateral.
Debt securities (held-for-trading, designated as at fair value through profit or loss and available-for-sale) – debt securities include those issued by governments, municipal bodies, mortgage agencies and financial institutions as well as corporate bonds, debentures and residual interests in securitisations.
Equity securities (held-for-trading, designated as at fair value through profit or loss and available-for-sale) – comprise equity shares of companies or corporations both listed and unlisted.
Deposits by banks and customer accounts (held-for-trading and designated as at fair value through profit or loss) – deposits measured at fair value principally include repurchase agreements (repos).
Debt securities in issue (held-for-trading and designated as at fair value through profit or loss) – measured at fair value and principally comprise medium term notes.
Short positions (held-for-trading) – arise in dealing and market making activities where debt securities and equity shares are sold which the Group does not currently possess.
Derivatives – these include swaps (currency swaps, interest rate swaps, credit default swaps, total return swaps and equity and equity index swaps), forward foreign exchange contracts, forward rate agreements, futures (currency, interest rate and equity) and options (exchange-traded options on currencies, interest rates and equities and equity indices and OTC currency and equity options, interest rate caps and floors and swaptions).
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair values are determined from quoted prices in active markets for identical financial assets or financial liabilities where these are available. Fair value for a net open position in a financial asset or financial liability in an active market is the current bid or offer price times the number of units of the instrument held. Where a trading portfolio contains both financial assets and financial liabilities which are derivatives of the same underlying instrument, fair value is determined by valuing the gross long and short positions at current mid market prices, with an adjustment at portfolio level to the net open long or short position to amend the valuation to bid or offer as appropriate. Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data. More details about the Group’s valuation methodologies and the sensitivity to reasonably possible alternative assumptions of the fair value of financial instruments valued using techniques where at least one significant input is unobservable are given in Note 10 on pages 103 to 114.
Deferred tax
The Group makes provision for deferred tax on short-term and other temporary differences where tax recognition occurs at a different time from accounting recognition. Deferred tax assets of £568 million were recognised as at 31 December 2009 (2008 – £496 million).
The Group has recognised deferred tax assets in respect of losses, principally in the UK, and short-term timing differences. Deferred tax assets are recognised in respect of unused tax losses to the extent that it is probable that there will be future taxable profits against which the losses can be utilised. Business projections prepared for impairment reviews (see Note 16) indicate that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within eight years. The number of years into the future for which forecast profits should be considered when assessing the recoverability of a deferred tax asset is a matter of judgment. A period of eight years is underpinned by the Group’s business projections, its history of profitable operation and the continuing strength of its core business franchises. The Group’s cumulative losses are principally attributable to the recent unparalleled market conditions. Deferred tax assets of £26 million (2008 – £17 million) have not been recognised in respect of tax losses carried forward in jurisdictions where doubt exists over the availability of future taxable profits.
94
Financial statements
Accounting developments
International Financial Reporting Standards
The International Accounting Standards Board (IASB) published a revised IFRS 3 ‘Business Combinations’ and related revisions to IAS 27 ‘Consolidated and Separate Financial Statements’ following the completion in January 2008 of its project on the acquisition and disposal of subsidiaries. The standards improve convergence with US GAAP and provide new guidance on accounting for changes in interests in subsidiaries. The cost of an acquisition will comprise only consideration paid to vendors for equity; other costs will be expensed immediately. Groups will only account for goodwill on acquisition of a subsidiary; subsequent changes in interest will be recognised in equity and only on a loss of control will there be a profit or loss on disposal to be recognised in income. The changes are effective for accounting periods beginning on or after 1 July 2009 but both standards may be adopted together for accounting periods beginning on or after 1 July 2007. These changes will affect the Group’s accounting for future acquisitions and disposals of subsidiaries.
The IASB issued amendments to a number of standards in April 2009 as part of its annual improvements project. The amendments are effective for annual periods beginning on or after 1 July 2009 and are not expected to have a material effect on the Group or the Bank.
The IASB issued an amendment, ‘Group Cash-settled Share-based Payment Transactions‘, to IFRS 2 ‘Share-based Payment’ in June 2009 that will change the accounting for share awards by permitting accounting for equity settlement only by entities that either grant awards over their own equity or have no obligation to settle a share-based payment transaction. The amendment is effective for annual periods beginning on or after 1 January 2010 and is not expected to have a material effect on the Group or the Bank.
The IASB published an amendment ‘Classification of Rights Issues’ to IAS 32 ‘Financial Instruments: Presentation’ and consequential revisions to other standards in October 2009 to improve the accounting for issues of equity for consideration fixed other than in the reporting entity’s functional currency. The amendment is effective for annual periods beginning on or after 1 February 2010 but it may be adopted earlier. It is not expected to have a material affect on the Group or the Bank.
The IASB reissued IAS 24, ‘Related Party Disclosures’, in November 2009 clarifying the existing standard and to provide certain exemptions for entities under government control. The revised standard is effective for annual periods beginning on or after 1 January 2011.
The IASB issued IFRS 9 ‘Financial Instruments’ in November 2009 simplifying the classification and measurement requirements in IAS 39 ‘Financial Instruments: Recognition and Measurement’ in respect of financial assets. The standard reduces the measurement categories for financial assets to two: fair value and amortised cost. A financial asset is classified on the basis of the entity’s business model for managing the financial asset and the contractual cash flow characteristics of the financial asset. Only assets with contractual terms that give rise to cash flows on specified dates that are solely payments of principal and interest on the principal amount outstanding and which are held within a business model whose objective is to hold assets in order to collect contractual cash flows are classified as amortised cost. All other financial assets are measured at fair value. Changes in the value of financial assets measured at fair value are generally taken to profit or loss. The standard is effective for annual periods beginning on or after 1 January 2013; early application is permitted.
This standard makes major changes to the framework for the classification and measurement of financial assets and will have a significant effect on the Group’s financial statements. The Group is assessing this impact which is likely to depend on the outcome of the other phases of IASB’s IAS 39 replacement project.
The International Financial Reporting Interpretations Committee (IFRIC) issued interpretation IFRIC 17 ‘Distributions of Non-Cash Assets to Owners’ and the IASB made consequential amendments to IFRS 5 ‘Non-Current Assets Held for Sale and Discontinued Operations’ in December 2008. The interpretation requires distributions to be presented at fair value with any surplus or deficit recognised in income. The amendment to IFRS 5 extends the definition of disposal groups and discontinued operations to disposals by way of distribution. The interpretation is effective for annual periods beginning on or after 1 July 2009, to be adopted at the same time as IFRS 3 ‘Business Combinations’ (revised 2008), and is not expected to have a material effect on the Bank.
The IFRIC issued interpretation IFRIC 18 ‘Transfers of Assets from Customers’ in January 2009. The interpretation addresses the accounting by suppliers for assets received from customers, requiring such assets to be measured at fair value. The interpretation is effective for assets from customers received on or after 1 July 2009 and is not expected to have a material effect on the Group or the Bank.
The IFRIC issued interpretation IFRIC 19 ‘Extinguishing Financial Liabilities with Equity Instruments’ in December 2009. The interpretation clarifies that the profit or loss on extinguishing liabilities by issuing equity instruments should be measured by reference to fair value, preferably of the equity instruments. The interpretation, effective for the Group for annual periods beginning on or after 1 January 2011, is not expected to have a material effect on the Group or the Bank.
95
Notes on the accounts
1 Net interest income
     Group    
  2009  2008  2007 
  £m  
£m
  
£m
 
Loans and advances to customers 
  4,985   10,063   9,422 
Loans and advances to banks 
  1,367   2,125   2,586 
Debt securities 
  99   185   170 
Interest receivable 
  6,451   12,373   12,178 
  
Customer accounts: demand deposits 
  318   1,413   1,993 
Customer accounts: savings deposits 
  761   1,389   1,218 
Customer accounts: other time deposits 
  603   2,032   1,929 
Deposits by banks 
  837   820   1,045 
Debt securities in issue 
  285   862   683 
Subordinated liabilities 
  454   509   271 
Internal funding of trading business 
  (4)   (49)   (52) 
Interest payable 
  3,254   6,976   7,087 
  
Net interest income 
  3,197   5,397   5,091 
  
             
2 Non-interest income 
            
      Group     
  2009  2008  2007 
   £m   £m   £m 
Fees and commissions receivable 
  4,079   4,367   4,226 
  
Fees and commissions payable 
  (1,241)   (1,178)   (1,036) 
  
Income/(loss) from trading activities (1) 
            
Foreign exchange 
  179   (384)   134 
Interest rate 
  886   (558)   310 
Credit 
  (609)   (18)   (843) 
Equities and commodities 
  998   (3)   39 
   1,454   (963)   (360) 
  
Gain on redemption of own debt (2) 
  381   —   — 
  
Other operating income 
            
Operating lease and other rental income 
  61   61   55 
Changes in the fair value of securities and other financial assets and liabilities 
  44   65   74 
Changes in the fair value of investment properties 
  107   2   — 
Profit on sale of available-for-sale financial assets 
  60   17   117 
Profit on sale of property, plant and equipment 
  4   7   189 
Profit/(loss) on sale of subsidiaries and associates 
  384   (31)   — 
Dividend income 
  592   5   14 
Share of profits less losses of associates 
  (27)   (23)   (5) 
Other income (3) 
  179   (22)   (11) 
   1,404   81   433 
Notes:
(1)The analysis of trading income is based on how the business is organised and the underlying risks managed. Trading income comprises gains and losses on financial instruments held for trading, realised and unrealised, interest income and dividends and the related funding costs.
The types of instruments include:
–  Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding.
–  Interest rate: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding.
–  Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding.
–  Equities and commodities: equities, commodities, equity derivatives, commodity contracts and related hedges and funding.
(2)In April 2009, the Group concluded a series of exchange offers and tender offers with the holders of a number of Tier 1 and Upper Tier 2 securities. The exchanges involving instruments classified liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability. Gains on these exchanges, and on the redemption of classified as liabilities for cash, totalling £381 million were credited to income.
(3)Other income includes contributions attributable to the Group from activities other than banking.
96

Notes on the accounts
3. Operating expenses
     Group    
  2009  2008  2007 
  £m  £m  £m 
Wages, salaries and other staff costs 
  1,590   1,296   1,339 
Social security costs 
  90   86   82 
Pension costs 
            
– defined benefit schemes (see Note 4) 
  54   2   132 
– curtailment gains (see Note 4) 
  (544)   —   — 
– defined contribution schemes 
  15   18   14 
Staff costs 
  1,205   1,402   1,567 
  
Premises and equipment 
  407   331   267 
Other administrative expenses 
  2,147   2,516   2,322 
  
Property, plant and equipment (see Note 17) 
  144   131   109 
Intangible assets (see Note 16) 
  103   106   155 
Depreciation and amortisation 
  247   237   264 
  
Write-down of goodwill and other intangible assets 
  —   716   — 
   4,006   5,202   4,420 
Integration costs included in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement programmes connected with acquisitions made by the Group.
     Group    
  2009  2008  2007 
  £m  £m  £m 
Staff costs 
  3   4   7 
Premises and equipment 
  (6)   —   4 
Other administrative expenses 
  12   14   1 
Depreciation and amortisation 
  7   20   31 
   16   38   43 
  
  
Restructuring costs included in operating expenses comprise: 
            
  
  2009  2008  2007 
   £m   £m   £m 
Staff costs 
  96   4   — 
Premises and equipment 
  34   —   — 
Other administrative expenses 
  4   —   — 
   134   4   — 
97
Notes on the accounts continued
3. Operating expenses continued
The average number of persons employed, rounded to the nearest hundred, in the Group during the year, excluding temporary staff, was 29,700 (2008 – 32,600; 2007 – 31,200). The number of persons employed by the Group at 31 December, excluding temporary staff, was as follows:
 
Core deposit intangibles
     Group    
  2009  2008  2007 
UK Retail 
  15,700   16,600   15,900 
UK Corporate 
  300   3,200   3,000 
Wealth 
  3,400   3,800   3,600 
Global Banking & Markets 
  2,000   1,200   1,200 
Ulster Bank 
  4,600   5,600   6,100 
Core 
  26,000   30,400   29,800 
Non-Core 
  100   300   400 
Business Services 
  1,300   1,400   1,300 
Total 
  27,400   32,100   31,500 
  
UK 
  20,500   25,100   23,900 
USA 
  1,900   1,300   1,300 
Europe 
  4,500   5,100   5,800 
Rest of the World 
  500   600   500 
Total 
  27,400   32,100   31,500 
4 Pension costs
The Group sponsors a number of pension schemes in the UK and overseas, predominantly defined benefit schemes, whose assets are independent of the Group’s finances. The Group’s defined benefit schemes generally provide a pension of one-sixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years. Employees do not make contributions for basic pensions but may make voluntary contributions to secure additional benefits on a money-purchase basis. Since October 2006 The Royal Bank of Scotland Group Pension Fund (‘Main scheme’) has been closed to new entrants.
The Group also provides post-retirement benefits other than pensions, principally through subscriptions to private healthcare schemes in the UK and the US and unfunded post-retirement benefit plans. Provision for the costs of these benefits is charged to the income statement over the average remaining future service lives of eligible employees. The amounts are not material.
The corridor method of accounting permits the Bank to defer recognition of actuarial gains and losses that are within 10% of the larger of the fair value of plan assets and present value of defined benefit obligations of the schemes, on an individual scheme basis, at the reporting date. Any excess variations are amortised prospectively over the average remaining service lives of current members of the schemes.
98
Other acquired intangibles
Notes on the accounts
Interim valuations of the Group’s schemes under IAS 19 ‘Employee Benefits’ were prepared to 31 December with the support of independentactuaries, using the following assumptions:
     Group        Bank    
Principal actuarial assumptions at 31 December (weighted average) 
 2009  2008  2007  2009  2008  2007 
Discount rate 
  5.9%   6.4%   6.0%   5.9%   6.5%   6.0% 
Expected return on plan assets 
  6.2%   7.0%   6.9%   6.2%   7.1%   6.9% 
Rate of increase in salaries 
  1.8%   3.8%   4.4%   1.8%   4.0%   4.5% 
Rate of increase in pensions in payment 
  3.4%   2.6%   3.2%   3.5%   2.7%   3.2% 
Inflation assumption 
  3.4%   2.6%   3.2%   3.5%   2.7%   3.2% 
  
  
      Group          Bank     
Major classes of plan assets as a percentage of total plan assets 
 2009  2008  2007  2009  2008  2007 
Equity interests 
  47.1%   58.0%   61.1%   47.6%   59.4%   61.0% 
Index-linked bonds 
  22.7%   17.4%   17.5%   23.7%   18.0%   18.2% 
Government fixed interest bonds 
  0.1%   2.0%   1.7%   —   1.2%   1.2% 
Corporate and other bonds 
  20.2%   18.1%   14.9%   19.7%   18.5%   15.1% 
Property 
  3.5%   4.2%   4.1%   3.5%   3.7%   3.8% 
Cash and other assets 
  6.4%   0.3%   0.7%   5.5%   (0.8%)   0.7% 
Ordinary shares of the ultimate holding company with a fair value of £4 million (2008 – £15 million; 2007 – £65 million) are held by the Group’s pension schemes together with holdings of other financial instruments issued by the Group with a value of £192 million (2008 – £421 million; 2007 – £606 million).
The expected return on plan assets at 31 December is based upon the weighted average of the following assumed returns on the major classes of plan assets:
     Group        Bank    
  2009  2008  2007  2009  2008  2007 
Equities 
  7.9%   8.4%   8.1%   7.9%   8.4%   8.1% 
Index-linked bonds 
  4.5%   3.9%   4.5%   4.5%   3.9%   4.5% 
Government fixed interest bonds 
  4.3%   4.3%   4.5%   —   3.9%   4.5% 
Corporate and other bonds 
  5.8%   6.1%   5.5%   5.9%   6.1%   5.5% 
Property 
  6.2%   6.0%   6.3%   6.2%   6.1%   6.3% 
Cash and other assets 
  1.3%   3.4%   4.6%   0.5%   2.5%   4.6% 
  
  
  
Post-retirement mortality assumptions (Main scheme)      2009  2008  2007 
Longevity at age 60 for current pensioners (years): 
                        
Males 
              27.1   26.1   26.0 
Females 
              29.5   26.9   26.8 
  
Longevity at age 60 for future pensioners (years): 
                        
Males 
              29.2   28.1   28.1 
Females 
              30.8   28.2   28.2 
The allowance for post-retirement mortality has been updated following an analysis of recent experience of pensioners in the main scheme.
99
Computer software
6 to 10 years
5 to 10 years
3 to 5
Notes on the accounts continued
4 Pension costs continued 
                  
     Group        Bank    
     Present        Present    
     value of  Net     value of  Net 
  Fair value  defined  pension  Fair value  defined  pension 
  of plan  benefit  deficit/  of plan  benefit  deficit/ 
  assets  obligations  (surplus)  assets  obligations  (surplus) 
Changes in value of net pension deficit/(surplus) 
 £m  £m  £m  £m  £m  £m 
At 1 January 2008 
  19,513   19,213   (300)   18,575   18,100   (475) 
Currency translation and other adjustments 
  389   450   61   —   —   — 
Income statement: 
                        
Expected return 
  1,338       (1,338)   1,271       (1,271) 
Interest cost 
      1,145   1,145       1,080   1,080 
Current service cost 
      491   491       437   437 
Less: direct contributions from other scheme members 
      (319)   (319)       (332)   (332) 
Past service cost 
      23   23       21   21 
   1,338   1,340   2   1,271   1,206   (65) 
Actuarial gains and losses 
  (5,089)   (3,527)   1,562   (4,784)   (3,390)   1,394 
Disposal of subsidiaries 
  —   (3)   (3)   —   —   — 
Contributions by employer 
  154   —   (154)   78   —   (78) 
Contributions by other scheme members 
  306   306   —   319   319   — 
Contributions by plan participants 
  5   5   —   —   —   — 
Benefits paid 
  (660)   (660)   —   (631)   (631)   — 
Expenses included in service cost 
  (24)   (24)   —   (24)   (24)   — 
At 31 December 2008 
  15,932   17,100   1,168   14,804   15,580   776 
  
  
Unrecognised actuarial gains 
          30           206 
Retirement benefit liabilities at 31 December 2008 
          1,198           982 
  
Unfunded schemes liabilities included in post-retirement benefit liabilities 
          29           14 
  
  
      Group          Bank     
      Present          Present     
      value of  Net      value of  Net 
  Fair value  defined  pension  Fair value  defined  pension 
  of plan  benefit  deficit/  of plan  benefit  deficit/ 
  assets  obligations  (surplus)  assets  obligations  (surplus) 
Changes in value of net pension deficit/(surplus) 
  £m   £m   £m   £m   £m   £m 
At 1 January 2009 
  15,932   17,100   1,168   14,804   15,580   776 
Currency translation and other adjustments 
  (52)   (76)   (24)   —   1   1 
Income statement: 
                        
Expected return 
  1,094       (1,094)   1,029       (1,029) 
Interest cost 
      1,073   1,073       1,000   1,000 
Current service cost 
      355   355       300   300 
Less: direct contributions from other scheme members      (302)   (302)       (315)   (315) 
Past service cost 
      22   22       15   15 
Gains on curtailment 
      (544)   (544)       (358)   (358) 
   1,094   604   (490)   1,029   642   (387) 
  
Actuarial gains and losses 
  1,076   4,659   3,583   993   4,475   3,482 
Transfer from fellow subsidiary 
  —   17   17   —   —   — 
Contributions by employer 
  213   —   (213)   124   —   (124) 
Contributions by other scheme members 
  405   405   —   414   414   — 
Contributions by plan participants 
  7   7   —   1   1   — 
Benefits paid 
  (802)   (802)   —   (742)   (742)   — 
Expenses included in service cost 
  (20)   (20)   —   (20)   (20)   — 
At 31 December 2009 
  17,853   21,894   4,041   16,603   20,351   3,748 
  
  
Unrecognised actuarial gains 
          (3,539)           (3,276) 
Retirement benefit liabilities at 31 December 2009 
          502           472 
  
Unfunded schemes liabilities included in post-retirement benefit liabilities 
          49           14 
100
Notes on the accounts
  Group  Bank 
  2009  2008  2009  2008 
Net pension deficit comprises: 
 £m  £m  
£m
  £m 
Net assets of schemes in surplus 
            
(included in Prepayments, accrued income and other assets, Note 18) 
  (10)   —   —   — 
Net liabilities of schemes in deficit 
  512   1,198   472   982 
   502   1,198   472   982 
Curtailment gains of £544 million for the Group (£358 million for the Bank) have been recognised in 2009 arising from changes to pension benefits in the Main scheme and certain other subsidiaries schemes due to the capping of future salary increases that will count for pension purposes to the lower of 2% or the rate of inflation in any year.
The Group expects to contribute £470 million (Bank – £414 million) to its defined benefit pension schemes in 2010.
The most recent funding valuation of the main UK scheme, as at 31 March 2007, showed a surplus of assets over liabilities of £0.7 billion. The next valuation is due as at 31 March 2010 and the Group expects this valuation to show that liabilities exceed the value of the assets. Following this valuation, the Group and scheme Trustees will agree the level of contributions to be paid to the scheme. This could result in the amount ofcontributions payable in 2010 and subsequent years being materially different from the current rates based on the previous valuation.
        Group              Bank       
  2009  2008  2007  2006  2005  2009  2008  2007  2006  2005 
History of defined benefit schemes 
 £m  £m  £m  £m  £m  £m  £m  
£m
  £m  £m 
Fair value of plan assets 
  17,853   15,932   19,513   18,213   16,697   16,603   14,804   18,575   17,374   15,914 
Present value of defined benefit obligations 
  21,894   17,100   19,213   20,006   20,174   20,351   15,580   18,100   18,986   19,105 
Net (deficit)/surplus 
  (4,041)   (1,168)   300   (1,793)   (3,477)   (3,748)   (776)   475   (1,612)   (3,191) 
  
Experience gains/(losses) on plan liabilities 
  165   (73)   (209)   (7)   (55)   135   (55)   (256)   (4)   (41) 
Experience gains/(losses) on plan assets 
  1,076   (5,089)   150   570   1,639   993   (4,784)   163   552   1,556 
Actual return on pension schemes assets 
  2,170   (3,751)   1,392   1,593   2,611   2,022   (3,513)   1,345   1,574   2,486 
Actual return on pension schemes assets – % 
  13.7%  (19.1)%  7.7%  9.6%  18.4%  13.8%  (19.0)%  7.8%  9.9%  18.4%
The table below sets out the sensitivities of the pension cost for the year and the present value of defined benefit obligations at the balance sheet dates to a change in the principal actuarial assumptions:
  
 Group
  
 Bank
 
     Increase/(decrease)        Increase/(decrease)    
  in pension  in obligation  in pension  in obligation 
  cost for the year  at 31 December  cost for the year  at 31 December 
  2009  2008  2009  2008  2009  2008  2009  2008 
  £m  £m  £m  £m  £m  £m  £m  £m 
0.25% increase in the discount rate 
  (27)   (42)   (854)   (754)   (21)   (37)   (790)   (696) 
0.25% increase in inflation 
  58   85   722   686   49   77   654   624 
0.25% additional rate of increase in pensions in payment 
  39   45   483   417   33   41   442   383 
0.25% additional rate of increase in deferred pensions 
  17   8   221   98   16   8   214   94 
0.25% additional rate of increase in salaries 
  11   32   85   190   8   28   66   168 
Longevity increase of 1 year 
  34   34   453   335   29   31   416   302 
101
Notes on the accounts continued
Amounts paid to the auditors for statutory audit and other services were as follows:
  Group 
  2009  2008 
  £m  £m 
Audit Services        
— Statutory Audit  2.6   
2.7
 
— audit related regulatory reporting  
0.2
   
0.1
 
   
2.8
   
2.8
 
Tax Fees  
0.1
   
0.2
 
All other services  
0.1
   0.3 
Total  
3.0
   3.3 
6 Tax 
         
  
 Group
 
  2009  2008  2007 
  £m  £m  £m 
Current taxation: 
         
(Credit)/charge for the year 
  (147)   677   989 
Over provision in respect of prior periods 
  (29)   (164)   (71) 
Relief for overseas taxation 
  —   —   (76) 
   (176)   513   842 
Deferred taxation: 
            
Charge/(credit) for the year 
  253   (4)   (60) 
(Over)/under provision in respect of prior periods 
  (82)   90   (14) 
Tax (credit)/charge for the year 
  (5)   599   768 
The actual tax (credit)/charge differs from the expected tax charge computed by applying the standard rate of UK corporation tax of 28% (2008 –28.5%; 2007 – 30%) as follows:
  2009  2008  2007 
  £m  £m  £m 
Expected tax charge 
  316   325   926 
Non-deductible goodwill impairment 
  —   165   — 
Other non-deductible items 
  70   78   52 
Non-taxable items: 
            
– gain on redemption of own debt 
  (107)   —   — 
– other 
  (203)   (32)   (178) 
Taxable foreign exchange movements 
  (101)   149   (3) 
Group relief at non-standard rates 
  (140)   (16)   94 
Foreign profits taxed at other rates 
  266   (1)   (57) 
(Increase)/decrease in deferred tax asset following change in the rate of UK corporation tax 
  —   (2)   18 
Unutilised losses brought forward and carried forward 
  5   7   1 
Adjustments in respect of prior periods 
  (111)   (74)   (85) 
Actual tax (credit)/charge for the year 
  (5)   599   768 
  
  
7 Dividends to preference shareholders 
            
      Group     
  2009  2008  2007 
   £m   £m   £m 
9% non-cumulative sterling preference shares, Series A 
  13   13   13 
Non-cumulative dollar preference shares, Series C 
  15   12   12 
   28   25   25 
  
Note:             
(1) In accordance with IAS 32, the Group’s preference shares are included in subordinated liabilities and the related finance cost in interest payable. 
102
Notes on the accounts
8 Ordinary dividends
  
 Group
 
  2009  2008  2007 
  £m  £m  £m 
Ordinary dividends paid to the parent company 
  —   1,000   1,850 
9 (Loss)/profit dealt with in the accounts of the Bank
As permitted by section 408(3) of the Companies Act 2006, no income statement or statement of comprehensive income for the Bank has been presented as a primary financial statement. Of the profit attributable to ordinary shareholders, a loss of £584 million (2008 – £1,387 million profit; 2007 – £3,210 million profit) has been dealt with in the accounts of the Bank.
10 Financial instruments
Classification
The following tables analyse the Group’s financial assets and financial liabilities in accordance with the categories of financial instruments in IAS 39.
Assets and liabilities outside the scope of IAS 39 are shown separately as non financial assets/liabilities.
  
 Group
 
     Designated        Other          
     as at fair        financial     Non    
     value        instruments     financial    
  
Held-for-
  through  Available-  Loans and  (amortised  Finance  assets/    
  trading  profit or loss  for-sale  receivables  cost)  leases  liabilities  Total 
2009  £m  £m  £m  £m  £m  £m  £m  £m 
Assets 
                        
Cash and balances at central banks 
  —   —   —   1,805            1,805 
Loans and advances to banks (1) 
  19,772   1,042   —   112,416            133,230 
Loans and advances to customers (2) 
  5,196   —   —   158,944      263      164,403 
Debt securities (3) 
  30,530   13   2,087   2,159             34,789 
Equity shares 
  5   25   936   —             966 
Settlement balances 
  —   —   —   4,573             4,573 
Derivatives 
  4,470   —   —   —             4,470 
Intangible assets 
                         748   748 
Property, plant and equipment 
                         3,300   3,300 
Deferred taxation 
                         568   568 
Prepayments, accrued income 
                               
and other assets 
  —   —   —   33          1,843   1,876 
   59,973   1,080   3,023   279,930      263   6,459   350,728 
  
Liabilities 
                               
Deposits by banks (4) 
  17,757   —           43,676           61,433 
Customer accounts (5, 6) 
  16,891   2,435           208,137           227,463 
Debt securities in issue (7) 
  —   —           11,470           11,470 
Settlement balances and short positions 
  13,917   —           3,027           16,944 
Derivatives 
  4,314   —                       4,314 
Accruals, deferred income 
                                
and other liabilities 
  —   —           717   5   3,105   3,827 
Retirement benefit liabilities 
                          512   512 
Deferred taxation 
                          285   285 
Subordinated liabilities (8) 
  1,142   —           7,857       —   8,999 
   54,021   2,435           274,884   5   3,902   335,247 
  
Equity 
                              15,481 
                               350,728 
For notes relating to this table refer to page 104                       
103
Notes on the accounts continued
10 Financial instruments continued
  
 Group
 
     Designated        Other          
     as at fair        financial     Non    
     value        instruments     financial    
  
Held-for-
  through  Available-  Loans and  (amortised  Finance  assets/    
  trading  profit or loss  for-sale  receivables  cost)  leases  liabilities  Total 
2008  £m  £m  £m  £m  £m  £m  £m  £m 
Assets 
                        
Cash and balances at central banks 
  —   —   —   1,285            1,285 
Loans and advances to banks (1) 
  11,432   302   —   54,500            66,234 
Loans and advances to customers (2) 
  2,883   —   —   195,080      304      198,267 
Debt securities (3) 
  32,357   21   3,615   —             35,993 
Equity shares 
  109   22   998   —             1,129 
Settlement balances 
  —   —   —   4,117             4,117 
Derivatives 
  8,895   —   —   —             8,895 
Intangible assets 
          ��              815   815 
Property, plant and equipment 
                         1,970   1,970 
Deferred taxation 
                         496   496 
Prepayments, accrued income 
                               
and other assets 
  —   —   —   32      —   1,986   2,018 
   55,676   345   4,613   255,014      304   5,267   321,219 
  
Liabilities 
                               
Deposits by banks (4) 
  22,610   —           31,023           53,633 
Customer accounts (5, 6) 
  20,561   2,291           177,532           200,384 
Debt securities in issue (7) 
  75   —           17,137           17,212 
Settlement balances and short positions 
  11,241   —           1,850           13,091 
Derivatives 
  8,066   —                       8,066 
Accruals, deferred income 
                                
and other liabilities 
  —   —           532   5   3,495   4,032 
Retirement benefit liabilities 
                          1,198   1,198 
Deferred taxation 
                          46   46 
Subordinated liabilities (8) 
  1,224   —           8,875           10,099 
   63,777   2,291   —   —   236,949   5   4,739   307,761 
  
Equity 
                              13,458 
                               321,219 
Notes:
Expenditure on internally generated goodwill and brands is written-off as incurred. Direct costs relating to the development
(1)Includes reverse repurchase agreements of internal-use computer software are capitalised once technical feasibility and economic viability have been established. These costs include payroll, the costs of materials and services, and directly attributable overhead. Capitalisation of costs ceases when the software is capable of operating as intended. During and after development, accumulated costs are reviewed for impairment against the projected benefits that the software is expected to generate. Costs incurred prior to the establishment of technical feasibility and economic viability are expensed as incurred as are all training costs and general overhead. The costs of licences to use computer software that are expected to generate economic benefits beyond one year are also capitalised.
Acquired goodwill being the excess of the cost of an acquisition over the Group's interest£7,287 million (2008 – £3,882 million), items in the net fair valuecourse of the identifiable assets, liabilitiescollection from other banks of £2,118 million (2008 – £2,107 million), amounts due from holding company of £116,616 million (2008 – £53,781 million) and contingent liabilitiesamounts due from fellow subsidiaries of the subsidiary, associate or joint venture acquired is initially recognised at cost£1,243 million (2008 – £404 million).
(2)
Includes reverse repurchase agreements of £9,916 million (2008 – £5,202 million) and subsequently at cost less any accumulated impairment losses. Goodwill arising on the acquisitionamounts due from fellow subsidiaries of subsidiaries£14,295 million (2008 – £40,970 million).
(3)
Includes treasury bills and joint ventures is includedsimilar securities of £1,015 million (2008 – £382 million) and other eligible bills of £253 million (2008 – £54 million).
(4)
Includes repurchase agreements of £10,591 million (2008 – £12,027 million), items in the balance sheet caption 'Intangible assets'course of transmission to other banks of £649 million (2008 – £545 million), amounts due to holding company of £36,162 million (2008 – £34,401 million) and that on associates within their carrying amounts. The gain or loss on the disposalamounts due to fellow subsidiaries of a subsidiary, associate or joint venture includes the carrying value£8,858 million (2008 – £881 million).
(5)
Includes repurchase agreements of any related goodwill.
On implementation£36,922 million (2008 – £23,985 million) and amounts due to fellow subsidiaries of IFRS, the Group did not restate business combinations that occurred before 1 January 2004. Under previous GAAP, goodwill arising on acquisitions was capitalised and amortised over its estimated useful economic life. £9,539 million (2008 – £6,741 million).
(6)
The carrying amount of goodwill in the Group's opening IFRS balance sheet (1 January 2004) was £273 million, its carrying value under previous GAAP.
6. Property, plant and equipment

Items of property, plant and equipment are stated at cost less accumulated depreciation (see below) and impairment losses. Where an item of property, plant and equipment comprises major components having different useful lives, they are accounted for separately. Property that is being constructed or developed for future use as investment property is classified as property, plant and equipment and stated at cost until construction or development is complete, at which time it is reclassified as investment property.
Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases (except investment property – see accounting policy 19 below)) over their estimated useful lives. The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows:
Freehold and long leasehold buildings
Short leaseholds
Property adaptation costs
Computer equipment
Other equipment
50 years
unexpired period of the lease
10 to 15 years
up to 5 years
4 to 15 years
Under previous GAAP, the Group's freehold and long leasehold property occupied for its own use was recorded at valuation on the basis of existing use value. The Group elected to use this valuation as at 31 December 2003 (£1,334 million) as deemed cost for its opening IFRS balance sheet (1 January 2004).



Accounting policies continued

7. Impairment of intangible assets and property, plant and equipment
At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent from those of other assets or groups of assets, recoverable amount is determined for the cash-generating unit to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash generating unit that have not been reflected in the estimation of future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed that which it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
8. Foreign currencies
The Group’s consolidated financial statements are presented in sterling which is the functional currency of the Bank.
Transactions in foreign currencies are translated into sterling at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into sterling at the rates of exchange ruling at the balance sheet date. Foreign exchange differences arising on translation are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations. Non-monetary items denominated in foreign currencies that are stated at fair value are translated into sterling at foreign exchange rates ruling at the dates the values were determined. Translation differences arising on non-monetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example equity shares, which are included in the available-for-sale reserve in equity unless the asset is the hedged item in a fair value hedge.
The assets and liabilities of foreign operations, including goodwill and fair value adjustments arising on acquisition, are translated into sterling at foreign exchange rates ruling at the balance sheet date. The revenues and expenses of foreign operations are translated into sterling at average exchange rates unless these do not approximate to the foreign exchange rates ruling at the dates of the transactions. Foreign exchange differences arising on the translation of a foreign operation are recognised directly in equity and included in profit or loss on its disposal.
9. Leases
Contracts to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer. Other contracts to lease assets are classified as operating leases.
Finance lease receivables are stated in the balance sheet at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment. Unguaranteed residual values are subject to regular review to identify potential impairment. If there has been a reduction in the estimated unguaranteed residual value, the income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.
Rental income from operating leases is credited to the income statement on a receivable basis over the term of the lease. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see accounting policy 6 above).
10. Taxation
Provision is made for taxation at current enacted rates on taxable profits, arising in income or in equity, taking into account relief for overseas taxation where appropriate. Deferred taxation is accounted for in full for all temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes, except in relation to overseas earnings where remittance is controlled by the Group, and goodwill.
Deferred tax assets are only recognised to the extent that it is probable that they will be recovered.
11. Financial assets
On initial recognition financial assets are classified into held-to-maturity investments; available-for-sale financial assets; held-for-trading; designated as at fair value through profit or loss; or loans and receivables.
Held-to-maturity investments – a financial asset may be classified as a held-to-maturity investment only if it has fixed or determinable payments, a fixed maturity and the Group has the positive intention and ability to hold to maturity. Held-to-maturity investments are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see accounting policy 3 above) less any impairment losses.
Held-for-trading – a financial asset is classified as held-for-trading if it is acquired principally for the purpose of selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial assets are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses on held-for-trading financial assets are recognised in profit or loss as they arise.
Designated as at fair value through profit or loss – financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.
Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss and are subsequently measured at fair value. Gains and losses on financial assets that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
The Group has designated financial assets as at fair value through profit or loss principally where the assets are economically hedged by derivatives and fair value designation eliminates the measurement inconsistency that would arise if the assets were carried at amortised cost or classified as available-for-sale.
Loans and receivables – non-derivative financial assets with fixed or determinable repayments that are not quoted in an active market are classified as loans and receivables except those that are classified as available-for-sale or as held-for-trading, or designated as at fair value through profit or loss. Loans and receivables are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at amortised cost using the effective interest method (see accounting policy 3 above) less any impairment losses.
Available-for-sale – financial assets that are not classified as held-to-maturity; held-for-trading; designated as at fair value through profit or loss; or loans and receivables are classified as available-for-sale. Financial assets can be designated as available-for-sale on initial recognition. Available-for-sale financial assets are initially recognised at fair value plus directly related transaction costs. They are subsequently measured at fair value. Unquoted equity investments whose fair value cannot be measured reliably are carried at cost and classified as available-for-sale financial assets. Impairment losses and exchange differences resulting from retranslating the amortised cost of currency monetary available-for-sale financial assets are recognised in profit or loss together with interest calculated using the effective interest method (see accounting policy 3 above). Other changes in the fair value of available-for-sale financial assets are reported in a separate component of shareholders’ equity until disposal, when the cumulative gain or loss is recognised in profit or loss.
Regular way purchases of financial assets classified as loans and receivables are recognised on settlement date; all other regular way purchases are recognised on trade date.
Fair value for a net open position in a financial asset that is quoted in an active market is the current bid price times the number of units of the instrument held. Fair values for financial assets not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial assets.
12. Impairment of financial assets
The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or group of financial assets classified as held-to-maturity, available-for-sale or loans and receivables is impaired. A financial asset or portfolio of financial assets is impaired and an impairment loss incurred if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
Financial assets carried at amortised cost – if there is objective evidence that an impairment loss on a financial asset or group of financial assets classified as loans and receivables or as held-to-maturity investments has been incurred, the Group measures the amount of the loss as the difference between the carrying amount of the asset or group of assets and the present value of estimated future cash flows from the asset or group of assets discounted at the effective interest rate of the instrument at initial recognition.
Impairment losses are assessed individually for financial assets that are individually significant and individually or collectively for assets that are not individually significant. In making collective assessment of impairment, financial assets are grouped into portfolios on the basis of similar risk characteristics. Future cash flows from these portfolios are estimated on the basis of the contractual cash flows and historical loss experience for assets with similar credit risk characteristics. Historical loss experience is adjusted, on the basis of current observable data, to reflect the effects of current conditions not affecting the period of historical experience.
Impairment losses are recognised in profit or loss and the carrying amount of the financial asset or group of financial assets reduced by establishing an allowance for impairment losses. If in a subsequent period the amount of the impairment loss reduces and the reduction can be ascribed to an event after the impairment was recognised, the previously recognised loss is reversed by adjusting the allowance. Once an impairment loss has been recognised on a financial asset or group of financial assets, interest income is recognised on the carrying amount using the rate of interest at which estimated future cash flows were discounted in measuring impairment.
Financial assets carried at fair value – when a decline in the fair value of a financial asset classified as available-for-sale has been recognised directly in equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in profit or loss. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on available-for-sale equity instruments are not reversed through profit or loss, but those on available-for-sale debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.

Accounting policies continued

13. Financial liabilities
A financial liability is classified as held-for-trading if it is incurred principally for the purpose of selling in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise.

Financial liabilities that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial liabilities that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
Financial liabilities may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.
The principal category of financial liabilitiescustomer accounts designated as at fair value through profit or loss is structured liabilities issued by£17 million greater (2008 – £81 million lower) than the Group: designation significantly reduces the measurement inconsistency between these liabilities and the related derivatives carried at fair value.
All other financial liabilities are measured at amortised cost using the effective interest method (see accounting policy 3 above).
Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument held or issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities.
14. Derecognition
A financial asset is derecognised when it has been transferred and the transfer qualifies for derecognition. A transfer requires that the Group either: (a) transfers the contractual rights to receive the asset’s cash flows; or (b) retains the right to the asset’s cash flows but assumes a contractual obligation to pay those cash flows to a third party. After a transfer, the Group assesses the extent to which it has retained the risks and rewards of ownership of the transferred asset. If substantially all the risks and rewardsprincipal amount. No amounts have been retained, the asset remains on the balance sheet. If substantially all the risks and rewards have been transferred, the asset is derecognised. If substantially all the risks and rewards have been neither retained nor transferred, the Group assesses whether or not it has retained control of the asset. If it has not retained control, the asset is derecognised. Where the Group has retained control of the asset, it continues to recognise the asset to the extent of its continuing involvement.
A financial liability is removed from the balance sheet when the obligation is discharged, or cancelled, or expires.
15. Sale and repurchase transactions
Securities subject to a sale and repurchase agreement under which substantially all the risks and rewards of ownership are retained by the Group continue to be shown on the balance sheet and the sale proceeds recorded as a deposit. Securities acquired in a reverse sale and repurchase transaction under which the Group is not exposed to substantially all the risks and rewards of ownership are not recognised on the balance sheet and the consideration is recorded in Loans and advances to banks or Loans and advances to customers as appropriate.
Securities borrowing and lending transactions are usually secured by cash or securities advanced by the borrower. Borrowed securities are not recognised on the balance sheet or lent securities derecognised. Cash collateral received or given is treated as a loan or deposit; collateral in the form of securities is not recognised. However, where securities borrowed are transferred to third parties, a liability for the obligation to return the securities to the stock lending counterparty is recorded.
16. Netting
Financial assets and financial liabilities are offset and the net amount presented in the balance sheet when, and only when, the Group currently has a legally enforceable right to set off the recognised amounts; and it intends either to settle on a net basis, or to realise the asset and settle the liability simultaneously. The Group is party to a number of arrangements, including master netting agreements, that give it the right to offset financial assets and financial liabilities but where it does not intend to settle the amounts net or simultaneously and therefore the assets and liabilities concerned are presented gross.
17. Capital instruments
The Group classifies a financial instrument that it issues as a financial asset, financial liability or an equity instrument in accordance with the substance of the contractual arrangement. An instrument is classified as a liability if it is a contractual obligation to deliver cash or another financial asset, or to exchange financial assets or financial liabilities on potentially unfavourable terms. An instrument is classified as equity if it evidences a residual interest in the assets of the Group after the deduction of liabilities. The components of a compound financial instrument issued by the Group are classified and accounted for separately as financial assets, financial liabilities or equity as appropriate.
18. Derivatives and hedging
Derivative financial instruments are recognised initially, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative’s components using appropriate pricing or valuation models.
A derivative embedded in a contract is accounted for as a stand-alone derivative if its economic characteristics are not closely related to the economic characteristics of the host contract; unless the entire contract is carried at fair value through profit or loss.

Gains and losses arising from changes in the fair value of a derivative are recognised as they arise in profit or loss unless the derivative is the hedging instrument in a qualifying hedge. There are three types of hedge relationship: hedges of changes in the fair value of a recognised asset or liability or firm commitment (fair value hedges); hedges of the variability in cash flows from a recognised asset or liability or a forecast transaction (cash flow hedges); and hedges of the net investment in a foreign operation.
Hedge relationships are formally documented at inception. The documentation includes identification of the hedged item and the hedging instrument, details the risk that is being hedged and the way in which effectiveness will be assessed at inception and during the period of the hedge. If the hedge is not highly effective in offsetting changes in fair values or cash flows attributable to the hedged risk, consistent with the documented risk management strategy, hedge accounting is discontinued.
Fair value hedge – in a fair value hedge, the gain or loss on the hedging instrument is recognised in profit or loss. The gain or loss on the hedged item attributable to the hedged risk is recognised in profit or loss and adjusts the carrying amount of the hedged item. Hedge accounting is discontinued if the hedge no longer meets the criteria for hedge accounting or if the hedging instrument expires or is sold, terminated or exercised or if hedge designation is revoked. If the hedged item is one for which the effective interest rate method is used, any cumulative adjustment is amortised to profit or loss over the life of the hedged item using a recalculated effective interest rate.
Cash flow hedge – where a derivative financial instrument is designated as a hedge of the variabilitychanges in cash flows of a recognised asset or liability or a highly probable forecast transaction, the effective portion of the gain or loss on the hedging instrument is recognised directly in equity. The ineffective portion is recognised in profit or loss. When the forecast transaction results in the recognition of a financial asset or financial liability, the cumulative gain or loss is reclassified from equity in the same periods in which the asset or liability affects profit or loss. Otherwise the cumulative gain or loss is removed from equity and recognised in profit or loss at the same timecredit risk associated with these liabilities as the hedged transaction. Hedge accounting is discontinued ifchanges are immaterial measured as the hedge no longer meets the criteria for hedge accounting; if the hedging instrument expires or is sold, terminated or exercised; if the forecast transaction is no longer expected to occur; or if hedge designation is revoked. On the discontinuance of hedge accounting (except where a forecast transaction is no longer expected to occur), the cumulative unrealised gain or loss recognised in equity is recognised in profit or loss when the hedged cash flow occurs or, if the forecast transaction results in the recognition of a financial asset or financial liability, in the same periods during which the asset or liability affects profit or loss. Where a  forecast transaction is no longer expected to occur, the cumulative unrealised gain or loss is recognised in profit or loss immediately.
Hedge of net investment in a foreign operation – in the hedge of a net investment in a foreign operation, the portion of foreign exchange differences arising on the hedging instrument determined to be an effective hedge is recognised directly in equity. Any ineffective portion is recognised in profit or loss. Non-derivative financial liabilities as well as derivatives may be the hedging instrument in a net investment hedge.
19. Investment property
Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. It is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognisedfrom movements in profit or loss. Rental income from investment property is recognised on a straight-line basis over the period in the credit risk premium payable.
(7)
Comprises bonds and medium term notes of the lease. Lease incentives granted are recognised as an integral part£8,839 million (2008 – £11,574 million) and certificates of the total rental income.
20. Cashdeposit and cash equivalentsother commercial paper of £2,631 million (2008 – £5,638 million).
(8)
Cash and cash equivalents comprises cash and demand deposits with banks together with short-term highly liquid investments that are readily convertible
Includes amounts due to known amountsholding company of cash and subject to insignificant risk of change in value.£5,148 million (2008 – £4,293 million).
(9)
21. Shares in Group entities
The Bank’s investments in its subsidiaries are stated at cost less any impairment.
Critical accounting policies and key sources of accounting judgements
The reported results of
During 2008 the Group are sensitive toreclassified financial assets from the accounting policies, assumptions and estimates that underlieheld-for-trading category into the preparation of its financial statements. UK company law and IFRS require the directors, in preparing the Group's financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB’s Framework for the Preparation and Presentation of Financial Statements. The judgements and assumptions involved in the Group’s accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
Loan impairment provisions
The Group’s loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost. A loan is impaired when there is objective evidence that
58category (see page 107).
104
Notes on the accounts
The following tables analyse the Bank’s financial assets and financial liabilities in accordance with the categories of financial instruments in IAS 39. Assets and liabilities outside the scope of IAS 39 are shown separately as non financial assets/liabilities.
           Bank          
     Designated        Other       
     as at fair        financial  Non    
     value        instruments  financial    
  
Held-for-
  through  Available-  Loans and  (amortised  assets/    
  trading  profit or loss  for-sale  receivables  cost)  liabilities  Total 
2009  £m  £m  £m  £m  £m  £m  £m 
Assets 
                     
Cash and balances at central banks 
  —   —   —   906         906 
Loans and advances to banks (1) 
  130   940   —   80,362         81,432 
Loans and advances to customers (2) 
  216   —   —   88,340         88,556 
Debt securities 
  —   —   5   2,158         2,163 
Equity shares 
  —   —   13   —         13 
Investment in Group undertakings 
                     6,783   6,783 
Derivatives 
  2,900   —   —   —          2,900 
Intangible assets 
                     380   380 
Property, plant and equipment 
                     837   837 
Prepayments, accrued income 
                           
and other assets 
  —   —   —   —      1,004   1,004 
   3,246   940   18   171,766      9,004   184,974 
  
Liabilities 
                           
Deposits by banks (3) 
  70   —           21,839       21,909 
Customer accounts (4, 5) 
  1,176   947           140,902       143,025 
Derivatives 
  2,506   —                   2,506 
Accruals, deferred income 
                            
and other liabilities 
  —   —               910   910 
Retirement benefit liabilities 
                      472   472 
Deferred taxation 
                      217   217 
Subordinated liabilities 
  —   —           7,105       7,105 
   3,752   947           169,846   1,599   176,144 
  
Equity 
                          8,830 
                           184,974 
For notes relating to this table refer to page 106                       
 
Accounting policiesNotes on the accounts continued
10 Financial instruments continued
  
 Bank
 
     Designated           Other       
     as at fair           financial  Non    
     value           instruments  financial    
  
Held-for-
  through  Hedging  Available-  Loans and  (amortised  assets/    
  trading  profit or loss  derivatives  for-sale  receivables  cost)  liabilities  Total 
2008  £m  £m  £m  £m  £m  £m  £m  £m 
Assets 
                        
Cash and balances at central banks 
  —   —      —   838         838 
Loans and advances to banks (1) 
  111   302      —   22,733         23,146 
Loans and advances to customers (2) 
  302   —      —   124,391         124,693 
Debt securities 
  —   —      41   —         41 
Equity shares 
  —   —      6   —         6 
Investment in Group undertakings 
  —   —      —   —      7,339   7,339 
Derivatives 
  4,897   —   —   —   —          4,897 
Intangible assets 
                         401   401 
Property, plant and equipment 
                         883   883 
Deferred taxation 
                         400   400 
Prepayments, accrued income 
                               
and other assets 
  —   —       —   —      674   674 
   5,310   302   —   47   147,962      9,697   163,318 
  
Liabilities 
                               
Deposits by banks (3) 
  311   —               8,225       8,536 
Customer accounts (4, 5) 
  500   302               129,893       130,695 
Debt securities in issue (6) 
  —   —               15       15 
Derivatives 
  5,325   —   918                   6,243 
Accruals, deferred income 
                                
and other liabilities 
  —   —               —   1,407   1,407 
Retirement benefit liabilities 
                          982   982 
Subordinated liabilities (7) 
  —   —               7,860       7,860 
   6,136   302   918   —   —   145,993   2,389   155,738 
  
Equity 
                              7,580 
                               163,318 

Notes:
events since
(1)Includes items in the loan was granted have affected expected cash flowscourse of collection from the loan. The impairment loss is the difference between the carrying valueother banks of the loan and the present value£1,881 million (2008 – £2,022 million), amounts due from holding company of estimated future cash flows at the loan's original effective interest rate.

At 31 December 2007, gross loans and advances to customers totalled £191,314£78,203 million (2006(2008 – £184,470£18,707 million), amounts due from fellow subsidiaries of £9 million (2008 – £534 million) and customer loan impairment provisions amountedamounts due from subsidiaries of £57 million (2008 – £333 million).
(2)
Includes amounts due from fellow subsidiaries of £12,995 million (2008 – £40,920 million) and amounts due from subsidiaries of £1,715 million (2008 – £4,142 million).
(3)
Includes items in the course of transmission to £2,338other banks of £467 million (2006(2008 – £2,059£532 million).
There are two components, amounts due to the Group’s loan impairment provisions: individualholding company of £16,572 million (2008 – £1,259 million), amounts due to fellow subsidiaries of £9 million (2008 – £4,316 million) and collective.
Individual component amounts due to subsidiaries of £2,365 million (2008 – all impaired loans that exceed specific thresholds are individually assessed for impairment. Individually assessed loans principally comprise the Group's portfolio£295 million).
(4)
Includes amounts due to fellow subsidiaries of commercial loans£9,185 million (2008 – £6,293 million) and amounts due to medium and large businesses. Impairment losses are recognised as the difference between thesubsidiaries of £2,152 million (2008 – £3,558 million).
(5)
The carrying value of the loan and the discounted value of management’s best estimate of future cash repayments and proceeds from any security held. These estimates take into account the customer’s debt capacity and financial flexibility; the level and quality of its earnings; the amount and sources of cash flows; the industry in which the counterparty operates; and the realisable value of any security held. Estimating the quantum and timing of future recoveries involves significant judgement. The size of receipts will depend on the future performance of the borrower and the value of security, both of which will be affected by future economic conditions; additionally, collateral may not be readily marketable. The actual amount of future cash flows and the date they are received may differ from these estimates and consequently actual losses incurred may differ from those recognised in these financial statements.
Collective component – this is made up of two elements: loan impairment provisions for impaired loans that are below individual assessment thresholds (collective impaired loan provisions) and for loan losses that have been incurred but have not been separately identified at the balance sheet date (latent loss provisions). These are established on a portfolio basis using a present value methodology taking into account the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends. The most significant factors in establishing these provisions are the expected loss rates and the related average life. These portfolios include credit card receivables and other personal advances including mortgages. The future credit quality of these portfolios is subject to uncertainties that could cause actual credit losses to differ materially from reported loan impairment provisions. These uncertainties include the economic environment, notably interest rates and their effect on customer spending, the unemployment level, payment behaviour and bankruptcy trends.
Pensions
The Group operates a number of defined benefit pension schemes as described in Note 3 on the accounts. The assets of the schemes are measured at their fair value at the balance sheet date. Scheme liabilities are measured using the projected unit method, which takes account of projected earnings increases, using actuarial assumptions that give the best estimate of the future cash flows that will arise under the scheme liabilities. These cash flows are discounted at the interest rate applicable to high-quality corporate bonds of the same currency and term as the liabilities. Any surplus or deficit in excess of 10% of the greater of scheme assets and scheme liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). In determining the value of scheme liabilities, assumptions are made as to price inflation, dividend growth, pension increases, earnings growth and employees. There is a range of assumptions that could be adopted in valuing the schemes’ liabilities. Different assumptions could significantly alter the amount of the deficit recognised in the balance sheet and the pension cost charged to the income statement. The assumptions adopted for the Group’s pension schemes are set out in Note 3 on the accounts. The pension deficit recognised in the balance sheet at 31 December 2007 was £1,322 million (2006 – £1,298 million).
Fair value – financial instruments
Financial instruments classified as held-for-trading oraccounts designated as at fair value through profit or loss and financial assets classified as available-for-sale areis £26 million greater (2008 – £8 million lower) than the principal amount. No amounts have been recognised in the financial statements at fair value. All derivatives are measured at fair value. Gains or losses arising from changes in the fair value of financial instruments classified as held-for-trading or designated as at fair value through profit or loss for changes in credit risk associated with these liabilities as the changes are includedimmaterial measured as the change in fair value from movement in the income statement. Unrealised gainsperiod in the credit risk premium payable.
(6)
Comprises bonds and losses on available-for-salemedium term notes of £15 million.
(7)
Includes amounts due to the holding company of £3,710 million (2007 – £2,751 million).
(8)
During 2008 the Bank reclassified financial assets are recognised directly in equity unless an impairment loss is recognised.

Financial instruments measured at fair value include:
Loans and advances (held-for-trading and designated as at fair value though profit or loss) – principally comprise reverse repurchase agreements (reverse repos) and US commercial mortgage loans. In repurchase agreements one party agrees to sell securities to another and simultaneously agrees to repurchase the securities at a future date for a specified price. The repurchase price is fixed at the outset, usually being the original sale price plus an amount representing interest for the period from the sale toheld-for-trading category into the repurchase.
Treasuryloans and other eligible bills and debt securities (held-for-trading and available-for-sale) – treasury bills are UK and foreign government treasury bills and other bank bills eligible for refinancing with central banks. Debt securities include those issued by governments, municipal bodies, mortgage agencies and financial institutions as well as corporate bonds, debentures and residual interests in securitisations.
Equity securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) comprise equity shares of companies or corporations both listed and unlisted.
Deposits by banks and customer accounts (held-for-trading and designated as at fair value though profit or loss) – deposits measured at fair value principally comprise repurchase agreements (repos) discussed above.
Short positions (held-for-trading) arise in dealing and market making activities where Treasury and other eligible bills, debt securities and equity shares are sold which the Group does not currently possess.
Derivatives – these include swaps, forwards, futures and options. They may be traded on an organised exchange (exchange-traded) or over-the-counter (OTC)receivables category (see page 107). Holders of exchange traded derivatives are generally required to provide margin daily in the form of cash or other collateral.
Swaps include currency swaps, interest rate swaps, credit default swaps, total return swaps and equity and equity index swaps. A swap is an agreement to exchange cash flows in the future in accordance with a pre-arranged formula. In currency swap transactions, interest payment obligations are exchanged on assets and liabilities denominated in different currencies; the exchange of principal may be notional or actual. Interest rate swap contracts generally involve exchange of fixed and floating interest payment obligations without the exchange of the underlying principal amounts.
Forwards include forward foreign exchange contracts and forward rate agreements. A forward contract is a contract to buy (or sell) a specified amount of a physical or financial commodity, at an agreed price, on an agreed future date. Forward foreign exchange contracts are contracts for the delayed delivery of currency on a specified future date. Forward rate agreements are contracts under which two counterparties agree on the interest to be paid on a notional deposit of a specified term starting on a specific future date; there is no exchange of principal.
Futures are exchange-traded forward contracts to buy (or sell) standardised amounts of underlying physical or financial commodities. The Group buys and sells currency, interest rate and equity futures. Options include exchange-traded options on currencies, interest rates and equities and equity indices and OTC currency and equity options, interest rate caps and floors and swaptions. They are contracts that give the holder the right but not the obligation to buy (or sell) a specified amount of the underlying physical or financial commodity at an agreed price on an agreed date or over an agreed period.
Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Fair values are determined from quoted prices in active markets for identical financial assets or financial liabilities where these are available. Fair value for a net open position in a financial asset or financial liability in an active market is the current bid or offer price times the number of units of the instrument held. Where a trading portfolio contains both financial assets and financial liabilities which are derivatives of the same underlying instrument, fair value determined by valuing the gross long and short positions at current mid market prices, with an adjustment at portfolio level to the net open long or short position to amend the valuation to bid or offer as appropriate. Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data.
Accounting policies continued

The table below analyses the Group’s financial instruments carried at fair value as at 31 December 2007 by valuation method.

        Valuation    
        techniques    
     Valuation  incorporating    
     techniques  information    
  Quoted prices  based on  other than    
  in active  observable  observable    
  markets(1)  market data(2)  market data(3)  Total 
Financial instruments measured at fair value £bn  £bn  £bn  £bn 
Assets            
Fair value through profit or loss            
Loans and advances to banks  —   18.1   —   18.1 
Loans and advances to customers  —   12.7   2.2   14.9 
Treasury and other eligible bills and debt securities  12.4   21.6   0.1   34.1 
Equity shares  —   —   0.2   0.2 
Derivatives  0.1   3.5   —   3.6 
Available for sale                
Treasury and other eligible bills and debt securities  2.3   1.5   —   3.8 
Equity shares  0.1   —   0.9   1.0 
   14.9   57.4   3.4   75.7 
Liabilities                
Deposits  —   34.2   —   34.2 
Short positions  11.7   0.7   —   12.4 
Derivatives  0.3   3.0   —   3.3 
   12.0   37.9   —   49.9 

Note:

(1)  Financial assets and financial liabilities which are valued using unadjusted quoted prices in active markets for identical assets or liabilities. This category includes listed equity shares, exchange-traded derivatives, UK, US and certain other government securities, and US agency securities in active markets.
 
(2)  Financial assets and financial liabilities valued using techniques based on observable market data. Instruments in this category have been valued using:
  
 Group
 
  2009  2008  2007 
Amounts included in the consolidated income statement 
 £m  £m  £m 
  
Gains on financial assets/liabilities designated as at fair value through profit or loss 
  45   2   19 
106

Notes on the accounts
Reclassification of financial instruments
The Group reclassified financial assets from the held-for-trading (HFT)category into the loans and receivables (LAR) category (as permitted byparagraph 50D of IAS 39 as amended).
The table below shows the carrying value, fair value and effect on profitor loss of reclassification undertaken by the Group in 2008.
  Group 
  31 December 2009  After reclassification  Amount  Increase in 
              that would  profit or loss 
  Carrying  Fair     Impairment  have been  as a result of 
  value  value  Income  losses  recognised  reclassification 
   £m   £m   £m   £m   £m  ��£m 
Reclassified from HFT to LAR: 
                        
Loans 
                        
Corporate and other loans 
  379   222   18   20   (88)   86 
The following table is for reclassifications made in 2008. The balancesheet values of these assets, the effect of the reclassification on theincome statement for the period from the date of reclassification to 31December 2008 and the gains and losses relating to these assetsrecorded in the income statement for the years ended 31 December2008, 2007 and 2006 were as follows:
  Group 
            2008 2007 2006 
  2008 – on reclassification 31 December 2008   After reclassification         
                      Increase Gains/(losses) 
            Gains/(losses)         in profit recognised in 
            up to the       Amount or loss the income 
    Effective Expected     date of       that would a result of statement 
  Carrying interest cash Carrying Fair reclassi-    Impairment  have been reclassi- in prior 
  value rate flows value value fication  Income  losses  recognised fication periods 
   £m %  £m  £m  £m  £m   £m  £m   £m £m  £m £m 
Reclassified from HFT to LAR: 
                                    
Loans 
                                    
Corporate and other loans 
  425 5.39  951  466  395  (25)  11  —   (60)71  — — 
The table below shows the carrying value and fair value of reclassification undertaken by the Bank in 2008.
  
Bank
 
  
31 December 2009
 
  
Carrying
value
  
Fair
value
 
Reclassified from HFT to LAR: 
Loans 
Corporate and other loans 
  203   45 
The following table is for reclassifications in 2008.
  Bank 
  2008 – on reclassification  31 December 2008 
    Effective Expected       
  Carrying interest cash  Carrying  Fair 
  value rate flows  value  value 
   £m %  £m   £m   £m 
Reclassified from HFT to LAR: 
                 
Loans 
                 
Corporate and other loans 
  260 3.09  328   264   193 
Note:
(1)2008 tables have been restated for the Group and Bank.
 
(a)  quoted prices for similar assets or liabilities, or identical assets or liabilities in markets which are considered to be less than active; or
(b)  valuation techniques where all the inputs that have a significant effect on the valuation are directly or indirectly based on observable market data.
107
 
Financial assets and financial liabilities in this category include repos, reverse repos, structured loans and deposits, corporate and municipal debt securities, the majority of the Group’s OTC derivatives and certain instruments listed in (1) above where markets are to be active.
Notes on the accounts continued
 
(3)  Valuation techniques incorporating information other than observable market data are used for instruments where at least one input (which could have a significant effect on the instrument’s valuation) cannot be based on observable market data. Where inputs can be observed from market data without undue cost and effort, the observed input is used, if not, the input is estimated. Financial assets in this category include certain US commercial mortgage loans, unlisted equity shares and less liquid debt securities.
10 Financial instruments continued
Valuation of financial instruments carried at fair value
Control environment
The RBS Group’s control environment for the determination of the fair value of financial instruments includes formalised protocols for the review and validation of fair values independent from the businesses entering into the transactions. There are specific controls to ensure consistent pricing policies and procedures, incorporating disciplined price verification. The Group ensures that appropriate attention is given to bespoke transactions, structured products, illiquid products and other instruments which are difficult to price.
A key element of the control environment is the independent price verification (‘IPV’) process. Valuations are first performed by the business which entered into the transaction. Such valuations may be directly from available prices, or may be derived using a model and variable model inputs. These valuations are reviewed, and if necessary amended, by a team, independent of those trading the financial instruments, in the light of available pricing evidence. IPV is performed at a frequency to match the availability of independent data. For liquid instruments IPV is performed daily. The minimum frequency of review in the RBS Group is monthly for exposures in the regulatory trading book, and six monthly for exposures in the regulatory banking. The IPV control includes formalised reporting and escalation of any valuation differences in breach of established thresholds. The Global Pricing Unit determines IPV policy, monitors adherence to that policy, and performs additional independent reviews on highly subjective valuation issues for GBM and Non-Core.
Certain assets in the non-core business are comparably more difficult and subjective to value. The valuations of these portfolios are subject to a further level of review through an additional Non-Core valuation committee comprising senior representatives of the trading function, risk management and the Global Pricing Unit which meets regularly and are responsible for monitoring, assessing and enhancing the adequacy of the valuation techniques being adopted for these instruments.
Valuation models are subject to a review process which requires different levels of model documentation, testing and review, depending on the complexity of the model and the size of the Group’s exposure. A key element of the control environment over model use in the RBS Group is a modelled product review committee, made up of valuations experts from several functions within the RBS Group. This committee sets the policy for model documentation, testing and review, and prioritises models with significant exposure for review by the RBS Group’s Quantitative Research Centre. Potential valuation uncertainty is a key input in determining model review priorities at these meetings. The Quantitative Research Centre, which is independent of the trading businesses, assesses the appropriateness of the application of the model to the product, the mathematical robustness of the model, and (where appropriate), considers alternative modelling approaches.
GBM’s senior management valuations control committee meets formally monthly to discuss independent pricing, reserving and valuation issues relating to both GBM and Non-Core exposures. All material methodology changes require review and ratification by this committee. The committee includes valuation specialists representing several independent review functions including Market Risk, the quantitative research centre and finance.
The Group Executive Valuation Committee discusses the issues escalated by the modelled product review committee, GBM senior management valuations committee and other relevant issues. The committee covers key material and subjective valuation issues within the trading business. The committee will provide ratification to the appropriateness of areas with very high residual valuation uncertainty. Committee membership includes the Group Finance Director, the Group Chief Accountant, Head of Group Market Risk, GBM CFO and Non-Core CFO, and representation from front office trading and Finance.
Valuation techniques
The RBS Group uses a number of methodologies to determine the fair values of financial instruments for which observable prices in active markets for identical instruments are not available. These techniques include: relative value methodologies based on observable prices for similar instruments; present value approaches where future cash flows from the asset or liability are estimated and then discounted using a risk-adjusted interest rate; option pricing models (such as Black-Scholes or binomial option pricing models) and simulation models such as Monte-Carlo.
The principal inputs to these valuation techniques are listed below. Values between and beyond available data points are obtained by interpolation and extrapolation. When utilising valuation techniques, the fair value can be significantly affected by the choice of valuation model and by underlying assumptions concerning factors such as the amounts and timing of cash flows, discount rates and credit risk.
 
61
Table of Contents●
The Group uses a number of methodologies to determine the fair value of financial instruments for which observable prices in active markets for identical instruments are not available. These techniques include: relative value methodologies based on observable prices for similar instruments; present value approaches where future cash flows from the asset or liability are estimated and then discounted using a risk-adjusted interest rate; and Black-Scholes, Monte-Carlo and binomial option pricing models. The principal inputs to these valuation techniques are listed below. Values between and beyond available data points are obtained by interpolation and extrapolation.

•  Bond prices – quoted prices are generally available for government bonds, certain corporate securities and some mortgage-related products.
●
•  Credit spreads – where available, these are derived from prices of credit default swapsCredit spreads – where available, these are derived from prices of CDS or other credit based instruments, such as debt securities. For others, credit spreads are obtained from pricing services.
●
•  Interest rates – these are principally benchmark interest rates such as the London Inter-Bank Offered Rate (LIBOR) and quoted interest rates in the swap, bond and futures markets.
●
•  Foreign currency exchange rates – there are observable markets both for spot and forward contracts and forward and in futures in the world’s major currencies.
●
•  Equity and equity index prices – quoted prices are generally readily available for equity shares listed on the world’s major stock exchanges and for major indices on such shares.
●
•  Commodity prices – many commodities are actively traded in spot and forward contracts and futures on exchanges in London, New York and other commercial centres.
●
Price volatilities and correlations – volatility is a measure of the tendency of a price to change with time. Correlation measures the degree to which two or more prices or other variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation. Volatility is a key input in valuing options and the valuation of certain products such as derivatives with more than one underlying variable that are correlation-dependent. Volatility and correlation values are obtained from broker quotations, pricing services or derived from option prices.
 
•  
Price volatilities and correlations – volatility is a measure of the tendency of a price to change with time. Correlation measures the degree to which two or more prices or other variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation. Volatility is a key input in valuing options and the value of certain products such as derivatives with more than one underlying is correlation-dependent. Volatility and correlation values are obtained from broker quotations, pricing services or derived from option prices.
108
 
•  Prepayment rates – the fair value of a financial instrument that can be prepaid by the issuer or borrower differs from that of an instrument that cannot be prepaid. In valuing prepayable instruments that are not quoted in active markets the Group incorporatesNotes on the accounts

●
Prepayment rates – the fair value of a financial instrument that can be prepaid by the issuer or borrower differs from that of an instrument that cannot be prepaid. In valuing prepayable instruments that are not quoted in active markets, the Group considers the value of the prepayment option.
●
Counterparty credit spreads – adjustments are made to market prices (or parameters) when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price (or parameters).
●
Recovery rates/loss given default – these are used as an input to valuation models and reserves for ABS and other credit products as an indicator of severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.
 
•  Counterparty credit spreads – adjustment is made to market prices (or parameters) when the creditworthiness of the counterparty differs from that of the assumed counterparty in the market price or parameter; for example many OTC derivative price quotations are for transactions with a counterparty with an ‘AA’ credit rating.In order to determine a reliable fair value, where appropriate, management applies valuation adjustments to the pricing information gathered from the above sources. These adjustments reflect the Group’s assessment of factors that market participants would consider in setting a price, to the extent that these factors are not reflected in that pricing information. Furthermore, on an ongoing basis, the Group assesses the appropriateness of any model used. To the extent that the price provided by internal models does not represent the fair value of the instrument, for instance in highly stressed market conditions, the Group makes adjustments to the model valuation to calibrate to other available pricing sources. Where unobservable inputs are used, the Group may determine a range of possible valuations derived from differing stress scenarios to determine the sensitivity associated with the valuation. When establishing the fair value of a financial instrument using a valuation technique, the Group considers certain adjustments to the modelled price which market participants would make when pricing that instrument. Such adjustments include the credit quality of the counterparty and adjustments to compensate for any known model limitations.
Valuation hierarchy
The table below shows the financial instruments carried at fair value by valuation method for the Group.
  
 2009
  
 2008
 
  Level 1(1)  Level 2 (2)  Level 3 (3)  Total  Level 1(1)  Level 2 (2)  Level 3(3)  Total 
  £bn  £bn  £bn  £bn  £bn  £bn  £bn  
£bn
 
Assets 
                        
Fair value through profit or loss: 
                        
Loans and advances to banks 
  —   20.8   —   20.8   —   11.7   —   11.7 
Loans and advances to customers 
  —   5.0   0.2   5.2   —   2.5   0.4   2.9 
Debt securities 
  12.4   18.1   —   30.5   8.2   23.7   0.5   32.4 
Equity shares 
  —   —   —   —   —   —   0.1   0.1 
Derivatives 
  0.5   3.5   0.5   4.5   0.1   7.7   1.1   8.9 
   12.9   47.4   0.7   61.0   8.3   45.6   2.1   56.0 
Available-for-sale: 
                                
Debt securities 
  1.6   0.5   —   2.1   2.5   1.1   —   3.6 
Equity shares (5) 
  —   —   0.9   0.9   —   —   1.0   1.0 
   1.6   0.5   0.9   3.0   2.5   1.1   1.0   4.6 
  
   14.5   47.9   1.6   64.0   10.8   46.7   3.1   60.6 
  
  
Liabilities 
                                
Fair value through profit or loss: 
                                
Deposits by banks and customers 
  0.4   36.7   —   37.1   —   45.5   —   45.5 
Debt securities in issue 
  —   —   —   —   —   0.1   —   0.1 
Short positions 
  10.8   3.1   —   13.9   9.9   1.3   —   11.2 
Derivatives 
  0.6   3.7   —   4.3   0.3   7.7   0.1   8.1 
Other financial liabilities (4) 
  —   1.1   —   1.1   —   1.1   0.1   1.2 
   11.8   44.6   —   56.4   10.2   55.7   0.2   66.1 
Notes:

The Group refines
(1)Level 1: valued using unadjusted quoted prices in active markets, examples include G10 government securities, listed equity shares, certain exchange-traded derivatives and modifies its valuation techniques as marketscertain US agency securities.
(2)Level 2: includes most government agency securities, investment-grade corporate bonds, certain mortgage products, certain bank and bridge loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most physical commodities and certain money market securities and loan commitments and most OTC derivatives.
(3)Level 3: includes cash instruments which trade infrequently, certain commercial mortgage loans, unlisted equity shares, certain residual interests in securitisations, other mortgage-based products develop and the pricing for individual products become more transparent.
Whilst the Group believes its valuation techniques are appropriate and consistent with other market participants, the use of different methodologies or assumptions could result in different estimates of fair value at the balance sheet date. Portfolios whose fair values are based on valuation techniques incorporating information other than observable market data and related sensitivity analysis at 31 December 2007 are discussed below.
Commercial mortgages – senior and mezzanine commercial mortgages of £2.2 billion in the Group’s US subsidiary are loans secured on commercial land and buildings that were originated or acquired by the Group for securitisation. Senior commercial mortgages carry a variable interest rate and mezzanine or more junior commercial mortgages may carry a fixed or variable interest rate. Factors affecting the value of these loans may include, but are not limited to, loan type, underlying property type and geographic location, loan interest rate, loan to value ratios, debt service coverage ratios, prepayment rates, cumulative loan loss information, yields, investor demand, market volatility since the last securitisation, and credit enhancement.
Where observable market prices for a particular loan are not available, the fair value will typically be determined with reference to observable market transactions in other loans or credit related products includingless liquid debt securities, and OTC derivatives where valuation depends upon unobservable inputs such as certain credit and exotic derivatives. Assumptions are made aboutNo gain or loss is recognised on the relationship between the loan and the available benchmarkinitial recognition of a financial instrument valued using a technique incorporating significant unobservable data. Using reasonably possible alternative assumptions for credit spreads (taking into account all other applicable factors) would reduce the fair value by up to £52 million or increase the fair value by up to £49 million.
(4)Comprise subordinated liabilities.
(5)2008 has been revised.
 
Notes on the accounts continued
10 Financial instruments continued
For each of the portfolio categories shown in the above table, set out below is a description of the types of products that comprise the portfolio and the valuation techniques that are applied in determining fair value, including a description of valuation techniques used for levels 2 and 3 and inputs to those models and techniques. Where reasonably possible alternative assumptions of unobservable inputs used in models would change the fair value of the portfolio significantly, the alternative inputs are indicated. Where there have been significant changes to valuation techniques during the year a discussion of the reasons for this are also included.
Loans and advances to customers
Loans in level 3 primarily comprise commercial mortgages.
Commercial mortgages
These senior and mezzanine commercial mortgages are loans secured on commercial land and buildings that were originated or acquired by the Group for securitisation. Senior commercial mortgages carry a variable interest rate and mezzanine or more junior commercial mortgages may carry a fixed or variable interest rate. Factors affecting the value of these loans may include, but are not limited to, loan type, underlying property type and geographic location, loan interest rate, loan to value ratios, debt service coverage ratios, prepayment rates, cumulative loan loss information, yields, investor demand, market volatility since the last securitisation, and credit enhancement. Where observable market prices for a particular loan are not available, the fair value will typically be determined with reference to observable market transactions in other loans or credit related products including debt securities and credit derivatives. Assumptions are made about the relationship between the loan and the available benchmark data. Using reasonably possible alternate assumptions for credit spread would reduce the fair value of £0.2 billion (2008 – £0.4 billion) by up to £10 million (2008 – £10 million) or increase by up to £20 million (2008 – £10 million).
Commercial mortgage backed securities
CMBS is valued using an industry standard model and the inputs, where possible, are corroborated using observable market data.
Equity shares
Level 3 equity shares principally comprise investments of £0.8 billion in fellow subsidiaries.
Derivatives
Derivatives are priced using quoted prices for the same or similar instruments where these are available. However, the majority of derivatives are valued using pricing models. Inputs for these models are usually observed directly in the market, or derived from observed prices. However, it is not always possible to observe or corroborate all model inputs. Unobservable inputs used are based on estimates taking into account a range of available information including historic analysis, historic traded levels, market practice, comparison to other relevant benchmark observable data and consensus pricing data.
Interest rate derivatives
Interest rate options provide a payout (or series of payouts) linked to the performance of one or more underlying, including interest rates and foreign exchange rates.
Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided, firstly, into modelling approaches and, secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades.
Exotic valuation inputs include correlation between interest rates and foreign exchange rates. Correlations for more liquid rate pairs are valued using independently sourced consensus pricing levels. Where a consensus pricing benchmark is unavailable, these instruments are categorised as level 3.
Using reasonably possible alternative assumptions the fair value of £0.5 billion (2008 – £1.1 billion) would be reduced by up to £50 million (2008 £80 million) or increased by up to £30 million (2008 – £80 million).
110
Notes on the accounts

Level 3 portfolio movement table
     Gains or                 Gains or 
     (losses)                 (losses) 
     recognised                 relating to 
  At  in the income  Transfers           At 31  instruments 
  1 January  statement or  in/(out) of  Purchases  Sales and  Foreign  December  held at 
  2009  
SOCI (1)
  Level 3  and issues  settlements  exchange  2009  year end 
  £m   £m   £m   £m   £m   £m   £m   £m  
Assets 
                        
FVTPL: (2) 
                        
Loans and advances 
  376   (73)   (68)   19   (40)   (32)   182   7 
Debt securities 
  464   (19)   (133)   104   (345)   (33)   38   (58) 
Equity shares 
  137   (18)   —   2   (112)   (6)   3   (14) 
Derivatives 
  1,099   6   (28)   —   (575)   —   502   (2) 
FVTPL assets 
  2,076   (104)   (229)   125   (1,072)   (71)   725   (67) 
AFS: (3) 
                                
Debt securities 
  28   —   —   3   (20)   —   11   — 
Equity shares 
  970   (32)   (2)   31   (23)   (32)   912   (9) 
AFS assets 
  998   (32)   (2)   34   (43)   (32)   923   (9) 
Total assets 
  3,074   (136)   (231)   159   (1,115)   (103)   1,648   (76) 
  
Liabilities 
                                
Derivatives 
  74   21   1   —   (70)   (2)   24   12 
Other financial liabilities 
  89   —   (89)   —   —   —   —   — 
Total liabilities 
  163   21   (88)   —   (70)   (2)   24   12 
 
Accounting policies continued

Equity shares – includes £0.6 billion relating to investments held by the Bank in fellow subsidiaries.
Other portfolios – other than the instruments discussed above, there are other financial instruments which are held, by the Group’s subsidiaries, at fair value determined from data which are not market observable, or incorporating a material adjustments to market observed data. Using reasonably possible alternative assumptions would reduce the fair value by up to £5 million or increase the fair value by up to £5 million.
Accounting developments
International Financial Reporting Standards
The International Financial Reporting Interpretations Committee (‘IFRIC’) issued interpretation IFRIC 11 ‘Group and Treasury Share Transactions’ in November 2006. Entities which buy their own shares, or whose shareholders buy shares in the reporting entity, in order to provide incentives to employees shall account for those incentives on an equity-settled basis. This principle applies also to the accounting by subsidiaries. The interpretation is effective for annual accounting periods beginning on or after 1 March 2007 and is not expected to have a material effect on the Group or the Bank.
The IFRIC issued interpretation IFRIC 12 ‘Service Concession Arrangements’ in November 2006. Entities providing infrastructure and services to governments under concession arrangements shall account for each component of the arrangement separately. Infrastructure provided under these arrangements may be recognised as either a financial asset or an intangible asset. The interpretation is effective for accounting periods beginning on or after 1 January 2008 and is not expected to have a material effect on the Group or the Bank.
The IASB issued IFRS 8 ‘Operating Segments’ in November 2006. This will replace IAS 14 ‘Segment Reporting’ for accounting periods beginning on or after 1 January 2009. IFRS 8 requires entities to report segment information as reported to management and reconcile it to the financial statements and is not expected to have a material effect on the Group or the Bank.
The IASB issued a revised IAS 23 ‘Borrowing Costs’ in March 2007. Entities are required to capitalise borrowing costs attributable to the development or construction of intangible assets or property plant or equipment. The standard is effective for accounting periods beginning on or after 1 January 2009 and is not expected to have a material effect on the Group or the Bank.
The IFRIC issued interpretation IFRIC 13 ‘Customer Loyalty Programmes’ in June 2007. Entities that provide customers with benefits ancillary to a sale of goods or services should apportion the sales proceeds to those benefits on the basis of relative fair values. The interpretation is effective for accounting periods beginning on or after 1 July 2008 and is not expected to have a material effect on the Group or the Bank.
The IFRIC issued interpretation IFRIC 14 ‘IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction’ in July 2007. The net pension asset that may be recognised by a sponsoring entity is limited to the amount to which it has an unconditional right of refund or can be recovered through the settlement of plan liabilities. Entities legally bound to minimum funding requirements should not overlook those obligations when recognising the net asset or liability for an employee benefit scheme. The interpretation is effective for accounting periods beginning on or after 1 January 2008 and is not expected to have a material effect on the Group or the Bank.
The IASB issued a revised IAS 1 ‘Presentation of Financial Statements’ in September 2007 effective for accounting periods beginning on or after 1 January 2009. The amendments to the presentation requirements for financial statements are not expected to have a material effect on the Group or the Bank.
The IASB published a revised IFRS 3 ‘Business Combinations’ and related revisions to IAS 27 ‘Consolidated and Separate Financial Statements’ following the completion in January 2008 of its project on the acquisition and disposal of subsidiaries. The standards improve convergence with US GAAP and provide new guidance on accounting for changes in interests in subsidiaries. The cost of an acquisition will comprise only consideration paid to vendors for equity; other costs will be expensed immediately. Groups will only account for goodwill on acquisition of a subsidiary; subsequent changes in interest will be recognised in equity and only on a loss of control will there be a profit or loss on disposal to be recognised in income. The changes are effective for accounting periods beginning on or after 1 July 2009 but both standards may be adopted together for accounting periods beginning on or after 1 July 2007. These changes will affect the Group's accounting for future acquisitions and disposals of subsidiaries.
The IASB published revisions to IAS 32 ‘Financial Instruments: Presentation’ and consequential revisions to other standards in February 2008 to improve the accounting for and disclosure of puttable financial instruments. The revisions are effective for accounting periods beginning on or after 1 January 2009 but together they may be adopted earlier. They are not expected to have a material affect on the Group or the Bank.
Notes on the accounts

1 Income from trading activities Group 
  2007  2006  2005 
   £m   £m   £m 
Foreign exchange (1)  134   595   (33)
Interest rates (2)  310   352   367 
Credit (3)  (843)  589   562 
Equities and commodities (4)  39   (78)  (88)
   (360)  1,458   808 
The analysis of trading income is based on how the business is organised and the underlying risks managed.
Notes:
Trading income comprises gains and losses on financial instruments held for trading, both realised and unrealised, interest income and dividends and the related funding costs. The types of instruments include:
(1) Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding.
(2) Interest rates: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding.
(3) Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding.
(4) Equities and commodities: equity derivatives, commodity contracts and related hedges and funding.
2 Operating expenses Group 
  2007  2006  2005 
   £m   £m   £m 
Wages, salaries and other staff costs  1,339   1,438   1,246 
Social security costs  82   78   70 
Pension costs (see Note 3)            
– defined benefit schemes  132   229   149 
– defined contribution schemes  14   9   12 
Staff costs  1,567   1,754   1,477 
Premises and equipment  267   266   114 
Other administrative expenses  2,322   2,741   2,510 
Property, plant and equipment (see Note 17)  109   98   105 
Intangible assets (see Note 16)  155   159   277 
Depreciation and amortisation  264   257   382 
   4,420   5,018   4,483 
Integration costs included
(1)Net losses recognised in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement targets set in connection with the various acquisitions made by the Group:
  Group 
  2007  2006  2005 
   £m   £m   £m 
Staff costs  7   48   17 
Premises and equipment  4   3   1 
Other administrative expenses  1   11   14 
Depreciation and amortisation  31   5   131 
   43   67   163 
Notes on the accounts continued
The average number of persons employed by the Group during the year, excluding temporary staff, was 31,200 (2006 – 31,000; 2005 –30,000). The number of persons employed by the Group at 31 December, excluding temporary staff, was as follows:
  Group 
  2007  2006  2005 
Global Banking & Markets  1,300   1,300   1,100 
Retail  19,200   19,700   20,300 
Wealth Management  3,400   3,100   2,800 
Ulster Bank  6,400   5,600   5,200 
Manufacturing  1,200   1,300   1,200 
Total  31,500   31,000   30,600 
             
UK  23,900   24,100   24,300 
USA  1,300   1,300   1,100 
Europe  5,800   5,200   4,900 
Rest of the World  500   400   300 
Total  31,500   31,000   30,600 
  Bank 
  2007  2006  2005 
   £m   £m   £m 
Wages, salaries and other staff costs  474   429   380 
Social security costs  30   29   27 
Pension costs (see Note 3)            
– defined benefit schemes  83   168   97 
– defined contribution schemes  1   —   4 
Staff costs  588   626   508 
The average number of persons employed by the Bank during the year, excluding temporary staff, was 20,000 (2006 – 20,700; 2005 – 20,600). The number of persons employed by the Bank at 31 December, excluding temporary staff, was as follows:
  Bank 
  2007  2006  2005 
Retail  19,100   19,700   20,200 
Wealth Management  600   600   600 
Total  19,700   20,300   20,800 
All of the above are employed in the UK.
3 Pension costs
Members of the Group sponsor a number of pension schemes in the UK and overseas, predominantly of the defined benefit type, whose assets are independent of the Group’s finances. Defined benefit pensions generally provide a pension of one-sixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years. Employees do not make contributions for basic pensions but may make voluntary contributions to secure additional benefits on a money-purchase basis. Since October 2006 the defined benefit section of The Royal Bank of Scotland Group Pension Fund (‘Main scheme’), has been closed to new entrants.
The Group also provides post-retirement benefits other than pensions, principally through subscriptions to private healthcare schemes in the UK and the US and unfunded post-retirement benefit plans. Provision for the costs of these benefits is charged to the income statement over the average remaining future service livesand statement of the eligible employees. The amounts are not material.comprehensive income were £107 million and £8 million respectively. Net losses on FVTPL assets and liabilities of £83 million were included in income from trading activities. £24 million net losses relating to AFS assets were recorded within interest income, dividend income and impairment losses as appropriate.
(2)FVTPL: Fair value through profit and loss.
(3)AFS: Available-for-sale.
Assets reduced in the year due to disposals and reclassifications. The decrease in debt securities of £484 million is due to transfers to level 2 to increase observability, write downs and sales. Derivative assets include illiquid rate derivatives.
111
Notes on the accounts continued
10 Financial instruments continued
Fair value of financial instruments not carried at fair value
The following table shows the carrying values and the fair values of financial instruments carried on the balance sheet at amortised cost.
  
 Group
  
 Bank
 
  2009  2009  2008  2008  2009  2009  2008  2008 
  Carrying  Fair  Carrying  Fair  Carrying  Fair  Carrying  Fair 
  value  value  value  value  value  value  value  value 
  £m  £m  £m  £m  £m  £m  £m  £m 
Financial assets 
                        
Cash and balances at central banks 
  1,805   1,805   1,285   1,285   906   906   838   838 
Loans and advances to banks 
  112,416   112,418   54,500   54,475   80,362   80,357   22,733   22,708 
Loans and advances to customers 
  159,207   152,758   195,384   188,404   88,340   84,419   124,391   120,165 
Debt securities 
  2,159   2,098   —   —   2,158   2,097   —   — 
Settlement balances 
  4,573   4,573   4,117   4,117   —   —   —   — 
  
Financial liabilities 
                                
Deposits by banks 
  43,676   43,665   31,023   31,022   21,839   21,830   8,225   8,224 
Customer accounts 
  208,137   207,440   177,532   177,532   140,902   140,169   129,893   129,884 
Debt securities in issue 
  11,470   9,362   17,137   16,087   —   —   15   15 
Subordinated liabilities 
  7,857   7,535   8,875   8,178   7,105   6,784   7,860   7,163 
Settlement balances and short positions 
  3,027   3,027   1,850   1,850   —   —   —   — 
The fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. Quoted market values are used where available; otherwise, fair values have been estimated based on discounted expected future cash flows and other valuation techniques. These techniques involve uncertainties and require assumptions and judgments covering prepayments, credit risk and discount rates. Changes in these assumptions would significantly affect estimated fair values. The fair values reported would not necessarily be realised in an immediate sale or settlement. As a wide range of valuation techniques is available, it may be inappropriate to compare the Group’s fair value information to independent markets or other financial institutions’ fair values.
The fair values of intangible assets, such as core deposits, credit card and other customer relationships are not included in the calculation of these fair values since these are not financial instruments.
The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are set out below:
The fair value of financial instruments which are of short maturity (3 months or less) approximates their carrying value. This applies mainly to cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks and demand deposits.
Loans and advances to banks and customers
Fair value is estimated by grouping loans into homogeneous portfolios and applying a discount rate to the cash flows. The discount rate is based on the market rate applicable at the balance sheet date for a similar portfolio with similar maturity and credit risk characteristics.
Debt securities
Fair values are determined using quoted prices where available or by reference to quoted prices of similar instruments.
Deposits by banks and customer accounts
The fair values of deposits are estimated using discounted cash flow valuation techniques.
Debt securities in issue and subordinated liabilities
Fair values are determined using quoted prices where available or by reference to valuation techniques and adjusting for own credit spreads where appropriate.
112
Notes on the accounts

Remaining maturity
The following tables show the residual maturity of financial instruments, based on contractual date of maturity.
        Group       
     2009        2008    
  Less than  More than     Less than  More than    
  12 months  12 months  Total  12 months  12 months  Total 
   £m  £m  £m  £m  £m  £m 
Assets 
                  
Cash and balances at central banks 
  1,804   1   1,805   1,283   2   1,285 
Loans and advances to banks 
  120,391   12,839   133,230   62,423   3,811   66,234 
Loans and advances to customers 
  78,298   86,105   164,403   110,546   87,721   198,267 
Debt securities 
  2,504   32,285   34,789   5,797   30,196   35,993 
Equity shares 
  —   966   966   —   1,129   1,129 
Settlement balances 
  4,573   —   4,573   4,117   —   4,117 
Derivatives 
  1,007   3,463   4,470   2,719   6,176   8,895 
  
Liabilities 
                        
Deposits by banks 
  50,435   10,998   61,433   50,793   2,840   53,633 
Customer accounts 
  219,559   7,904   227,463   195,111   5,273   200,384 
Debt securities in issue 
  3,978   7,492   11,470   8,364   8,848   17,212 
Settlement balances and short positions 
  3,441   13,503   16,944   2,691   10,400   13,091 
Derivatives 
  736   3,578   4,314   2,308   5,758   8,066 
Subordinated liabilities 
  937   8,062   8,999   1,050   9,049   10,099 
  
          Bank         
      2009          2008     
  Less than  More than      Less than  More than     
  12 months  12 months  Total  12 months  12 months  Total 
   £m   £m   £m   £m   £m   £m 
Assets 
                        
Cash and balances at central banks 
  906   —   906   838   —   838 
Loans and advances to banks 
  73,633   7,799   81,432   23,033   113   23,146 
Loans and advances to customers 
  42,532   46,024   88,556   81,196   43,497   124,693 
Debt securities 
  5   2,158   2,163   41   —   41 
Equity shares 
  —   13   13   —   6   6 
Derivatives 
  461   2,439   2,900   1,216   3,681   4,897 
  
Liabilities 
                        
Deposits by banks 
  12,594   9,315   21,909   7,462   1,074   8,536 
Customer accounts 
  139,768   3,257   143,025   128,599   2,096   130,695 
Debt securities in issue 
  —   —   —   15   —   15 
Derivatives 
  412   2,094   2,506   1,081   5,162   6,243 
Subordinated liabilities 
  625   6,480   7,105   856   7,004   7,860 
On balance sheet liabilities
The following tables show, by contractual maturity, the undiscounted cash flows payable up to a period of 20 years from the balance sheet date, including future payments of interest.
        Group       
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2009  £m  £m  £m  £m  £m  £m 
Deposits by banks 
  39,886   2,031   1,103   499   224   5 
Customers accounts 
  203,751   3,094   2,465   1,836   108   20 
Debt securities in issue 
  3,605   1,354   444   408   —   — 
Subordinated liabilities 
  1,946   588   1,160   1,393   4,621   732 
Settlement balances and other liabilities 
  3,744   —   —   —   1   4 
   252,932   7,067   5,172   4,136   4,954   761 
  
Guarantees and commitments - notional amount 
                        
Guarantees (1) 
  2,450   —   —   —   —   — 
Commitments (2) 
  57,199   —   —   —   —   — 
   59,649   —   —   —   —   — 
113
Notes on the accounts continued
10 Financial instruments continued
        Group          
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2008  £m  £m  £m  £m  £m  £m 
Deposits by banks 
  25,194   3,198   2,046   509   319   4 
Customers accounts 
  171,888   4,319   2,498   1,540   153   24 
Debt Securities in Issue 
  8,482   3,131   1,185   1,105   445   742 
Subordinated liabilities 
  227   1,536   2,257   824   3,869   2,468 
Settlement balances and other liabilities 
  2,382   —   —   —   4   — 
   208,173   12,184   7,986   3,978   4,790   3,238 
 
Notes:
(1)The corridor method of accounting permitsGroup is only called upon to satisfy a guarantee when the Bankguaranteed party fails to defer recognition of actuarial gains and losses that are within 10% of the larger of the fair value of plan assets and present value of defined benefit obligations of the schemes, on an individual scheme basis, at the reporting date. Any excess variations are amortised prospectively over the average remaining service lives of current members of the schemes.
Interim valuations of the Group’s schemes were prepared to 31 December by independent actuaries, using the following assumptions:
  Group  Bank 
Principal actuarial assumptions at 31 December (weighted average) 2007  2006  2005  2007  2006  2005 
Discount rate  6.0%  5.3%  4.8%  6.0%  5.3%  4.8%
Expected return on plan assets  6.9%  6.9%  6.5%  6.9%  6.9%  6.5%
Rate of increase in salaries  4.4%  4.1%  3.9%  4.5%  4.2%  3.9%
Rate of increase in pensions in payment  3.2%  2.9%  2.7%  3.2%  2.9%  2.7%
Inflation assumption  3.2%  2.9%  2.7%  3.2%  2.9%  2.7%
                       
   Group   Bank 
Major classes of plan assets as a percentage of total plan assets 2007  2006  2005  2007  2006  2005 
Equities  61.1%  60.5%  61.4%  61.0%  60.5%  61.3%
Index-linked bonds  17.5%  16.7%  17.5%  18.2%  17.3%  18.1%
Government fixed interest bonds  1.7%  3.0%  2.3%  1.2%  2.5%  1.8%
Corporate and other bonds  14.9%  13.8%  14.4%  15.1%  14.0%  14.6%
Property  4.1%  4.6%  3.8%  3.8%  4.3%  3.6%
Cash and other assets  0.7%  1.4%  0.6%  0.7%  1.4%  0.6%
Ordinary shares of the holding company with a fair value of £65 million (2006 – £87 million; 2005 – £76 million) are held by the Group’s pension schemes together with holdings of other financial instruments issued by the Group with a value of £606 million (2006 – £258 million; 2005 – £299 million).
The expected return on plan assets at 31 December 2007 is based upon the weighted average of the following assumed returns on the major classes of plan assets:
  Group  Bank 
  2007  2006  2005  2007  2006  2005 
Equities  8.1%  8.1%  7.7%  8.1%  8.1%  7.7%
Index-linked bonds  4.5%  4.5%  4.1%  4.5%  4.5%  4.1%
Government fixed interest bonds  4.5%  4.5%  4.0%  4.5%  4.5%  4.1%
Corporate and other bonds  5.5%  5.3%  4.8%  5.5%  5.3%  4.8%
Property  6.3%  6.3%  5.9%  6.3%  6.3%  5.9%
Cash and other assets  4.6%  4.6%  4.1%  4.6%  4.6%  4.2%
                      
Post-retirement mortality assumptions (Main scheme)             2007  2006  2005 
Longevity at age 60 for current pensioners (years)                        
Males              26.0   26.0   25.4 
Females              26.8   28.9   28.2 
                         
Longevity at age 60 for future pensioners (years)                        
Males              28.1   26.8   26.2 
Females              28.2   29.7   29.0 
These post-retirement mortality assumptions are derived from standard mortality tables used by the scheme actuary to value the liabilities for the main scheme. Following a comprehensive review of the mortality experience of the main scheme over the last three years by the scheme actuary, different standard mortality tables (adjusted as appropriate) have been used in valuing the scheme liabilities as at 31 December 2007.
Notes on the accounts continued
3 Pension costs (continued)
 Group Bank
     Present        Present    
     value of  Net     value of  Net 
  Fair value  defined  pension  Fair value  defined  pension 
  of plan  benefit  deficit/  of plan  benefit  deficit/ 
  assets  obligations  (surplus)  assets  obligations  (surplus) 
Changes in value of net pension liability  £m   £m   £m   £m   £m   £m 
At 1 January 2006  16,697   20,174   3,477   15,914   19,105   3,191 
Currency translation and other adjustments  (10)  (40)  (30)  —   (28)  (28)
Income statement:                        
Expected return  1,023       (1,023)  1,022       (1,022)
Interest cost      938   938       919   919 
Current service cost      597   597       571   571 
Less: direct contributions from other scheme members      (328)  (328)      (340)  (340)
Past service cost      24   24       20   20 
Amortisation of net unrecognised actuarial losses      21   21       20   20 
   1,023   1,252   229   1,022   1,190   168 
Actuarial gains and losses  570   (1,156)  (1,726)  552   (1,077)  (1,629)
Disposal of subsidiaries  —   (1)  (1)  —   —   — 
Contributions by employer  135   —   (135)  70   —   (70)
Contributions by other scheme members  342   342   —   359   359   — 
Benefits paid  (517)  (517)  —   (517)  (517)  — 
Expenses included in service cost  (27)  (27)  —   (26)  (26)  — 
Amortisation of net unrecognised actuarial losses      (21)  (21)      (20)  (20)
At 31 December 2006  18,213   20,006   1,793   17,374   18,986   1,612 
Unrecognised actuarial losses          495           502 
Retirement benefit liabilities at 31 December 2006          1,298           1,110 
Unfunded schemes liabilities included in post-retirement benefit liabilities       26           15 
At 1 January 2007  18,213   20,006   1,793   17,374   18,986   1,612 
Currency translation and other adjustments  40   49   9   —   —   — 
Income statement:                        
Expected return  1,242       (1,242)  1,182       (1,182)
Interest cost      1,060   1,060       1,008   1,008 
Current service cost      610   610       566   566 
Less: direct contributions from other scheme members      (316)  (316)      (328)  (328)
Past service cost      20   20       19   19 
   1,242   1,374   132   1,182   1,265   83 
Actuarial gains and losses  150   (1,967)  (2,117)  163   (1,938)  (2,101)
Transfer from fellow subsidiary  30   30   —   30   30   — 
Contributions by employer  117   —   (117)  69   —   (69)
Contributions by other scheme members  335   335   —   348   348   — 
Contributions by plan participants  4   4   —   —   —   — 
Benefits paid  (579)  (579)  —   (552)  (552)  — 
Expenses included in service cost  (39)  (39)  —   (39)  (39)  — 
At 31 December 2007  19,513   19,213   (300)  18,575   18,100   (475)
Unrecognised actuarial gains          (1,622)          (1,599)
Retirement benefit liabilities at 31 December 2007          1,322           1,124 
Unfunded schemes liabilities included in post-retirement benefit liabilities       28           15 
meet its obligations. The Group expects most guarantees it provides to contribute £456 million (Bank – £414 million)expire unused.
(2)The Group has given commitments to its defined benefit pension schemes in 2008.provide funds to customers under undrawn formal facilities, credit lines and other commitments to lend subject to certain conditions being met by the counterparty. The Group does not expect all facilities to be drawn, and some may lapse before drawdown.
        Bank          
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2009  £m  £m  £m  £m  £m  £m 
Deposits by banks 
  20,432   1,230   4   4   183   — 
Customers accounts 
  141,596   253   7   —   3   — 
Subordinated liabilities 
  1,653   272   1,146   1,322   4,564   681 
   163,681   1,755   1,157   1,326   4,750   681 
  
Guarantees and commitments - notional amount 
                        
Guarantees 
  1,369   —   —   —   —   — 
Commitments 
  46,930   —   —   —   —   — 
   48,299   —   —   —   —   — 
  
2008                         
Deposits by banks 
  6,332   798   948   11   157   — 
Customer accounts 
  128,925   593   741   7   —   — 
Debt securities in issue 
  —   15   —   —   —   — 
Derivatives held for hedging 
  10   57   125   95   203   366 
Subordinated liabilities 
  178   1,055   1,892   752   3,816   2,432 
   135,445   2,518   3,706   865   4,176   2,798 
The tables above show the timing of cash outflows to settle financial liabilities. They have been prepared on the following basis:
Financial liabilities are included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If repayment is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the liability is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period whatever the level of the index at the year end. The settlement date of debt securities in issue issued by certain securitisation vehicles consolidated by the Group depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date.
Liabilities with a contractual maturity of greater than 20 years – the principal amounts of financial liabilities that are repayable after 20 years or where the counterparty has no right to repayment of the principal are excluded from the table as are interest payments after 20 years.
Held-for-trading liabilities – held-for-trading liabilities amounting to £54.0 billion (2008 – £63.8 billion) for the Group and £3.8 billion (2008 – £6.1 billion) for the Bank have been excluded from the table in view of their short term nature.
114
Notes on the accounts
11 Financial assets – impairments
The following tables show the movement in the provision for impairment losses for loans and advances.
        Group       
  Individually  Collectively     Total       
  assessed  assessed  Latent  2009
 
 2008  2007 
  £m  £m  £m  £m  £m  £m 
At 1 January 
  637   2,009   280   2,926   2,340   2,061 
Currency translation and other adjustments 
  25   (15)   (8)   2   65   41 
Amounts written-off 
  (237)   (934)   —   (1,171)   (792)   (617) 
Recoveries of amounts previously written-off 
  3   45   —   48   62   94 
Charged to the income statement 
  1,922   1,605   588   4,115   1,351   848 
Unwind of discount 
  (152)   (94)   —   (246)   (100)   (87) 
At 31 December (1) 
  2,198   2,616   860   5,674   2,926   2,340 
  
Note:                         
(1) The provision for impairment losses at 31 December 2009 includes £9 million relating to loans and advances to banks (2008 – £2 million; 2007 – £2 million). 
  
          Bank         
  Individually  Collectively      Total         
  assessed  assessed  Latent  2009
 
 2008  2007 
   £m   £m   £m   £m   £m   £m 
At 1 January 
  201   1,748   154   2,103   1,921   1,707 
Currency translation and other adjustments 
  (2)   (1)   —   (3)   6   13 
Amounts written-off 
  (226)   (898)   —   (1,124)   (739)   (541) 
Recoveries of amounts previously written-off 
  2   45   —   47   55   71 
Charged to the income statement 
  414   1,335   417   2,166   929   742 
Unwind of discount 
  (12)   (65)   —   (77)   (69)   (71) 
At 31 December (1) 
  377   2,164   571   3,112   2,103   1,921 
  
Note:                         
(1) The provision for impairment losses at 31 December 2009 includes £8 million relating to loans and advances to banks (2008 and 2007 – nil). 
  
                  Group     
              2009  2008  2007 
Impairment losses charged to the income statement 
              £m   £m   £m 
Loans and advances to customers 
              4,108   1,351   848 
Loans and advances to banks 
              7   —   — 
               4,115   1,351   848 
Equity shares 
              24   11   1 
               4,139   1,362   849 
  
  
                  Group     
              2009  2008  2007 
               £m   £m   £m 
Gross income not recognised but which would have been recognised under the original terms of non-accrual and restructured loans 
                        
Domestic 
              310   243   200 
Foreign 
              153   108   10 
               463   351   210 
  
  
Interest on non-accrual and restructured loans included in net interest income                     
Domestic 
              124   78   75 
Foreign 
              122   22   12 
               246   100   87 
115
Notes on the accounts continued
11 Financial assets – impairmentscontinued
The following tables show an analysis of impaired financial assets.
     2009        2008    
        Carrying        Carrying 
  Cost  Provision  value  Cost  Provision  value 
Group 
 £m  £m  £m  £m  £m  £m 
Loans and receivables 
                  
Loans and advances to banks (1) 
  9   9   —   2   2   — 
Loans and advances to customers (2) 
  12,906   4,805   8,101   6,070   2,644   3,426 
   12,915   4,814   8,101   6,072   2,646   3,426 
  
                  Group 
                  Carrying  Carrying 
                  Value  Value 
                  2009  2008 
                   £m   £m 
Available-for-sale 
                        
Equity shares 
                  15   7 
  
  
      2009          2008     
          Carrying          Carrying 
  Cost  Provision  value  Cost  Provision  value 
Bank   £m   £m   £m   £m   £m   £m 
Loans and receivables 
                        
Loans and advances to banks (1) 
  8   8   —   —   —   — 
Loans and advances to customers (3) 
  4,362   2,533   1,829   3,135   1,949   1,186 
   4,370   2,541   1,829   3,135   1,949   1,186 
 
67
  Group  Bank 
  2007  2006  2005  2004  2007  2006  2005  2004 
History of defined benefits schemes  £m   £m   £m   £m   £m   £m   £m   £m 
Fair value of plan assets  19,513   18,213   16,697   14,236   18,574   17,374   15,914   13,569 
Present value of defined benefit obligations  19,213   20,006   20,174   17,894   18,099   18,986   19,105   16,922 
Net surplus/(deficit)  300   (1,793)  (3,477)  (3,658)  475   (1,612)  (3,191)  (3,353)
                                 
Experience losses on plan liabilities  (209)  (7)  (55)  (611)  (256)  (4)  (41)  (624)
Experience gains on plan assets  150   570   1,639   403   163   552   1,556   392 
Actual return on pension schemes assets  1,392   1,593   2,611   1,283   1,345   1,574   2,486   1,230 
4 Auditors' remuneration   
    
Amounts paid to the auditors for statutory audit and other services were as follows:   
 Group 
  2007  2006  2005 
    £m   £m   £m 
Audit services            
-Statutory audit  2.2   2.2   2.0 
-Audit related regulatory reporting  0.1   0.1   1.2 
   2.3   2.3   3.2 
All other services  1.0   0.1   1.5 
Total  3.3   2.4   4.7 
5 Tax Group 
  2007  2006  2005 
     £m   £m   £m 
Current taxation:            
Charge for the year  989   1,095   1,142 
Over provision in respect of prior periods  (71)  (251)  (68)
Relief for overseas taxation  (76)  —   (24)
   842   844   1,050 
Deferred taxation:            
Credit for the year  (60)  (42)  (81)
(Over)/under provision in respect of prior periods  (14)  29   (21)
Tax charge for the year  768   831   948 
The actual tax charge differs from the expected tax charge computed by applying the standard rate of UK Corporation Tax of 30% as follows:
  2007  2006  2005 
   £m   £m   £m 
Expected tax charge  926   1,037   1,023 
Non-deductible items  52   157   70 
Non-taxable items  (178)  (35)  (71)
Taxable foreign exchange movements  (3)  (106)  35 
Group relief at non-standard rates  94   13   — 
Foreign profits taxed at other rates  (57)  (23)  (21)
Increase in deferred tax asset following change in the rate of UK Corporation Tax  18   —   — 
Unutilised losses brought forward and carried forward  1   10   1 
Adjustments in respect of prior periods  (85)  (222)  (89)
Actual tax charge for the year  768   831   948 
The effective tax rate for the year was 24.9% (2006 – 24.0%; 2005 – 27.8%) .. The tax rate was affected by an increase of £18 million in the deferred tax asset following the change in the rate of UK Corporation Tax from 30% to 28% from 1 April 2008.
Notes on the accounts continued

6 Dividends to preference shareholders Group 
  2007  2006  2005 
   £m   £m   £m 
9% non-cumulative sterling preference shares, Series A  13   13   13 
Non-cumulative dollar preference shares, Series B (2)  —   11   11 
Non-cumulative dollar preference shares, Series C  12   12   12 
Total  25   36   36 
Notes:
(1)   In accordance with IAS 32, the Group’s preference shares are included in subordinated liabilities and the related finance cost in interest payable.
(2) Redeemed in January 2007.
7 Ordinary dividends Group 
  2007  2006  2005 
   £m   £m   £m 
Ordinary dividend paid to the parent company  1,850   1,500   350 
8 Profit dealt with in the accounts of the Bank
As permitted by section 230(3) of the Companies Act 1985, no income statement for the Bank has been presented as a primary financial statement. Of the profit attributable to ordinary shareholders, £3,210 million (2006 – £1,688 million; 2005 – £1,774 million) has been dealt with in the accounts of the Bank.
9 Financial instruments
The following tables analyse the financial assets and financial liabilities in accordance with the categories of financial instruments in IAS 39. Assets and liabilities outside the scope of IAS 39 are shown separately.
  Group
     Designated                   
     as at fair              Non    
     value        Other     financial    
  Held-for-  through  Available-  Loans and  (amortised  Finance  assets/    
  trading  profit or loss  for-sale  receivable  cost) leases  liabilities  Total 
2007  £m   £m   £m   £m   £m   £m   £m   £m 
Assets                                
Cash and balances at central banks  —   —   —   1,363       —       1,363 
Treasury and other eligible bills (1)  1,975   —   46   —       —       2,021 
Loans and advances to banks (2)  17,912   237   —   53,300       —       71,449 
Loans and advances to customers (3)  13,642   1,280   —   173,603       451       188,976 
Debt securities  31,980   154   3,782   —       —       35,916 
Equity shares  152   32   926   —       —       1,110 
Settlement balances  —   —   —   2,700       —       2,700 
Derivatives  3,575   —   —   —       —       3,575 
Intangible assets                          1,244   1,244 
Property, plant and equipment                          1,514   1,514 
Prepayments, accrued income                                
and other assets  —   —   —   19       —   2,395   2,414 
   69,236   1,703   4,754   230,985       451   5,153   312,282 
                                 
Liabilities                                
Deposits by banks (4)  17,255   —           27,606   —   —   44,861 
Customer accounts (5, 6)  15,341   1,661           188,517   —   —   205,519 
Debt securities in issue (7)  —   —           20,923   —   —   20,923 
Settlement balances                                
and short positions  12,437   —           2,518   —   —   14,955 
Derivatives  3,251   —           —   —   —   3,251 
Accruals, deferred income                                
and other liabilities  —   —           465   4   2,948   3,417 
Retirement benefit liabilities                          1,322   1,322 
Subordinated liabilities (8)  —   —           5,932   —   —   5,932 
   48,284   1,661           245,961   4   4,270   300,180 
                                 
Equity                              12,102 
                               312,282 
  Group
     Designated                   
     as at fair                  
     value             Non    
     through        Other     financial    
  Held-for-  profit or  Available-  Loans and  (amortised  Finance  assets/    
  trading  loss  for-sale  receivables  cost) leases  liabilities  Total 
2006  £m   £m   £m   £m   £m   £m   £m   £m 
Assets                                
Cash and balances at central banks  —   —   —   1,525       —       1,525 
Treasury and other eligible bills (1)  225   —   50   —       —       275 
Loans and advances to banks (2)  11,884   654   —   49,025       —       61,563 
Loans and advances to customers (3)  21,935   516   —   159,516       444       182,411 
Debt securities  28,531   1,649   2,088   —       —       32,268 
Equity shares  42   36   1,080   —       —       1,158 
Settlement balances  —   —   —   3,574       —       3,574 
Derivatives  2,746   —   —   —       —       2,746 
Intangible assets                          1,209   1,209 
Property, plant and equipment                          1,719   1,719 
Prepayments, accrued income                                
and other assets  —   —   —   18       —   2,195   2,213 
   65,363   2,855   3,218   213,658       444   5,123   290,661 
                                 
Liabilities                                
Deposits by banks (4)  6,770   —           39,488   —   —   46,258 
Customer accounts (5, 6)  8,665   1,448           171,106   —   —   181,219 
Debt securities in issue (6)  —   —           14,335   —   —   14,335 
Settlement balances                                
and short positions  21,296   —           2,978   —   —   24,274 
Derivatives  2,343   —           —   —   —   2,343 
Accruals, deferred income                                
and other liabilities  —   —           405   4   3,699   4,108 
Retirement benefit liabilities                          1,298   1,298 
Subordinated liabilities (8)  —   —           5,641   —   —   5,641 
   39,074   1,448           233,953   4   4,997   279,476 
                                 
Equity                              11,185 
                               290,661 
Notes:
(1)  Comprises treasury bills and similar securities of £134 million (2006 – £185 million) and other eligible bills of £1,887 million (2006 – £90 million).
(2)  Includes reverse repurchase agreements of £8,487 million (2006 – £10,793 million), items in the course of collection from other banks of £2,296 million (2006 – £2,306 million), amounts due from holding company of £54,006 million (2006 – £44,834 million) and amounts due from fellow subsidiaries of £1,175 million (2006 – £24 million).
(3)  Includes reverse repurchase agreements of £15,557 million (2006 – £19,459 million), amounts due from ultimate holding company of nil (2006 – £737 million), amounts due from fellow subsidiaries of £35,880 million (2006 – £35,358 million) and amounts due from holding company of £912 million (2006 – nil).
(4)  Includes repurchase agreements of £13,139 million (2006 – £20,386 million), items in the course of transmission to other banks of £714 million (2006 – £742 million), amounts due to holding company of £27,884 million (2006 – £20,871 million) and amounts due to fellow subsidiaries of £58 million (2006 – £33 million).
(5)  Includes repurchase agreements of £30,239 million (2006 – £25,806 million), amounts due to fellow subsidiaries of £7,583 million (2006 – £7,380 million) and amounts due to holding company of £181 million (2006 – nil).
(6)  The carrying amount of other customer accounts designated as at fair value through profit and loss is £69 million (2006 – £80 million) greater than the principal amount. No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial measured as the change in fair value from movements in the period in the credit risk premium payable. The amount includes investment contracts with a carrying value of nil (2006 – nil).
(7)  Comprises bonds and medium term notes of £6,101 million (2006 – £4,656 million) and certificates of deposit and other commercial paper of £14,822 million (2006 – £9,679 million).
(8)  Includes amounts due to holding company of £1,173 million (2006 – £267 million).
  Group 
  2007  2006  2005 
Amounts included in the income statement  £m   £m   £m 
Gains on financial assets/liabilities designated as at fair value through profit or loss  19   116   26 
Gains on disposal or settlement of loans and receivables  —   1   — 
Notes on the accounts continued

9 Financial instruments (continued)
          Bank          
     Designated                   
     as at fair                   
     value              Non    
     through           Other  financial    
  
Held-for-
trading
  
profit or
 loss
  
Hedging
derivatives
  
Available-
for-sale
  
Loans and
receivables
  
(amortised
cost
) 
assets/
liabilities
  Total 
2007  £m   £m   £m   £m   £m   £m   £m   £m 
Assets                                
Cash and balances at central banks  —   —       —   1,006       —   1,006 
Loans and advances to banks (1)  116   17       —   27,163       —   27,296 
Loans and advances to customers (2)  355   —       —   115,277       —   115,632 
Debt securities  —   —       31   —       —   31 
Equity shares  —   —       18   —       —   18 
Investment in Group undertakings  —   —       —   —       6,052   6,052 
Derivatives  1,523   —   65   —   —       —   1,588 
Intangible assets                          375   375 
Property, plant and equipment                          908   908 
Prepayments, accrued income                                
and other assets  —   —       —   —       879   879 
   1,994   17   65   49   143,446       8,214   153,785 
                                 
Liabilities                                
Deposits by banks (3)  735   —               5,589   —   6,324 
Customer accounts (4, 5)  107   170               131,971   —   132,248 
Debt securities in issue (6)  —   —               9   —   9 
Derivatives  1,318   —   34           —   —   1,352 
Accruals, deferred income                                
and other liabilities  —   —               —   1,091   1,091 
Retirement benefit liabilities                          1,124   1,124 
Subordinated liabilities  —   —               4,244   —   4,244 
   2,160   170   34           141,813   2,215   146,392 
                                 
Equity                              7,393 
                               153,785 
           Bank          
     Designated                   
     as at fair                   
     value              Non    
     through           Other  financial    
  
Held-for-
trading
  
profit
or loss
  
Hedging
derivatives
  
Available-
for-sale
  
Loans and
receivables
  
(amortised
cost
) 
assets/
liabilities
  Total 
2006  £m   £m   £m   £m   £m   £m   £m   £m 
Assets                                
Cash and balances at central banks  —   —       —   876       —   876 
Loans and advances to banks (1)  147   —       —   24,859       —   25,006 
Loans and advances to customers (2)  1,056   —       —   108,440       —   109,496 
Debt securities  1   —       41   —       —   42 
Equity shares  —   —       50   —       —   50 
Investment in Group undertakings  —   —       —   —       6,758   6,758 
Derivatives  1,339   —   61   —   —       —   1,400 
Intangible assets                          359   359 
Property, plant and equipment                          1,009   1,009 
Prepayments, accrued income                                
and other assets  —   —       —   —       705   705 
   2,543   —   61   91   134,175       8,831   145,701 
                                 
Liabilities                                
Deposits by banks (3)  328   —               6,110   —   6,438 
Customer accounts (4, 5)  196   116               124,783   —   125,095 
Debt securities in issue (6)  —   —               29   —   29 
Derivatives  1,082   —   63           —   —   1,145 
Accruals, deferred income                                
and other liabilities  —   —               —   1,231   1,231 
Retirement benefit liabilities                          1,110   1,110 
Subordinated liabilities  —   —               4,583   —   4,583 
   1,606   116   63           135,505   2,341   139,631 
                                 
Equity                              6,070 
                               145,701 
Notes:
(1)  
Comprises items in the course of collection from other banks of £2,206 million (2006 – £2,108 million), amounts due from holding company of £22,749 million (2006 – £21,684 million), amounts due from fellow subsidiaries of £383 million (2006 – £24 million) and amounts due from subsidiaries of £553 million (2006 – £641 million).
(2)  
Includes amounts due from ultimate holding company of nil (2006 – £737 million), amounts due from fellow subsidiaries of £35,500 million (2006 – £34,119 million), amounts due from subsidiaries of £3,095 million (2006 – £4,143 million) and amounts due from holding company of £335 million (2006 – nil).
(3)  
Includes items in the course of transmission to other banks of £764 million (2006 – £777 million), amounts due to holding company of £1,908 million (2006 – £4,242 million), amounts due to fellow subsidiaries of £1,721 million (2006 – £8 million) and amounts due to subsidiaries of £636 million (2006 – £366 million).
(4)  
Includes amounts due to fellow subsidiaries of £7,360 million (2006 – £6,901 million), amounts due to subsidiaries of £1,461 million (2006 – £6,576 million) and amounts due to holding company of £181 million (2006 – nil).
(5)  
The carrying amount of other customer accounts designated as at fair value through profit and loss is £17 million (2006 – £4 million) greater than the principal amount. No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial measured as the change in fair value from movement in the period in the credit risk premium payable. The amount includes investment contracts with a carrying value of nil (2006 – nil).
(6)  
Comprises bonds and medium term notes of £9 million (2006 – £29 million).
Notes on the accounts continued

9 Financial instruments (continued)
The following table shows the carrying values and the fair values of financial instruments on the balance sheets at amortised cost.
     Group        Bank   
  2007  2007  2006  2006  2007  2007  2006  2006 
  Carrying  Fair  Carrying  Fair  Carrying  Fair  Carrying  Fair 
  value  value  value  value  value  value  value  value 
   £m   £m   £m   £m   £m   £m   £m   £m 
Financial assets                                
Cash and balances at central banks  1,363   1,363   1,525   1,525   1,006   1,006   876   876 
                                 
Loans and advances to banks                                
Loans and receivables  53,300   53,293   49,025   49,022   27,163   27,164   24,859   24,859 
                                 
Loans and advances to customers                                
Loans and receivables  173,603   173,554   159,516   159,447   115,277   115,250   108,440   108,321 
Finance leases  451   458   444   477   —   —   —   — 
                                 
Settlement balances  2,700   2,700   3,574   3,574   —   —   —   — 
                                 
Financial liabilities                                
Deposits by banks                                
Amortised cost  27,606   27,606   39,488   39,487   5,589   5,590   6,110   6,110 
                                 
Customer accounts                                
Amortised cost  188,517   188,502   171,106   171,099   131,971   131,967   124,783   124,781 
                                 
Debt securities in issue                                
Amortised cost  20,923   20,943   14,335   14,390   9   9   29   29 
                                 
Subordinated liabilities                                
Amortised cost  5,932   5,842   5,641   6,061   4,244   4,214   4,583   4,940 
                                 
Settlement balances and short positions  2,518   2,518   2,978   2,978   —   —   —   — 
Remaining maturity                  
        Group       
  2007 2006
  Less than  More than     Less than  More than    
  12 months  12 months  Total  12 months  12 months  Total 
   £m   £m   £m   £m   £m   £m 
Assets                        
Cash and balances at central banks  1,363   —   1,363   1,525   —   1,525 
Treasury and other eligible bills  2,021   —   2,021   275   —   275 
Loans and advances to banks  69,783   1,666   71,449   60,280   1,283   61,563 
Loans and advances to customers  117,090   71,886   188,976   113,393   69,018   182,411 
Debt securities  3,442   32,474   35,916   1,838   30,430   32,268 
Equity shares  —   1,110   1,110   —   1,158   1,158 
Settlement balances  2,700   —   2,700   3,574   —   3,574 
Derivatives  1,230   2,345   3,575   1,111   1,635   2,746 
                         
Liabilities                        
Deposits by banks  42,978   1,883   44,861   44,308   1,950   46,258 
Customer accounts  201,014   4,505   205,519   177,858   3,361   181,219 
Debt securities in issue  10,429   10,494   20,923   8,250   6,085   14,335 
Settlement balances and short positions  3,444   11,511   14,955   3,978   20,296   24,274 
Derivatives  1,315   1,936   3,251   1,169   1,174   2,343 
Subordinated liabilities  195   5,737   5,932   113   5,528   5,641 
        Bank       
     2007        2006    
  Less than  More than     Less than  More than    
  12 months  12 months  Total  12 months  12 months  Total 
   £m   £m   £m   £m   £m   £m 
Assets                        
Cash and balances at central banks  1,006   —   1,006   876   —   876 
Loans and advances to banks  27,058   238   27,296   24,442   564   25,006 
Loans and advances to customers  78,387   37,245   115,632   76,651   32,845   109,496 
Debt securities  30   1   31   42   —   42 
Equity shares  —   18   18   —   50   50 
Derivatives  319   1,269   1,588   442   958   1,400 
                         
Liabilities                        
Deposits by banks  5,733   591   6,324   5,696   742   6,438 
Customer accounts  129,787   2,461   132,248   122,191   2,904   125,095 
Debt securities in issue  —   9   9   20   9   29 
Derivatives  302   1,050   1,352   422   723   1,145 
Subordinated liabilities  106   4,138   4,244   111   4,472   4,583 
Notes on the accounts continued

10 Asset quality
Asset grades
Internal reporting and oversight of risk assets is principally differentiated by credit ratings. Internal ratings are used to assess the credit quality of borrowers. Customers are assigned credit ratings based on various credit grading models that reflect the probability of default. All credit ratings across the Group map to a RBS Group level asset quality scale.
Expressed as an annual probability of default, the upper and lower boundaries and the midpoint for each of these RBS Group level asset quality grades are as follows:
 Annual probability of default
 MinimumMidpointMaximum
Asset quality grade%%%
AQ10.000.100.20
AQ20.210.400.60
AQ30.611.051.50
AQ41.513.255.00
AQ55.0152.50100.00
The following table provides an analysis of the credit quality of financial assets by the RBS Group’s internal credit ratings.
                   Group                  
                       Balances with Group   Accruing   Non-   Impairment     
   AQ1   AQ2   AQ3   AQ4   AQ5   companies   past due   accrual   provision   Total 
2007  £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
Cash and balances at central banks  1,363   —   —   —   —   —   —   —   —   1,363 
Treasury and other eligible bills
  2,021   —   —   —   —   —   —   —   —   2,021 
Loans and advances to banks*  13,308   492   146   23   2   55,181   —   2   (2)  69,152 
Loans and advances to customers  31,716   21,636   61,593   22,471   10,485   36,792   3,324   3,297   (2,338)  188,976 
Debt securities  34,877   765   133   31   110   —   —   —   —   35,916 
Settlement balances  1,376   9   202   32   29   —   1,052   —   —   2,700 
Derivatives  1,443   198   162   41   16   1,715   —   —   —   3,575 
Other financial instruments  19   —   —   —   —   —   —   —   —   19 
   86,123   23,100   62,236   22,598   10,642   93,688   4,376   3,299   (2,340)  303,722 
                                         
Commitments  16,363   22,106   21,931   10,321   5,615   —   —   —   —   76,336 
Contingent liabilities  1,708   1,357   1,680   383   217   —   —   —   —   5,345 
Total off-balance sheet  18,071   23,463   23,611   10,704   5,832   —   —   —   —   81,681 
Balances with GroupAccruingNon-
Impairment
Impairment provisions individually assessed.     
AQ1AQ2AQ3AQ4AQ5companiespast dueaccrualprovisionTotal
2006£m£m£m£m£m£m£m£m£m£m
Cash and balances at central banks  1,525   —   —   —   —   —   —   —   —   1,525 
Treasury and other eligible bills
  275   —   —   —   —   —   —   —   —   275 
Loans and advances to banks*  13,994   119   —   278   8   44,858    —   2   (2)  59,257 
Loans and advances to customers  37,412   15,228   49,314   32,203   8,166   36,095   3,070   2,982   (2,059)  182,411 
Debt securities  29,804   1,191   795   78   400   —   —   —   —   32,268 
Settlement balances  1,904   127   251   97   —   —   1,195   —   —   3,574 
Derivatives  1,198   193   172   14   6   1,163   —   —   —   2,746 
Other financial instruments  18   —   —   —   —   —   —   —   —   18 
   86,130   16,858   50,532   32,670   8,580   82,116   4,265   2,984   (2,061)  282,074 
                                         
Commitments  24,411   15,531   19,845   8,653   6,659   —   —   —   —   75,099 
Contingent liabilities  2,465   1,534   833   250   79   —   —   —   —   5,161 
Total off-balance sheet  26,876   17,065   20,678   8,903   6,738   —   —   —   —   80,260 
* Excluding items in the course of collection of £2,297 million (2006 – £2,306 million).
The following table provides an analysis of the credit quality of financial assets by the RBS Group’s internal credit ratings.
              Bank                
                 Balances with Group  Accruing  Non  Impairment    
  AQ1  AQ2  AQ3  AQ4  AQ5  companies  past due  accrual  provision  Total 
2007  
£m
   £m   £m   £m   £m   £m   £m   £m   £m   £m 
Cash and balances at central banks  1,006   —   —   —   —   —   —   —   —   1,006 
Loans and advances to banks*  968   268   146   23   —   23,685   —   —   —   25,090 
Loans and advances to customers  11,165   16,147   26,468   12,000   8,423   38,930   1,786   2,634   (1,921)  115,632 
Debt securities  31   —   —   —   —   —   —   —   —   31 
Derivatives  321   171   144   31   16   905   —   —   —   1,588 
   13,491   16,586   26,758   12,054   8,439   63,520   1,786   2,634   (1,921)  143,347 
                                         
Commitments  11,769   19,930   13,477   6,471   3,682   193   —   —   —   55,522 
Contingent liabilities  1,181   1,282   1,035   262   192   —   —   —   —   3,952 
Total off-balance sheet  12,950   21,212   14,512   6,733   3,874   193   —   —   —   59,474 
Balances with GroupAccruingNonImpairment
AQ1AQ2AQ3AQ4AQ5companiespast dueaccrualprovisionTotal
2006£m£m£m£m£m£m£m£m£m£m
Cash and balances at central banks  876   —   —   —   —   —   —   —   —   876 
Loans and advances to banks*  244   19   —   278   8   22,349   —   —   —   22,898 
Loans and advances to customers  7,084   10,338   19,123   24,207   7,118   38,999   1,872   2,462   (1,707)  109,496 
Debt securities  —   —   —   42   —   —   —   —   —   42 
Derivatives  214   184   152   14   6   830   —   —   —   1,400 
   8,418   10,541   19,275   24,541   7,132   62,178   1,872   2,462   (1,707)  134,712 
                                         
Commitments  21,462   14,960   8,138   6,650   5,857   273   —   —   —   57,340 
Contingent liabilities  2,058   1,481   304   170   55   —   —   —   —   4,068 
Total off-balance sheet  23,520   16,441   8,442   6,820   5,912   273   —   —   —   61,408 
* Excluding items in the course of collection of £2,206 million (2006 – £2,108 million).
Notes on the accounts continued
10 Asset quality (continued)
Industry risk – geographical analysis
The following table analyses financial assets by location of office and industry type.
        Group       
  Loans and advances to banks and customers  Treasury bills, debt securities and equity shares  Derivatives  
Other(1)
  Total  
Netting
offset(2)
 
2007  £m   £m   £m   £m   £m   £m 
UK                        
Central and local government  2,067   1,341   —   —   3,408   1,144 
Manufacturing  6,737   2   101   —   6,840   2,256 
Construction  6,147   —   25   —   6,172   917 
Finance  73,279   1,571   1,216   —   76,066   368 
Service industry and business activities  27,051   2   184   —   27,237   4,546 
Agriculture, forestry and fishing  1,733   1   2   —   1,736   18 
Property  24,211   26   103   —   24,340   1,445 
Individuals                        
Home mortgages  3,565   —   2   —   3,567   — 
Other  16,486   —   —   —   16,486   2 
Finance leases and instalment credit  310   —   —   —   310   — 
Interest accruals  470   —   —   —   470   — 
Total UK  162,056   2,943   1,633   —   166,632   10,696 
                         
US                        
Central and local government  —   7,050   —   212   7,262   — 
Manufacturing  —   112   —   —   112   — 
Construction  —   48   —   —   48   — 
Finance  41,858   26,046   577   2,478   70,959   2,485 
Service industry and business activities  16   823   1   1   841   1 
Property  1,975   —   —   —   1,975   — 
Individuals                        
Home mortgages  967   —   —   —   967   — 
Other  9   —   —   —   9   — 
Interest accruals  224   241   —   —   465   2 
Total US  45,049   34,320   578   2,691   82,638   2,488 
                         
Europe                        
Central and local government  104   959   —   —   1,063   — 
Manufacturing  1,803   —   —   —   1,803   — 
Construction  2,860   —   —   —   2,860   — 
Finance  11,381   780   1,336   28   13,525   — 
Service industry and business activities  6,123   —   8   —   6,131   16 
Agriculture, forestry and fishing  587   —   —   —   587   — 
Property  8,028   15   —   —   8,043   — 
Individuals                        
Home mortgages  16,201   18   —   —   16,219   — 
Other  4,892   —   —   —   4,892   — 
Finance leases and instalment credit  43   —   —   —   43   — 
Interest accruals  177   —   —   —   177   — 
Total Europe  52,199   1,772   1,344   28   55,343   16 
                         
Rest of the World                        
Central and local government  —   1   —   —   1   — 
Finance  2,114   12   20   —   2,146   — 
Service industry and business activities  —   1   —   —   1   — 
Individuals                        
Home mortgages  197   —   —   —   197   — 
Other  1,147   —   —   —   1,147   — 
Interest accruals  3   —   —   —   3   — 
Total Rest of the World  3,461   14   20   —   3,495   — 
Industry risk – geographical analysis
        Group       
  Loans and advances to banks and customers  Treasury bills, debt securities and equity shares  Derivatives  Other(1)  Total  
Netting
offset(2)
 
2007  £m   £m   £m   £m   £m   £m 
Total                        
Central and local government  2,171   9,351   —   212   11,734   1,144 
Manufacturing  8,540   114   101   —   8,755   2,256 
Construction  9,007   48   25   —   9,080   917 
Finance  128,632   28,409   3,149   2,506   162,696   2,853 
Service industry and business activities  33,190   826   193   1   34,210   4,563 
Agriculture, forestry and fishing  2,320   1   2   —   2,323   18 
Property  34,214   41   103   —   34,358   1,445 
Individuals                        
Home mortgages  20,930   18   2   —   20,950   — 
Other  22,534   —   —   —   22,534   2 
Finance leases and instalment credit  353   —   —   —   353   — 
Interest accruals  874   241   —   —   1,115   2 
   262,765   39,049   3,575   2,719   308,108   13,200 
Notes:
(1)  
Includes settlement balances of £2,700 million.
(2)  
This column shows the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.


Notes on the accounts continued

10 Asset quality (continued)
Industry risk – geographical analysis
        Group       
  Loans and advances to banks and customers  Treasury bills, debt securities and equity shares  Derivatives  
Other(1)
  Total  
Netting
offset(2)
 
2006  £m   £m   £m   £m   £m   £m 
UK                        
Central and local government  2,130   1,428   4   —   3,562   1,050 
Manufacturing  6,635   1   74   —   6,710   3,174 
Construction  5,083   1   34   —   5,118   766 
Finance  84,028   1,748   979   —   86,755   421 
Service industry and business activities  24,150   22   241   —   24,413   3,707 
Agriculture, forestry and fishing  2,004   1   1   —   2,006   34 
Property  19,966   18   64   —   20,048   744 
Individuals                        
Home mortgages  3,449   —   —   —   3,449   — 
Other  16,172   —   —   —   16,172   6 
Finance leases and instalment credit  308   —   —   —   308   — 
Interest accruals  402   —   —   —   402   — 
Total UK  164,327   3,219   1,397   —   168,943   9,902 
                         
US                        
Central and local government  —   8,641   —   102   8,743   — 
Manufacturing  —   248   —   —   248   — 
Construction  —   48   —   —   48   — 
Finance  32,237   19,158   468   3,462   55,325   1,265 
Service industry and business activities  21   643   1   —   665   — 
Property  2,647   —   —   —   2,647   — 
Individuals                        
Home mortgages  6,708   —   —   —   6,708   — 
Other  3   —   —   —   3   — 
Interest accruals  128   230   —   —   358   2 
Total US  41,744   28,968   469   3,564   74,745   1,267 
                         
Europe                        
Central and local government  263   310   —   —   573   — 
Manufacturing  1,005   —   —   —   1,005   — 
Construction  2,291   —   —   —   2,291   — 
Finance  5,045   1,202   865   17   7,129   4 
Service industry and business activities  4,795   1   10   8   4,814   — 
Agriculture, forestry and fishing  469   2   —   —   471   — 
Property  6,053   —   —   —   6,053   — 
Individuals                        
Home mortgages  13,597   —   —   —   13,597   — 
Other  3,567   —   —   —   3,567   — 
Finance leases and instalment credit  38   —   —   —   38   — 
Interest accruals  144   —   —   —   144   — 
Total Europe  37,267   1,515   875   25   39,682   4 
                         
Rest of the World                        
Central and local government  —   1   —   —   1   — 
Finance  1,823   —   —   —   1,823   — 
Service industry and business activities
  —   —   5   3   8   — 
Individuals                        
Home mortgages  90   —   —   —   90   — 
Other  781   —   —   —   781   — 
Interest accruals  3   —   —   —   3   — 
Total Rest of the World  2,697   1   5   3   2,706   — 
Industry risk – geographical analysis
Group
Loans and advances to banks and customersTreasury bills, debt securities and equity sharesDerivatives
Other(1)
Total
Netting
offset(2)
2006£m£m£m£m£m£m
Total                  
Central and local government  2,393   10,380   4   102   12,879   1,050 
Manufacturing  7,640   249   74   —   7,963   3,174 
Construction  7,374   49   34   —   7,457   766 
Finance  123,133   22,108   2,312   3,479   151,032   1,690 
Service industry and business activities  28,966   666   257   11   29,900   3,707 
Agriculture, forestry and fishing  2,473   3   1   —   2,477   34 
Property  28,666   18   64   —   28,748   744 
Individuals                        
Home mortgages  23,844   —   —   —   23,844   — 
Other  20,523   —   —   —   20,523   6 
Finance leases and instalment credit  346   —   —   —   346   — 
Interest accruals  677   230   —   —   907   2 
   246,035   33,703   2,746   3,592   286,076   11,173 
Note:
(1)  
Includes settlement balances of £3,574 million.
(2)  
This column shows the amount by which the Group’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.

Notes on the accounts continued
10 Asset quality (continued)
Industry risk – geographical analysis
        Bank       
  Loans and advances to banks and customers  Treasury bills, debt securities and equity shares  Derivatives  Total  
Netting
offset (1)
 
2007  £m   £m   £m   £m   £m 
UK                    
Central and local government  2,066   —   —   2,066   1,144 
Manufacturing  6,472   —   101   6,573   2,256 
Construction  4,720   —   25   4,745   917 
Finance  59,312   48   1,174   60,534   368 
Service industry and business activities  25,948   1   181   26,130   4,546 
Agriculture, forestry and fishing  1,445   —   2   1,447   18 
Property  20,568   —   103   20,671   1,445 
Individuals                    
Home mortgages  26   —   2   28   — 
Other  14,527   —   —   14,527   2 
Finance lease and instalment credit  13   —   —   13   — 
Interest accruals  402   —   —   402   — 
Total UK  135,499   49   1,588   137,136   10,696 
                     
US                    
Finance  5,867   —   —   5,867   — 
Total US  5,867   —   —   5,867   — 
                     
Europe                    
Finance  3,035   —   —   3,035   — 
Total Europe  3,035   —   —   3,035   — 
                     
Rest of the World                    
Finance  448   —   —   448   — 
Total Rest of the World  448   —   —   448   — 
                     
Total                    
Central and local government  2,066   —   —   2,066   1,144 
Manufacturing  6,472   —   101   6,573   2,256 
Construction  4,720   —   25   4,745   917 
Finance  68,662   48   1,174   69,884   368 
Service industry and business activities  25,948   1   181   26,130   4,546 
Agriculture, forestry and fishing  1,445   —   2   1,447   18 
Property  20,568   —   103   20,671   1,445 
Individuals                    
Home mortgages  26   —   2   28   — 
Other  14,527   —   —   14,527   2 
Finance lease and instalment credit  13   —   —   13   — 
Interest accruals  402   —   —   402   — 
   144,849   49   1,588   146,486   10,696 
Note:
(1)  
This column shows the amount by which the Bank’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Bank a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Bank holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Bank obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
Industry risk – geographical analysis
Bank
Loans and advances to banks and customersTreasury bills, debt securities and equity sharesDerivativesTotal
Netting
offset (1)
2006£m£m£m£m£m
UK               
Central and local government  2,126   —   4   2,130   1,050 
Manufacturing  6,391   —   74   6,465   3,174 
Construction  4,225   —   34   4,259   766 
Finance  66,045   91   981   67,117   399 
Service industry and business activities  23,080   —   242   23,322   3,707 
Agriculture, forestry and fishing  1,736   —   1   1,737   34 
Property  17,329   —   64   17,393   744 
Individuals                    
Home mortgages  35   —   —   35   — 
Other  14,000   —   —   14,000   6 
Interest accruals  334   —   —   334   — 
Total UK  135,301   91   1,400   136,792   9,880 
                     
US                    
Finance  2   —   —   2   — 
Service industry and business activities  —   1   —   1   — 
Total US  2   1   —   3   — 
                     
Europe                    
Finance  906   —   —   906   — 
Total Europe  906   —   —   906   — 
                     
Total                    
Central and local government  2,126   —   4   2,130   1,050 
Manufacturing  6,391   —   74   6,465   3,174 
Construction  4,225   —   34   4,259   766 
Finance  66,953   91   981   68,025   399 
Service industry and business activities  23,080   1   242   23,323   3,707 
Agriculture, forestry and fishing  1,736   —   1   1,737   34 
Property  17,329   —   64   17,393   744 
Individuals                    
Home mortgages  35   —   —   35   — 
Other  14,000   —   —   14,000   6 
Interest accruals  334   —   —   334   — 
   136,209   92   1,400   137,701   9,880 
Note:
(1)  
This column shows the amount by which the Bank’s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Bank a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Bank holds collateral in respect of individual loans and advances to banks and to customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Bank obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.

Notes on the accounts continued

11 Past due and impaired financial assets
The following table shows the movement in the provision for impairment losses for loans and advances.
        Group       
  Individually  Collectively     Total       
  assessed  assessed  Latent  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
At 1 January  269   1,596   196   2,061   2,031   1,940 
Implementation of IAS 39 on 1 January 2005  —   —   —   —   —   185 
Currency translation and other adjustments  8   (8)  41   41   (25)  (2)
Disposals of subsidiaries  —   —   —   —   —   (7)
Amounts written-off (1)  (58)  (559)  —   (617)  (801)  (818)
Recoveries of amounts previously written-off  11   83   —   94   71   56 
Charged to the income statement  79   749   20   848   852   753 
Unwind of discount  (13)  (74)  —   (87)  (67)  (76)
At 31 December (2)  296   1,787   257   2,340   2,061   2,031 
Notes:
(1)  
Amounts written-off include £3 million in 2005 relating to loans and advances to banks.
(2)  
Impairment losses at 31 December 2007 include £2 million relating to loans and advances to banks (2006 – £2 million; 2005 – £3 million).
        Bank       
  Individually  Collectively     Total       
  assessed  assessed  Latent  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
At 1 January  178   1,421   108   1,707   1,673   1,633 
Implementation of IAS 39 on 1 January 2005  —   —   —   —   —   177 
Currency translation and other adjustments  —   (21)  34   13   (21)  5 
Disposals of subsidiaries  —   —   —   —   —   (17)
Amounts written-off  (53)  (488)  —   (541)  (702)  (758)
Recoveries of amounts previously written-off  9   62   —   71   58   43 
Charged to the income statement  56   685   1   742   754   651 
Unwind of discount  (8)  (63)  —   (71)  (55)  (61)
At 31 December  182   1,596   143   1,921   1,707   1,673 
     Group    
  2007  2006  2005 
Impairment losses charged to the income statement  £m   £m   £m 
Loans and advances to customers  848   852   753 
Equity shares  1   —   3 
   849   852   756 
          
          
  2007  2006  2005 
Group  £m   £m   £m 
Gross income not recognised but which would have been            
recognised under the original terms of non-accrual and restructured loans            
Domestic  200   225   99 
Foreign  10   24   21 
   210   249   120 
             
Group            
Interest on non-accrual and restructured loans included in net interest income            
Domestic  75   68   67 
Foreign  12   9   9 
   87   77   76 
The following tables show analyses of impaired financial assets.
     2007        2006    
        Net book        Net book 
  Cost  Provision  value  Cost  Provision  value 
Group  £m   £m   £m   £m   £m   £m 
Impaired financial assets                        
Loans and advances to banks (1)  2   2   —   2   2   — 
Loans and advances to customers (2)  3,297   2,081   1,216   2,982   1,863   1,119 
Equity shares (1)  10   2   8   11   2   9 
   3,309   2,085   1,224   2,995   1,867   1,128 

     2007        2006    
        Net book        Net book 
  Cost  Provision  value  Cost  Provision  value 
Bank  £m   £m   £m   £m   £m   £m 
Impaired financial assets ��                      
Loans and advances to customers (3)  2,634   1,778   856   2,462   1,599   863 
Notes:
(1) Impairment provisions individually assessed.
(2)   Impairment provisions individually assessed on balances of £539£8,340 million (2006(2008 – £453£2,654 million).
(3)   Impairment provisions individually assessed on balances of £270£1,122 million (2006(2008 – £265£404 million).
The Group and Bank hold collateral in respect of certain loans and advances to banks and to customers that are past due or impaired. Such collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. 
The following table shows financial and non-financial assets, recognised on the Group's and Bank’s balance sheets, obtained during the year by taking possession of collateral or calling on other credit enhancements. 
  Group  Bank 
  2009  2008  2009  2008 
  £m  £m  £m  £m 
Other property 
  104   —   —   — 
Cash 
  41   28   41   28 
   145   28   41   28 
In general, the Group seeks to dispose of property and other assets not readily convertible into cash obtained by taking possession of collateral as rapidly as the market for the individual asset permits.
116
Notes on the accounts

11 Financial assets – impairments continued
The following loans and advances to customers were past due at the balance sheet date but not considered impaired:
      Group           Bank       
        Past due            Past due    
  Past due Past due Past due 90 days     Past due Past due Past due  90 days    
  1-29 days 30-59 days 60-89 days or more  Total  1-29 days 30-59 days 60-89 days  or more  Total 
  £m £m £m £m  £m  £m £m £m  £m  £m 
  
2009 
  2,465  1,010  1,387  1,670  6,532   1,075  600  1,084   1,016  3,775 
2008 
  2,909  743  500  1,000  5,152   1,151  302  207   556  2,216 
These balances include loans and advances to customers that are past due through administrative and other delays in recording payments or in finalising documentation and other events unrelated to credit quality.
Loans that have been renegotiated in the past 12 months that would otherwise have been past due or impaired amounted to £514 million (Bank – £173 million) as at 31 December 2009 (2008: Group – £127 million; Bank – £127 million).
12 Derivatives
Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
The following table shows the notional amounts and fair values of the Group’s derivatives.
        Group       
  
 
  2009        2008    
  Notional        Notional       
  amounts  Assets  Liabilities  amounts  Assets  Liabilities 
  £bn  
£m
  £m  £bn  £m  £m 
Exchange rate contracts 
                  
Spot, forwards and futures 
  22   366   335   41   1,916   1,424 
Currency swaps 
  5   265   478   7   404   824 
Options purchased 
  3   90   —   5   267   — 
Options written 
  2   —   90   4   —   266 
  
Interest rate contracts 
                        
Interest rate swaps 
  410   3,197   3,146   264   4,490   4,927 
Options purchased 
  60   391   —   34   407   — 
Options written 
  63   —   196   28   —   162 
Futures and forwards 
  40   4   4   63   —   6 
  
Credit derivatives 
  5   86   54   242   1,376   447 
  
Equity and commodity contracts 
  2   71   11   1   35   10 
       4,470   4,314       8,895   8,066 
Amounts above include: 
                        
Due from/to holding company 
      2,422   3,940       5,647   6,132 
Due from/to fellow subsidiaries 
      7   1       8   1 
117
Notes on the accounts continued
12 Derivatives continued
The following table shows the nominal amounts and fair values of the Bank’s derivatives.
        Bank       
     2009        2008    
  Notional        Notional       
  amounts  Assets  Liabilities  amounts  Assets  Liabilities 
  £bn  £m  £m  £bn  £m  £m 
Exchange rate contracts 
                  
Spot, forwards and futures 
  11   197   199   16   954   883 
Currency swaps 
  3   154   184   3   206   282 
Options purchased 
  2   88   —   4   259   — 
Options written 
  2   —   87   3   —   259 
  
Interest rate contracts 
                        
Interest rate swaps 
  260   2,095   1,863   82   3,136   4,753 
Options purchased 
  9   332   —   6   304   — 
Options written 
  12   —   162   2   —   40 
Futures and forwards 
  4   4   4   —   —   — 
  
Credit derivatives 
  1   30   7   2   38   26 
       2,900   2,506       4,897   6,243 
Amounts above include: 
                        
Due from/to holding company 
      1,559   2,343       2,617   3,621 
Due from/to fellow subsidiaries 
      —   —       —   — 
Due from/to subsidiaries 
      —   —       54   1,517 
  
Certain derivative asset and liability balances with the London Clearing House, which meet the offset criteria in IAS 32 ‘Financial Instruments: 
Presentation’, are shown net. 
                        
  
Included above are derivatives held for hedging purposes as follows:
 
         
          2009  2008 
          Assets  Liabilities  Assets  Liabilities 
           £m   £m   £m   £m 
Fair value hedging: 
                        
Interest rate contracts 
          —   —   —   720 
  
Cash flow hedging: 
                        
Interest rate contracts 
          —   —   —   198 
The following tables show, for the Bank, when the hedged cash flows are expected to occur and when they will affect income for designated cash flow hedges.
           2008          
   0-1   1-2   2-3   3-4   4-5   5-10   10-20  Over 20    
  years  years  years  years  years  years  years  years  Total 
Hedged forecast cash flows expected to occur 
  £m   £m   £m   £m   £m   £m   £m  £m  £m 
Forecast payable cash flows 
  (5)   (5)   (5)   (5)   (5)   (25)   (51)   (15)   (116) 
  
  
Hedged forecast cash flows affect profit or loss 
                                    
Forecast payable cash flows 
  (5)   (5)   (5)   (5)   (5)   (25)   (51)   (15)   (116) 
118
Notes on the accounts
13 Debt securities
        Group       
      Other   Mortgage-       
  UK central US central central Bank and and other       
  and local and local and local building asset backed       
  government  government  government  society  securities (1, 2) Corporate Other Total  
2009  £m £m £m £m £m £m £m £m 
Held-for-trading 
  —  12,189  301  487  15,416  2,137  —  30,530 
Designated as at fair value through profit or loss 
  1  —  —  3  1  8  —  13 
Available-for-sale 
  —  —  1,559  375  128  25  —  2,087 
Loans and receivables 
  —  —  —  —  2,159  —  —  2,159 
   1  12,189  1,860  865  17,704  2,170  —  34,789 
  
Available-for-sale 
                         
Gross unrealised gains 
  —  —  16  3  2  1  —  22 
Gross unrealised losses 
  —  —  —  (7)  —  —  —  (7) 
  
2008                          
Held-for-trading 
  —  8,157  63  62  20,338  3,737  —  32,357 
Designated as at fair value through profit or loss 
  1  —  —  —  1  17  2  21 
Available-for-sale 
  1,372  —  1,343  713  168  19  —  3,615 
   1,373  8,157  1,406  775  20,507  3,773  2  35,993 
  
Available-for-sale 
                         
Gross unrealised gains 
  —  —  24  —  1  —  —  25 
Gross unrealised losses 
  (25)  —  —  (24)  (14)  —  —  (63) 
 
Notes:
The Group and Bank hold collateral in respect of certain loans and advances to banks and to customers that are past due or impaired. Such collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower.
The following loans and advances to customers were past due at the balance sheet date but not considered impaired:
        Group              Bank       
  Past due 1-29 days  Past due 30-59 days  Past due 60-89 days  
Past due
90 days or
more
  Total  Past due 1-29 days  Past due 30-59 days  Past due 60-89 days  
Past due
90 days or
more
  Total 
   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
2007  2,285   569   381   89   3,324   1,213   357   176   40   1,786 
                                         
2006  2,276   428   271   95   3,070   1,379   275   148   70   1,872 
These balances include loans and advances to customers that are past due through administrative and other delays in recording payments or in finalising documentation and other events unrelated to credit quality.
Loans that have been renegotiated in the past 12 months that would otherwise have been past due or impaired amounted to £169 million (Bank – £167 million) as at 31 December 2007 (2006: Group – £135 million; Bank – £133 million).
Notes on the accounts continued

12 Derivatives
Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
  Group 
     2007        2006    
  Notional        Notional       
  amounts  Assets  Liabilities  amounts  Assets  Liabilities 
  £bn   £m   £m  £bn   £m   £m 
Exchange rate contracts                      
Spot, forwards and futures  36   378   478   33   202   311 
Currency swaps  30   513   504   22   326   230 
Options purchased  4   122   —   6   275   — 
Options written  3   —   122   6   —   302 
                         
Interest rate contracts                        
Interest rate swaps  204   1,852   1,854   408   1,721   1,428 
Options purchased  79   89   —   174   44   — 
Options written  68   —   37   116   —   43 
Futures and forwards  24   —   —   196   —   — 
                         
Credit derivatives  9   464   256   12   15   28 
                         
Equity and commodity contracts  1   157   —   1   163   1 
       3,575   3,251       2,746   2,343 
Amounts above include:                        
Due from/to holding company      1,711   2,000       1,163   974 
Due from/to fellow subsidiaries      4   —       —   — 
  Bank 
     2007        2006    
  Notional        Notional       
  amounts  Assets  Liabilities  amounts  Assets  Liabilities 
  £bn   £m   £m  £bn   £m   £m 
Exchange rate contracts                      
Spot, forwards and futures  13   226   164   11   164   165 
Currency swaps  3   207   100   1   116   3 
Options purchased  4   119   —   6   272   — 
Options written  3   —   119   6   —   272 
                         
Interest rate contracts                        
Interest rate swaps  78   969   954   82   832   687 
Options purchased  6   58   —   3   15   — 
Options written  3   —   7   2   —   13 
                         
Credit derivatives  1   9   8   4   —   4 
                         
Equity and commodity contracts  —   —   —   —   1   1 
       1,588   1,352       1,400   1,145 
                         
Included in the above are derivatives held for hedging as follows                        
Fair value hedging:                        
Interest rate swaps      65   —       61   36 
                         
Cash flow hedging:                        
Interest rate swaps      —   34       —   27 
                         
Amounts above include:                        
Due from/to holding company      850   786       763   540 
Due from/to fellow subsidiaries      3   —       —   — 
Due from/to subsidiaries      52   201       67   146 
13 Debt securities
  Group 
  UK government  US government state and federal agency  Other government  US government sponsored entity  Bank and building society  Mortgage-backed securities(1)  Corporate  Other  Total 
2007  £m   £m   £m   £m   £m   £m   £m   £m   £m 
Held-for-trading  —   8,334   9   18,193   —   4,220   1,224   —   31,980 
Designated as at fair value                                    
through profit or loss  5   —   6   —   123   —   11   9   154 
Available-for-sale  1,320   —   940   —   831   124   14   553   3,782 
At 31 December 2007  1,325   8,334   955   18,193   954   4,344   1,249   562   35,916 
                                     
Available-for-sale                                    
Gross unrealised gains  25   —   —   —   —   —   —   —   25 
Gross unrealised losses  —   —   (2)  —   (26)  —   —   —   (28)
                                     
2006                                    
Held-for-trading  —   10,240   87   10,064   —   6,521   1,618   1   28,531 
Designated as at fair value                                    
through profit or loss  1,285   —   85   —   26   —   248   5   1,649 
Available-for-sale  —   —   925   —   692   104   101   266   2,088 
At 31 December 2006  1,285   10,240   1,097   10,064   718   6,625   1,967   272   32,268 
                                     
Available-for-sale                                    
Gross unrealised gains  —   —   4   —   —   —   —   —   4 
Gross unrealised losses  —   —   (20)  —   (6)  —   (1)  —   (27)
Note:
(1) ExcludesIncludes AAA rated securities issued by US federal agencies of £2,646 million (2008 – £1,222 million) and government sponsored entities.entities of £11,250 million (2008 – £17,847 million) of current year vintage.
(2)Includes sub-prime RMBS of £451 million (2008 – £396 million) and Alt-A RMBS of £335 million (2008 – £229 million).
Gross gains of £60 million (2008 – £14 million; 2007 – £1 million) and gross losses of £2 million (2008 – nil; 2007 – £1 million) were realised on the sale of available-for-sale securities.
        Bank       
     2009        2008    
  Mortgage        Bank and      ��
  backed        building       
  securities  Corporate  Total  society  Corporate  Total 
  £m  £m  £m  
£m
  £m  £m 
Available-for-sale 
  —   5   5   34   7   41 
Loans and receivables 
  2,158   —   2,158   —   —   — 
   2,158   5   2,163   34   7   41 
119
Notes on the accounts continued
14 Equity shares                  
        Group          
     2009        2008    
  Listed  Unlisted  Total  Listed  Unlisted  Total 
  £m  £m  £m  £m  £m  
£m
 
Held-for-trading  4   1   5   7   102   109 
Designated as at fair value through profit or loss  25   —   25   22   —   22 
Available-for-sale  13   923   936   4   994   998 
   42   924   966   33   1,096   1,129 
  
Available-for-sale                        
Gross unrealised gains  8   35   43   —   42   42 
Gross unrealised losses  —   (30)   (30)   (4)   (12)   (16) 
Gross gains of £3 million (2008 – £4 million; 2007 – £117 million) and gross losses of £1 million (2008 – £1 million; 2007 – nil) were realised by the Group on the sale of available-for-sale equity shares.
Dividend income from available-for-sale equity shares was £592 million (2008 – £5 million; 2007 – £14 million).
Unquoted equity investments whose fair value cannot be reliablymeasured are carried at cost and classified as available-for-salefinancial assets. They include investments in fellow subsidiaries of £766 million (2008 – £634 million; 2007 – £634 million). Disposals in the year generated losses of £0.6 million (2008 – nil; 2007 – £0.6 million).
        Bank       
     2009        2008    
  Listed  Unlisted  Total  Listed  Unlisted  Total 
  £m  £m  £m  £m  £m  £m 
Available-for-sale  9   4   13   2   4   6 
 
Available-for-sale                        
Gross unrealised gains  7   —   7   —   —   — 
Disposals in the year of unquoted equity investments classified as available-for-sale financial assets generated no gains or losses in 2009, 2008 or 2007.
120
Notes on the accounts
15 Investments in Group undertakings
Investments in Group undertakings are carried at cost less impairment. Movements during the year were as follows:
  Bank 
  2009  2008 
  £m  £m 
At 1 January 
  7,339   6,052 
Currency translation and other adjustments 
  (130)   441 
Additional investments in Group undertakings 
  3,005   — 
Additions 
  —   846 
Redemption of investments in Group undertakings 
  (1,150)   — 
Impairments 
  (2,281)   — 
At 31 December 
  6,783   7,339 
The principal subsidiary undertakings of the Bank are shown below. Their capital consists of ordinary and preference shares, which are unlisted. All of the subsidiary undertakings are owned directly or indirectly through intermediate holding companies and are all wholly-owned. All of these subsidiary undertakings are included in the Group’s consolidated financial statements and have an accounting reference date of 31 December.
 
Country of incorporation 
Nature of and principal area 
business of operations 
Gross gains of £1 million (2006 – £2 million) and gross losses of £1 million (2006 – nil) were realised on the sale of available-for-sale securities.Coutts & Company (1)
  Bank 
  2007 2006
  Bank and             
  building             
  society  Corporate  Total  Other  Total 
   £m   £m   £m   £m   £m 
Held-for-trading  —   —   —   1   1 
Available-for-sale  24   7   31   41   41 
At 31 December  24   7   31   42   42 

Notes on the accounts continuedPrivate banking 
14 Equity shares
  Group 
   2007        2006    
  Listed  Unlisted  Total  Listed  Unlisted  Total 
   £m   £m   £m   £m   £m   £m 
Held-for-trading  12   140   152   42   —   42 
Designated as at fair value through profit or loss  32   —   32   36   —   36 
Available-for-sale  34   892   926   22   1,058   1,080 
   78   1,032   1,110   100   1,058   1,158 
                         
Available-for-sale                        
Gross unrealised gains  13   31   44   15   44   59 
Gross unrealised losses  (3)  (6)  (9)  —   (5)  (5)
   10   25   35   15   39   54 
Gross gains of £86 million (2006 – £84 million) and gross losses of nil (2006 – nil) were realised by the Group on the sale of available-for-sale equity shares.Great Britain
Dividend income from available-for-sale equity shares was £14 million (2006 – £36 million; 2005 – £48 million).RBS Securities Inc. (2)
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include investments in fellow subsidiaries of £634 million (2006 – £910 million; 2005 – £634 million). Disposals in the year generated gains of £0.6 million (2006 – £31 million; 2005 – £4 million) based on cost of sales of £4 million (2006 – £14 million; 2005 – £3 million).Broker dealer
  Bank 
   2007        2006    
  Listed  Unlisted  Total  Listed  Unlisted  Total 
   £m   £m   £m   £m   £m   £m 
Available-for-sale  15   3   18   10   40   50 
                         
Available-for-sale                        
Gross unrealised gains  13   —   13   8   36   44 
There were no disposals in the year of unquoted equity investments classified as available-for-sale financial assets (2006 – £24 million gain; 2005 – nil).US
15 Investments in Group undertakings
Investments in Group undertakings are carried at cost less impairment. Movements during the year were as follows:
  Bank
  2007  2006 
   £m   £m 
At 1 January  6,758   6,633 
Currency translation and other adjustments  (25)  (177)
Additions  965   622 
Additional investments in Group undertakings  251   719 
Repayment of investments  (1,823)  (1,022)
Increase in provisions  (74)  (17)
At 31 December  6,052   6,758 
The principal subsidiary undertakings of theUlster Bank are shown below. Their capital consists of ordinary and preference shares, which are unlisted. All of the subsidiary undertakings are owned directly or indirectly through intermediate holding companies and are all wholly-owned. All of these subsidiary undertakings are included in the Group’s consolidated financial statements and have an accounting reference date of 31 December.Limited (3)
Country of incorporation
Nature ofand principal area
businessof operations
Coutts & Co (1)Private bankingGreat Britain
Greenwich Capital Markets, Inc. (2)Broker dealerUS
Ulster Bank Limited (3)Banking
Banking
Northern Ireland
 
Notes:
(1)Coutts & CoCompany is incorporated with unlimited liability. Its registered office is 440 Strand, London WC2R 0QS.
(2)Shares are not directly held by the Bank.
(3)Ulster Bank Limited and its subsidiary undertakings also operate in the Republic of Ireland.
The above information is provided in relation to the principal related undertakings as permitted by section 231(5) of the Companies Act 1985.
The above information is provided in relation to the principal related undertakings as permitted by section 410(2) of the Companies Act 2006. Full information on all related undertakings will be included in the Annual Return filed with the UK Companies House.
121
Notes on the accounts continued
16 Intangible assets
        Group       
     Core  Other  Internally    
     deposit  purchased  generated    
  Goodwill  intangibles  intangibles  software  Total 
2009  £m  £m  £m  £m  £m 
Cost: 
               
At 1 January 2009 
  973   35   49   2,195   3,252 
Currency translation and other adjustments 
  (72)   (2)   (3)   (6)   (83) 
Additions 
  —   —   —   70   70 
Disposals and write-off of fully amortised assets 
  —   (2)   —   —   (2) 
At 31 December 2009 
  901   31   46   2,259   3,237 
  
Accumulated amortisation and impairment: 
                    
At 1 January 2009 
  579   24   41   1,793   2,437 
Currency translation and other adjustments 
  (41)   (2)   (2)   (5)   (50) 
Disposals and write-off of fully amortised assets 
  —   (1)   —   —   (1) 
Charge for the year 
  —   10   2   91   103 
At 31 December 2009 
  538   31   41   1,879   2,489 
  
Net book value at 31 December 2009 
  363   —   5   380   748 
  
2008                     
Cost: 
                    
At 1 January 2008 
  773   27   32   2,028   2,860 
Currency translation and other adjustments 
  247   8   10   8   273 
Additions 
  —   —   8   159   167 
Disposals of subsidiaries 
  (47)   —   —   —   (47) 
Disposals and write-off of fully amortised assets 
  —   —   (1)   —   (1) 
At 31 December 2008 
  973   35   49   2,195   3,252 
  
Accumulated amortisation and impairment: 
                    
At 1 January 2008 
  —   14   13   1,589   1,616 
Currency translation and other adjustments 
  —   7   4   1   12 
Disposals and write-off of fully amortised assets 
  —   —   (1)   —   (1) 
Charge for the year 
  —   3   4   99   106 
Write down of goodwill and other intangible assets 
  579   —   21   104   704 
At 31 December 2008 
  579   24   41   1,793   2,437 
  
Net book value at 31 December 2008 
  394   11   8   402   815 
122
Notes on the accounts
16 Intangible assets continued
 
Bank
Internally generated software £m
Cost:
At 1 January 2009
2,064
Additions
69
At 31 December 2009
2,133
Accumulated amortisation:
At 1 January 2009
1,663
88Charge for the year
90
At 31 December 2009
1,753
Net book value at 31 December 2009
380
Cost:
At 1 January 2008
1,912
Additions
152
At 31 December 2008
2,064
Accumulated amortisation:
At 1 January 2008
1,537
Charge for the year
81
Write down
45
At 31 December 2008
1,663
Net book value at 31 December 2008
401
123
Notes on the accounts continued
16 Intangible assets continued
Impairment review
The Group’s goodwill acquired in business combinations is reviewed annually at 30 September for impairment by comparing the recoverable amount of each cash generating unit (CGU) to which goodwill has been allocated with its carrying value.
Changes were made to the Group’s reporting structure in the first half of 2009, which is detailed on page 144. Following the reorganisation of the Group, goodwill was reallocated to the appropriate CGUs.
The CGUs where the goodwill is significant are as follows: 
        
  
          Goodwill at 
 SignificantRecoverable amount       30 September 
2009 acquisition based on       £m 
Global Banking & Markets 
Greenwich 
Fair value less cost to sell 
        117 
Wealth 
Bank Von Ernst 
Value in use 
        170 
  
            
    Goodwill prior to     Goodwill at 
 Significant Recoverable amount  write down  Write down  31 December 
2008 acquisition based on  £m  £m   £m 
Global Banking & Markets 
Greenwich 
Fair value less cost to sell 
  128   —   128 
Europe & Middle East Retail & Commercial Banking 
First Active 
Value in use 
  576   (576)   — 
Asia Retail & Commercial Banking 
Bank Von Ernst 
Value in use 
  182   —   182 
The analysis of goodwill by operating segment is shown in Note 34.
The Group has adopted value in use test for Wealth based upon management’s latest five year forecasts. For the value in use test, the long-term growth rates have been based on respective country GDP rates adjusted for inflation. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis. Fair value less costs to sell test has been adopted for Global Banking & Markets.
The goodwill in Global Banking & Markets arose from the Group’s interest in Greenwich Capital. The recoverable amount exceeds the carrying value by more than 100% (2008 – £0.7 billion). The earnings multiples, validated against independent analyst information, or the earnings would have to reduce by a quarter of those used to cause the value in use to equal its carrying value.
In Wealth there was no impairment recognised in respect of the goodwill arising on the acquisition of Bank von Ernst. The recoverable amount was based on a 5% (2008 – 5%) terminal growth rate and 11% (2008 – 11%) pre tax risk discount rate. A 1% change in the discount rate or similar change in the terminal growth rate would change the recoverable amount by approximately £250 million (2008 – £150 million) and £200 million (2008 – £100 million) respectively. In addition a 5% change in forecast pre tax earnings would change the recoverable amount by £100 million (2008 – £50 million).
In 2008, a goodwill write down was recorded in Europe & Middle East Retail & Commercial Banking.
124
Notes on the accounts
17 Property, plant and equipment
        Group       
        Long  Short  Computers    
  Investment  Freehold  leasehold  leasehold  and other    
  properties  premises  premises  premises  equipment  Total 
2009  £m  £m  £m  £m  £m  £m 
Cost or valuation: 
                  
At 1 January 2009 
  212   1,299   142   717   484   2,854 
Currency translation and other adjustments 
  (52)   (47)   —   (30)   (27)   (156) 
Reclassifications 
  1   18   1   (23)   3   — 
Additions 
  1,336   126   7   31   45   1,545 
Change in fair value of investment properties 
  107   —   —   —   —   107 
Disposals and write-off of fully depreciated assets 
  —   (19)   (14)   (43)   (62)   (138) 
At 31 December 2009 
  1,604   1,377   136   652   443   4,212 
  
Accumulated impairment, depreciation and amortisation: 
                        
At 1 January 2009 
  —   291   52   267   274   884 
Currency translation and other adjustments 
  —   (2)   1   (4)   (14)   (19) 
Write down of property, plant and equipment 
  —   5   —   4   —   9 
Disposals and write-off of fully depreciated assets 
  —   (8)   —   (41)   (57)   (106) 
Charge for the year 
  —   34   4   51   55   144 
At 31 December 2009 
  —   320   57   277   258   912 
  
Net book value at 31 December 2009 
  1,604   1,057   79   375   185   3,300 
  
  
  
2008                         
Cost or valuation: 
                        
At 1 January 2008 
  110   980   133   635   359   2,217 
Currency translation and other adjustments 
  45   110   5   42   88   290 
Additions 
  125   215   5   52   75   472 
Change in fair value of investment properties 
  2   —   —   —   —   2 
Transfer to fellow subsidiary 
  —   —   —   (8)   (6)   (14) 
Disposal of subsidiaries 
  —   —   —   (2)   (21)   (23) 
Disposals and write-off of fully depreciated assets 
  (70)   (6)   (1)   (2)   (11)   (90) 
At 31 December 2008 
  212   1,299   142   717   484   2,854 
  
Accumulated impairment, depreciation and amortisation: 
                        
At 1 January 2008 
  —   247   48   204   204   703 
Currency translation and other adjustments 
  —   4   1   15   49   69 
Transfer to fellow subsidiary 
  —   —   —   (1)   (2)   (3) 
Disposal of subsidiaries 
  —   —   —   (1)   (15)   (16) 
Write down of property, plant and equipment 
  —   12   —   —   —   12 
Disposals and write-off of fully depreciated assets 
  —   (1)   —   (1)   (10)   (12) 
Charge for the year 
  —   29   3   51   48   131 
At 31 December 2008 
  —   291   52   267   274   884 
  
Net book value at 31 December 2008 
  212   1,008   90   450   210   1,970 
 

Notes on the accounts continued
16 Intangible assets
        Group       
     Core  Other  Internally    
     deposit  purchased  generated    
  Goodwill  intangibles  intangibles  software  Total 
2007  £m   £m   £m   £m   £m 
Cost:                    
At 1 January 2007  719   25   30   1,893   2,667 
Currency translation and other adjustments  54   2   2   3   61 
Additions  —   —   —   132   132 
At 31 December 2007  773   27   32   2,028   2,860 
                     
Accumulated amortisation:                    
At 1 January 2007  —   10   9   1,439   1,458 
Currency translation and other adjustments  —   1   1   1   3 
Charge for the year  —   3   3   149   155 
At 31 December 2007  —   14   13   1,589   1,616 
                     
Net book value at 31 December 2007  773   13   19   439   1,244 
                     
2006                    
Cost:                    
At 1 January 2006  760   25   29   1,682   2,496 
Currency translation and other adjustments  (38)  —   —   (1)  (39)
Additions  —   —   1   229   230 
Disposal of subsidiaries  (3)  —   —   —   (3)
Disposals and write-off of fully amortised assets  —   —   —   (17)  (17)
At 31 December 2006  719   25   30   1,893   2,667 
                     
Accumulated amortisation:                    
At 1 January 2006  —   7   5   1,286   1,298 
Currency translation and other adjustments  —   —   1   —   1 
Charge for the year  —   3   3   153   159 
At 31 December 2006  —   10   9   1,439   1,458 
                     
Net book value at 31 December 2006  719   15   21   454   1,209 
 
 
Bank
2007
Internally generated software£m
Cost:
At 1 January 20071,781
Additions131
At 31 December 20071,912
Accumulated amortisation:
At 1 January 20071,422
Charge for the year115
At 31 December 20071,537
Net book value at 31 December 2007375
Bank
2006
Internally generated software£m
Cost:
At 1 January 20061,622
Additions159
At 31 December 20061,781
Accumulated amortisation:
At 1 January 20061,275
Charge for the year147
At 31 December 20061,422
Net book value at 31 December 2006359
Impairment review
The Group’s goodwill acquired in business combinations is reviewed annually at 30 September for impairment by comparing the recoverable amount of each cash generating unit (CGU) to which goodwill has been allocated with its carrying value. There was no impairment recognised in 2007 or 2006.
CGUs where goodwill is significant were as follows:
    Goodwill at 30 September 
 Significant  2007  2006 
DivisionacquisitionBasis  £m   £m 
Global Banking & MarketsGreenwichFair value less costs to sell  92   100 
Wealth ManagementBank Von ErnstFair value less costs to sell  121   124 
Ulster BankFirst ActiveFair value less costs to sell  421   409 
The recoverable amounts for all CGUs were based on fair value less costs to sell. Fair value was based upon a price-earnings methodology using current earnings for each unit. Approximate price earnings multiples, validated against independent analyst information were applied to each CGU. The multiples used for both 2007 and 2006 were in the range 9.5 – 13.0 times earnings after charging manufacturing costs. The multiples or earnings would have to be less than one fifth of those used to cause the value in use of the units to equal their carrying value.
Notes on the accounts continued
17 Property, plant and equipment
continued
  Group
        Long  Short  Computers    
  Investment  Freehold  leasehold  leasehold  and other    
  properties  premises  premises  premises  equipment  Total 
2007  £m   £m   £m   £m   £m   £m 
Cost or valuation:
                        
At 1 January 2007  202   1,089   200   590   306   2,387 
Currency translation and other adjustments  8   9   1   6   15   39 
Additions  75   113   10   58   41   297 
Disposals and write-off of fully depreciated assets  (175)  (231)  (78)  (19)  (3)  (506)
At 31 December 2007  110   980   133   635   359   2,217 
                         
Accumulated depreciation and amortisation:                        
At 1 January 2007  —   259   71   173   165   668 
Currency translation and other adjustments  —   1   —   2   9   12 
Disposals and write-off of fully depreciated assets  —   (44)  (28)  (11)  (3)  (86)
Charge for the year  —   31   5   40   33   109 
At 31 December 2007  —   247   48   204   204   703 
                         
Net book value at 31 December 2007  110   733   85   431   155   1,514 
  Group
        Long  Short  Computers  Operating    
  Investment  Freehold  leasehold  leasehold  and other  lease    
  properties  premises  premises  premises  equipment  assets  Total 
2006  £m   £m   £m   £m   £m   £m   £m 
Cost or valuation:                            
At 1 January 2006  69   1,108   269   448   280   11   2,185 
Currency translation and other adjustments  (1)  (5)  (1)  (4)  (11)  (1)  (23)
Reclassifications  —   25   (41)  17   (1)  —   — 
Additions  135   76   9   139   81   —   440 
Change in fair value of investment properties  (1)  —   —   —   —   —   (1)
Disposals and write-off of fully depreciated assets  —   (115)  (36)  (4)  (41)  —   (196)
Disposals of subsidiaries  —   —   —   (1)  (1)  —   (2)
Transfer to fellow subsidiary  —   —   —   (5)  (1)  (10)  (16)
At 31 December 2006  202   1,089   200   590   306   —   2,387 
                             
Accumulated depreciation and amortisation:                            
At 1 January 2006  —   232   98   142   181   1   654 
Currency translation and other adjustments
  —   —   —   (2)  (6)  —   (8)
Reclassifications  —   3   (7)  4   —   —   — 
Disposals and write-off of fully depreciated assets  —   (6)  (25)  (3)  (38)  —   (72)
Transfer to fellow subsidiary  —   —   —   (2)  (1)  (1)  (4)
Charge for the year  —   30   5   34   29   —   98 
At 31 December 2006  —   259   71   173   165   —   668 
                             
Net book value at 31 December 2006  202   830   129   417   141   —   1,719 
 
91
Investment properties are valued to reflect fair value, that is, the market value of the Group’s interest at the reporting date excluding any special terms or circumstances relating to the use or financing of the property and transaction costs that would be incurred in making a sale. Observed market data such as rental yield, replacement cost and useful life, reflect relatively few transactions involving property that, necessarily, is not identical to property owned by the Group.
 
Valuations are carried out by qualified surveyors who are members of the Royal Institution of Chartered Surveyors, or an equivalent overseas body. The valuation as at 31 December 2007 valuation2009 for a significant majority of the Group’s investment properties was undertaken by with the support of external valuers.

Investment property acquired during 2009 includes £1,336 million arising on assumption by the Group of control of the properties for which it provided finance to a customer.
 
The fair value of investment properties does not include anyincludes £105 million (2008 – £5 million loss) of appreciation since purchase.
Rental income from investment properties was nil (2008 – £10 million (2006 – £5 million).
 
Property, plant and equipment, excluding investment properties, include £91 million (2006nil (2008 – £43£339 million) assets in the course of construction.
 
Freehold and long leasehold properties with a net book value of £202 £3 million (2006(2008 – £62 million; 2005 – £44 million)nil) were sold subject to operating leases.
        Bank       
     Long  Short  Computers    
  Freehold  leasehold  leasehold  and other    
  premises  premises  premises  equipment  Total 
2009  £m  £m  £m  £m  £m 
Cost or valuation: 
               
At 1 January 2009 
  762   90   523   7   1,382 
Currency translation and other adjustments 
  —   —   (18)   —   (18) 
Reclassifications 
  22   1   (23)   —   — 
Additions 
  30   7   12   —   49 
Disposals and write-off of fully depreciated assets 
  (15)   (10)   (3)   —   (28) 
At 31 December 2009 
  799   88   491   7   1,385 
  
Accumulated depreciation and amortisation: 
                    
At 1 January 2009 
  254   45   194   6   499 
Disposals and write-off of fully depreciated assets 
  (7)   (1)   (9)   —   (17) 
Charge for the year 
  27   2   37   —   66 
At 31 December 2009 
  274   46   222   6   548 
  
Net book value at 31 December 2009 
  525   42   269   1   837 
  
2008                     
Cost or valuation: 
                    
At 1 January 2008 
  729   90   518   7   1,344 
Additions 
  36   1   7   —   44 
Disposals and write-off of fully depreciated assets 
  (3)   (1)   (2)   —   (6) 
At 31 December 2008 
  762   90   523   7   1,382 
  
Accumulated depreciation and amortisation: 
                    
At 1 January 2008 
  229   42   160   5   436 
Disposals and write-off of fully depreciated assets 
  —   —   (1)   —   (1) 
Charge for the year 
  25   3   35   1   64 
At 31 December 2008 
  254   45   194   6   499 
  
Net book value at 31 December 2008 
  508   45   329   1   883 
126
Notes on the accounts
18 Prepayments, accrued income and other assets
  Group Bank
  2009  2008  2009  2008 
  £m  £m  £m  £m 
Prepayments 
  41   42   12   4 
Accrued income 
  261   294   190   212 
Deferred expenses 
  93   18   —   — 
Pension schemes in net surplus 
  10   —   —   — 
Other assets 
  1,471   1,664   802   458 
   1,876   2,018   1,004   674 
  
  
19 Settlement balances and short positions 
                
          Group 
          2009  2008 
           £m   £m 
Settlement balances (amortised cost) 
          3,027   1,850 
Short positions (held-for-trading): 
                
Debt securities  – Government 
          10,141   9,869 
– Other issuers 
          3,776   1,372 
           16,944   13,091 
  
                 
20 Accruals, deferred income and other liabilities                
  Group  Bank 
  2009  2008  2009  2008 
   £m   £m   £m   £m 
Notes in circulation 
  717   532   —   — 
Current taxation 
  82   647   45   633 
Accruals 
  1,463   943   402   177 
Deferred income 
  290   188   209   118 
Other liabilities 
  1,275   1,722   254   479 
   3,827   4,032   910   1,407 
  
  
Included in other liabilities are provisions for liabilities and charges as follows:                
          Group  Bank 
           £m   £m 
At 1 January 2009 
          99   94 
Currency translation and other movements 
          (19)   (21) 
Charge to income statement 
          90   20 
Releases to income statement 
          (15)   (13) 
Provisions utilised 
          (29)   (15) 
At 31 December 2009 
          126   65 
 
  Bank
     Long  Short  Computers    
  Freehold  leasehold  leasehold  and other    
  premises  premises  premises  equipment  Total 
2007  £m   £m   £m   £m   £m 
Cost or valuation:                    
At 1 January 2007  835   98   498   7   1,438 
Additions  59   6   39   —   104 
Disposals and write-off of fully depreciated assets  (165)  (14)  (19)  —   (198)
At 31 December 2007  729   90   518   7   1,344 
                     
Accumulated depreciation and amortisation:                    
At 1 January 2007  239   47   140   3   429 
Disposals and write-off of fully depreciated assets  (37)  (8)  (10)  —   (55)
Charge for year  27   3   30   2   62 
At 31 December 2007  229   42   160   5   436 
                     
Net book value at 31 December 2007  500   48   358   2   908 
                     
2006                    
Cost or valuation:                    
At 1 January 2006  930   105   383   7   1,425 
Additions  19   3   121   —   143 
Disposals and write-off of fully depreciated assets  (114)  (10)  (2)  —   (126)
Transfer to fellow subsidiary  —   —   (4)  —   (4)
At 31 December 2006  835   98   498   7   1,438 
                     
Accumulated depreciation and amortisation:                    
At 1 January 2006  217   45   116   3   381 
Disposals and write-off of fully depreciated assets  (4)  —   (1)  —   (5)
Transfer to fellow subsidiary  —   —   (2)  —   (2)
Charge for year  26   2   27   —   55 
At 31 December 2006  239   47   140   3   429 
                     
Net book value at 31 December 2006  596   51   358   4   1,009 
Notes on the accounts continued
18 Prepayments, accrued income and other assets
  Group Bank
  2007  2006  2007  2006 
   £m   £m   £m   £m 
Prepayments  39   147   1   52 
Accrued income  247   192   154   124 
Deferred tax asset (see Note 21)  521   418   321   311 
Other assets  1,607   1,456   403   218 
   2,414   2,213   879   705 
Amounts above include:                
Due from holding company  —   —   —   11 
Due from fellow subsidiaries  —   75   —   — 
Due from subsidiaries  —   —   —   6 
19 Settlement balances and short positions
Note:
          Group 
          2007  2006 
           £m   £m 
Settlement balances (amortised cost)          2,518   2,978 
Short positions (held-for-trading):                
Debt securities  – Government
          10,046   18,981 
– Other issuers
          2,120   2,022 
Treasury and other eligible bills          271   239 
Equity shares          —   54 
           14,955   24,274 
20 Accruals, deferred income and other liabilities
(1)
  Group  Bank 
  2007  2006  2007  2006 
   £m   £m   £m   £m 
Notes in circulation  465   405   —   — 
Current taxation  534   136   419   10 
Accruals  824   943   126   286 
Deferred income  174   145   99   108 
Deferred tax liability (see Note 21)  36   11   —   — 
Other liabilities  1,384   2,468   447   827 
   3,417   4,108   1,091   1,231 
Amounts above include:                
Due to holding company  —   27   —   10 
Due to fellow subsidiaries  —   —   —   17 
Included in other liabilities are provisions for liabilities and charges as follows:
GroupBank
TotalTotal
£m£m
At 1 January 2007          135   119 
Currency translation and other movements          (1)  — 
Charge to income statement          96   94 
Releases to income statement          (29)  (29)
Provisions utilised          (135)  (123)
At 31 December 2007          66   61 
Note:
(1) Comprises property provisions and other provisions arising in the normal course of business.

21 Deferred taxation
Provision for deferred taxation has been made as follows:
  Group  Bank 
  2007  2006  2007  2006 
   £m   £m   £m   £m 
Deferred tax liability (included in Accruals, deferred income and other liabilities, Note 20)  36   11   —   — 
Deferred tax asset (included in Prepayments, accrued income and other assets, Note 18)  (521)  (418)  (321)  (311)
Net deferred tax  (485)  (407)  (321)  (311)
  Group 
                 Fair             
     Accelerated           value of             
     capital     Deferred  IAS  financial             
  Pension  allowances  Provisions  gains  transition  instruments  Intangibles  Hedging  Other  Total 
   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
At 1 January 2006  (340)  202   (220)  92   (134)  7   31   30   (28)  (360)
Charge to income statement  (25)  32   65   6   (96)  (4)  (3)  16   (7)  (16)
Charge to equity directly  —   —   —   —   (2)  (1)  —   (7)  —   (10)
Acquisitions/(disposals) of subsidiaries  —   (19)  —   —   (2)  —   —   —   —   (21)
Other  (18)  (11)  12   —   (4)  (1)  —   —   22   — 
At 1 January 2007  (383)  204   (143)  98   (238)  1   28   39   (13)  (407)
Charge to income statement  13   (42)  (73)  (34)  58   2   (8)  (7)  17   (74)
Charge to equity directly  17   —   —   (10)  —   9   —   (3)  —   13 
Other  (1)  —   5   —   1   —   —   —   (22)  (17)
At 31 December 2007  (354)  162   (211)  54   (179)  12   20   29   (18)  (485)
  Bank 
  Pension  Accelerated capital allowances  Provisions  Deferred gains  IAS transition  Intangibles  Hedging  Total 
   £m   £m   £m   £m   £m   £m   £m   £m 
At 1 January 2006  (302)  120   (119)  76   (134)  31   10   (318)
Charge to income statement  (28)  39   95   6   (99)  (23)  17   7 
Charge to equity directly  —   —   —   —   —   —   (3)  (3)
Other  1   2   —   —   (1)  —   1   3 
At 1 January 2007  (329)  161   (24)  82   (234)  8   25   (311)
Charge to income statement  14   (28)  17   (34)  48   (8)  (4)  5 
Charge to equity directly  —   —   —   (10)  —   —   (5)  (15)
At 31 December 2007  (315)  133   (7)  38   (186)  —   16   (321)
Notes:
(1)  
Deferred tax assets of £22 million (2006 – £31 million) have not been recognised in respect of tax losses carried forward of £65 million (2006 – £88 million) as it is not considered probable that taxable profits will arise against which they could be utilised. Of these losses, £45 million will expire within one year. The balance of tax losses carried forward has no time limit.
 
(2)  
127
Notes on the accounts continued
Deferred tax liabilities of £594 million (2006 – £484 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further taxation.
21 Deferred taxation
Provision for deferred taxation has been made as follows:
  Group  Bank 
  2009  2008  2009  2008 
  £m  £m  £m  £m 
Deferred tax liability 
  285   46   217   — 
Deferred tax asset 
  (568)   (496)   —   (400) 
Net deferred tax 
  (283)   (450)   217   (400) 
                 Group                
  Pension  
Accelerated
capital
allowances
  Provisions  
Deferred
gains
  
IAS
transition		  
Fair
value of
financial
instruments
  
Available-
for-sale
financial
assets		  Intangibles  
Cash flow
hedging		  
Tax losses
carried
forward
  Other  Total 
  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m  £m 
At 1 January 2008 
  (354)   162   (211)   54   (179)   12   —   20   29   —   (18)   (485) 
Charge/(credit) to income statement 
  45   (137)   14   13   10   (5)   1   (8)   110   —   43   86 
Charge/(credit) to equity directly 
  4   —   —   (3)   —   3   —   —   (10)   —   —   (6) 
Disposals of subsidiaries 
  —   —   —   —   —   —   —   —   —   —   (6)   (6) 
Other 
  (6)   (1)   (71)   2   3   —   3   (1)   30   —   2   (39) 
At 1 January 2009 
  (311)   24   (268)   66   (166)   10   4   11   159   —   21   (450) 
Charge/(credit) to income statement 
  654   (16)   (159)   5   (2)   (154)   27   (8)   5   (175)   (6)   171 
(Credit)/charge to equity directly 
  —   —   —   (33)   —   —   (194)   —   181   —   —   (46) 
Other 
  2   —   33   —   1   5   5   1   (20)   —   15   42 
At 31 December 2009 
  345   8   (394)  ��38   (167)   (139)   (158)   4   325   (175)   30   (283) 
        Bank       
  Pension  
Accelerated 
capital 
allowances
  
Accelerated 
Provisions
  
Deferred 
gains
  
IAS 
transition
  
Cash flow 
hedging
  Total 
  £m  £m  £m  £m  £m  £m  £m 
At 1 January 2008 
  (315)   133   (7)   38   (186)   16   (321) 
Charge/(credit) to income statement 
  40   (108)  2   14   30   3   (19) 
Credit to equity directly 
  —   —   —   (4)   —   (43)   (47) 
Other 
  —   —   —   —   —   (13)   (13) 
At 1 January 2009 
  (275)   25   (5)   48   (156)   (37)   (400) 
Charge/(credit) to income statement 
  619   (16)  (11)   (34)   4   4   566 
Charge to equity directly 
  —   —   —   2   —   44   46 
Other 
  —   —   —   —   —   5   5 
At 31 December 2009 
  344   9   (16)   16   (152)   16   217 
Notes:
(1)Deferred tax assets of £26 million (2008 – £17 million) have not been recognised in respect of tax losses carried forward of £100 million (2008 – £67 million) as it is not considered probable that taxable profits will arise against which they could be utilised. Of these losses, £24 million will expire after five years. The balance of tax losses carried forward has no time limit.
(2)Deferred tax liabilities of £262 million (2008 – £621 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further taxation. No taxation is expected to arise in the foreseeable future in respect of held-over gains. The temporary differences at the balance sheet date are significantly reduced from the previous year as a result of a change to UK tax legislation which largely exempts from UK tax, overseas dividends received on or after 1 July 2009.
No taxation is expected to arise in the foreseeable future in respect of held-over gains.
128
Notes on the accounts
22 Subordinated liabilities
  Group  Bank 
  2009  2008  2009  2008 
  £m  £m  £m  
£m
 
Dated loan capital 
  6,403   6,560   4,695   4,518 
Undated loan capital 
  2,271   3,194   2,085   2,997 
Preference shares 
  325   345   325   345 
   8,999   10,099   7,105   7,860 
In April 2009, the Group concluded a series of exchange offers and tenderoffers with the holders of a number of Upper Tier 2 securities. Theexchanges involving instruments classified as liabilities all met the criteriain IFRS for treatment as the extinguishment of the original liability and therecognition of a new financial liability. Gains on these exchanges, and onthe redemption of securities classified as liabilities for cash, totalling £381million were credited to income.
The RBS Group has undertaken that, unless otherwise agreed with theEuropean Commission, neither the ultimate holding company nor any of itsdirect or indirect subsidiaries (excluding companies in the ABN AMROGroup) will pay external investors any dividends or coupons on existinghybrid capital instruments (including preference shares, B shares andupper and lower tier 2 instruments) from a date starting not later than 30April 2010 and for a period of two years thereafter (“the deferral period”),or exercise any call rights in relation to these capital instruments between24 November 2009 and the end of the deferral period, unless there is alegal obligation to do so. Hybrid capital instruments issued after 24November 2009 will generally not be subject to the restriction on dividendor coupon payments or call options.
The Group’s preference shares are classified as liabilities; these securitiesremain subject to the capital maintenance rules of the Companies Act2006.
The following tables analyse the remaining maturity of subordinatedliabilities by (1) the final redemption date; and (2) the next call date.
              Group          
     2010  2011   2012-2014   2015-2019  Thereafter  Perpetual  Total 
2009 – final redemption 
    
£m
  £m   £m   £m  £m  £m  £m 
Sterling 
     40   —   —   3,497   353   1,211   5,101 
US Dollars 
     316   —   —   247   —   756   1,319 
Euro 
     581   443   —   437   516   602   2,579 
      937   443   —   4,181   869   2,569   8,999 
  
             Group             
  Currently  2010  2011   2012–2014   2015–2019  Thereafter  Perpetual  Total 
2009 – call date 
 £m   £m   £m   £m   £m   £m   £m   £m 
Sterling 
  174   128   —   766   3,331   534   168   5,101 
US Dollars 
  1,008   311   —   —   —   —   —   1,319 
Euro 
  649   458   443   —   355   516   158   2,579 
   1,831   897   443   766   3,686   1,050   326   8,999 
  
                  Group             
      2009  2010   2011-2013   2014-2018  Thereafter  Perpetual  Total 
2008 – final redemption 
      £m   £m   £m   £m   £m   £m   £m 
Sterling 
      94   —   —   2,403   456   1,597   4,550 
US Dollars 
      896   342   —   —   274   1,225   2,737 
Euro 
      60   586   476   382   643   651   2,798 
Other 
      —   —   —   —   14   —   14 
       1,050   928   476   2,785   1,387   3,473   10,099 
  
              Group             
  Currently  2009  2010   2011–2013   2014–2018  Thereafter  Perpetual  Total 
2008 – call date 
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling 
  —   94   430   766   2,337   755   168   4,550 
US Dollars 
  1,513   882   342   —   —   —   —   2,737 
Euro 
  —   633   586   476   382   555   166   2,798 
Other 
  —   —   —   —   —   14   —   14 
   1,513   1,609   1,358   1,242   2,719   1,324   334   10,099 
129
Notes on the accounts continued
22 Subordinated liabilities continued
              Bank          
     2010  2011   2012-2014   2015-2019  Thereafter  Perpetual  Total 
2009 – final redemption 
    £m  £m   £m   £m  £m  £m  £m 
Sterling 
     40   —   —   3,331   323   1,183   4,877 
US Dollars 
     5   —   —   —   —   756   761 
Euro 
     580   443   —   —   —   444   1,467 
      625   443   —   3,331   323   2,383   7,105 
  
  
             Bank             
  Currently  2010  2011   2012–2014   2015–2019  Thereafter  Perpetual  Total 
2009 – call date 
 £m   £m   £m   £m   £m   £m   £m   £m 
Sterling 
  174   28   —   700   3,331   504   140   4,877 
US Dollars 
  761   —   —   —   —   —   —   761 
Euro 
  564   460   443   —   —   —   —   1,467 
   1,499   488   443   700   3,331   504   140   7,105 
  
  
  
                  Bank             
      2009  2010   2011-2013   2014-2018  Thereafter  Perpetual  Total 
2008 – final redemption 
      £m   £m   £m   £m   £m   £m   £m 
Sterling 
      94   —   —   2,337   326   1,569   4,326 
US Dollars 
      710   —   —   —   —   1,225   1,935 
Euro 
      52   586   476   —   —   485   1,599 
       856   586   476   2,337   326   3,279   7,860 
  
  
              Bank             
  Currently  2009  2010   2011–2013   2014–2018  Thereafter  Perpetual  Total 
2008 – call date 
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling 
  —   94   330   700   2,337   725   140   4,326 
US Dollars 
  1,238   697   —   —   —   —   —   1,935 
Euro 
  —   537   586   476   —   —   —   1,599 
   1,238   1,328   916   1,176   2,337   725   140   7,860 
130
Notes on the accounts
Dated loan capital  
2009
£m
  
2008
£m
 
The Bank       
US$1,000 million 7.375% subordinated notes 2009 (redeemed October 2009)   —   697 
€600 million 6.0% subordinated notes 2010   564   619 
€500 million 5.125% subordinated notes 2011   455   488 
£300 million 7.875% subordinated notes 2015   338   344 
£300 million 6.5% subordinated notes 2021   329   332 
£2,000 million subordinated loan capital floating rate notes 2018 (4)
   2,009   2,038 
£1,000 million subordinated loan capital floating rate notes 2019 (issued November 2009) (4)
   1,000   — 
    4,695   4,518 
RBS Holdings USA Inc.         
US$100 million 5.575% senior subordinated revolving credit 2009 (redeemed October 2009)   —   69 
US$170 million subordinated loan capital floating rate notes 2009 (redeemed October 2009)   —   116 
US$500 million subordinated loan capital floating rate notes 2010 (callable on any interest payment date)   311   342 
          
First Active plc         
£60 million 6.375% subordinated bonds 2018 (callable April 2013)   66   66 
          
Ulster Bank Limited         
€120 million floating rate notes 2020 (4)
   107   115 
£100 million floating rate subordinated loan capital 2019 (callable September 2010) (4)
   100   100 
€60 million floating rate notes 2020 (4)
   53   57 
€100 million floating rate notes 2022 (4)
   89   97 
€280 million floating rate notes 2022 (4)
   247   271 
€400 million floating rate notes 2017 (4)
   355   382 
          
RBS Coutts Bank Limited         
CHF22 million floating rate note 2022 (redeemed February 2009)   —   14 
          
Coutts & Company         
£30 million 7.278% subordinated notes 2023 (4)
   30   30 
€20 million 6.274% subordinated notes 2023 (4)
   18   19 
          
RBS Netherlands Holdings B.V.         
£92 million floating rate note 2019 (callable April 2010) (4)
   85   89 
          
NatWest Group Holdings Corporation         
US$400 million floating rate note 2018 (callable on any interest payment date) (4)
   247   275 
    6,403   6,560 
Notes:
(1)
In the event of certain changes in the tax laws of the UK, all of the dated loan capital issues are redeemable in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior approval of the UK Financial Services Authority.
94
Table
(2)Except as stated above, claims in respect of Contents
Notes on the accounts continued
22 Subordinated liabilitiesGroup’s dated loan capital are subordinated to the claims of other creditors. None of the Group’s undated loan capital is secured.
  Group  Bank 
  2007  2006  2007  2006 
   £m   £m   £m   £m 
Dated loan capital  3,586   2,916   2,050   2,000 
Undated loan capital  2,056   2,303   1,904   2,161 
Preference shares  290   422   290   422 
   5,932   5,641 �� 4,244   4,583 
The Group’s preference shares are classified as liabilities; these securities remain subject to the capital maintenance rules of the Companies Act 1985.
The following tables analyse the remaining maturity of subordinated liabilities by (1) the final redemption date; and (2) the next callable date.
     Group 
     2008  2009   2010-2012   2013-2017  Thereafter  Perpetual  Total 
2007 – final redemption
     £m   £m   £m   £m   £m   £m   £m 
Sterling     43   —   —   343   491   985   1,862 
US$     108   548   249   —   200   895   2,000 
Euro     44   —   826   294   480   416   2,060 
Other     —   —   —   —   10   —   10 
Total     195   548   1,075   637   1,181   2,296   5,932 
                                
                                
  Group 
  Currently  2008  2009   2010– 2012   2013– 2017  Thereafter  Perpetual  Total 
2007 – call date
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling  —   43   —   433   408   725   253   1,862 
US$  1,109   94   548   249   —   —   —   2,000 
Euro  —   44   445   826   294   412   39   2,060 
Other  —   —   —   —   —   10   —   10 
Total  1,109   181   993   1,508   702   1,147   292   5,932 
                                 
                                 
      Group 
      2007  2008   2009-2011   2012-2016  Thereafter  Perpetual  Total 
2006 – final redemption
      £m   £m   £m   £m   £m   £m   £m 
Sterling      43   —   —   348   493   900   1,784 
US$      33   87   761   22   203   1,299   2,405 
Euro      37   —   763   —   183   469   1,452 
Total      113   87   1,524   370   879   2,668   5,641 
                                 
                                 
  Group 
  Currently  2007  2008   2009– 2011   2012– 2016  Thereafter  Perpetual  Total 
2006 – call date
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling  —   43   —   437   413   726   165   1,784 
US$  1,260   551   87   507   —   —   —   2,405 
Euro  —   37   —   1,177   —   121   117   1,452 
Total  1,260   631   87   2,121   413   847   282   5,641 
     Bank 
     2008  2009   2010-2012   2013-2017  Thereafter  Perpetual  Total 
2007 – final redemption
     £m   £m   £m   £m   £m   £m   £m 
Sterling     43   —   —   343   326   872   1,584 
US$     23   498   —   —   —   895   1,416 
Euro     40   —   826   —   —   378   1,244 
Total     106   498   826   343   326   2,145   4,244 
                                
                                
  Bank
  Currently  2008  2009   2010– 2012   2013– 2017  Thereafter  Perpetual  Total 
2007 – call date
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling  —   43   —   333   343   725   140   1,584 
US$  909   9   498   —   —   —   —   1,416 
Euro  —   40   378   826   —   —   —   1,244 
Total  909   92   876   1,159   343   725   140   4,244 
                                 
                                 
      Bank
      2007  2008   2009-2011   2012-2016  Thereafter  Perpetual  Total 
2006 – final redemption
      £m   £m   £m   £m   £m   £m   £m 
Sterling      43   —   —   348   328   875   1,594 
US$      31   —   507   —   —   1,299   1,837 
Euro      37   —   763   —   —   352   1,152 
Total      111   —   1,270   348   328   2,526   4,583 
                                 
                                 
  Bank
  Currently  2007  2008   2009– 2011   2012– 2016  Thereafter  Perpetual  Total 
2006 – call date
  £m   £m   £m   £m   £m   £m   £m   £m 
Sterling  —   43   —   337   348   726   140   1,594 
US$  1,057   273   —   507   —   —   —   1,837 
Euro  —   37   —   1,115   —   —   —   1,152 
Total  1,057   353   —   1,959   348   726   140   4,583 
Notes on the accounts continued

22 Subordinated liabilities (continued)
  2007  2006 
Dated loan capital  £m   £m 
The Bank        
US$1,000 million 7.375% fixed rate subordinated notes 2009  507   516 
€600 million 6.0% subordinated notes 2010
  485   452 
€500 million 5.125% subordinated notes 2011
  376   343 
£300 million 7.875% subordinated notes 2015
  350   355 
£300 million 6.5% subordinated notes 2021
  332   334 
   2,050   2,000 
Greenwich Capital Holdings, Inc.        
US$100 million 5.575% senior subordinated revolving credit 2009 (issued June 2007)  50   — 
US$170 million subordinated loan capital floating rate notes 2008  85   87 
US$500 million subordinated loan capital floating rate notes 2010 (callable on any interest payment date)
  249   256 
         
First Active plc        
US$35 million 7.24% subordinated notes 2012 (redeemed December 2007)  —   22 
£60 million 6.375% subordinated notes 2018 (callable April 2013)
  65   65 
         
Ulster Bank Limited        
€120 million floating rate notes 2019
  88   81 
£100 million floating rate subordinated loan capital 2020 (callable September 2010)
  100   100 
€60 million floating rate notes 2020
  44   40 
€100 million floating rate notes 2019 (issued April 2007)
  74   — 
€280 million floating rate notes 2022 (issued July 2007)
  208   — 
€400 million floating rate notes 2017 (issued December 2007)
  295   — 
         
Coutts Bank Von Ernst        
CHF22 million floating rate note 2022 (callable January 2009)  10   — 
         
RBS Netherlands Holdings B.V.        
€22 million floating rate note 2019 (callable January 2009)
  68   62 
         
NatWest Group Holdings Corporation        
US$400 million floating rate note 2018 (callable on any interest payment date)
  200   203 
   3,586   2,916 
Notes:        
(1)  
In the event of certain changes in the tax laws of the UK, all of the dated loan capital issues are redeemable in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior approval of the UK Financial Services Authority.
(2)  
Except as stated above, claims in respect of the Group’s dated loan capital are subordinated to the claims of other creditors. None of the Group’s undated loan capital is secured.
(3)
Interest on all floating rate subordinated notes is calculated by reference to market rates.
(4)On-lent to The Royal Bank of Scotland plc on a subordinated basis.
  2007  2006 
Undated loan capital  £m   £m 
The Bank        
US$500 million primary capital floating rate notes, Series A (callable on any interest payment date)  251   256 
US$500 million primary capital floating rate notes, Series B (callable on any interest payment date)  256   267 
US$500 million primary capital floating rate notes, Series C (callable on any interest payment date)
  255   254 
US$500 million 7.75% reset subordinated notes (redeemed October 2007)  —   264 
€400 million 6.625% fixed/floating rate undated subordinated notes (callable October 2009)
  309   289 
€100 million floating rate undated subordinated step-up notes (callable October 2009)
  74   68 
£325 million 7.625% undated subordinated step-up notes (callable January 2010)
  356   361 
£200 million 7.125% undated subordinated step-up notes (callable October 2022)
  201   201 
£200 million 11.5% undated subordinated notes (callable December 2022) (1)
  202   201 
   1,904   2,161 
First Active plc        
£20 million 11.75% perpetual tier two capital
  23   23 
€30 million 11.375% perpetual tier two capital
  39   36 
£1.3 million floating rate perpetual tier two capital
  2   2 
         
Ulster Bank Limited        
€120 million perpetual floating rate subordinated notes
  88   81 
   2,056   2,303 
Notes:        
 
(1)  
Exchangeable at the option of the issuer into 200 million 8.392% (gross) non-cumulative preference shares of £1 each of National Westminster Bank Plc at any time.
(2)  
Except as stated above, claims in respect of the Group’s undated loan capital are subordinated to the claims of other creditors. None of the Group’s undated loan capital is secured.
131
(3)  
In the event of certain changes in the tax laws of the UK, all of the undated loan capital issues are redeemable in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior approval of the UK Financial Services Authority.
(4)  
Interest on all floating rate subordinated notes is calculated by reference to market rates.
Notes on the accounts continued
22 Subordinated liabilities continued
Undated loan capital 
2009
£m
  
2008
£m
 
The Bank      
US$293 million (2008 – US$500 million) primary capital floating rate notes, Series A (callable on any interest payment date) (1)
  205   343 
US$312 million (2008 – US$500 million) primary capital floating rate notes, Series B (callable on any interest payment date) (1)
  182   347 
US$332 million (2008 – US$500 million) primary capital floating rate notes, Series C (callable on any interest payment date) (1)
  192   346 
€400 million 6.625% fixed/floating rate undated subordinated notes (callable April 2010)  358   395 
€100 million floating rate undated step-up notes (callable April 2010)  90   97 
£162 million (2008 – £325 million) 7.625% undated subordinated step-up notes (callable January 2010) (1)
  174   353 
£127 million (2008 – £200 million) 7.125% undated subordinated step-up notes (callable October 2022) (1)
  127   201 
£68 million (2008 – £200 million) 11.5% undated subordinated notes (callable December 2022) (1,2)
  56   202 
£700 million subordinated loan capital floating rate notes (6)
  701   713 
         
   2,085   2,997 
First Active plc        
£20 million 11.75% perpetual tier two capital  26   26 
€38 million 11.375% perpetual tier two capital  51   52 
£1.3 million floating rate perpetual tier two capital  2   2 
         
Ulster Bank Limited        
€120 million perpetual floating rate subordinated notes (6)
  107   117 
         
   2,271   3,194 

Notes:
(1)  Partially redeemed following the completion of the exchange and tender offers in April 2009.
  2007  2006 
Preference shares (1)
  £m   £m 
Non-cumulative preference shares of £1
        
Series A £140 million 9% (non-redeemable)
  142   142 
         
Non-cumulative preference shares of US$25        
Series B US$250 million 7.8752% (redeemed January 2007)
  —   129 
Series C US$300 million 7.7628% (2)
  148   151 
   290   422 
Notes:        
(1)  
Further details of the contractual terms of the preference shares is given in Note 24 below.
(2)  
Series C preference shares carry a gross dividend of 8.625% inclusive of associated tax credit. They are redeemable at the option of the Bank, at US$25 per share.
23 Minority interests
  Group
  2007  2006 
   £m   £m 
At 1 January  1,012   744 
Currency translation adjustments and other movements  (1)  (8)
Profit attributable to minority interests  89   39 
Dividends paid  (72)  (34)
Equity raised  288   271 
Equity withdrawn  (2)  — 
At 31 December  1,314   1,012 
24 Share capital
  Group and Bank
  Allotted, called up and fully paid  Authorised 
  2007  2006  2007  2006 
   £m   £m   m   m 
Ordinary shares of £1
  1,678   1,678   £2,250   £2,250 
Non-cumulative preference shares of £1
  140   140   £1,000   £1,000 
Non-cumulative preference shares of US$25  150   320   $2,000   $2,000 
                 
                 
  Allotted, called up and fully paid  Authorised 
Number of shares – millions
 2007  2006  2007  2006 
Ordinary shares of £1
  1,678   1,678   2,250   2,250 
Non-cumulative preference shares of £1
  140   140   1,000   1,000 
Non-cumulative preference shares of US$25  12   22   80   80 
The 9% non-cumulative preference shares, Series A, of £1 each are non-redeemable.
In January 2007, the Bank redeemed all of the non-cumulative preference shares, Series B of US$25 each at US$25 per share.
The non-cumulative preference shares, Series C, of US$25 each carry the right to a gross dividend of 8.625% inclusive of associated tax credit. They are redeemable
(2)  Exchangeable at the option of the Bank at US$25 per share.

The holders of sterling and dollarissuer into 8.392% (gross) non-cumulative preference shares are entitled, on the winding-up of the£1 each of National Westminster Bank to priority over the ordinary shareholders as regards payment of capital. Otherwise the holders of preference shares are not entitled to any further participation in the profits or assets of the Bank and accordingly these shares are classified as non-equity shares.
The holders of sterling and dollar preference shares are not entitled to receive notice of, attend, or votePlc at any general meeting unless the business of the meeting includes the consideration of a resolution for the winding-up of the Bank or the sale of the whole of the business of the Bank or any resolution directly affecting any of the special rights or privileges attached to any of the classes of preference shares.time.
Under IFRS, the Group’s preference shares are classified
(3)  Except as debt and are includedstated above, claims in subordinated liabilities on the balance sheet (see Note 22).
Notes on the accounts continued
25 Shareholders’ equity
  Group Bank
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
Called-up share capital
                        
At 1 January  1,678   1,678   2,102   1,678   1,678   2,102 
Implementation of IAS 32 on 1 January 2005  —   —   (424)  —   —   (424)
At 31 December  1,678   1,678   1,678   1,678   1,678   1,678 
                         
Share premium account                        
At 1 January  1,291   1,291   1,286   1,291   1,291   1,286 
Reclassification of preference shares on                        
implementation of IAS 32 on 1 January 2005  —   —   5   —   —   5 
At 31 December  1,291   1,291   1,291   1,291   1,291   1,291 
                         
Available-for-sale reserve                        
At 1 January  18   —       31   —     
Implementation of IAS 32 and IAS 39 on 1 January 2005  —   —   200   —   —   201 
Unrealised gains in the year  87   81   38   40   44   33 
Realised gains in the year  (85)  (55)  (324)  (72)  —   (320)
Taxation  3   (8)  86   10   (13)  86 
At 31 December  23   18   —   9   31   — 
                         
Cash flow hedging reserve                        
At 1 January  72   148   —   42   94   — 
Implementation of IAS 32 and IAS 39 on 1 January 2005  —   —   156   —   —   122 
Amount recognised in equity during the year  —   (2)  —   (9)  13   (39)
Amount transferred from equity to earnings in the year (1)  (20)  (39)  (28)  (13)  (28)  (13)
Taxation  4   (35)  20   5   (37)  24 
At 31 December  56   72   148   25   42   94 
                         
Foreign exchange reserve                        
At 1 January  (314)  169   (19)  1   (5)  — 
Implementation of IAS 32 and IAS 39 on 1 January 2005  —   —   6   —   —   — 
Retranslation of net assets  248   (483)  182   2   6   (5)
At 31 December  (66)  (314)  169   3   1   (5)
                         
Other reserves                        
At 1 January  486   298   298   486   298   298 
Redemption of preference shares classified as debt  128   —   —   128   —   — 
Capital contribution  —   188   —   —   188   — 
At 31 December  614   486   298   614   486   298 
                         
Retained earnings                        
At 1 January  6,942   5,856   4,342   2,541   2,353   1,416 
Implementation of IAS 32 and IAS 39 on 1 January 2005  —   —   (582)  —   —   (487)
Profit attributable to ordinary shareholders  2,228   2,586   2,446   3,210   1,688   1,774 
Ordinary dividends paid  (1,850)  (1,500)  (350)  (1,850)  (1,500)  (350)
Redemption of preference shares classified as debt  (128)  —   —   (128)  —   — 
At 31 December  7,192   6,942   5,856   3,773   2,541   2,353 
                         
Shareholders’ equity at 31 December
  10,788   10,173   9,440   7,393   6,070   5,709 
Note:
(1) The amounts transferred to earnings were included in net interest income.
UK law prescribes that only reserves of the Bank are taken into account for the purpose of making distributions and the permissible applications of the share premium account and capital redemption reserve of £426 million (2006 – £298 million) included within other reserves.
The Group optimises capital efficiency by maintaining reserves in subsidiaries, including regulated entities. Certain preference shares and subordinated debt are also included within regulatory capital. The remittance of reserves to the parent or the redemption of shares or subordinated capital by regulated entities may be subject to maintaining the capital resources required by the relevant regulator.
26 Leases
Minimum amounts receivable and payable under non-cancellable leases.
  2007  2006 
  Year in which receipt or payment will occur  Year in which receipt or payment will occur 
     After 1 year           After 1 year       
  Within 1  but within  After 5     Within 1  but within  After 5    
  year  5 years  years  Total  year  5 years  years  Total 
Group  £m   £m   £m   £m   £m   £m   £m   £m 
Finance lease assets:                                
Amounts receivable  162   231   206   599   157   238   227   622 
Present value adjustment  (22)  (60)  (66)  (148)  (23)  (75)  (80)  (178)
Present value amounts receivable  140   171   140   451   134   163   147   444 
Operating lease obligations:                                
Future minimum lease payables:                                
Premises  105   358   1,017   1,480   87   293   708   1,088 
Equipment  3   4   —   7   —   —   —   — 
   108   362   1,017   1,487   87   293   708   1,088 
                                 
Bank                                
Operating lease obligations:                                
Future minimum lease payables:                                
Premises  79   283   803   1,165   69   239   525   833 
                       
                  Group  Bank 
                  2007  2006  2007  2006 
Amounts recognised as income and expense   £m   £m   £m   £m 
Operating lease payables – minimum payments
   100   106   77   76 
                  
Finance lease receivables                 
Unearned finance income   148   178   —   — 
The Group provides asset finance to its customers through acting as a lessor. It purchases plant, equipment and intellectual property; renting them to customers under lease arrangements that, depending on their terms, qualify as either operating or finance leases.


Notes on the accounts continued

27 Collateral
Securities repurchase agreements and lending transactions
The Group enters into securities repurchase agreements and securities lending transactions under which it receives or transfers collateral in accordance with normal market practice. Generally, the agreements require additional collateral to be provided if the value of the securities fall below a predetermined level. Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction.
The fair value (and carrying value) of securities transferred under repurchase transactions included within securities on the balance sheet were as follows:
  Group
  2007  2006 
   £m   £m 
Treasury and other eligible bills  1,974   225 
Debt securities  31,970   29,346 
   33,944   29,571 
All of the above securities could be sold or repledged by the holder. Securities received as collateral under reverse repurchase agreements amounted to £36.7 billion (2006 – £42.1 billion), of which £34.1 billion (2006 – £36.8 billion) has been resold or repledged as collateral for the Group’s own transactions.
Other collateral given Group Bank
  2007  2006  2007  2006 
Group assets charged as security for liabilities  £m   £m   £m   £m 
Loans and advances to customers  9,301   7,318   1,259   1,384 
             
  2007  2006  2007  2006 
Liabilities secured by charges on Group assets  £m   £m   £m   £m 
Customer accounts  1,173   1,286   1,173   1,286 
Debt securities in issue  8,041   5,907   —   — 
   9,214   7,193   1,173   1,286 
The balances above relate to securitisations (see note 28).


28 Securitisations and other asset transfers
The Group engages in securitisation transactions and other transfers of its financial assets including commercial and residential mortgage loans, commercial and residential mortgage related securities, US Government agency collateralised mortgage obligations, and other types of financial assets.
In the normal course of business, the Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (“SPE”) which then issues liabilities to third party investors.
SPEs are vehicles set up for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms – trusts, partnerships and companies – and fulfil many different functions. As well as being a key element of securitisations, SPEs are also used in fund management activities to segregate custodial duties from the fund management advice provided by the Group.
Securitisations may, depending on the individual arrangement, result in continued recognition of the securitised assets; continued recognition of the assets to the extentrespect of the Group’s continuing involvement in those assets; or derecognition of the assets and the separate recognition, as assets or liabilities, of any rights and obligations created or retained in the transfer (see Accounting policy on page 57). The Group has securitisations in each of these categories.
Continued recognition
The table below sets out the asset categories together with the carrying amounts of the assets and associated liabilities.
  Group
  2007 2006
  Assets  Liabilities  Assets  Liabilities 
Asset type  £m   £m   £m   £m 
Residential mortgages  7,693   7,692   5,550   5,547 
Credit card receivables  1,259   1,173   1,384   1,286 
Other loans  349   349   384   360 
Residential mortgages securitisations – the Group has securitised portfolios of residual mortgages. Mortgages have been transferred to SPEs, held ultimately by charitable trusts, funded principally through the issue of floating rate notes. The Group has entered into arm’s length fixed/floating interest rate swaps and cross-currency swaps with the securitisation SPEs and provides mortgage management and agency servicesundated loan capital are subordinated to the SPEs. On repaymentclaims of the financing, any further amounts generated by the mortgages will be paid to the Group. The SPEs are consolidated and the mortgages remain on the Group’s balance sheet.
Credit card securitisations – credit card receivables in the UK have been securitised. Notes have been issued by an SPE. the note holders have a proportionate interest in a pool of credit card receivables that have been equitably assigned by the Group to a receivables trust. The Group continues to be exposed to the risks and rewards of the transferred receivables through its right to excess spread (after charge-offs). The SPE is consolidated and the credit card receivables remain on the Group’s balance sheet.
Other securitisations – other loans originated by the Group have been transferred to SPEs funded through the issue of notes. Any proceeds from the loans in excess of the amounts required to service and repay the notes are payable to the Group after deduction of expenses. The SPEs are consolidated and the loans remain on the Group’s balance sheet.
Continuing involvement
In certain securitisations of US residential mortgages, substantially all the risks and rewards have been neither transferred nor retained, but the Group has retained control, as defined by IFRS, of the assets and continues to recognise the assets to the extent of its continuing involvement which takes the form of retaining certain subordinated bonds issued by the securitisation vehicles. These bonds have differing rights and, depending on their terms, they may expose the Group to interest rate risk where they carry a fixed coupon or to credit risk depending on the extent of their subordination. Certain bonds entitle the Group to additional interest if the portfolio performs better than expected and others give the Group the right to prepayment penalties received on the securitised mortgages. At 31 December 2007, securitised assets were £17.6 billion (2006 – £37.3 billion); retained interests £888 million (2006 – £930 million); subordination assets £314 million (2006 – £694 million) and related liabilities £314 million (2006 –£694 million).
Derecognition
Other securitisationscreditors. None of the Group’s financial assetsundated loan capital is secured.
(4)In the event of certain changes in the US qualify for derecognition as substantially all the risks and rewardstax laws of the assets have been transferred. The Group continues to recognise any retained interests in the securitisation vehicles.

Notes on the accounts continued

29 Risk management
Risk Management is conducted on an overall basis within the RBS Group. Therefore in the discussion on risk management (pages103 to 109) references to “the Group” or “Group” Board and committees are to the RBS Group.
Governance framework
The Group Board of directors sets the overall risk appetite and philosophy for the Group; the risk and capital framework underpins deliveryUK, all of the Board’s strategy.undated loan capital issues are redeemable in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior approval of the UK Financial Services Authority.
(5)Interest on all floating rate subordinated notes is calculated by reference to market rates.
(6)On-lent to The Board is supported by three committees:
•  
Group Audit Committee (“GAC”) comprising independent non-executive directors focuses on financial reporting and application of accounting policies as part of the internal control and risk assessment framework. GAC monitors the identification, evaluation and management of all significant risks throughout the Group. This work is supported by Group Internal Audit which provides an independent assessment of the design, adequacy and effectiveness of internal controls.
Royal Bank of Scotland plc on a subordinated basis.
 
•  
Advances Committee (“AC”), reporting to the Board deals with transactions that exceed the Group Credit Committee’s delegated authority.
Preference shares (1)
 
2009
£m
  
2008
£m
 
The Bank      
Non-cumulative preference shares of £1      
Series A £140 million 9% (non-redeemable) 143   143 
        
Non-cumulative preference shares of US$25       
Series C US$300 million 7.7628% 182   202 
        
  325   345 
 
•  
Group Executive Management Committee (“GEMC”), an executive committee ensures that implementation of strategy and operations are in line with the agreed risk appetite. GEMC is supported by the following:
Note:
 
–  
Group Risk Committee (“GRC”) recommends and approves limits, processes and policies that ensure the effective management of all material non-balance sheet risks across the Group.
(1)      Further details of the contractual terms of the preference shares are given in Note 24 on page 133.
 
–  
132
Group Credit Committee (“GCC”) approves credit proposals under authority delegated to it by the Board and/or Advances Committee.
 
–  
Group Asset and Liability Management Committee (“GALCO”) is responsible for identifying, managing and controlling the Group balance sheet risks. These risks are managed by setting limits and controls for capital adequacy, funding and liquidity intra-group exposure and non-trading interest rate equity and foreign currency risk.
Notes on the accounts
 
Risk and capital
It is the Group’s policy to optimise return to shareholders while maintaining a strong capital base and credit rating to support business growth and meet regulatory capital requirements at all times.
Risk appetite is measured as the maximum level of retained risk the Group will accept to deliver its business objectives. Risk appetite is generally defined through both quantitative and qualitative techniques including stress testing, risk concentration, value-at-risk and risk underwriting criteria, ensuring that appropriate principles, policies and procedures are in place and applied.
The main financial risks facing the Group are as follows:
 
•  
Credit risk: is the risk arising from the possibility that the Group will incur losses from the failure of customers to meet their obligations.
23 Minority interests        
   Group 
   
2009
£m
   
2008
£m
 
At 1 January  1,323   1,314 
Currency translation adjustments and other movements  (41)  12 
Profit attributable to minority interests  —   93 
Dividends paid  —   (94)
Equity raised  —   70 
Equity withdrawn and disposals  —   (72)
At 31 December  1,282   1,323 
 
•  
Funding and liquidity risk: is the risk that the Group is unable to meet its obligations as they fall due.
 
•  
Market risk: the Group is exposed to market risk because of positions held in its trading portfolios and its non-trading businesses.
•  
Equity risk: reflects the variability in the value of equity investments resulting in gains or losses
Credit risk
Credit risk is managed to achieve sustainable and superior risk-reward performance whilst maintaining exposures within acceptable risk appetite parameters. This is achieved through the combination of governance, policies, systems and controls, underpinned by sound commercial judgement as described below.
•  
Policies and risk appetite: policies provide a clear framework for the assessment, approval, monitoring and management of credit risk where risk appetite sets the tolerance of loss. Limits are used to manage concentration risk by single name, sector and country.
•  
Decision makers: credit authority is granted to independent persons or committees with the appropriate experience, seniority and commercial judgement. Credit authority is not extended to relationship managers. Specialist internal credit risk departments independently oversee the credit process and make credit decisions or recommendations to the appropriate credit committee.
•  
Models: credit models are used to measure and assess risk decisions and to aid on-going monitoring. Measures, such as Probability of Default, Exposure at Default, Loss Given Default (see below) and Expected Loss are calculated using duly authorised models. All credit models are subject to independent review prior to implementation and existing models are reviewed on at least an annual basis.
•  
Mitigation techniques to reduce the potential for loss: credit risk may be mitigated by the taking of financial or physical security, the assignment of receivables or the use of credit derivatives, guarantees, risk participations, credit insurance, set off or netting.
•  
Risk systems and data quality: systems are well organised to produce timely, accurate and complete inputs for risk reporting and to administer key credit processes.
•  
Analysis and reporting: portfolio analysis and reporting are used to ensure the identification of emerging concentration risks and adverse movements in credit risk quality.
103
24 Share capital and reserves                
   
Allotted, called up
and fully paid
   Authorised 
   
2009
£m
   
2008
£m
   
2009
m
   
2008
m
 
Ordinary shares of £1  1,678   1,678   £2,250   £2,250 
Non-cumulative preference shares of £1  140   140   £1,000   £1,000 
Non-cumulative preference shares of US$25  150   150   $2,000   $2,000 
 
 
•  
   
Allotted, called up
and fully paid
   Authorised 
Number of shares – millions  
2009
   
2008
   
2009
   
2008
 
Ordinary shares of £1  1,678   1,678   2,250   2,250 
Non-cumulative preference shares of £1  140   140   1,000   1,000 
Non-cumulative preference shares of US$25  12   12   80   80 
Stress testing: stress testing forms an integral part of portfolio analysis, providing a measure of potential vulnerability to exceptional but plausible economic and geopolitical events which assists management in the identification of risk not otherwise apparent in more benign circumstances. Stress testing informs risk appetite decisions.
 
•  
Ordinary shares and preference shares
During the year the Bank issued 935 new ordinary shares of £1 each to the parent company at £1 million per share.

The 9% non-cumulative preference shares Series A of £1 each are non-redeemable.

The non-cumulative preference shares Series C of US$25 each carry the right to a gross dividend of 8.625% inclusive of associated tax credit. They are redeemable at the option of the Bank at US$25 per share.

The holders of sterling and dollar preference shares are entitled, on the winding-up of the Bank, to priority over the ordinary shareholders as regards payment of capital. Otherwise the holders of preference shares are not entitled to any further participation in the profits or assets of the Bank and accordingly these shares are classified as non-equity shares.

The holders of sterling and dollar preference shares are not entitled to receive notice of, attend, or vote at any general meeting unless the business of the meeting includes the consideration of a resolution for the winding-up of the Bank or the sale of the whole of the business of the Bank or any resolution directly affecting any of the special rights or privileges attached to any of the classes of preference shares.

Under IFRS, the Group’s preference shares are classified as debt and are included in subordinated liabilities on the balance sheet (see Note 22).

Reserves
UK law prescribes that only reserves of the Bank are taken into account for the purpose of making distributions and the permissible applications of the share premium account and capital redemption reserve of £426 million (2008 – £426 million) included within other reserves.

The Group optimises capital efficiency by maintaining reserves in subsidiaries, including regulated entities. Certain preference shares and subordinated debt are also included within regulatory capital. The remittance of reserves to the parent or the redemption of shares or subordinated capital by regulated entities may be subject to maintaining the capital resources required by the relevant regulator.
Portfolio management: active management of portfolio concentrations as measured by risk reporting and stress testing, where credit risk may be mitigated through promoting asset sales, buying credit protection or curtailing risk appetite for new transactions.
 
•
133
Notes on the accounts continued
Credit stewardship: customer transaction monitoring and management is a continuous process, ensuring performance is satisfactory and that documentation, security and valuations are complete and up to date.
 
•  
Problem debt identification: policies and systems encourage the early identification of problems and the employment of specialised staff focused on collections and problem debt management.
25 Leases         
          
Minimum amounts receivable under non-cancellable leases:         
  Group 
  Finance lease contracts 
Year in which receipt will occur 
Gross
amount
£m
  
Unearned
finance
income
£m
  
Present
value
£m
 
2009         
Receivable:         
Within 1 year  167   (13)  154 
After 1 year but within 5 years  58   (16)  42 
After 5 years  109   (43)  66 
Total  334   (72)  262 
 
•  
Provisioning: independent assessment using best practice models for collective and latent loss. Professional evaluation is applied to individual cases, to ensure that such losses are comprehensively identified and adequately provided for.
2008         
Receivable:         
Within 1 year  65   (19)  46 
After 1 year but within 5 years  203   (35)  168 
After 5 years  152   (61)  91 
Total  420   (115)  305 
 
•  
Recovery: maximising the return to the Group through the recovery process.
  Group  Bank 
  
2009
£m
  
2008
£m
  
2009
£m
  
2008
£m
 
Amounts recognised as income and expenses            
Finance leases – contingent rental income  (2)  (1)  (1)  (1)
Operating leases – minimum rentals payable  141   112   88   85 
The Group provides asset finance to its customers through acting as a lessor. It purchases plant, equipment and intellectual property; renting them to customers under lease arrangements that, depending on their terms, qualify as either operating or finance leases.
134
Notes on the accounts
26 Collateral and securitisations
Securities repurchase agreements and lending transactions
The Group enters into securities repurchase agreements and securities lending transactions under which it receives or transfers collateral in accordance with normal market practice. Generally, the agreements require additional collateral to be provided if the value of the securities fall below a predetermined level.

Under standard terms for repurchase transactions in the UK and US markets, the recipient of collateral has an unrestricted right to sell or repledge it, subject to returning equivalent securities on settlement of the transaction.

The fair value (and carrying value) of securities transferred under repurchase transactions included within debt securities on the balance sheet were £30.6 billion (2008 – £33.8 billion). All of these securities could be sold or repledged by the holder. Securities received as collateral under reverse repurchase agreements amounted to £17.2 billion (2008 – £9.1 billion), of which £17.2 billion (2008 – £9.1 billion) had been resold or repledged as collateral for the Group’s own transactions.
Other collateral given
   Group   Bank
 Group assets pledged against Group liabilities  
2009
£m
   
2008
£m
   
2009
£m
   
2008
£m
 
Loans and advances to customers  30,052   8,668   15,201   1,465 
Liabilities secured by Group assets
Deposits by banks  1,749   —   —   — 
Customer accounts  630   990   630   990 
Debt securities in issue  3,857   7,042   —   — 
   6,236   8,032   630   990 
Note:
Credit risk models
Credit risk models are
(1)The table above includes assets used throughout the Group to support the analytical elements of the credit risk management framework, in particular the risk assessment part of the credit approval process, ongoing monitoring as well as portfolio analysis and reporting. Credit risk models used by the Group can be broadly grouped into three categories.collateral for central bank liquidity schemes
Of the assets above, £16.3 billion (2008 – £15.2 billion) relate to securitisations.
Securitisations and other asset transfers
Continued recognition
The Group arranges securitisations to facilitate client transactions and undertakes securitisations to sell financial assets or to fund specific portfolios of assets. The Group also acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. In a securitisation, assets, or interests in a pool of assets, are transferred generally to a special purpose entity (SPE) which then issues liabilities to third party investors. SPEs are vehicles established for a specific, limited purpose, usually do not carry out a business or trade and typically have no employees. They take a variety of legal forms – trusts, partnerships and companies – and fulfil many different functions.
It is primarily the extent of risks and rewards assumed that determines whether these entities are consolidated in the Group’s financial statements. The following section aims to address the significant exposures which arise from the Group’s activities through specific types of SPEs.

The table below sets out the asset categories together with the carrying amounts of the assets and associated liabilities for those securitisations and other asset transfers where substantially all the risks and rewards of the asset have been retained by the Group.
   2009   2008 
Asset type  
Assets
£m
   
Liabilities
£m
   
Assets
£m
   
Liabilities
£m
 
Residential mortgages  14,540   3,507   13,384*  6,693 
Credit card receivables  1,449   630   1,465   990 
Other loans  349   349   349   349 
   16,338   4,486   15,198   8,032 
* revised
Continuing involvement
At 31 December 2009, securitised assets were £3.1 billion (2008 – £323 million); retained interest £101 million (2008 – £50 million); subordinated assets £91 million (2008 – £9 million); and related liabilities £33 million (2008 – £9 million).
135
Notes on the accounts continued
 
•  
Probability of default (“PD”): the likelihood that a customer will fail to make full and timely repayment of credit obligations over a one year time horizon. Customers are assigned an internal credit grade which corresponds to probability of default. Every customer credit grade across all grading scales in the Group can be mapped to a Group level credit grade (see page 75).
•  
Exposure at default (“EAD”):such models estimate the expected level of utilisation of a credit facility at the time of a borrower’s default. The EAD is typically higher than the current utilisation (e.g. in the case where further drawings are made on a revolving credit facility prior to default) but will not typically exceed the total facility limit.
•  
Loss given default (“LGD”):models estimate the economic loss that may occur in the event of default, being the debt that cannot be recovered. The Group’s LGD models take into account the type of borrower, facility and any risk mitigation such as security or collateral held.
Impairment loss provision methodology
Provisions for impairment losses are assessed under three categories as described below:
Individually assessed provisions are the provisions required for individually significant impaired assets which are assessed on a case-by-case basis, taking into account the financial condition of the counterparty and any guarantor. This incorporates an estimate of the discounted value of any recoveries and realisation of security or collateral. The asset continues to be assessed on an individual basis until it is repaid in full, transferred to the performing portfolio or written-off.
Collectively assessed provisions are the provisions on impaired credits below an agreed threshold which are assessed on a portfolio basis, to reflect the homogeneous nature of the assets, such as credit cards or personal loans. The provision is determined from a quantitative review of the relevant portfolio, taking account of the level of arrears, security and average loss experience over the recovery period.
Latent loss provisions are the provisions held against the estimated impairment in the performing portfolio which has yet to be identified as at the balance sheet date. To assess the latent loss within the portfolio, the Group has developed methodologies to estimate the time that an asset can remain impaired within a performing portfolio before it is identified and reported as such.
Provision analysis
The Group’s consumer portfolios, which consist of small value, high volume credits, have highly efficient, largely automated processes for identifying problem credits and very short timescales, typically three months, before resolution or adoption of various recovery methods.
Corporate portfolios consist of higher value, lower volume credits, which tend to be structured to meet individual customer requirements. Provisions are assessed on a case by case basis by experienced specialists, with input from professional valuers and accountants as appropriate. The Group operates a provisions governance framework which sets thresholds whereby suitable oversight and challenge is undertaken. These opinions and levels of provision are overseen by each division’s Provision Committee. Significant cases are presented to, and challenged by, the Group Problem Exposure Review Forum.
Early and active management of problem exposures ensures that credit losses are minimised. Specialised units are used for different customer types to ensure that the appropriate risk mitigation is taken in a timely manner.
Portfolio provisions are reassessed regularly as part of the Group’s ongoing monitoring process.
Notes on the accounts continued
29 Risk management (continued)
Liquidity risk
The Group’s liquidity policy is designed to ensure that it can at all times meet its obligations as they fall due.
Liquidity management within the Group focuses on both overall balance sheet structure and the control, within prudent limits, of risk arising from the mismatch of maturities across the balance sheet and from exposure to undrawn commitments and other contingent obligations. The management of liquidity risk within the Group is undertaken within limits and other policy parameters set by GALCO. Compliance is monitored and coordinated by Group Treasury both in respect of internal policy and the regulatory requirements of the Financial Services Authority. In addition, all subsidiaries and branches outside the UK ensure compliance with any local regulatory liquidity requirements and are subject to Group Treasury oversight.
Diversification of funding sources
The structure of the Group’s balance sheet is managed to maintain substantial diversification, to minimise concentration across its various deposit sources, and to limit the reliance on total short-term wholesale sources of funds (gross and net of repos) within prudent levels.
Management of term structure
The Group evaluates on a regular basis its structural liquidity risk and applies a variety of balance sheet management and term funding strategies to maintain this risk within its normal policy parameters.
The degree of maturity mismatch within the overall long-term structure of the Group’s assets and liabilities is managed within internal policy guidelines, to ensure that term asset commitments may be funded on an economic basis over their life. In managing its overall term structure, the Group analyses and takes into account the effect of retail and corporate customer behaviour on actual asset and liability maturities where they differ materially from the underlying contractual maturities.
Stress testing
The Group performs stress tests to simulate how events may impact the Groups’ funding and liquidity capabilities. Such tests inform the overall balance sheet structure and help define prudent limits for control of the risk arising from the mismatch of maturities across the balance sheet and from undrawn commitments and other contingent obligations. The nature of stress tests is kept under review in line with evolving market conditions.
Daily management
The short-term maturity structure of the Group’s liabilities and assets is managed daily to ensure that all material or potential cash flow obligations arising from undrawn commitments and other contingent obligations, can be met. Potential sources include cash inflows from maturing assets, new borrowing or the sale or repurchase of debt securities held (after allowing for appropriate haircuts).
Short-term liquidity risk is generally managed on a consolidated basis with internal liquidity mismatch limits set for all subsidiaries and non-UK branches which have material local treasury activities, thereby assuring that the daily maintenance of the Group’s overall liquidity risk position is not compromised.
The following tables show cash flows payable on financial liabilities up to a period of 20 years including future payments of interest.
  NatWest Group
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2007  £m   £m   £m   £m   £m   £m 
Deposits by banks  24,056   2,489   808   270   138   3 
Customer accounts  184,228   2,881   2,515   893   252   81 
Debt securities in issue
  9,074   2,769   4,455   4,208   1,460   — 
Subordinated liabilities  102   985   1,807   542   2,145   1,622 
Settlement balances and other liabilities  2,983   —   —   —   1   2 
   220,443   9,124   9,585   5,913   3,996   1,708 
                         
2006                        
Deposits by banks  35,648   2,450   687   416   465   — 
Customer accounts  169,142   1,579   1,711   284   170   8 
Debt securities in issue  6,366   2,127   1,929   1,823   2,748   571 
Subordinated liabilities  145   255   1,314   1,567   1,578   2,072 
Settlement balances and other liabilities  3,383   —   —   3   —   — 
   214,684   6,411   5,641   4,093   4,961   2,651 
                        
   Bank 
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2007  £m   £m   £m   £m   £m   £m 
Deposits by banks  5,123   91   353   7   84   — 
Customer accounts  130,693   393   1,344   111   —   — 
Debt securities in issue  —   9   —   —   —   — 
Derivatives held for hedging  1   4   11   6   9   12 
Subordinated liabilities  62   685   1,184   340   1,074   1,622 
   135,879   1,182   2,892   464   1,167   1,634 
2006 
Deposits by banks  5,284   119   286   179   317   — 
Customer accounts  123,433   291   1,334   —   19   — 
Debt securities in issue  —   21   9   —   —   — 
Derivatives held for hedging  —   5   21   12   21   24 
Subordinated liabilities  68   200   1,061   1,197   1,233   1,869 
   128,785   636   2,711   1,388   1,590   1,893 
The tables above show the timing of cash outflows to settle financial liabilities. They have been prepared on the following basis:
Prepayable liabilities – where a financial liability can be prepaid by the counterparty, the cash outflow has been included at the earliest date on which the counterparty can require repayment regardless of whether or not such early repayment results in a penalty. If the repayment of a financial liability is triggered by, or is subject to, specific criteria such as market price hurdles being reached, it is included at the earliest possible date that the conditions could be fulfilled without considering the probability of the conditions being met. For example, if a structured note is automatically prepaid when an equity index exceeds a certain level, the cash outflow will be included in the less than three months period whatever the level of the index at the year end. The settlement date of debt securities in issue issued by certain securitisation vehicles consolidated by the Bank depends on when cash flows are received from the securitised assets. Where these assets are prepayable, the timing of the cash outflow relating to securities assumes that each asset will be prepaid at the earliest possible date.

Notes on the accounts continued

29 Risk management (continued)
Liabilities with a contractual maturity of greater than 20 years –the principal amounts of financial liabilities that are repayable after 20 years or where the counterparty has no right to repayment of the principal are excluded from the table as are interest payments after 20 years.
Held-for-trading liabilities – held-for-trading liabilities amounting to £48.3 billion (2006 – £39.1 billion) (Bank £2.1 billion (2006 –£1.6 billion)) have been excluded from the table in view of their short term nature.
Financial assets held by the NatWest Group to meet these cash outflows include cash, balances at central banks and treasury bills of £3.4 billion (2006 – £1.8 billion), loans to banks and customers of £260.4 billion (2006 – £244.0 billion) including £163.7 billion (2006 – £150.0 billion) repayable within three months. The Natwest Group also held debt securities with a market value of £35.9 billion (2006 – £32.3 billion) of which £32.0 billion (2006 – £29.3 billion) were pledged to secure liabilities. Funds can be raised in the short-term from highly liquid securities held by the NatWest Group by sale or by disposal or by sale and repurchase transactions regardless of their stated maturity.
As explained above the table is prepared on the basis that prepayable liabilities are called at the earliest possible date. In practice, the average maturity of these liabilities significantly exceeds that shown in the table. In addition, although many customer accounts are contractually repayable on demand or at short notice, the short-term deposit base of the Bank and its subsidiaries is stable over the long term as deposit rollovers and new deposits offset cash outflows.
Other contractual cash obligations
Other contractual obligations are summarised by payment date in the tables below.
  NatWest Group
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2007  £m   £m   £m   £m   £m   £m 
Operating leases  27   81   189   173   354   663 
Contractual obligations to purchase goods or services  23   88   3   —   —   — 
   50   169   192   173   354   663 
2006 
Operating leases  22   65   157   136   260   448 
Contractual obligations to purchase goods or services  4   11   1   —   —   — 
   26   76   158   136   260   448 
                        
   Bank 
  0-3 months  3-12 months  1-3 years  3-5 years  5-10 years  10-20 years 
2007  £m   £m   £m   £m   £m   £m 
Operating leases  20   59   146   137   278   525 
2006 
Operating leases  17   52   125   114   209   316 
Undrawn formal facilities, credit lines and other commitments to lend were £76,116 million (2006 – £74,918 million) for the NatWest Group. Undrawn formal facilities, credit lines and other commitments to lend for the Bank were £55,411 million (2006 – £57,240 million). While commitments have been given to provide these funds, some may be subject to certain conditions being met by the counterparty. Not all facilities are expected to be drawn, and some may lapse before drawdown.
Market risk
Market risk is defined as the risk of loss resulting from adverse changes in risk factors including interest rates, foreign currency and equity prices together with related factors such as market volatilities.
The Group is exposed to market risk because of positions held in its trading portfolios as well as its non-trading business including the Group’s treasury operations.
Value-at-risk (“VaR”)
VaR is a technique that produces estimates of the potential negative change in the market value of a portfolio over a specified time horizon at given confidence levels. For internal risk management purposes, the Group’s VaR assumes a time horizon of one day and a confidence level of 95%. The Group uses historical simulation models in computing VaR. This approach, in common with many other VaR models, assumes that risk factor changes observed in the past are a good estimate of those likely to occur in the future and is, therefore, limited by the relevance of the historical data used. The Group’s method, however, does not make any assumption about the nature or type of underlying loss distribution. The Group typically uses the previous 500 trading days of market data.
The Group’s VaR should be interpreted in light of the limitations of the methodology used. These limitations include:
27 Capital resources
The Group’s regulatory capital resources at 31 December in accordance with Financial Services Authority (FSA) definitions were as follows:
 
•  
Composition of regulatory capital 
2009
£m
  
2008
£m
 
Tier 1      
Ordinary shareholders’ equity  14,199   12,135 
Minority interests  1,282   1,323 
Adjustment for:        
– Goodwill and other intangible assets  (748)  (815)
– Unrealised losses on available-for-sale debt securities  (12)  32 
– Reserves arising on revaluation of property and unrealised gains on available-for-sale equities  (109)  (14)
– Reallocation of preference shares and innovative securities  (1,207)  (1,246)
– Other regulatory adjustments  (492)  17 
Less expected loss over provisions  (1,351)  (986)
Less securitisation positions  (380)  (112)
Core Tier 1 capital  11,182   10,334 
         
Preference shares  1,532   1,591 
Tax on the excess of expected losses over provisions  539   393 
Less deductions from Tier 1 capital  (327)  (330)
Total Tier 1 capital  12,926   11,988 
         
Tier 2        
Reserves arising on revaluation of property and unrealised gains on available-for-sale equities  109   14 
Collective impairment allowances  3   5 
Perpetual subordinated debt  2,170   3,043 
Term subordinated debt  4,830   4,234 
Less deductions from Tier 2 capital  (2,598)  (1,821)
Total Tier 2 capital  4,514   5,475 
         
Supervisory deductions        
Unconsolidated investments  (121)  (119)
Other deductions  (170)  (171)
Deductions from total capital  (291)  (290)
Total regulatory capital  17,149   17,173 

In the management of capital resources, the Group is governed by the RBS Group’s policy which is to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the RBS Group has regard to the supervisory requirements of the FSA. The FSA uses Risk Asset Ratio (RAR) as a measure of capital adequacy for UK banks, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a tier 1 component of not less than 4%. The RBS Group has complied with the FSA’s capital requirements throughout the year.
Historical data may not provide the best estimate of the joint distribution of risk factor changes in the future and may fail to capture the risk of possible extreme adverse market movements which have not occurred in the historical window used in the calculations.
•  

A number of subsidiaries and sub-groups within the Group, principally banking entities, are subject to various individual regulatory capital requirements in the UK and overseas.
VaR using a one-day time horizon does not fully capture the market risk of positions that cannot be liquidated or hedged within one day.
 
•  
VaR using a 95% confidence level does not reflect the extent of potential losses beyond that percentile.
The Group largely computes the VaR of trading portfolios at the close of business and positions may change substantially during the course of the trading day. Further controls are in place to limit the Group’s intra-day exposure; such as the calculation of the VaR for selected portfolios. These limitations and the nature of the VaR measure mean that the Group cannot guarantee that losses will not exceed the VaR amounts indicated.
The Group calculates both general market risk (i.e. the risk due to movement in general benchmark) and idiosyncratic market risk (i.e. the risk due to movements in the value of securities by reference to specific issuers) using its VaR models.
Trading
The primary focus of the Group’s trading activities is client facilitation – providing products to the Group’s client base at competitive prices. The Group also undertakes: market making – quoting firm bid (buy) and offer (sell) prices with the intention of profiting from the spread between the quotes; arbitrage –entering into offsetting positions in different but closely related markets in order to profit from market imperfections; and proprietary activity – taking positions in financial instruments as principal in order to take advantage of anticipated market conditions. The principal risk factors are interest rates, credit spreads, equity prices and foreign exchange. Financial instruments held in the Group’s trading portfolios include, but are not limited to, debt securities, loans, deposits, equity shares, securities sale and repurchase agreements and derivative financial instruments (futures, forwards, swaps and options). For a discussion of the Group’s accounting policies for derivative financial instruments, see Accounting policies.
The VaR for NatWest Group’s trading portfolios segregated by type of market risk exposure, including idiosyncratic risk, is presented in the table below.
  2007 2006
  Average  Period end  Maximum  Minimum  Average  Period end  Maximum  Minimum 
   £m   £m   £m   £m   £m   £m   £m   £m 
Interest rate  5.9   4.8   9.6   3.1   5.1   5.7   8.3   3.5 
Credit spread  9.9   11.6   30.4   4.6   5.6   5.9   7.1   4.1 
Currency  0.3   0.4   1.0   —   0.5   0.3   1.6   — 
Equity and commodity  1.0   0.1   2.8   —   0.6   0.8   4.2   — 
Diversification      (3.9)              (5.4)        
Total trading VaR  11.8   13.0   32.0   6.8   6.8   7.3   9.0   4.9 
Non-trading
The principal market risks arising from the Group’s non-trading activities are interest rate risk, currency risk and equity risk.
Treasury activity and mismatches between the repricing of assets and liabilities in its retail and commercial banking operations account for most of the non-trading interest rate risk. Non-trading currency risk derives from the Group’s investments in overseas subsidiaries, associates and branches. The Group’s portfolios of non-trading financial instruments mainly comprise loans (including finance leases), debt securities, equity shares, deposits, certificates of deposits and other debt securities issued, loan capital and derivatives.
Non-trading interest rate VaR
Non-trading interest rate VaR for NatWest Group’s treasury and retail and commercial banking activities was £27.6 million at 31 December 2007 (2006 – £24.6 million). During the year, the maximum VaR was £27.6 million (2006 – £28.8 million), the minimum £21.6 million (2006 – £24.6 million) and the average £24.5 million (2006 – £27.1 million).

108
136
Notes on the accounts continued

29 Risk management (continued)
Interest rate risk
Non-trading interest rate risk arises from the Group’s treasury activities and retail and commercial banking businesses.
Treasury
The Group’s treasury activities include its money market business and the management of internal funds flow within the Group’s businesses. Money market portfolios include cash instruments (principally debt securities, loans and deposits) and related hedging derivatives.
Retail and commercial banking
Non-trading interest rate risk is calculated in each business on the basis of establishing the repricing behaviour of each asset, liability and off-balance sheet product. For many products, the actual interest rate repricing characteristics differ from the contractual repricing. In most cases, the repricing maturity is determined by the market interest rate that most closely fits the historical behaviour of the product interest rate. For non-interest bearing current accounts, the repricing maturity is determined by the stability of the portfolio. The repricing maturities used are approved by Group Treasury and divisional asset and liability committees at least annually. Key conventions are reviewed annually by GALCO.
A static maturity gap report is produced as at the month-end for each division, in each functional currency based on the behaviouralised repricing for each product. It is Group policy to include in the gap report, non-financial assets and liabilities, mainly property, plant and equipment and the Group’s capital and reserves, spread over medium and longer term maturities. This report also includes hedge transactions, principally derivatives.
Any residual non-trading interest rate exposures are controlled by limiting repricing mismatches in the individual business balance sheets. Potential exposures to interest rate movements in the medium to long term are measured and controlled using a version of the same VaR methodology that is used for the Group’s trading portfolios but without discount factors. Net accrual income exposures are measured and controlled in terms of sensitivity over time to movements in interest rates.
Risk is managed within limits approved by GALCO through the execution of cash and derivative instruments. Execution of the hedging is carried out by the relevant division through the Group’s treasury function. The residual risk position is reported to divisional asset and liability committees, GALCO and the Board.
Currency risk
The Group does not maintain material non-trading open currency positions other than the structural foreign currency translation exposures arising from its investments in foreign subsidiaries and associated undertakings and their related currency funding. The Group’s policy in relation to structural positions is to match fund the structural foreign currency exposure arising from net asset value, including goodwill, in foreign subsidiaries, equity accounted investments and branches, except where doing so would materially increase the sensitivity of either the Group’s or the subsidiary’s regulatory capital ratios to currency movements. The policy requires structural foreign exchange positions to be reviewed regularly by GALCO. Foreign exchange differences arising on the translation of foreign operations are recognised directly in equity together with the effective portion of foreign exchange differences arising on hedging instruments.
The table below sets out NatWest Group’s structural foreign currency exposures.
  2007  2006 
  Net investments in foreign operations  Related currency borrowings  Structured foreign currency exposures  Net investments in foreign operations  Related currency borrowings  Structured foreign currency exposures 
   £m   £m   £m   £m   £m   £m 
US dollar  2,786   2,681   105   3,022   2,936   86 
Euro  3,116   894   2,222   2,622   455   2,167 
Swiss franc  563   —   563   462   457   5 
Other non-sterling  7   7   —   6   4   2 
   6,472   3,582   2,890   6,112   3,852   2,260 
The structural foreign currency exposure in euros is principally due to Ulster Bank running an open structural foreign exchange position to minimise the sensitivity of its capital ratios to possible movements in the Euro exchange rate against Sterling.
At 31 December 2007 and 31 December 2006, NatWest Group had no net investment hedge relationships. The table above shows net investments in foreign operations and related currency borrowings. These borrowings do not qualify as hedges and gains or losses on their retranslation are taken to profit or loss: a five percent strengthening of foreign currencies would result in a loss of £179 million (2006 – £193 million) and a five percent weakening of foreign currencies would result in a gain of £171 million (2006 – £183 million). Gains or losses on retranslating net investments in foreign operations are taken to equity: a five percent strengthening of foreign currencies would result in a gain of £324 million (2006 – £306 million) and a five percent weakening of foreign currencies would result in a loss of £308 million (2006 – £291 million).
30 Capital resources

The Group’s regulatory capital resources at 31 December in accordance with Financial Services Authority (“FSA”) definitions were as follows:

  2007  2006 
Composition of regulatory capital  £m   £m 
Tier 1 capital:        
Shareholders' funds and minority interests  12,083   11,147 
Subordinated liabilities  285   288 
Goodwill capitalised and intangible assets  (1,244)  (1,209)
Pension deficit and other regulatory adjustments  890   1,074 
Total qualifying tier 1 capital  12,014   11,300 
         
Tier 2 capital:        
Unrealised gains on available-for-sale equities  19   38 
Collective impairment allowances, net of taxes  1,430   1,254 
Qualifying subordinated debt  4,044   4,043 
Total qualifying tier 2 capital  5,493   5,335 
         
Supervisory deductions:        
Unconsolidated investments  729   660 
Other deductions  625   1,272 
Total supervisory deductions  1,354   1,932 
Total regulatory capital  16,153   14,703 

In the management of capital resources, the Group is governed by RBS Group’s policy which is to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the FSA. The FSA uses Risk Asset Ratio (“RAR”) as a measure of capital adequacy in the UK banking sector, comparing a bank’s capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a tier 1 component of not less than 4%. The Group has complied with the FSA’s capital requirements throughout the year.
A number of subsidiaries and sub-groups within the Group, principally banking entities, are subject to various individual regulatory capital requirements in the UK and overseas.

Notes on the accounts continued

31 Memorandum items

Contingent liabilities and commitments

The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group’s expectation of future losses.

  Group  Bank 
  2007  2006  2007  2006 
   £m   £m   £m   £m 
Contingent liabilities:                
Guarantees and assets pledged as collateral security  2,438   2,272   1,811   1,895 
Other contingent liabilities  2,907   2,889   2,141   2,173 
   5,345   5,161   3,952   4,068 
Commitments:                
Undrawn formal standby facilities, credit lines and other commitments to lend                
– less than one year  62,298   58,611   43,073   42,086 
– one year and over  13,818   16,307   12,338   15,154 
Other commitments  220   181   111   100 
   76,336   75,099   55,522   57,340 

Note:
 
Notes on the accounts
28 Memorandum items
Contingent liabilities and commitments
The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group’s expectation of future losses.
  Group  Bank 
  
2009
£m
  
2008
£m
  
2007
£m
  
2009
£m
  
2008
£m
  
2007
£m
 
Contingent liabilities:                  
Guarantees and assets pledged as collateral security  2,494   2,609   2,438   1,369   1,840   1,811 
Other contingent liabilities  2,241   2,654   2,907   1,814   2,032   2,141 
   4,735   5,263   5,345   3,183   3,872   3,952 
Commitments:                  
Undrawn formal standby facilities, credit lines and other commitments to lend                  
– less than one year  44,203   53,902   62,298   35,749   38,954   43,073 
– one year and over  12,996   13,485   13,818   11,181   9,194   12,338 
Other commitments  397   709   220   315   627   111 
   57,596   68,096   76,336   47,245   48,775   55,522 
Note:
(1)  In the normal course of business, the Bank guarantees specified third party liabilities of certain subsidiaries; it also gives undertakings that individual subsidiaries will fulfil their obligations to third parties under contractual or other arrangements.
Banking commitments and contingent obligations, which have been entered into on behalf of customers and for which there are corresponding obligations from customers, are not included in assets and liabilities. The Group’s maximum exposure to credit loss, in the event of non-performance by the other party and where all counterclaims, collateral or security proves valueless, is represented by the contractual nominal amount of these instruments included in the table above. These commitments and contingent obligations are subject to the Group’s normal credit approval processes.

Contingent liabilities
Guarantees – the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.
Other contingent liabilities – these include standby letters of credit, supporting customer debt issues and contingent liabilities relating to customer trading activities such as those arising from performance and customs bonds, warranties, indemnities and acceptances.

Commitments
Commitments to lend – under a loan commitment the Group agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.

Other commitments – these include documentary credits, which are commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents, forward asset purchases, forward deposits placed and undrawn note issuance and revolving underwriting facilities, and other short-term trade related transactions.
137
Notes on the accounts continued
28 Memorandum items continued
Contractual obligations for future expenditure not provided in the accounts
The following table shows contractual obligations for future expenditure not provided for in the accounts at the year end.
  Group  Bank 
  
2009
£m
  
2008
£m
  
2009
£m
  
2008
£m
 
Operating leases:            
Minimum rentals payable under non-cancellable leases (1)
            
Within 1 year  115   114   82   80 
After 1 year but within 5 years  393   410   281   286 
After 5 years  866   938   632   701 
   1,374   1,462   995   1,067 
Other capital expenditure  2   6   —   — 
Contracts to purchase goods or services (2)
  21   41   —   — 
Total  1,397   1,509   995   1,067 
Notes:

(1)Predominantly property leases
Banking commitments and contingent obligations,
(2)Of which have been entered into on behalf of customers and for which there are corresponding obligations from customers, are not included in assets and liabilities. The Group’s maximum exposure to credit loss, in the event of non-performance by the other party and where all counterclaims, collateral or security proves valueless, is represented by the contractual nominal amount of these instruments included in the table above. These commitments and contingent obligations are subject to the Group’s normal credit approval processes and any potential loss is taken into account in assessing provisions for bad and doubtful debts in accordance with the Group’s provisioning policy.due within 1 year: £17 million (2008 – £34 million).
Trustee and other fiduciary activities
In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group’s financial statements. The Group earned fee income of £320 million (2008 – £385 million; 2007 – £409 million). The Bank earned fee income of £53 million (2008 – £58 million; 2007 – £62 million).

The Financial Services Compensation Scheme
The Financial Services Compensation Scheme (FSCS), the UK's statutory fund of last resort for customers of authorised financial services firms, pays compensation if a firm is unable to meet its obligations. The FSCS funds compensation for customers by raising management expenses levies and compensation levies on the industry. In relation to protected deposits, each deposit-taking institution contributes towards these levies in proportion to their share of total protected deposits on 31 December of the year preceding the scheme year (which runs from 1 April to 31 March), subject to annual maxima set by the Financial Services Authority (FSA). In addition, the FSCS has the power to raise levies (‘exit levies’) on firms who have ceased to participate in the scheme and are in the process of ceasing to be authorised for the amount that the firm would otherwise have been asked to pay during the relevant levy year. The FSCS also has the power to raise exit levies on such firms which look at their potential liability to pay levies in future years.

FSCS has borrowed from HM Treasury to fund the compensation costs associated with Bradford & Bingley, Heritable Bank, Kaupthing Singer & Friedlander, Landsbanki ‘Icesave’ and London Scottish Bank plc. These borrowings are on an interest-only basis until September 2011. The annual limit on the FSCS management expenses levy for the three years from September 2008 in relation to these institutions has been capped at £1 billion per annum.
The FSCS will receive funds from asset sales, surplus cash flow, or other recoveries in relation to these institutions which will be used to reduce the principal amount of the FSCS's borrowings. Only after the interest only period, which is expected to end in September 2011, will a schedule for repayment of any remaining principal outstanding (after recoveries) on the borrowings be agreed between the FSCS and HM Treasury. It is expected that, from that point, the FSCS will begin to raise compensation levies (principal repayments). No provision has been made for these levies as the amount is not yet known and is unlikely to be determined before 2011.

Litigation
As a participant in the financial services industry, the Group operates in a legal and regulatory environment that exposes it to potentially significant litigation risks. As a result, the Bank and other members of the RBS Group are involved in various disputes and legal proceedings in the United Kingdom, the United States and other jurisdictions, including litigation. Such cases are subject to many uncertainties, and their outcome is often difficult to predict, particularly in the earlier stages of a case.

Other than as set out in this section, so far as the Group is aware, neither the Bank nor any member of the RBS Group is or has been engaged in or has pending or threatened any governmental, legal or arbitration proceedings which may have or have had in the recent past (covering the 12 months immediately preceding the date of this document) a significant effect on the Group’s financial position or profitability.
138
Notes on the accounts
28 Memorandum items continued
Unarranged overdraft charges
In common with other banks in the United Kingdom, the Royal Bank and NatWest have received claims and complaints from a large number of customers in the United Kingdom seeking refunds of unarranged overdraft charges (the “Charges”). The vast majority of these claims and complaints have challenged the Charges on the basis that they contravene the Unfair Terms in Consumer Contracts Regulations 1999 (the “Regulations”) or are unenforceable under the common law penalty doctrine (or both).

In July 2007, the Office of Fair Trading (“OFT”) issued proceedings in a test case in the English High Court against the banks which was intended to determine certain issues concerning the legal status and enforceability of contractual terms relating to the Charges. The test case concluded in November 2009 with a judgment of the Supreme Court in favour of the banks. As a result of the court rulings made in the test case, the RBS Group expects substantially all of the customer claims and complaints it has received relating to the Charges to fail. The RBS Group cannot at this stage predict with any certainty the final outcome of all customer claims and complaints. It is unable reliably to estimate any liability that may arise as a result of or in connection with these matters or its effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Shareholder litigation
The ultimate holding company and a number of its subsidiaries and certain individual officers and directors have been named as defendants in a class action filed in the United States District Court for the Southern District of New York. The consolidated amended complaint alleges certain false and misleading statements and omissions in public filings and other communications during the period 1 March 2007 to 19 January 2009, and variously asserts claims under Sections 11, 12 and 15 of the Securities Act 1933, Sections 10 and 20 of the Securities Exchange Act 1934 and Rule 10b-5 thereunder.

The putative class is composed of (1) all persons who purchased or otherwise acquired RBS Group securities between 1 March 2007 and 19 January 2009; and/or (2) all persons who purchased or otherwise acquired Series Q, R, S, T and/or U non-cumulative dollar preference shares issued pursuant or traceable to the 8 April 2005 SEC registration statement and were damaged thereby. Plaintiffs seek unquantified damages on behalf of the putative class.

RBS Group has also received notification of similar prospective claims in the United Kingdom and elsewhere but no court proceedings have been commenced in relation to these claims.

RBS Group considers that it has substantial and credible legal and factual defences to these claims and will defend them vigorously. The RBS Group is unable reliably to estimate the liability, if any, that might arise or its effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Other securitisation and securities related litigation in the United States
RBS Group companies have been named as defendants in a number of purported class action and other lawsuits in the United States that relate to the securitisation and securities underwriting businesses. In general, the cases involve the issuance of mortgage backed securities, collateralised debt obligations, or public debt or equity where the plaintiffs have brought actions against the issuers and underwriters of such securities (including RBS Group companies) claiming that certain disclosures made in connection with the relevant offerings of such securities were false or misleading with respect to alleged “sub-prime” mortgage exposure. The RBS Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously. The RBS Group cannot at this stage reliably estimate the liability, if any, that may arise as a result of or in connection with the these lawsuits, individually or in the aggregate, or their effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.

Summary of other disputes, legal proceedings and litigation
Members of the RBS Group are engaged in other litigation in the United Kingdom and a number of overseas jurisdictions, including the United States, involving claims by and against them arising in the ordinary course of business. RBS Group has reviewed these other actual, threatened and known potential claims and proceedings and, after consulting with its legal advisers, does not expect that the outcome of these other claims and proceedings will have a material adverse effect on the Group’s financial position or profitability in any particular period.

Investigations
The RBS Group’s businesses and financial condition can be affected by the fiscal or other policies and other actions of various governmental and regulatory authorities in the United Kingdom, the European Union, the United States and elsewhere. The RBS Group has engaged, and will continue to engage, in discussions with relevant regulators, including in the United Kingdom and the United States, on an ongoing and regular basis informing them of operational, systems and control evaluations and issues as deemed appropriate or required, and it is possible that any matters discussed or identified may result in investigatory actions by the regulators, increased costs being incurred by the RBS Group, remediation of systems and controls, public or private censure or fines. Any of these events or circumstances could have a material adverse impact on Group, its business, reputation, results of operations or the price of securities issued by it.

In particular there is continuing political and regulatory scrutiny of the operation of the retail banking and consumer credit industries in the United Kingdom and elsewhere. The nature and impact of future changes in policies and regulatory action are not predictable and are beyond the RBS Group’s control but could have an adverse impact on the Group’s businesses and earnings.
139

Notes on the accounts continued


28 Memorandum items continued
Retail banking
In the European Union, regulatory actions included an inquiry into retail banking initiated on 13 June 2005 in all of the then 25 member states by the European Commission’s Directorate General for Competition. The inquiry examined retail banking in Europe generally. On 31 January 2007, the European Commission announced that barriers to competition in certain areas of retail banking, payment cards and payment systems in the European Union had been identified. The European Commission indicated that it will consider using its powers to address these barriers and will encourage national competition authorities to enforce European and national competition laws where appropriate.

Multilateral interchange fees
In 2007, the European Commission issued a decision that while interchange is not illegal per se, MasterCard’s current multilateral interchange fee (“MIF”) arrangement for cross border payment card transactions with MasterCard and Maestro branded consumer credit and debit cards in the European Union are in breach of competition law. MasterCard was required by the decision to withdraw the relevant cross-border MIFs (i.e. set these fees to zero) by 21 June 2008.

MasterCard appealed against the decision to the European Court of First Instance on 1 March 2008, and the RBS Group has intervened in the appeal proceedings. In addition, in Summer 2008, MasterCard announced various changes to its scheme arrangements. The European Commission was concerned that these changes might be used as a means of circumventing the requirements of the infringement decision. In April 2009 MasterCard agreed an interim settlement on the level of cross-border MIF with the European Commission pending the outcome of the appeal process and, as a result, the European Commission has advised it will no longer investigate the non-compliance issue (although MasterCard is continuing with its appeal).

Visa’s cross-border MIFs were exempted in 2002 by the European Commission for a period of five years up to 31 December 2007 subject to certain conditions. On 26 March 2008, the European Commission opened a formal inquiry into Visa’s current MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit cards in the European Union and on 6 April 2009 the European Commission announced that it had issued Visa with a formal Statement of Objections. At the same time Visa announced changes to its interchange levels and introduced some changes to enhance transparency. There is no deadline for the closure of the inquiry.

In the UK, the OFT has carried out investigations into Visa and MasterCard domestic credit card interchange rates. The decision by the OFT in the MasterCard interchange case was set aside by the Competition Appeal Tribunal (the “CAT”) in June 2006. The OFT’s investigations in the Visa interchange case and a second MasterCard interchange case are ongoing. On 9 February 2007, the OFT announced that it was expanding its investigation into domestic interchange rates to include debit cards. In January 2010 the OFT advised that it did not anticipate issuing a Statement of Objections prior to the European Court’s judgment, although it has reserved the right to do so if it considers it appropriate.

The outcome of these investigations is not known, but they may have an impact on the consumer credit industry in general and, therefore, on the RBS Group’s business in this sector.

Payment protection insurance
Having conducted a market study relating to Payment Protection Insurance (“PPI”), on 7 February 2007 the OFT referred the PPI market to the Competition Commission (“CC”) for an in-depth inquiry. The CC published its final report on 29 January 2009 and announced its intention to order a range of remedies, including a prohibition on actively selling PPI at point of sale of the credit product (and for 7 days thereafter), a ban on single premium policies and other measures to increase transparency (in order to improve customers’ ability to search and improve price competition). Barclays Bank PLC subsequently appealed certain CC findings to the Competition Appeal Tribunal (“CAT”). On 16 October 2009, the CAT handed down a judgment quashing the ban on selling PPI at the point of sale of credit products and remitted the matter back to the CC for review. The CC’s current Administrative Timetable is to publish a supplementary report by Summer 2010 and give further consideration to its full range of recommended remedies and a draft order to implement them during Autumn 2010.

The FSA has been conducting a broad industry thematic review of PPI sales practices and in September 2008, the FSA announced that it intended to escalate its level of regulatory intervention. Substantial numbers of customer complaints alleging the mis-selling of PPI policies have been made to banks and to the FOS and many of these are being upheld by the FOS against the banks.

In September 2009, the FSA issued a consultation paper on guidance on the fair assessment of PPI mis-selling complaints and, where necessary, the provision of an appropriate level of redress. The consultation also covers proposed rules requiring firms to re-assess (against the new guidance) all PPI mis-selling complaints received and rejected since 14 January 2005. A policy statement containing final guidance and rules is expected in early 2010. Separately, discussions continue between the FSA and the RBS Group in respect of concerns expressed by the FSA over certain categories of historical PPI sales.
140

Notes on the accounts
28 Memorandum items continued
Personal current accounts
On 16 July 2008, the OFT published the results of its market study into personal current accounts in the United Kingdom. The OFT found evidence of competition and several positive features in the personal current account market but believes that the market as a whole is not working well for consumers and that the ability of the market to function well has become distorted.

On 7 October 2009, the OFT published a follow-up report summarising the initiatives agreed between the OFT and personal current account providers to address the OFT’s concerns about transparency and switching, following its market study. Personal current account providers will take a number of steps to improve transparency, including providing customers with an annual summary of the cost of their account and making charges prominent on monthly statements. To improve the switching process, a number of steps are being introduced following work with BACS, the payment processor, including measures to reduce the impact on consumers of any problems with transferring direct debits.

On 22 December 2009, the OFT published a further report in which it stated that it continued to have significant concerns about the operation of the personal current account market in the United Kingdom, in particular in relation to unarranged overdrafts, and that it believed that fundamental changes are required for the market to work in the best interests of bank customers. The OFT stated that it would discuss these issues intensively with banks, consumer groups and other organisations, with the aim of reporting on progress by the end of March 2010.

Securitisation and collateralised debt obligation business
The New York State Attorney General has issued subpoenas to a wide array of participants in the securitisation and securities industry, focusing on the information underwriters obtained as part of the due diligence process from the independent due diligence firms. RBS Securities Inc. has produced documents requested by the New York State Attorney General, principally related to loans that were pooled into one securitisation transaction and will continue to cooperate with the investigation. More recently, the Massachusetts Attorney General has issued a subpoena to RBS Securities Inc. seeking information related to residential mortgage lending practices and sales and securitisation of residential mortgage loans. These respective investigations are in the early stages and therefore it is difficult to predict the potential exposure from any such investigation. The ultimate holding company and its subsidiaries are cooperating with these various investigations and requests.

Other investigations
In the UK, the OFT has also been investigating the RBS Group for alleged conduct in breach of Article 101 of the Treaty on the Functioning of the European Union and/or the Chapter 1 prohibition of the Competition Act 1998 relating to the provision of loan products to professional services firms. The ultimate holding company and its subsidiaries are co-operating fully with the OFT’s investigation.

In April 2009 the FSA notified the RBS Group that it was commencing a supervisory review of the acquisition of ABN AMRO in 2007 and the 2008 capital raisings and an investigation into conduct, systems and controls within the Global Banking & Markets division of the RBS Group. The ultimate holding company and its subsidiaries are cooperating fully with this review and investigation.

In November 2009, the FSA informed the RBS Group that it was commencing an investigation into certain aspects of the policies of, and training and controls within, certain of the RBS Group’s UK subsidiaries relating to compliance with UK money laundering regulations during the period from December 2007 to December 2008. The ultimate holding company and its subsidiaries are cooperating fully with this investigation.

In January 2010, the FSA informed the RBS Group that it intended to commence an investigation into certain aspects of the handling of customer complaints. The scope of the proposed investigation (including which businesses and subsidiaries are affected) is not yet clear. The ultimate holding company and its subsidiaries intend to co-operate fully with this investigation.

In the United States, the RBS Group and certain subsidiaries have received requests for information from various governmental agencies, self-regulatory organisations, and state governmental agencies including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. In particular, during March 2008, the RBS Group was advised by the US Securities and Exchange Commission that it had commenced a non-public, formal investigation relating to the RBS Group’s United States sub-prime securities exposures and United States residential mortgage exposures. The ultimate holding company and its subsidiaries are cooperating with these various requests for information and investigations.
141
Notes on the accounts continued
29 Net cash inflow/(outflow) from operating activities
   Group   Bank 
   
2009
£m
   
2008
£m
   
2007
£m
   
2009
£m
   
2008
£m
   
2007
£m
 
Operating profit/(loss) before tax  1,129   1,140   3,085   (692)  1,866   3,729 
(Increase)/decrease in prepayments and accrued income  (41)  (59)  (92)  14   (61)  (66)
Interest on subordinated liabilities  454   509   271   414   432   239 
Increase/(decrease) in accruals and deferred income  561   181   (431)  278   110   (521)
Provisions for impairment losses  4,139   1,362   849   2,166   929   742 
Loans and advances written-off net of recoveries  (1,123)  (730)  (523)  (1,077)  (684)  (470)
Unwind of discount on impairment losses  (246)  (100)  (87)  (77)  (69)  (71)
Profit on sale of property, plant and equipment  (4)  (7)  (189)  (1)  (1)  (114)
(Loss)/profit on sale of subsidiaries and associates  (384)  31   —   (3)  2   73 
Profit on sale of available-for-sale financial assets  (60)  (17)  (117)  —   —   (72)
Charge for defined benefit pension schemes  54   2   132   (29)  (65)  83 
Pension scheme curtailment gains  (544)  —   —   (358)  —   — 
Cash contribution to defined benefit pension schemes  (213)  (154)  (117)  (124)  (78)  (69)
Other provisions utilised  (29)  (10)  (135)  (15)  (10)  (123)
Depreciation and amortisation  247   237   264   156   145   177 
Gain on redemption of own debt  (381)  —   —   (381)  —   — 
Write-down of goodwill and other intangible assets  —   716   —   —   45   — 
Write-down of investment in subsidiaries  —   —   —   2,281   —   — 
Elimination of foreign exchange differences  2,063   (5,850)  (464)  421   (1,002)  5 
Other non-cash items  459   66   650   164   (148)  242 
Net cash inflow/(outflow) from trading activities  6,081   (2,683)  3,096   3,137   1,411   3,784 
Decrease/(increase) in loans and advances to banks and customers  23,042   (22,246)  (1,856)  22,038   (9,345)  (2,958)
Decrease/(increase) in securities  1,348   1,758   (2,061)  —   (1)  1 
Decrease/(increase) in other assets  820   (19)  (1,772)  300   (57)  (167)
Decrease/(increase) in derivative assets  4,425   (5,320)  (829)  1,997   (3,309)  (188)
Changes in operating assets  29,635   (25,827)  (6,518)  24,335   (12,712)  (3,312)
Increase in deposits by banks and customers  34,879   4,878   22,903   25,703   659   7,064 
(Decrease)/increase in debt securities in issue  (5,742)  (3,711)  6,588   (15)  6   (20)
(Decrease)/increase in other liabilities  (305)  285   (432)  (195)  (7)  60 
(Decrease)/increase in derivative liabilities  (3,752)  4,815   908   (3,737)  4,891   207 
Increase/(decrease) in settlement balances and short positions  3,397   (3,281)  (8,445)  —   —   — 
Changes in operating liabilities  28,477   2,986   21,522   21,756   5,549   7,311 
Total income taxes paid  (1,092)  (331)  (592)  (554)  (290)  (104)
Net cash inflow/(outflow) from operating activities  63,101   (25,855)  17,508   48,674   (6,042)  7,679 
30 Analysis of the net investment in business interests and intangible assets
   Group   Bank 
   
2009
£m
   
2008
£m
   
2007
£m
   
2009
£m
   
2008
£m
   
2007
£m
 
Fair value given for businesses acquired  (22)  (60)  (35)  (3)  —   — 
Additional investments in Group undertakings  —   —   —   (3,005)  (846)  (1,216)
Net outflow of cash in respect of purchases  (22)  (60)  (35)  (3,008)  (846)  (1,216)
                         
Other assets sold  (324)  277   3   1,150   —   — 
Repayment of investments  —   —   —   —   —   1,823 
Profit/(loss) on disposal  384   (31)  —   3   (2)  (73)
Net cash inflow/(outflow) on disposals  60   246   3   1,153   (2)  1,750 
                         
Dividends received from joint ventures  —   4   5   —   —   — 
Net cash expenditure on other intangible assets  (69)  (167)  (132)  (69)  (152)  (131)
Net (outflow)/inflow  (31)  23   (159)  (1,924)  (1,000)  403 
142
Notes on the accounts
31 Interest received and paid
   Group   Bank 
   
2009
£m
   
2008
£m
   
2007
£m
   
2009
£m
   
2008
£m
   
2007
£m
 
Interest received  6,720   12,472   12,035   4,204   7,917   7,942 
Interest paid  (4,975)  (6,893)  (5,752)  (2,551)  (4,144)  (4,325)
   1,745   5,579   6,283   1,653   3,773   3,617 
32 Analysis of changes in financing during the year
   Group   Bank 
   
Share capital
and share premium
   
Subordinated
liabilities
   
Share capital
and share premium
   
Subordinated
liabilities
 
   
2009
£m
   
2008
£m
   
2009
£m
   
2008
£m
   
2009
£m
   
2008
£m
   
2009
£m
   
2008
£m
 
At 1 January  2,969   2,969   10,099   5,932   2,969   2,969   7,860   4,244 
Issue of ordinary shares  935   —           935   —         
Net proceeds from issue of subordinated liabilities          1,000   2,749           1,000   2,700 
Repayment of subordinated liabilities          (1,250)  —           (1,052)  — 
Net cash inflow/(outflow) from financing  935   —   (250)  2,749   935   —   (52)  2,700 
Currency translation and other adjustments  —   —   (850)  1,418   —   —   (703)  916 
At 31 December  3,904   2,969   8,999   10,099   3,904   2,969   7,105   7,860 
33 Analysis of cash and cash equivalents
  Group  Bank 
  
2009
£m
  
2008
£m
  
2007
£m
  
2009
£m
  
2008
£m
  
2007
£m
 
At 1 January                  
– cash  31,365   37,364   38,650   12,529   18,071   16,340 
– cash equivalents  18,710   28,825   12,810   8,405   7,265   3,187 
   50,075   66,189   51,460   20,934   25,336   19,527 
Net cash inflow/(outflow)  59,445   (16,114)  14,729   45,267   (4,402)  5,809 
At 31 December  109,520   50,075   66,189   66,201   20,934   25,336 
Comprising:                        
Cash and balances at central banks  1,726   1,203   1,258   842   771   921 
Treasury bills and debt securities  —   —   28   —   —   — 
Loans and advances to banks  107,794   48,872   64,903   65,359   20,163   24,415 
Cash and cash equivalents  109,520   50,075   66,189   66,201   20,934   25,336 
The Bank and certain subsidiary undertakings are required to maintain balances with Central banks which, at 31 December 2009, amounted to £78 million (2008 – £82 million).
143
Notes on the accounts continued
 
Contingent liabilities

Guarantees – the Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount as disclosed in the table above. The Group expects most guarantees it provides to expire unused.

Other contingent liabilities – these include standby letters of credit, supporting customer debt issues and contingent liabilities relating to customer trading activities such as those arising from performance and customs bonds, warranties, indemnities and acceptances.
Commitments

Commitments to lend – under a loan commitment the Group agrees to make funds available to a customer in the future. Loan commitments, which are usually for a specified term may be unconditionally cancellable or may persist, provided all conditions in the loan facility are satisfied or waived. Commitments to lend include commercial standby facilities and credit lines, liquidity facilities to commercial paper conduits and unutilised overdraft facilities.

Other commitments – these include forward asset purchases, forward deposits placed and undrawn note issuance and revolving underwriting facilities, documentary credits and other short-term trade related transactions.
Regulatory enquiries and investigations

In the normal course of business the Group and its subsidiaries co-operate with regulatory authorities in various jurisdictions in their enquiries or investigations into alleged or possible breaches of regulations.
Certain of the Group’s subsidiaries have received requests for information from various US governmental agencies and self-regulatory organisations including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. The Group and its subsidiaries are cooperating with these various requests for information and investigations.
Trustee and other fiduciary activities

In its capacity as trustee or other fiduciary role, the Group may hold or place assets on behalf of individuals, trusts, companies, pension schemes and others. The assets and their income are not included in the Group’s financial statements. The Group earned fee income of £409 million (2006 – £381 million; 2005 – £278 million). The Bank earned fee income of £62 million (2006 – £64 million; 2005 – £57 million).

Litigation

Proceedings, including consolidated class actions on behalf of former Enron securities holders, have been brought in the United States against a large number of defendants, including the Group, following the collapse of Enron. The claims against the Group could be significant; the class plaintiff’s position is that each defendant is responsible for an entire aggregate damage amount less settlements – they have not quantified claimed damages against the Group in particular. The Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously. Recent Supreme Court and Fifth Circuit decisions provide further support for the Group’s position. The Group is unable reliably to estimate the liability, if any, that might arise or its effect on the Group’s consolidated net assets, its operating results or cash flows in any particular period.
On 27 July 2007, following discussions between the Office of Fair Trading (‘OFT’), the Financial Ombudsman Service, the Financial Services Authority and all the major UK banks (including the Group) in the first half of 2007, the OFT issued proceedings in a test case against the banks including the Group to determine the legal status and enforceability of certain charges relating to unauthorised overdrafts. The hearing of the test case commenced on 17 January 2008. The Group maintains that its charges are fair and enforceable and is defending its position vigorously. It cannot, however, at this stage predict with any certainty the outcome of the test case and is unable reliably to estimate the liability, if any, that may arise or its effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
Members of the Group are engaged in other litigation in the United Kingdom and a number of overseas jurisdictions, including the United States, involving claims by and against them arising in the ordinary course of business. The Group has reviewed these other actual, threatened and known potential claims and proceedings and, after consulting with its legal advisers, does not expect that the outcome of these other claims and proceedings will have a material adverse effect on its consolidated net assets, operating results or cash flows in any particular period.
Additional contingent liabilities arise in the normal course of the Group’s business. It is not anticipated that any material loss will arise from these transactions.
32 Net cash flows from operating activities
     Group        Bank    
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
Operating profit before tax  3,085   3,456   3,411   3,729   1,963   2,315 
(Increase)/decrease in prepayments and accrued income  (92)  (17)  988   (66)  30   557 
Interest on subordinated liabilities  271   310   304   239   271   283 
(Decrease)/increase in accruals and deferred income  (431)  37   (1,278)  (521)  (28)  (846)
Provisions for impairment losses  849   852   756   742   754   651 
Loans and advances written-off net of recoveries  (523)  (730)  (762)  (470)  (644)  (715)
Unwind of discount on impairment losses  (87)  (67)  (76)  (71)  (55)  (61)
Profit on sale of property, plant and equipment  (189)  (31)  (51)  (114)  (31)  (39)
Loss/(profit) on sale of subsidiaries and associates  —   (70)  (12)  73   45   (221)
Loss/(profit) on sale of investment securities  117   (86)  (327)  72   (24)  (320)
Charge for defined benefit pension schemes  132   229   149   83   168   97 
Cash contribution to defined benefit pension schemes  (117)  (135)  (1,007)  (69)  (70)  (976)
Other provisions utilised  (135)  (30)  (18)  (123)  (20)  (16)
Depreciation and amortisation  264   257   382   177   202   326 
Elimination of foreign exchange differences  (464)  1,503   (2,178)  5   143   189 
Other non-cash items  416   (147)  (227)  98   1   (60)
Net cash inflow from trading activities  3,096   5,331   54   3,784   2,705   1,164 
Increase in loans and advances to banks and customers  (1,856)  (40,552)  (24,532)  (2,958)  (15,215)  (4,182)
(Increase)/decrease in securities  (2,061)  (4,316)  (5,565)  1   2   1 
(Increase)/decrease in other assets  (1,772)  1,303   (1,469)  (167)  707   (625)
(Increase)/decrease in derivative assets  (829)  230   797   (188)  (197)  335 
Changes in operating assets  (6,518)  (43,335)  (30,769)  (3,312)  (14,703)  (4,471)
Increase in deposits by banks and customers  22,903   39,118��  49,683   7,064   16,281   9,815 
Increase/(decrease) in debt securities in issue  6,588   3,534   5,724   (20)  (9)  (1)
(Decrease)/increase in other liabilities  (432)  646   1,138   60   (26)  953 
Increase/(decrease) in derivative liabilities  908   (314)  (951)  207   16   (286)
(Decrease)/increase in settlement balances and short positions  (8,445)  3,057   (652)  —   —   — 
Changes in operating liabilities  21,522   46,041   54,942   7,311   16,262   10,481 
Total income taxes paid  (592)  (1,157)  (1,170)  (104)  (588)  (662)
Net cash inflow from operating activities  17,508   6,880   23,057   7,679   3,676   6,512 


Notes on the accounts continued
33 Analysis of the net investment in business interests and intangible assets
     Group        Bank    
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
Fair value given for businesses acquired  (35)  (20)  (238)  —   (624)  — 
Additional investments in Group undertakings  —   —   —   (1,216)  (719)  (217)
Cash and cash equivalents acquired  —   —   25   —   —   — 
Non-cash consideration  —   —   3   —   —   — 
Net outflow of cash in respect of purchases  (35)  (20)  (210)  (1,216)  (1,343)  (217)
                         
Cash and cash equivalents in businesses sold  —   —   (2)  —   —   — 
Other assets sold  3   (41)  260   —   1   7 
Repayment of investments  —   —   —   1,823   1,022   2 
Non-cash consideration  —   112   (25)  —   —   — 
Profit/(loss) on disposal  —   70   12   (73)  (45)  221 
Net cash inflow on disposals  3   141   245   1,750   978   230 
                         
Dividends received from joint ventures  5   17   7   —   —   — 
Net cash expenditure on other intangible assets  (132)  (230)  (210)  (131)  (159)  (180)
Net outflow  (159)  (92)  (168)  403   (524)  (167)

34 Interest received and paid
     Group        Bank    
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
Interest received  12,035   9,952   8,475   7,942   6,601   5,621 
Interest paid  (5,752)  (5,527)  (4,164)  (4,325)  (3,405)  (2,683)
   6,283   4,425   4,311   3,617   3,196   2,938 
35 Analysis of changes in financing during the year
  
Group
  
Bank
 
  Share capital  Subordinated  Share capital  Subordinated 
  and share premium  liabilities  and share premium  liabilities 
  2007  2006  2007  2006  2007  2006  2007  2006 
   £m   £m   £m   £m   £m   £m   £m   £m 
At 1 January  2,969   2,969   5,641   6,648   2,969   2,969   4,583   5,501 
Net proceeds from issue of                                
subordinated liabilities          634   91           —   — 
Repayment of subordinated liabilities          (403)  (719)          (381)  (590)
Net cash outflow from financing  —   —   231   (628)  —   —   (381)  (590)
Currency translation and other adjustments  —   —   60   (379)  —   —   42   (328)
At 31 December  2,969   2,969   5,932   5,641   2,969   2,969   4,244   4,583 
36 Analysis of cash and cash equivalents
     Group        Bank    
  2007  2006  2005  2007  2006  2005 
   £m   £m   £m   £m   £m   £m 
At 1 January                        
– cash  38,650   33,273   14,816   16,340   13,952   9,952 
– cash equivalents  12,810   15,151   8,029   3,187   4,636   1,959 
Net cash inflow  14,729   3,036   25,579   5,809   939   6,677 
At 31 December  66,189   51,460   48,424   25,336   19,527   18,588 
                         
Comprising:                        
Cash and balances at central banks  1,258   1,430   1,446   921   795   779 
Treasury bills and debt securities  28   1   1   —   —   — 
Loans and advances to banks  64,903   50,029   46,977   24,415   18,732   17,809 
Cash and cash equivalents  66,189   51,460   48,424   25,336   19,527   18,588 

The Bank and certain subsidiary undertakings are required to maintain balances with the Central banks which, at 31 December 2007, amounted to £105 million (2006 – £95 million).

37 Segmental analysis
(a)  Divisions
Following a comprehensive strategic review, changes have been made to the Group’s operating segments in 2009. A Non-Core division has been created comprising those lines of business, portfolios and individual assets that the Group intends to run off or sell. Furthermore, Business Services (formerly Group Manufacturing) is no longer reported as a separate division and its costs are now allocated to the customer-facing divisions. UK Retail & Commercial Banking has been split into three segments (UK Retail, UK Corporate and Wealth). Ulster Bank has become a specific segment. The remaining elements of Europe & Middle East Retail & Commercial Banking and Asia Retail & Commercial Banking form part of Non-Core. The segment measure is now Operating profit/(loss) before tax which differs from Contribution used previously; it excludes certain infrequent items. Comparative data have been restated accordingly.

The directors manage the Group primarily by class of business and present the segmental analysis on that basis. Segments charge market prices for services rendered to other parts of the Group.

The Group’s activities are organised as follows:

•  UK Retail offers a comprehensive range of banking products and related financial services to the personal market. It serves customers through the NatWest network of branches and ATMs in the United Kingdom, and also through telephone and internet channels.

UK Corporate is a 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.

Wealth provides private banking and investment services in the UK through Coutts & Company offshore banking through NatWest Offshore, and international private banking through RBS Coutts.
Global Banking & Markets (GBM) is a leading banking partner to major corporations and financial institutions around the world, providing an extensive range of debt and equity financing, risk management and investment services to its customers. The division is currently organised along six principal business lines: money markets; rates flow trading; currencies and commodities; equities; credit markets and portfolio management & origination.

Global Transaction Services offers global payments, cash and liquidity management, and trade finance, United Kingdom and international merchant acquiring and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States.

Ulster Bank is the leading retail and commercial bank in Northern Ireland and the third largest banking group on the island of Ireland. It provides a comprehensive range of financial services through both its Retail Markets division which has a network of branches and operates in the personal and bancassurance sectors, and its Corporate Markets division provides services to SME business customers, corporates and institutional markets.

Central Functions comprises group and corporate functions, such as treasury, funding and 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. The division contains a range of businesses and asset portfolios, linked to proprietary trading, 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.
144
Notes on the accounts
34Segmental analysis continued
   
  
 Group
  
 Total revenue
 
 Total Income
             
  External  Inter segment  Total  External  Inter segment  Total  Operating expenses  Depreciation and amortisation  Impairment losses  Operating (loss)/profit before tax 
2009   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
UK Retail   2,396   10   2,406   2,539   10   2,549   (1,625)   (1)   (988)   (65) 
UK Corporate   1,669   2   1,671   1,854   (132)   1,722   (610)   —   (485)   627 
Wealth   1,014   63   1,077   668   51   719   (488)   (10)   (13)   208 
Global Banking & Markets   1,936   292   2,228   1,080   (30)   1,050   (606)   (14)   (3)   427 
Global Transaction Services   1,680   —   1,680   1,041   (13)   1,028   (542)   —   (5)   481 
Ulster Bank   1,703   5   1,708   865   218   1,083   (709)   (5)   (649)   (280) 
Central Items   1,724   287   2,011   20   245   265   538   (198)   —   605 
Core   12,122   659   12,781   8,067   349   8,416   (4,042)   (228)   (2,143)   2,003 
Non-Core   1,266   679   1,945   826   (349)   477   (108)   —   (1,996)   (1,627) 
   13,388   1,338   14,726   8,893   —   8,893   (4,150)   (228)   (4,139)   376 
Eliminations   —   (1,338)   (1,338)   —   —   —   —   —   —   — 
   13,388   —   13,388   8,893   —   8,893   (4,150)   (228)   (4,139)   376 
Reconciling items                                         
Amortisation of purchased intangible assets   —   —   —   —   —   —   —   (12)   —   (12) 
Integration and restructuring costs   —   —   —   —   —   —   (143)   (7)   —   (150) 
Gain on redemption of own debt   381   —   381   381   —   381   —   —   —   381 
Gains on pensions curtailment   —   —   —   —   —   —   544   —   —   544 
Bonus tax   —   —   —   —   —   —   (10)   —   —   (10) 
   13,769   —   13,769   9,274   —   9,274   (3,759)   (247)   (4,139)   1,129 
                                         
                                         
2008                                         
UK Retail   4,143   7   4,150   3,260   18   3,278   (1,655)   (1)   (601)   1,021 
UK Corporate   3,203   1   3,204   2,277   (472)   1,805   (589)   —   (102)   1,114 
Wealth   1,691   87   1,778   728   70   798   (498)   (8)   (10)   282 
Global Banking & Markets   1,375   1,029   2,404   440   53   493   (379)   (10)   —   104 
Global Transaction Services   1,660   —   1,660   1,077   (27)   1,050   (488)   —   (15)   547 
Ulster Bank   3,233   277   3,510   1,319   (204)   1,115   (678)   —   (106)   331 
Central Items   (1,250)   837   (413)   (2,291)   1,195   (1,096)   188   (190)   —   (1,098) 
Core   14,055   2,238   16,293   6,810   633   7,443   (4,099)   (209)   (834)   2,301 
Non-Core   1,803   286   2,089   894   (633)   261   (128)   (1)   (528)   (396) 
   15,858   2,524   18,382   7,704   —   7,704   (4,227)   (210)   (1,362)   1,905 
Eliminations   —   (2,524)   (2,524)   —   —   —   —   —   —   — 
   15,858   —   15,858   7,704   —   7,704   (4,227)   (210)   (1,362)   1,905 
Reconciling items                                         
Amortisation of purchased intangible assets   —   —   —   —   —   —   —   (7)   —   (7) 
Integration and restructuring costs   —   —   —   —   —   —   (22)   (20)   —   (42) 
Goodwill and other asset write-downs   —   —   —   —   —   —   (716)   —   —   (716) 
   15,858   —   15,858   7,704   —   7,704   (4,965)   (237)   (1,362)   1,140 

145
Notes on the accounts continued
34 Segmental analysis continued
  
 Group
  
 Total revenue
 
 Total Income
            
  External  
Inter
segment
  Total  External  
Inter
segment
  Total  Operating expenses  Depreciation and amortisation  Impairment losses  Operating profit/(loss) before tax 
2007   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
UK Retail   5,236   2   5,238   4,118   15   4,133   (971)   (2)   (654)   2,506 
UK Corporate   2,462   —   2,462   1,528   (450)   1,078   (168)   —   (82)   828 
Wealth   1,586   76   1,662   624   73   697   (359)   (10)   (1)   327 
Global Banking & Markets   1,463   1,168   2,631   131   (110)   21   (394)   (5)   (2)   (380) 
Global Transaction Services   1,638   —   1,638   1,055   (47)   1,008   (134)   —   (6)   868 
Ulster Bank   2,637   —   2,637   1,136   (117)   1,019   (582)   (5)   (39)   393 
Central Items   360   618   978   (411)   656   245   (1,427)   (204)   —   (1,386) 
Core   15,382   1,864   17,246   8,181   20   8,201   (4,035)   (226)   (784)   3,156 
Non-Core   1,095   600   1,695   173   (20)   153   (109)   (1)   (65)   (22) 
   16,477   2,464   18,941   8,354   —   8,354   (4,144)   (227)   (849)   3,134 
Eliminations   —   (2,464)   (2,464)   —   —   —   —   —   —   — 
   16,477   —   16,477   8,354   —   8,354   (4,144)   (227)   (849)   3,134 
Reconciling items                                         
Amortisation of purchased intangible assets   —   —   —   —   —   —   —   (6)   —   (6) 
Integration costs   —   —   —   —   —   —   (12)   (31)   —   (43) 
   16,477   —   16,477   8,354   —   8,354   (4,156)   (264)   (849)   3,085 
Note:
(1)Segmental results for 2008 and 2007 have been restated to reflect transfers of businesses between segments in 2009.

146
Notes on the accounts
34 Segmental analysis continued
  
 Group
  
 2009
 
 2008
  Assets  Liabilities  Cost to acquire fixed assets and intangible assets  Assets  Liabilities  Cost to acquire fixed assets and intangible assets 
   £m   £m   £m   £m   £m   £m 
UK Retail   19,932   66,632   —   51,038   59,280   — 
UK Corporate   45,111   42,011   —   46,312   37,912   — 
Wealth   31,993   30,381   5   29,834   28,273   20 
Global Banking & Markets   143,163   79,744   126   88,882   70,585   347 
Global Transaction Services   5,422   22,890   —   6,653   21,661   — 
Ulster Bank   47,156   56,020   —   53,056   59,856   7 
Central Items   18,471   26,645   148   2,712   12,889   263 
Core   311,248   324,323   279   278,487   290,456   637 
Non-Core   39,480   10,924   1,336   42,732   17,305   2 
Group   350,728   335,247   1,615   321,219   307,761   639 
Note:
(1)Segmental results for 2008 have been restated to reflect transfers of businesses between segments in 2009.
 
•  UK Corporate Banking provides banking, finance and risk management services to UK corporate customers. Through its network of relationship managers across the country it distributes the full range of Corporate Markets’ products and services to companies.
Segmental analysis of goodwill is as follows:
 
•  Retail comprises the NatWest retail brand, and a number of direct providers offering a full range of banking products and related financial services to the personal, premium and small business markets across several distribution channels.
  Wealth  
Global
Banking &
Markets
  
Global
Transaction Services
  Ulster Bank  Non-Core  Total 
   £m   £m   £m   £m   £m   £m 
At 1 January 2008   128   93   64   443   45   773 
Currency translation and other adjustments   57   35   20   133   2   247 
Disposals   —   —   —   —   (47)   (47) 
Write-down of goodwill   (3)   —   —   (576)   —   (579) 
At 1 January 2009   182   128   84   —   —   394 
Currency translation and other adjustments   (12)   (13)   (6)   —   —   (31) 
At 31 December 2009   170   115   78   —   —   363 

Retail also includes the Group’s non-branch based retail business that issues a comprehensive range of credit and charge cards to personal and corporate customers and provides card processing services for retail businesses.
147
 
•  Wealth Management provides private banking and investment services to its global clients through Coutts Group and NatWest Offshore.

•  Ulster Bank Group brings together the Ulster Bank and First Active businesses. Retail Markets serves personal customers through both brands and Corporate Markets caters for the banking needs of business and corporate customers.
Notes on the accounts continued
 
•  Manufacturing 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.

Segments charge market prices for services rendered to other parts of the Group with the exception of Manufacturing and central items. The expenditure incurred by Manufacturing relates to costs principally in respect of the Group’s banking operations in the UK and Ireland. These costs reflect activities that are shared between the various customer-facing divisions. These shared costs and related assets and liabilities are not allocated to divisions in the day-to-day management of the businesses but they are allocated to customer-facing divisions for financial reporting purposes on a basis the directors consider to be reasonable. Funding charges between segments are determined by Group Treasury, having regard to commercial demands. The results of each division before amortisation of purchased intangible assets, integration costs and net gain on sale of strategic investments and subsidiaries, and where appropriate, allocation of Manufacturing costs (‘Contribution’) and after allocation of Manufacturing costs (‘Operating profit before tax’) are shown below.
   Group 
   Revenue   Total income                         
   External   Inter
segment		   Total   External   Inter
segment		   Total   Operating expenses   Depreciation and amortisation   Impairment losses   Contribution   Allocation of Manufac- turing costs   Operating profit before tax 
2007  £m   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
Global Banking & Markets  2,294   1,768   4,062   134   (154)  (20)  (468)  (11)  (5)  (504)  (59)  (563)
UK Corporate Banking  2,734   —   2,734   2,027   (459)  1,568   (270)  —   (82)  1,216   (226)  990 
Retail  6,466   4   6,470   4,544   17   4,561   (992)  (2)  (657)  2,910   (1,128)  1,782 
Wealth Management  1,581   74   1,655   618   71   689   (363)  (10)  (2)  314   (33)  281 
Ulster Bank  3,043   —   3,043   1,428   (131)  1,297   (430)  (24)  (104)  739   (219)  520 
Manufacturing  (85)  1   (84)  (144)  (1)  (145)  (1,362)  (178)  —   (1,685)  1,685   — 
Central items  444   617   1,061   (253)  657   404   (259)  (2)  1   144   (20)  124 
Eliminations  —   (2,464)  (2,464)  —   —   —   —   —   —   —   —   — 
   16,477   —   16,477   8,354   —   8,354   (4,144)  (227)  (849)  3,134   —   3,134 
Amortisation of intangibles  —   —   —   —   —   —   —   (6)  —   (6)  —   (6)
Integration costs  —   —   —   —   —   —   (12)  (31)  —   (43)  —   (43)
   16,477   —   16,477   8,354   —   8,354   (4,156)  (264)  (849)  3,085   —   3,085 

Notes on the accounts continued
37 Segmental analysis (continued)
   Group  
  Revenue  Total Income                        
   External   Inter
segment		   Total   External   Inter
segment		   Total   Operating expenses   Depreciation and amortisation   Impairment losses   Contribution   Allocation of Manufac- turing costs   Operating profit before tax 
2006  £m   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m   £m 
Global Banking & Markets  3,180   1,334   4,514   1,769   (63)  1,706   (896)  (8)  24   826   (96)  730 
UK Corporate Banking  2,222   —   2,222   1,805   (350)  1,455   (233)  —   (72)  1,150   (228)  922 
Retail  5,938   4   5,942   4,337   9   4,346   (979)  (1)  (697)  2,669   (1,130)  1,539 
Wealth Management  1,260   2   1,262   594   (6)  588   (317)  (11)  (1)  259   (52)  207 
Ulster Bank  2,557   20   2,577   1,175   (33)  1,142   (364)  (28)  (104)  646   (215)  431 
Manufacturing  26   5   31   (60)  (21)  (81)  (1,482)  (204)  —   (1,767)  1,767   — 
Central items  479   570   1,049   (294)  464   170   (428)  6   (2)  (254)  (46)  (300)
Eliminations  —   (1,935)  (1,935)  —   —   —   —   —   —   —   —   — 
   15,662   —   15,662   9,326   —   9,326   (4,699)  (246)  (852)  3,529   —   3,529 
Amortisation of intangibles  —   —   —   —   —   —   —   (6)  —   (6)  —   (6)
Integration costs  —   —   —   —   —   —   (62)  (5)  —   (67)  —   (67)
   15,662   —   15,662   9,326   —   9,326   (4,761)  (257)  (852)  3,456   —   3,456 
                                                 
2005                                                
Global Banking & Markets  2,212   1,002   3,214   1,507   114   1,621   (467)  (7)  27   1,174   (93)  1,081 
UK Corporate Banking  1,923   1   1,924   1,617   (373)  1,244   (330)  —   (35)  879   (224)  655 
Retail  5,772   1,301   7,073   4,109   (90)  4,019   (808)  (6)  (624)  2,581   (1,136)  1,445 
Wealth Management  1,102   2   1,104   508   (1)  507   (276)  (13)  (6)  212   (54)  158 
Ulster Bank  1,945   25   1,970   976   26   1,002   (314)  (25)  (95)  568   (207)  361 
Manufacturing  45   6   51   3   (30)  (27)  (1,550)  (57)  —   (1,634)  1,634   — 
Central items  64   438   502   (623)  354   (269)  (254)  (137)  (19)  (679)  80   (599)
Eliminations  —   (2,775)  (2,775)  —   —   —   —   —   —   —   —   — 
Continuing operations  13,063   —   13,063   8,097   —   8,097   (3,999)  (245)  (752)  3,101   —   3,101 
Discontinued operations  246   —   246   221   —   221   (70)  —   (4)  147   —   147 
Amortisation of intangibles  —   —   —   —   —   —   —   (6)  —   (6)  —   (6)
Integration costs  —   —   —   —   —   —   (32)  (131)  —   (163)  —   (163)
Net gain on sale of                                                
strategic investments                                                
and subsidiaries  332   —   332   332   —   332   —   —   —   332   —   332 
   13,641   —   13,641   8,650   —   8,650   (4,101)  (382)  (756)  3,411   —   3,411 

Note:
(1) Revenue represents total income included in the income statement grossed-up for interest payable and commissions payable.
   Group
   Assets - before allocation of Manufacturing assets   Allocation of Manufacturing assets   Assets   Loabilities - before allocation of Manufacturing liabilities   Alloocation of Manufacturing liabilities   Liabilities   Cost to acquire fixed assets and intangible assets - before allocation of Manufacturing assets   Allocation of Manufacturing assets   Cost to acquire fixed assets and intangible assets 
2007  £m   £m   £m   £m   £m   £m   £m   £m   £m 
Global Banking & Markets  121,506   115   121,621   99,891   —   99,891   138   13   151 
UK Corporate Banking  41,555   179   41,734   40,631   —   40,631   —   33   33 
Retail  59,357   857   60,214   69,546   —   69,546   1   110   111 
Wealth Management  26,688   79   26,767   25,646   —   25,646   19   13   32 
Ulster Bank  59,626   103   59,729   55,678   —   55,678   35   17   52 
Manufacturing  1,691   (1,691)  —   578   (578)  —   234   (234)  — 
Central items  1,859   358   2,217   8,210   578   8,788   2   48   50 
Group  312,282   —   312,282   300,180   —   300,180   429   —   429 
                                     
2006                                    
Global Banking & Markets  126,238   106   126,344   107,242   —   107,242   182   14   196 
UK Corporate Banking  36,476   179   36,655   36,921   —   36,921   —   38   38 
Retail  55,640   1,003   56,643   62,910   —   62,910   3   156   159 
Wealth Management  21,741   86   21,827   20,795   —   20,795   13   17   30 
Ulster Bank  46,507   117   46,624   41,874   —   41,874   166   21   187 
Manufacturing  1,977   (1,977)  —   329   (329)  —   302   (302)  — 
Central items  2,082   486   2,568   9,405   329   9,734   4   56   60 
Group  290,661   —   290,661   279,476   —   279,476   670   —   670 

115
34 Segmental analysis continued
(b) Geographical segments
The geographical analyses in the tables below have been compiled on the basis of location of office where the transactions are recorded.
 
  
 Group
  UK  USA  Europe  Rest of the World  Total 
2009   £m   £m   £m   £m   £m 
Total revenue   9,873   1,558   2,221   117   13,769 
                     
Net interest income   2,317   (5)   864   21   3,197 
Net fees and commissions   2,254   340   206   38   2,838 
Income/(loss) from trading activities   391   1,133   (77)   7   1,454 
Other operating income   1,515   5   265   —   1,785 
Total income   6,477   1,473   1,258   66   9,274 
                     
Operating profit/(loss) before tax   1,018   1,013   (899)   (3)   1,129 
                     
Total assets   213,085   74,112   59,440   4,091   350,728 
                     
Total liabilities   208,123   70,754   52,291   4,079   335,247 
                     
Net assets attributable to equity shareholders and minority interests   4,962   3,358   7,149   12   15,481 
                     
Contingent liabilities and commitments   59,892   83   1,220   1,136   62,331 
                     
Cost to acquire property, plant and equipment and intangible assets   124   126   1,365   —   1,615 
 
 
 
2008                     
Total revenue   12,046   134   3,476   202   15,858 
                     
Net interest income   4,577   141   658   21   5,397 
Net fees and commissions   2,518   333   293   45   3,189 
(Loss)/income from trading activities   (518)   (389)   (65)   9   (963) 
Other operating income/(loss)   78   (20)   22   1   81 
Total income   6,655   65   908   76   7,704 
                     
Operating profit/(loss) before tax   2,097   (187)   (767)   (3)   1,140 
                     
Total assets   186,140   63,984   66,589   4,506   321,219 
                     
Total liabilities   179,488   60,728   63,050   4,495   307,761 
                     
Net assets attributable to equity shareholders and minority interests   6,652   3,256   3,539   11   13,458 
                     
Contingent liabilities and commitments   64,470   3,355   1,378   4,156   73,359 
                     
Cost to acquire property, plant and equipment and intangible assets   218   214   188   19   639 

 
148
Segmental analysis of goodwill is as follows:
Notes on the accounts
34 Segmental analysis continued
  
 Group
  UK  USA  Europe  Rest of the World  Total 
2007   £m   £m   £m   £m   £m 
Total revenue   13,759   (250)   2,766   202   16,477 
Net interest income   4,379   (14)   711   15   5,091 
Net fees and commissions   2,506   341   281   62   3,190 
Income/(loss) from trading activities   186   (658)   108   4   (360) 
Other operating income   357   11   64   1   433 
Total income   7,428   (320)   1,164   82   8,354 
                     
Operating profit/(loss) before tax   2,989   (341)   423   14   3,085 
                     
Total assets   181,249   74,775   52,329   3,929   312,282 
                     
Total liabilities   174,797   72,521   48,950   3,912   300,180 
                     
Net assets attributable to equity shareholders and minority interests   6,452   2,254   3,379   17   12,102 
                     
Contingent liabilities and commitments   64,384   3,040   12,143   2,114   81,681 
                     
Cost to acquire property, plant and equipment and intangible assets   239   63   124   3   429 
35 Directors’ and key management remuneration
The directors of the Bank are also directors of the ultimate holding company and are remunerated for their services to the RBS Group as a whole. The remuneration of the directors is disclosed in the Report and Accounts of the RBS Group. Pensions paid to former directors of the Bank and their dependants amounted to £167,000 (2008 – £244,000).
 
        Group       
  Global             
  Banking &     Wealth  Ulster    
  Markets  Retail  Management  Bank  Total 
   £m   £m   £m   £m   £m 
At 1 January 2006  108   107   131   414   760 
Currency translation and other adjustments  (14)  (8)  (7)  (9)  (38)
Disposals  —   —   (3)  —   (3)
At 1 January 2007  94   99   121   405   719 
Currency translation and other adjustments  (1)  9   7   39   54 
Transfer between divisions  —   (44)  —   44   — 
At 31 December 2007  93   64   128   488   773 

(b) Geographical segments

The geographical analyses in the tables below have been compiled on the basis of location of office where the transactions are recorded.

        Group       
           Rest of    
  UK  USA  Europe  the World  Total 
2007  £m   £m   £m   £m   £m 
Total revenue  13,759   (250)  2,766   202   16,477 
                     
Net interest income  4,379   (14)  711   15   5,091 
Fees and commissions (net)  2,506   341   281   62   3,190 
Income from trading activities  186   (658)  108   4   (360)
Other operating income  357   11   64   1   433 
Total income  7,428   (320)  1,164   82   8,354 
                     
Operating profit before tax  2,989   (341)  423   14   3,085 
                     
Total assets  181,249   74,775   52,329   3,929   312,282 
                     
Total liabilities  174,797   72,521   48,950   3,912   300,180 
                     
Net assets attributable to equity shareholders and minority interests  6,452   2,254   3,379  ��17   12,102 
                     
Contingent liabilities and commitments  64,384   3,040   12,143   2,114   81,681 
                     
Cost to acquire property, plant and equipment and intangible assets  239   63   124   3   429 
                     
2006                    
Total revenue  11,811   1,140   2,506   205   15,662 
                     
Net interest income  3,865   (11)  581   14   4,449 
Fees and commissions (net)  2,327   258   309   74   2,968 
Income from trading activities  547   783   126   2   1,458 
Other operating income  315   48   88   —   451 
Total income  7,054   1,078   1,104   90   9,326 
                     
Operating profit before tax  2,434   623   399   —   3,456 
                     
Total assets  168,696   76,883   42,334   2,748   290,661 
                     
Total liabilities  163,083   74,723   38,938   2,732   279,476 
                     
Net assets attributable to equity shareholders and minority interests  5,613   2,160   3,396   16   11,185 
                     
Contingent liabilities and commitments  66,273   3,978   8,049   1,960   80,260 
                     
Cost to acquire property, plant and equipment and intangible assets  490   46   130   4   670 

Notes on the accounts continued
37 Segmental analysis (continued)
        Group       
           Rest of    
  UK  USA  Europe  the World  Total 
2005  £m   £m   £m   £m   £m 
Total revenue  10,417   1,078   1,982   164   13,641 
                     
Net interest income  3,858   12   578   13   4,461 
Fees and commissions (net)  2,308   157   208   73   2,746 
Income from trading activities  (5)  777   33   3   808 
Other operating income  493   45   97   —   635 
Total income  6,654   991   916   89   8,650 
                     
Operating profit before tax  2,522   560   297   32   3,411 
                     
Total assets  138,574   74,162   44,673   3,194   260,603 
                     
Total liabilities  133,341   72,218   41,787   3,073   250,419 
                     
Net assets attributable to equity shareholders and minority interests  5,233   1,944   2,886   121   10,184 
                     
Contingent liabilities and commitments  58,532   6,231   9,177   —   73,940 
                     
Cost to acquire property, plant and equipment and intangible assets  368   29   144   7   548 

38 Directors’ and key management remuneration

The current directors of the Bank are also directors of the ultimate holding company and are remunerated for their services to the RBS Group as a whole. The remuneration of the directors is disclosed in the Report and Accounts of the RBS Group. Pensions paid to former directors of the Bank and their dependants amounted to £243,000 (2006 – £307,000).

Compensation of key management
The aggregate remuneration of directors and other members of key management during the year, borne by the RBS Group, was as follows:
  2009  2008 
   £000   £000 
Short-term benefits   29,292   16,813 
Post-employment benefits   9,781   13,174 
Other long-term benefits   —   496 
Termination benefits   —   345 
Share-based payments   8,953   2,078 
   48,026   32,906 

149
Notes on the accounts continued
36 Transactions with directors and key management

The aggregate remuneration of directors and other members of key management during the year was as follows:

  RBS Group 
  2007  2006 
   £000   £000 
Short-term benefits  37,763   41,003 
Post-employment benefits  10,051   11,264 
Other long-term benefits  708   3,309 
Share-based payments  5,165   2,787 
   53,687   58,363 

39 Transactions with directors, officers and others

(a)At 31 December 2007,2009, the amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined in UK legislation, were £39,125£53,334 in respect of loans to 10 persons who were directors of the Bank (or persons connected with them) at any time during the financial period and £1,211,846 to 3 people who were officers of the Bank at any time during the financial period.
 
(b)For the purposes of IAS 24 ‘Related Party Disclosures’, key management comprise directors of the Bank and members of the RBS Group’s Group Executive Management Committee. The captions in the primary financial statements include the following amounts attributable, in aggregate, to key management:

  2007  2006 
   £000   £000 
Loans and advances to customers  1,479   1,884 
Customer accounts  2,177   1,797 

  2009  2008 
   £000   £000 
Loans and advances to customers   3,805   2,753 
Customer accounts   5,129   4,508 
Key management have banking relationships with Group entities which are entered into in the normal course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with other persons of a similar standing or, where applicable, with other employees. These transactions did not involve more than the normal risk of repayment or present other unfavourable features.
Key management had no reportable transactions or balances with the ultimate holding company.
150
Notes on the accounts
37 Related parties
UK Government
On 1 December 2008, the UK Government through HM Treasury became the ultimate controlling party of The Royal Bank of Scotland Group plc. The UK Government’s shareholding is managed by UK Financial Investments Limited, a company wholly owned by the UK Government. As a result the UK Government and UK Government controlled bodies became related parties of the Group.
The Group enters into transactions with many of these bodies on an arm’s length basis. Such transactions include the payment of: taxes including UK corporation tax and value added tax; national insurance contributions; local authority rates; and regulatory fees and levies; together with banking transactions such as loans and deposits undertaken in the normal course of banker-customer relationships. The volume and diversity of these transactions are such that disclosure of their amounts is impractical.
As at 31 December 2009 and 2008 balances with the UK Government and UK Government controlled bodies were:
  
 2009
 
 2008
  
Central government (including
the Bank of
England)
  
Local
government
  
Banks,
financial
corporations
and public
corporations
  Total  
Central
government
(including
the Bank of
England)
  
Local
government
  
Banks,
financial
corporations
and public
corporations
  Total 
Group   £m   £m   £m   £m   £m   £m   £m   £m 
Assets                                 
Balances at central banks   79   —   —   79   82   —   —   82 
Loans and advances to customers   6   247   32   285   5   146   37   188 
Debt securities   1   —   —   1   1,373   —   10   1,383 
Derivatives   —   3   1   4   —   4   3   7 
Other   —   —   3   3   —   —   —   — 
  
Liabilities                                 
Customer accounts   1,262   1,832   358   3,452   1,315   1,886   449   3,650 
Derivatives   —   6   —   6   —   9   7   16 
  
  
Bank                                 
Assets                                 
Balances at central banks   65   —   —   65   67   —   —   67 
Loans and advances to customers   4   106   28   138   4   146   32   182 
Derivatives   —   3   1   4   —   4   3   7 
  
Liabilities                                 
Customer accounts   1,228   1,672   325   3,325   1,307   1,249   444   3,000 
Derivatives   —   6   —   6   —   9   7   16 
No impairment losses were recognised by the Group in 2009 or 2008 in respect of balances with UK Government and UK Government controlled bodies.
Notes:
(1)In addition to the UK Government’s shareholding in the Group, the UK Government and UK Government controlled bodies may hold debt securities, subordinated liabilities and other liabilities or shares issued by the Group in the normal course of their business. It is not practicable to ascertain and disclose these amounts.
(2)Certain of the liability balances are secured.

151
Notes on the accounts continued
37 Related parties continued
Other related parties
(a)In their roles as providers of finance, Group companies provide development and other types of capital support to businesses. These investments are made in the normal course of business and on substantially the same terms, including interest rates and security, as for comparable transactions with other persons of a similar standing or, where applicable, with other employees. These transactions did not involve more than the normal risk of repayment or present other unfavourable features.
Key management had no reportable transactions or balances with the holding company except for dividends.

40 Related parties

(a)  
Group companies provide development and other types of capital support to businesses in their roles as providers of finance. These investments are made in the normal course of business and on arm’s-lengtharm’s length terms. In some instances, the investment may extend to ownership or control over 20% or more of the voting rights of the investee company. However, these investments are not considered to give rise to transactions of a materiality requiring disclosure under IAS 24.
(b)
The Group recharges The Royal Bank of Scotland Group Pension Fund with the cost of administration services incurred by it. The amounts involved are not material to the Group.
(c)
In accordance with IAS 24, transactions or balances between Group entities that have been eliminated on consolidation are not reported.
(d)
The captions in the primary financial statements of the Bank include amounts attributable to subsidiaries. These amounts have been disclosed in aggregate in the relevant notes to the financial statements. The table below discloses items included in income and operating expenses on transactions between the Group and fellow subsidiaries of the RBS Group.

  2007  2006 
   £m   £m 
Income        
Interest receivable  4,257   3,204 
Interest payable  1,090   744 
Fees and commissions receivable  235   122 
Fees and commissions payable  81   106 
         
Expenses        
Other administrative expenses  1,725   1,761 

41 Ultimate holding company

The Group’s ultimate holding company and ultimate controlling party is The Royal Bank of Scotland Group plc and its immediate parent company is The Royal Bank of Scotland plc. Both companies are incorporated in Great Britain and registered in Scotland. As at 31 December 2007, The Royal Bank of Scotland Group plc heads the largest group in which the Group is consolidated and The Royal Bank of Scotland plc heads the smallest group in which the Group is consolidated. Copiesfellow subsidiaries of the consolidated accounts of both companies may be obtained from The Secretary, The Royal Bank of Scotland Group plc, Gogarburn, PO Box 1000, Edinburgh EH12 1HQ.
42 Post balance sheet events

There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.

ITEM 19. EXHIBIT INDEXRBS Group.

  2009  2008 
   £m   £m 
Income         
Interest receivable   1,299   3,857 
Interest payable   1,119   1,147 
Fees and commissions receivable   221   299 
Fees and commissions payable   74   184 
  
Expenses         
Other administrative expenses   1,015   1,509 
38 Ultimate holding company
The Group’s ultimate holding company is The Royal Bank of Scotland Group plc and its immediate parent company is The Royal Bank of Scotland plc. Both companies are incorporated in Great Britain and registered in Scotland. As at 31 December 2009, The Royal Bank of Scotland Group plc heads the largest group in which the Group is consolidated and The Royal Bank of Scotland plc heads the smallest group in which the Group is consolidated. Copies of the consolidated accounts of both companies may be obtained from The Secretary, The Royal Bank of Scotland Group plc, Gogarburn, PO Box 1000, Edinburgh EH12 1HQ.
Following placing and open offers by The Royal Bank of Scotland Group plc in December 2008 and April 2009, the UK Government, through HM Treasury, currently holds 70.3% of the issued ordinary share capital of the ultimate holding company and is therefore the Group’s ultimate controlling party.
39 Post balance sheet events
There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.
On 25 March 2010, the RBS Group announced its intention to launch (i) an offer to exchange certain subordinated debt securities issued by Group members for new senior debt and (ii) tender offers in respect of certain preference shares, preferred securities and perpetual securities issued by Group members. The RBS Group expects to announce the offers in early April and will seek shareholder approvals as required in coordination with the annual general meeting of The Royal Bank of Scotland Group plc scheduled to take place on 28 April 2010.
On 30 March 2010, the Office of Fair Trading announced that it had arrived at an early resolution agreement with the RBS Group by which the RBS Group will pay a fine of £29 million and admit a breach in competition law relating to the provision of loan products to professional services firms.
152
Additional information
Glossary of terms
Adjustable rate mortgage (ARM) – in the US a variable-rate mortgage. ARMs include: hybrid ARMs which typically have a fixed-rate period followed by an adjustable-rate period; interest-only ARMs where interest only is payable for a specified number of years, typically for three to ten years; and payment-option ARMs that allow the borrower to choose periodically between various payment options.
 
Exhibit numberDescription
1.1*Memorandum and Articles of Association of National Westminster Bank Plc
7.1Explanation of ratio calculations
8.1Omitted pursuant to General Instruction I(2)(b) of Form 10-K as applied to reports on Form 20-F
12.1CEO certifications required by Rule 13a-14(a)
12.2CFO certifications required by Rule 13a-14(a)
13.1Certifications required by Rule 13a-14(b)Alt-A (Alternative A-paper) are mortgage loans with a higher credit quality than sub-prime loans but with features that disqualify the borrower from a traditional prime loan. Alt-A lending characteristics include limited documentation; high loan-to-value ratio; secured on non-owner occupied properties; and debt-to-income ratio above normal limits.
Arrears are the aggregate of contractual payments due on a debt that have not been met by the borrower. A loan or other financial asset is said to be ’in arrears’ when payments have not been made.
Asset-backed commercial paper (ABCP) – a form of asset-backed security generally issued by a commercial paper conduit.
Asset-backed securities (ABS) are securities that represent interests in specific portfolios of assets. They are issued by a special purpose entity following a securitisation. The underlying portfolios commonly comprise residential or commercial mortgages but can include any class of asset that yields predictable cash flows. Payments on the securities depend primarily on the cash flows generated by the assets in the underlying pool and other rights designed to assure timely payment, such as guarantees or other credit enhancements. Collateralised bond obligations, collateralised debt obligations, collateralised loan obligations, commercial mortgage backed securities and residential mortgage backed securities are all types of ABS.
Assets under management are assets managed by the Group on behalf of clients.
Collateralised bond obligations (CBOs) are asset-backed securities for which the underlying asset portfolios are bonds, some of which may be sub-investment grade.
Collateralised debt obligations (CDOs) are asset-backed securities for which the underlying asset portfolios are debt obligations: either bonds (collateralised bond obligations) or loans (collateralised loan obligations) or both. The credit exposure underlying synthetic CDOs derives from credit default swaps. The CDOs issued by an individual vehicle are usually divided in different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are borne first by the equity securities, next by the junior securities, and finally by the senior securities; junior tranches offer higher coupons (interest payments) to compensate for their increased risk.
Collateralised debt obligation squared (CDO-squared) is a type of collateralised debt obligation where the underlying asset portfolio includes tranches of other CDOs.
Collateralised loan obligations (CLOs) are asset-backed securities for which the underlying asset portfolios are loans, often leveraged loans.
Collectively assessed loan impairment provisions – impairment loss provisions in respect of impaired loans, such as credit cards or personal loans, that are below individual assessment thresholds. Such provisions are established on a portfolio basis, taking account the level of arrears, security, past loss experience, credit scores and defaults based on portfolio trends.
Commercial mortgage backed securities (CMBS) are asset-backed securities for which the underlying asset portfolios are loans secured on commercial real estate.
Commercial paper (CP) comprises unsecured obligations issued by a corporate or a bank directly or secured obligations (asset-backed CP), often issued through a commercial paper conduit, to fund working capital. Maturities typically range from two to 270 days. However, the depth and reliability of some CP markets means that issuers can repeatedly roll over CP issuance and effectively achieve longer term funding. Commercial paper is issued in a wide range of denominations and can be either discounted or interest-bearing.
Commercial paper conduit is a special purpose entity that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed either by further commercial paper issuance, repayment of assets or liquidity drawings.
Commercial real estate – freehold and leasehold properties used for business activities. Commercial real estate includes office buildings, industrial property, medical centres, hotels, retail stores, shopping centres, agricultural land and buildings, warehouses, garages etc.
Contractual maturity is the date in the terms of a financial instrument on which the last payment or receipt under the contract is due for settlement.
Core Tier 1 capital – called-up share capital and eligible reserves plus equity non-controlling interests, less intangible assets and other regulatory deductions.
Core Tier 1 capital ratio – core Tier 1 capital as a percentage of risk-weighted assets.
Cost: income ratio – operating expenses as a percentage of total income.
Covered mortgage bonds are debt securities backed by a portfolio of mortgages that is segregated from the issuer’s other assets solely for the benefit of the holders of the covered bonds.
Credit default swap (CDS) is a contract where the protection seller receives premium or interest-related payments in return for contracting to make payments to the protection buyer upon a defined credit event in relation to a reference financial asset or portfolio of financial assets. Credit events usually include bankruptcy, payment default and rating downgrades.
153
Additional information continued
Glossary of terms continued
Credit derivative product company (CDPC) is a special purpose entity that sells credit protection under credit default swaps or certain approved forms of insurance policies. Sometimes they can also buy credit protection. CDPCs are similar to monoline insurers. However, unlike monoline insurers, they are not regulated as insurers.
Credit derivatives are contractual agreements that provide protection against a credit event on one or more reference entities or financial assets. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency or failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event. Credit derivatives include credit default swaps, total return swaps and credit swap options.
Credit enhancements are techniques that improve the credit standing of financial obligations; generally those issued by an SPE in a securitisation. External credit enhancements include financial guarantees and letters of credit from third-party providers. Internal enhancements include excess spread – the difference between the interest rate received on the underlying portfolio and the coupon on the issued securities; and over-collateralisation – on securitisation, the value of the underlying portfolio is greater than the securities issued.
Credit risk assets – loans and advances (including overdraft facilities), instalment credit, finance lease receivables and other traded instruments across all customer types.
Credit risk spread is the difference between the coupon on a debt instrument and the benchmark or the risk-free interest rate for the instrument’s maturity structure. It is the premium over the risk-free rate required by the market for the credit quality of an individual debt instrument.
Credit valuation adjustments are adjustments to the fair values of derivative assets to reflect the creditworthiness of the counterparty.
Currency swap – an arrangement in which two parties exchange specific principal amounts of different currencies at inception and subsequently interest payments on the principal amounts. Often, one party will pay a fixed interest rate, while the other will pay a floating exchange rate (though there are also fixed-fixed and floating-floating arrangements). At the maturity of the swap, the principal amounts are usually re-exchanged.
Customer accounts comprise money deposited with the Group by counterparties other than banks and classified as liabilities. They include demand, savings and time deposits; securities sold under repurchase agreements; and other short term deposits. Deposits received from banks are classified as deposits by banks.
Debt restructuring – see renegotiated loans.
Debt securities are transferable instruments creating or acknowledging indebtedness. They include debentures, bonds, certificates of deposit, notes and commercial paper. The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue, such as the right to receive certain information. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities can be secured or unsecured.
Debt securities in issue comprise unsubordinated debt securities issued by the Group. They include commercial paper, certificates of deposit, bonds and medium-term notes.
Deferred tax asset – income taxes recoverable in future periods as a result of deductible temporary differences – temporary differences between the accounting and tax base of an asset or liability that will result in tax deductible amounts in future periods – and the carry-forward of tax losses and unused tax credits.
Deferred tax liability – income taxes payable in future periods as a result of taxable temporary differences (temporary differences between the accounting and tax base of an asset or liability that will result in taxable amounts in future periods).
Defined benefit obligation – the present value of expected future payments required to settle the obligations of a defined benefit plan resulting from employee service.
Defined benefit plan – pension or other post-retirement benefit plan other than a defined contribution plan.
Defined contribution plan – pension or other post-retirement benefit plan where the employer’s obligation is limited to its contributions to the fund.
Delinquency - a debt or other financial obligation is considered delinquent when one or more contractual payments are overdue. Delinquency is usually defined in terms of days past due. Delinquent and in arrears are synonymous.
Deposits by banks comprise money deposited with the Group by banks and recorded as liabilities. They include money-market deposits, securities sold under repurchase agreements, federal funds purchased and other short term deposits. Deposits received from customers are recorded as customer accounts.
Derivative – a contract or agreement whose value changes with changes in an underlying index such as interest rates, foreign exchange rates, share prices or indices and which requires no initial investment or an initial investment that is smaller than would be required for other types of contracts with a similar response to market factors. The principal types of derivatives are: swaps, forwards, futures and options.
Exposure at default (EAD) – an estimate of the expected level of utilisation of a credit facility at the time of a borrower’s default. The EAD may be higher than the current utilisation (e.g. in the case where further drawings may be made under a revolving credit facility prior to default) but will not typically exceed the total facility limit.
Fannie Mae (Federal National Mortgage Association) is a US Government Sponsored Enterprise. It buys mortgages, principally issued by banks, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.
154
Additional information
Federal Home Loan Mortgage Corporation see Freddie Mac.
Federal National Mortgage Association see Fannie Mae.
First/second lien – a lien is a charge such as a mortgage held by one party, over property owned by a second party, as security for payment of some debt, obligation, or duty owed by that second party. The holder of a first lien takes precedence over all other encumbrances on that property i.e. second and subsequent liens.
Forward contract – a contract to buy (or sell) a specified amount of a physical or financial commodity, at an agreed price, at an agreed future date.
Freddie Mac (Federal Home Loan Mortgage Corporation) is a US Government Sponsored Enterprise. It buys mortgages, principally issued by thrifts, on the secondary market, pools them, and sells them as residential mortgage-backed securities to investors on the open market. Its obligations are not explicitly guaranteed by the full faith and credit of the US Government.
Futures contract is a contract which provides for the future delivery (or acceptance of delivery) of some type of financial instrument or commodity under terms established at the outset. Futures differ from forward contracts in that they are traded on recognised exchanges and rarely result in actual delivery; most contracts are closed out prior to maturity by acquisition of an offsetting position.
G10 - the Group of Ten comprises the eleven industrial countries (Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States) that have agreed to participate in the IMF’s General Arrangements to Borrow.
Ginnie Mae (Government National Mortgage Association) is a US Government Agency that guarantees investors the timely payment of principal and interest on mortgage-backed securities for which the underlying asset portfolios comprise federally insured or guaranteed loans – mainly loans insured by the Federal Housing Administration or guaranteed by the Department of Veterans Affairs. Ginnie Mae obligations are fully and explicitly guaranteed as to the timely payment of principal and interest by the full faith and credit of the US Government.
Government Sponsored Enterprises (GSEs) are a group of financial services corporations created by the US Congress. Their function is to improve the efficiency of capital markets and to overcome statutory and other market imperfections which otherwise prevent funds from moving easily from suppliers of funds to areas of high loan demand. They include Fannie Mae and Freddie Mac.
Gross yield is the interest rate earned on average interest-earning assets, i.e. interest income divided by average interest-earning assets.
Guaranteed mortgages are mortgages that are guaranteed by a government or government agency. In the US, government loan guarantee programmes are offered by the Federal Housing Administration, the Department of Veterans Affairs, and the Department of Agriculture’s Rural Housing Service. In the Netherlands, the Gemeentegarantie programme is run partly by the central government and partly by the municipalities.
Home equity loan is a type of loan in which the borrower uses the equity in their home as collateral. A home equity loan creates a charge against the borrower’s house.
Impaired loans – a loan or other financial asset or portfolio of financial assets classified as held-to-maturity, available-for-sale or loans and receivables is impaired if there is objective evidence that an event or events since initial recognition of the asset have adversely affected the amount or timing of future cash flows from the asset.
Impairment allowance – see loan impairment provisions.
Impairment losses – for impaired financial assets measured at amortised cost, impairment losses – the difference between carrying value and the present value of estimated future cash flows discounted at the asset’s original effective interest rate – are recognised in profit or loss and the carrying amount of the financial asset reduced by establishing a provision (allowance). For impaired available-for-sale financial assets, the cumulative loss that had been recognised directly in equity is removed from equity and recognised in profit or loss as an impairment loss.
Individually assessed loan impairment provisions – impairment loss provisions for individually significant impaired loans assessed on a case-by-case basis, taking into account the financial condition of the counterparty and any guarantor and the realisable value of any collateral held.
International Accounting Standards Board (IASB) is the independent standard-setting body of the IASC Foundation. Its members are responsible for the development and publication of International Financial Reporting Standards (IFRS) and for approving Interpretations of IFRS as developed by the International Financial Reporting Interpretations Committee (IFRIC).
Interest rate swap – a contract under which two counterparties agree to exchange periodic interest payments on a predetermined monetary principal, the notional amount.
Interest spread is the difference between the gross yield and the interest rate paid on average interest-bearing liabilities.
Investment grade generally represents a risk profile similar to a rating of a “BBB-”/”Baa3” or better, as defined by independent rating agencies.
Latent loss provisions – loan impairment provisions held against impairments in the performing loan portfolio that have been incurred as a result of events occurring before the balance sheet date but which have not been identified as impaired at the balance sheet. The Group has developed methodologies to estimate latent loss provisions that reflect historical loss experience (adjusted for current economic and credit conditions) and the period between an impairment occurring and a loan being identified and reported as impaired.
Loan impairment provisions – are established to recognise incurred impairment losses on a portfolio of loans classified as loans and receivables and carried at amortised cost. It has three components: individually assessed loan impairment provisions, collectively assessed loan impairment provisions and latent loss provisions.
155
Additional information continued
Glossary of terms continued
Loan-to-value ratio – the amount of a secured loan as a percentage of the appraised value of the security, e.g. the outstanding amount of a mortgage loan as a percentage of the property’s value.
Loss given default (LGD) – the economic loss that may occur in the event of default i.e. the actual loss – that part of the exposure that is not expected to be recovered – plus any costs of recovery.
Master netting agreement is an agreement between two counterparties that have multiple derivative contracts with each other that provides for the net settlement of all contracts through a single payment, in a single currency, in the event of default on, or termination of, any one contract.
Medium term notes (MTNs) are debt securities usually with a maturity of five to ten years, but the term may be less than one year or as long as 50 years. They can be issued on a fixed or floating coupon basis or with an exotic coupon; with a fixed maturity date (non-callable) or with embedded call or put options or early repayment triggers. MTNs are most generally issued as senior, unsecured debt.
Monoline insurers are entities that specialise in providing credit protection against the notional and interest cash flows due to the holders of debt instruments in the event of default. This protection is typically in the form of derivatives such as credit default swaps.
Mortgage-backed securities – are asset-backed securities for which the underlying asset portfolios are loans secured on property. See residential mortgage backed securities and commercial mortgage backed securities.
Mortgage servicing rights are the rights of a mortgage servicer to collect mortgage payments and forward them, after deducting a fee, to the mortgage lender.
Mortgage vintage – the year in which a mortgage loan was made to the customer.
Negative equity mortgages – mortgages where the value of the property mortgaged is less than the outstanding balance on the loan.
Net interest income is the difference between interest receivable on financial assets classified as loans and receivables or available-for-sale and interest payable on financial liabilities carried at amortised cost.
Net interest margin is net interest income as a percentage of average interest-earning assets.
Net principal exposure is the carrying value of a financial asset after taking account of credit protection purchased but excluding the effect of any counterparty credit valuation adjustment to that protection.
Non-accrual loans comprise all loans for which an impairment provision has been established; for collectively assessed loans, impairment loss provisions are not allocated to individual loans and the entire portfolio is included in non-accrual loans.
Option - an option is a contract that gives the holder the right but not the obligation to buy (or sell) a specified amount of the underlying physical or financial commodity, at a specific price, at an agreed date or over an agreed period. Options can be exchange-traded or traded over-the-counter.
Past due – a financial asset such as a loan is past due when the counterparty has failed to make a payment when contractually due.
Potential problem loans – are loans other than non-accrual loans, accruing loans which are contractually overdue 90 days or more as to principal or interest and troubled debt restructurings where known information about possible credit problems of the borrower causes management to have serious doubts about the borrower’s ability to meet the loan’s repayment terms.
Prime - prime mortgage loans generally have low default risk and are made to borrowers with good credit records and a monthly income that is at least three to four times greater than their monthly housing expense (mortgage payments plus taxes and other debt payments). These borrowers provide full documentation and generally have reliable payment histories.
Private equity investments are equity investments in operating companies not quoted on a public exchange. Capital for private equity investment is raised from retail or institutional investors and used to fund investment strategies such as leveraged buyouts, venture capital, growth capital, distressed investments and mezzanine capital.
Probability of default (PD) – the likelihood that a customer will fail to make full and timely repayment of credit obligations over a one year time horizon.
Regular way purchase or sale is a purchase or sale of a financial asset under a contract whose terms require delivery of the asset within the time frame established generally by regulation or convention in the marketplace concerned.
Renegotiated loans – loans are generally renegotiated (‘restructured’) either as part of the ongoing banking relationship with a creditworthy customer or in response to a borrower’s financial difficulties. In the latter case renegotiation may result in an extension of the due date of payment, a concessionary rate of interest or other changes in the terms of the loan; the loan continues to be overdue and will be individually impaired if the renegotiated payments of interest and principal are insufficient to recover the loan’s original carrying amount.
Repurchase agreement (Repo) see Sale and repurchase agreements.
Residential mortgage backed securities (RMBS) are asset-backed securities for which the underlying asset portfolios are residential mortgages.
Retail loans are loans made to individuals rather than institutions. The loans may be for car purchases, home purchases, medical care, home repair, holidays and other consumer uses.
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Additional information
Reverse repurchase agreement (Reverse repo) – see Sale and repurchase agreements.
Risk asset ratio (RAR) – total regulatory capital as a percentage of risk-weighted assets.
Risk elements in lending (REIL) comprise non-accrual loans, accruing loans which are contractually overdue 90 days or more as to principal or interest and troubled debt restructurings.
Risk-weighted assets – assets adjusted for their associated risks using weightings established in accordance with the Basel Capital Accord as implemented by the FSA. Certain assets are not weighted but deducted from capital.
Sale and repurchase agreements – in a sale and repurchase agreement one party, the seller, sells a financial asset to another party, the buyer, at the same time the seller agrees to reacquire, and the buyer to resell, the asset at a later date. From the seller’s perspective such agreements are repurchase agreements (repos) and from the buyer’s reverse repurchase agreements (reverse repos).
Securitisation is a process by which assets or cash flows are transformed into transferable securities. The underlying assets or cash flows are transferred by the originator or an intermediary, typically an investment bank, to a special purpose entity which issues securities to investors. Asset securitisations involve issuing debt securities (asset-backed securities) that are backed by the cash flows of income-generating assets (ranging from credit card receivables to residential mortgage loans). Liability securitisations typically involve issuing bonds that assume the risk of a potential insurance liability (ranging from a catastrophic natural event to an unexpected claims level on a certain product type).
Special purpose entity (SPE) is an entity created by a sponsor, typically a major bank, finance company, investment bank or insurance company. An SPE can take the form of a corporation, trust, partnership, corporation or a limited liability company. Its operations are typically limited for example in a securitisation to the acquisition and financing of specific assets or liabilities.
Structured notes are securities that pay a return linked to the value or level of a specified asset or index. Structured notes can be linked to equities, interest rates, funds, commodities and foreign currency.
Student loan related assets are assets that are referenced to underlying student loans.
Subordinated liabilities are liabilities which, in the event of insolvency or liquidation of the issuer, are subordinated to the claims of depositors and other creditors of the issuer.
Sub-prime – sub-prime mortgage loans are designed for customers with one or more high risk characteristics, such as: unreliable or poor payment histories; loan-to-value ratio of greater than 80%; high debt-to-income ratio; the loan is not secured on the borrower’s primary residence; or a history of delinquencies or late payments on the loan.
Super senior CDO is the most senior class of instrument issued by a CDO vehicle. They benefit from the subordination of all other instruments, including AAA-rated securities, issued by the CDO vehicle.
Tier 1 capital – core Tier 1 capital plus other Tier 1 securities in issue, less material holdings in financial companies.
Tier 1 capital ratio – Tier 1 capital as a percentage of risk-weighted assets.
Tier 2 capital – qualifying subordinated debt and other Tier 2 securities in issue, eligible collective impairment allowances, unrealised available for sale equity gains and revaluation reserves less certain regulatory deductions.
Troubled debt restructurings – comprise those loans that are troubled debt restructurings but that are not included in either non-accrual loans or in accruing loans which are contractually overdue 90 days or more as to principal or interest. A restructuring of a loan is a troubled debt restructuring if the lender, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider.
US Government National Mortgage Association see Ginnie Mae.
Unaudited – unaudited financial information is information that has not been subjected to the audit procedures undertaken by the Group’s auditors to enable them to express an opinion on the Group’s financial statements.
VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels.
Wrapped security – a wrapped security is a debt security where the holder benefits from credit protection provided by a third party, typically a financial guarantor or monoline insurer.
Write down – a reduction in the carrying value of an asset to record a decline in its fair value or value in use.

157
Additional information continued
Five year summary
  2009  2008  2007  2006  2005 
Summary consolidated income statement  £m   £m   £m   £m   £m 
Net interest income   3,197   5,397   5,091   4,449   4,461 
Non-interest income (1)
  6,077   2,307   3,263   4,877   4,189 
Total income   9,274   7,704   8,354   9,326   8,650 
Operating expenses (2, 3, 4) 
  (4,006)   (5,202)   (4,420)   (5,018)   (4,483) 
Profit before impairment losses   5,268   2,502   3,934   4,308   4,167 
Impairment losses   (4,139)   (1,362)   (849)   (852)   (756) 
Operating profit before tax   1,129   1,140   3,085   3,456   3,411 
Tax credit/(charge)   5   (599)   (768)   (831)   (948) 
Profit after tax   1,134   541   2,317   2,625   2,463 
Minority interests   —   (93)   (89)   (39)   (17) 
Profit attributable to ordinary shareholders   1,134   448   2,228   2,586   2,446 
Notes:
(1)Includes gain on redemption of own debt of £381 million in 2009.
 
* Incorporated by reference to
(2)Includes integration and restructuring costs of £150 million (2008 – £42 million, 2007 – £43 million, 2006 – £67 million, 2005 – £163 million).
(3)Includes write-down of goodwill and other intangible assets of £716 million in 2008.
(4)Includes gain on pensions curtailment of £544 million in 2009.

  2009  2008  2007  2006  2005 
Summary consolidated balance sheet  £m   £m   £m   £m   £m 
Loans and advances   297,633   264,501   260,425   243,974   215,938 
Debt securities and equity shares   35,755   37,122   39,047   33,701   30,338 
Derivatives and settlement balances   9,043   13,012   6,275   6,320   6,907 
Other assets   8,297   6,584   6,535   6,666   7,420 
Total assets   350,728   321,219   312,282   290,661   260,603 
  
Shareholders’ equity   14,199   12,135   10,788   10,173   9,440 
Minority interests   1,282   1,323   1,314   1,012   744 
Subordinated liabilities   8,999   10,099   5,932   5,641   6,648 
Deposits   288,896   254,017   250,380   227,477   203,925 
Derivatives, settlement balances and short positions   21,258   21,157   18,206   26,617   24,231 
Other liabilities   16,094   22,488   25,662   19,741   15,615 
Total liabilities and equity   350,728   321,219   312,282   290,661   260,603 

158
ITEM 19. EXHIBIT INDEX
Exhibit numberDescription
1.1 to the*Memorandum and Articles of Association of National Westminster Bank Plc Annual Report
7.1Explanation of ratio calculations
8.1Omitted pursuant to General Instruction I(2)(b) of Form 10-K as applied to reports on Form 20-F for the fiscal year ended 31 December 2002 (File No. 1-9266).
12.1CEO certifications required by Rule 13a-14(a)
12.2CFO certifications required by Rule 13a-14(a)
13.1Certifications required by Rule 13a-14(b)
*  Previously filed and incorporated by reference to Exhibit 1.1 to the company’s Annual Report on Form 20-F for the fiscal year ended 31 December 2009 (File No. 1-09266)
159
 
SIGNATURE
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report to be signed on its behalf.
 
Signatures
Pursuant to the requirements of Section 12 of the Securities Exchange Act of 1934, the registrant certifies that it meets all of the requirements for filing on Form 20-F and has duly caused this annual report to be signed on its behalf by the undersigned, thereunto duly authorised.
National Westminster Bank Plc
Registrant
 
/s/ Guy Robert WhittakerBruce Van Saun
 
Guy Robert WhittakerBruce Van Saun
Group Finance Director
 
25 June27 April 20082010
 
 
Exhibit number Description 
     
1.1* Memorandum and Articles of Association of National Westminster Bank Plc 
     
7.1  Explanation of ratio calculations 
     
8.1  Omitted pursuant to General Instruction I(2)(b) of Form 10-K as applied to reports on Form 20-F 
     
12.1  CEO certifications required by Rule 13a-14(a) 
     
12.2  CFO certifications required by Rule 13a-14(a) 
     
13.1  Certifications required by Rule 13a-14(b) 

*  IncorporatedPreviously filed and incorporated by reference to Exhibit 1.1 to the National Westminster Bank Plccompany’s Annual Report on Form 20-F for the fiscal year ended 31 December 20022009 (File No. 1-9266).1-09266)
 
121161