Santander Bank Risk management report 2011
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Transcript of Santander Bank Risk management report 2011
Risk management report
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:17 Página 144
Executive summary
Corporate principles of risk management
Corporate governance of the risks function
Integral control of risk
Credit riskCredit exposure in Spain
Market riskManagement of financing and liquidity risk
Operational risk
Reputational risk
Adjustment to the new regulatory framework
Economic capital
Risk training activities
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146 ANNUAL REPORT 2011
Executive summary
Independence of the risk function.
Involvement of senior management in decision-taking.
Collegiate decisions that ensure the contrast of opinions.
Clear definition of attributions.
Control and management of risk integrated via a corporatestructure with all risk, all businesses and all countries scope.
Banco Santander’s risk management principlespages 148 to 151
Amount of provisions
Additional provisions under new rules at 31.12.2011
Against results 2011
Buffer covered with surplus of existing capital
Provisions pending
Financing of new provisions in 2012
Charged to capital gains from the sale of Santander Colombia
Charged to other capital gains and ordinary allowances 2012
Impact on Grupo Santander of the financialreform in Spain Million euros
6,100
-1,800
-2,000
= 2,300
2,300
900
1,400
Credit risk
12
59
26
105
23.4
8.6
225
Residential mortgages
Other loans to individuals
Companies excluding real estate purpose
With real estate purpose
Foreclosed properties32.0
Public administrations
Total Spain (Billion euros)
Spain 29%
Exposure to the construction sector andreal estate promotion Billion euros
Doubtful loans6.7 (21%)
Foreclosed properties 8.6 (27%)
Normal portfolio12.8 (40%) Sub standard 3.9 (12%)
Total: 32.0
pages 156 to 177
United Kingdom34%
Brazil 11%
Mexico 3%
Rest of Latin America2%
Chile3%
Portugal 4%
Sovereign 5%
Germany 4%Commercial Poland 1%Rest of Europe 4%
Credit to clients (gross)% of operating areas
It accounts for 4% of the Group's gross loans plus foreclosed properties in Spain.
Exposure to real estate sector in Spainpages 168 to 170
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147ANNUAL REPORT 2011
Management of funding and liquidity riskpages 188 to 192
• Santander’s subsidiaries are autonomous and self-sufficient in capital and liquidity and are subject tocoordination and the Group’s corporate policies.
• The portfolio of loans (77% of net assets) is whollyfinanced by customer deposits and medium- and long-term funding.
• In 2011, EUR 40,000 million of debt was issued,covering 124% of the year’s maturities andamortisations.
• Santander has a total discounting capacity in centralbanks of around EUR 100,000 million.
Metrics
Loans/Net assets
Customer deposits, insurance and medium and long-term funding/Lending
Customer deposits, insurance and medium and long-term financing,shareholders’ funds and other liabilities/Loans+fixed assets
Short-term funding/Net liabilities
Loan-to-deposit ratio
2011
77%
113%
114%
2%
117%
2010
75%
115%
117%
3%
117%
Monitoring metrics
2009
79%
106%
110%
5%
135%
Market riskpages 178 to 192
03 Jan
.
22 Jan
.
10 Feb
.
20 M
ar.
08 Apr.
27 Apr.
16 M
ay.
04 Jun
.
23 Jun
.
12 Jul.
31 Jul.
19 Aug
.
07 Sep
.
26 Sep
.
15 O
ct.
03 Nov.
22 Nov.
11 Dec.
30 Dec.
34
30
26
22
18
14
10
Max. (33.2)
Min. (12.0)
• Santander maintains a moderate exposure tomarket risk.
• Despite high volatility in financial markets, theaverage exposure in trading activity was lowerthan in 2010.
• In 2011, the Group continued to reduce, from analready low level, its exposure related to complexstructured assets.
Economic capitalpages 200 to 202
• The Group’s economic capital at the end of 2011was EUR 45,838 million.
• By business units, continental Europe accountsfor 39%, Latin America 34%, the UK 10%,Sovereign 6% and financial management andequity stakes 11%.
• The Group’s diversification generates economiccapital savings.
Analysis of the global risk profileBy type of risk
Material assets 2%
FX structural 5%
ALM 8%
Business 7%
Non-trading equity 4%
Credit 64%
Trading 1%Operational 9%
VaR evolution in 2011 Million euros. VaR at 99%. Time frame of one day
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The importance of Grupo Santander’s risk policy wasunderscored again in 2011. The policy is focused on maintaininga medium-low and predictive profile in all risks, which, togetherwith the Group’s high degree of diversification, was again thedifferential element that enabled Santander to maintain aleading position in the market.
For Grupo Santander, quality management of risk is one of itshallmarks and thus a priority in its activity. Throughout its 150years, Santander has combined prudence in risk managementwith use of advanced risk management techniques, which haveproven to be decisive in generating recurrent and balancedearnings and creating shareholder value.
The risks model is based on the following principles:
• Independent working from the business areas. Mr. MatíasRodríguez Inciarte, the Group’s third vice-chairman andchairman of the board’s risk committee, reports directly to theexecutive committee and to the board. The establishment ofseparate functions between the business areas (risk takers)and the risk areas responsible for measurement, analysis,control and information provides sufficient independence andautonomy to control risks appropriately.
• Involvement of senior management in all decisions taken.
• Collegiate decision-making (including at the branch level),which ensures a variety of opinions and does not make resultsdependent on decisions solely taken by individuals. Jointresponsibility for decisions on credit operations between riskand business areas, with the former having the last word inthe event of disagreement.
• Defining functions. Each risk taker unit and, whereappropriate, risk manager has clearly defined the types ofactivities, segments, risks in which they could incur anddecisions they might make in the sphere of risks, inaccordance with delegated powers. How risk is contracted,managed and where operations are recorded is also defined.
• Centralised control. Risk control and management isconducted on an integrated basis through a corporatestructure, with global scope responsibilities (all risk, allbusinesses, all countries).
Management and control of risk is developed in the followingway:
• Formulate the risk appetite. The purpose is to delimit,synthetically and explicitly, the levels and types of risk that thebank is ready to assume in the development of its business.
• Establish risk policies and procedures. They constitute thebasic framework for regulating risk activities and processes. Atthe local level, the risk units incorporate the corporate rules totheir internal policies.
• Building, independent validation and approval of the riskmodels developed in accordance with the corporatemethodological guidelines. These models systemise the riskorigination processes as well as their monitoring and recoveryprocesses, calculate the expected loss, the capital needed andevaluate the products in the trading portfolio.
• Execute a system to monitor and control risks, which verifiesevery day and with the corresponding reports the extent towhich Santander’s risks profile is in line with the risk policiesapproved and the limits established.
Santander’s risk management is fully identified with the Baselprinciples as it recognises and supports the industry’s mostadvanced practices which the Group has been anticipating and,as a result, it has been using for many years various tools andtechniques which will be referred to later in this section. Theyinclude:
• Internal rating and scoring models which, by assessing thevarious qualitative and quantitative components by client andoperation, enable the probability of failure to be estimatedfirst and then, on the basis of estimates of loss given default,the expected loss.
• Economic capital, as the homogeneous metric of the riskassumed and the basis for measuring management, usingRORAC, for pricing operations (bottom up), and for analysis ofportfolios and units (top down), and VaR, as the element ofcontrol and setting the market risk limits of the various tradingportfolios.
• Analysis of scenarios and stress tests to complement theanalysis of market and credit risk, in order to assess theimpact of alternative scenarios, including on provisions andon the capital.
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Corporate principles of risk management, control and appetite
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Grupo Santander calculates the minimum regulatory capital inaccordance with Bank of Spain circular 3/2008 and subsequentchanges on determining and controlling the minimum equity ofcredit institutions. This regulation completed the transfer toSpanish banking legislation of various EU directives.
As a result of the new elements introduced into the regulatoryframework, commonly known as BIS III, Grupo Santander tooksteps to apply with sufficient prevision the future requirementsindicated in BIS III. This entails a greater requirement for highquality capital, sufficiency of capital conservation and countercyclical.
Grupo Santander’s risk appetiteThe risk appetite is defined in Santander as the amount and typeof risks considered reasonable to assume for implementing itsbusiness strategy, so that the Group can maintain its ordinaryactivity in the event of unexpected events that could have anegative impact on its level of capital, levels of profitabilityand/or its share price.
The board is responsible for establishing the risk appetite andmonitoring the risk profile and ensuring the consistencybetween both of them. Senior management is responsible forachieving the desired risk profile as well managing risks on adaily basis. The establishment of the risk appetite covers boththe risks whose assumption constitutes the strategic objectiveand for which maximum exposure criteria are set —minimumobjectives of return/risk— as well as those whose assumption isnot desired but which cannot be avoided in an integral way. Theboard will ensure that the amount and type of risks relevant forthe bank have been taken into account. These derive from theannual budget approved as well as the medium-term strategicplan. It also ensures that sufficient resources have been assignedto manage and control these risks, at both the global and locallevels.
The board will regularly revise, at least once a year, the Group’srisk appetite and its management framework, analysing theimpact of unlikely but plausible tension scenarios and adoptingthe pertinent measures to ensure the policies set are met.
The risk appetite is formulated for the whole Group as well asfor each of its main business units. The boards of thesubsidiaries must approve the respective risk appetite proposalsadapted to the corporate framework.
Risk appetite frameworkSantander’s risk appetite framework has quantitative as well asqualitative elements that are integrated into a series of basicmetrics (applicable to both the whole of the Group as well as itsmain business units) and another series of transversal metricswhich because of their nature are directly applied for the wholeof the Group’s units.
Qualitative elements of the risk appetite:The qualitative elements of the risk appetite framework define,both generally and for the main risk factors, the positioning thatSantander’s senior management wises to adopt or maintain inthe development of its business model. Generally, GrupoSantander’s risk appetite framework is based on maintaining thefollowing qualitative objectives:
• A general medium-low and predictable risk profile based on adiversified business model, focused on retail banking and withan internationally diversified presence and with significantmarket shares. Develop a wholesale banking model whichattaches importance to the relationship with clients in theGroup’s core markets.
• Maintain a rating in a range between AA- and A- on the basisof the environment at both Group level as well as in the localunits (in local scale), and the evolution of sovereign risk.
• Maintain a stable and recurring policy of profit generation andshareholder remuneration on the foundations of a strongcapital base and liquidity and an efficient diversificationstrategy by sources and maturities.
• Maintain an organisational structure based on autonomousand self-sufficient subsidiaries in terms of capital and liquidity,minimising the use of non-operational or investmentcompanies, and ensuring that no subsidiary has a risk profilethat could jeopardise the Group’s solvency.
• Maintain an independent risk function and intenseinvolvement by senior management that guarantees a strongrisk culture centred on protecting and ensuring an adequatereturn on capital.
• Maintain a management model that ensure a global visionand one inter-related with all risks, through an environmentof control and robust corporate monitoring of risks, withglobal scope responsibilities: all risk, all businesses, allcountries.
• Focus the business model on those products which the Grouphas sufficient knowledge of and the management capacity(systems, processes and resources).
• The confidence of customers, shareholders, employees andprofessional counterparts, guaranteeing the development oftheir activity within its social and reputational commitment, inaccordance with the Group’s strategic objectives.
• Maintain adequate and sufficient availability of the necessaryhuman resources, systems and tools that guarantee thecontinuation of a risk profile compatible with the risk appetiteestablished, both at the global and local levels.
• Implement a remuneration policy that contains the necessaryincentives to ensure that the individual interests of employeesand executives are aligned with the corporate framework ofrisk appetite and these are consistent with the evolution ofthe institution’s results over the long term.
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Quantitative elements of risk appetiteThe quantitative elements that comprise the risk appetiteframework are specified in the following basic metrics:
• The maximum losses that the bank has to assume,
• The minimum capital position that the bank wants tomaintain, and
• The minimum liquidity position that the bank wishes to have
in the event of unlikely but plausible tension scenarios.
The Group also has a series of transversal metrics to limit theexcessive concentration of the Group’s risk profile, both by riskfactors as well as from the standpoint of customers, businesses,countries and products.
The risk appetite framework distinguishes between:
a) Risk capacity: the maximum level of risk that the Group cantechnically assume in the development of its business planswithout compromising its commercial viability;
b) Risk appetite: the level, type of risk and geographicdistribution that the Group is ready to accept in order toattain the strategic objectives in its business plan;
c) Objective risk: the level and type of risk the Groupincorporates into its budgets.
Risk tolerance is defined as the difference between riskappetite and objective risk. The risk appetite framework includessetting a series of triggers as the risk tolerance is consumed.Once these levels are reached and the board is informed thenecessary management measures are adopted so that the riskprofile can be reconducted.
LossesOne of the three basic metrics used to formulate Santander’srisk appetite is expressed in terms of the maximum losses it isprepared to assume in the event of unfavourable scenarios —internal and external— whose probability ofoccurrence is considered low but plausible.
We regularly conduct analysis of the impact, in terms of losses,of submitting the portfolios and other elements that make upthe bank’s risk profile to stress scenarios that take into accountvarious degrees of the probability of occurring.
The time frame for materialisation of the negative impact for allrisks considered will normally be 12 months, except for creditrisk where an additional impact analysis is conducted with athree year time frame.
Capital positionSantander wants to operate with a large capital base thatenables it not only to comply with the regulatory requirementsbut also have a reasonable surplus of capital. Its core capitaltarget is 10%, which is one percentage point above the 9%required by the European Banking Authority (EBA).
The capital target extends to a period of three years, within thecapital planning process implemented in the Group.
Liquidity positionThe Group’s liquidity management model is based on thefollowing principles:
• Decentralised liquidity model: autonomy of the subsidiarieswithin management coordinated at the Group level.
• Comfortable structural liquidity position supported by stablefunding: mainly customer deposits (principally in the retailsegment) and medium- and long-term wholesale funding(with an objective of an average maturity of more than threeyears).
• Ample access to wholesale markets and diversification bymarkets, instruments and maturities.
• High discounting capacity in central banks.
Bearing in mind the Group’s wish to be structured on the basisof autonomous subsidiaries, liquidity management is executedby each of our subsidiaries. All of them, thus, must be self-sufficient as regards the availability of liquidity.
Transversal metrics of risk appetite: concentrationSantander wants to maintain a well diversified risk portfolio fromthe standpoint of its exposure to large risks, certain markets andspecific products. In the first instance, this is achieved by virtue ofSantander’s focus on retail banking business with a high degreeof international diversification.
Concentration risk: this is measured via three focuses, whichinclude limits set as signs of alert or control:
• Customer: individual and aggregate exposure to the 20 largestclients as a proportion of shareholders’ funds.
• Product: maximum exposure of clients to derivatives.
• Sector: maximum percentage of exposure of the portfolio ofcompanies to an economic sector.
Specific objectives by type of riskIn addition, Grupo Santander’s risk appetite framework includesspecific objectives for the following types of risk:
Credit risk• Complete management of the credit risk cycle with a
corporate model based on establishing budgets, structure oflimits and management plans for them and on monitoringand control integrated with global reach responsibilities.
• Global and inter-related vision of the credit exposure, withportfolio vision, including, for example, lines committed,guarantees, off-balance sheet, etc.
• Involvement of the risk function in all credit risk admissions,avoiding the taking of discretionary decisions at the personallevel, combined with a strict structure of delegation ofpowers.
• Systematic use of scoring and rating models.
• Centralised control and in real time of the counterparty risk.
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Market risk
• Moderate market risk appetite.
• Business model focused on the customer with scant exposureto own account business activities.
• Independent calculation of the results of market activities bythe risk function.
• Daily centralised control of the market risk of trading activity(VaR).
• Strict control ex ante of products, underlying assets,currencies, etc, for which operations are authorised as well asof the corresponding valuation models.
Structural risks
• Conservative management of balance sheet and of liquidityrisk on the basis of the what is stated in the previous sections.
• Active management of exchange rates in relation to thehedging of capital and the results in subsidiaries.
• Reduced sensitivity of margins and capital to changes ininterest rates in stress situations.
• Limited assumption of credit risk in managing the Group’sbalance sheet.
• Limited assumption of cross-border risk.
Technology and operational risk
• Supervision of technology and operational risk managementthrough approval of the management framework and of thestructure of the corresponding limits.
• Management focus centred on risk mitigation, based onmonitoring and controlling gross losses/gross income, self-assessment questionnaires/risk maps and managementindicators.
• Operational and technology integration model via corporateplatforms and tools.
• Systems’ architecture with adequate redundancies andcontrols in order to guarantee a minimum probability ofoccurrence of high impact events and which, in their case,limit their severity.
• Business Continuity Master Plan with local developments;local plans of contingency coordinated with the corporatearea of technology and operational risk.
Compliance and reputational risk
• Compliance with all the regulatory requirements, ensuringqualifications and substantial recommendations are avoidedin audits and supervisors’ reviews.
• Maintain the confidence of customers, shareholders andemployees, as well as society in general, regarding solvencyand reputation.
• Maintain a zero appetite in compliance and reputational riskthrough corporate policies, with local implementation, backedby risk indicators and the functioning of corporate and localcommittees that enable risk to be identified, monitored andmitigated in matters of:
• – Prevention of money laundering: (Analysis and resolutionCommittee);
• – Compliance (committee of compliance with regulations):codes of conduct in the securities market; suspiciousoperations; abuse of market; institutional relations; Marketsin Financial Instruments Directive (MiFid); customers’complaints to supervisors; data protection regulations andcode of conduct of employees;
• – Commercialisation of products: reputational riskmanagement office and committees of approval, marketingand monitoring of products, observing operational, conductand reputational risk criteria.
• Registry and monitoring of disciplinary procedures, total costby losses including fines and sanctions.
• Continuous monitoring of audits and revisions of thesupervisors and of their corresponding recommendations inthe sphere of compliance and reputational risk.
Risk appetite and living willThe Group has an organisational structure based onautonomous and self-sufficient subsidiaries in terms of capitaland liquidity, minimising the use of non-operating or investmentcompanies, and ensuring that no subsidiary has a risk profilethat could jeopardise the Group’s solvency.
Grupo Santander was the first of the international financialinstitutions considered globally systemic by the Financial StabilityBoard to present (in 2010) to its consolidated supervisor (theBank of Spain) its corporate living will including, as required, aviability plan and all the information needed to plan a possibleliquidation (resolution plan). Furthermore, and even though notrequired, in 2010 more summarised individual plans were drawnup for the main geographic units, including Brazil, Mexico, Chile,Portugal and the UK. The second version of the corporate livingwill was presented in 2011 and also the second version of themain summarised local and voluntary plans, and progress wasmade in drawing up the local obligatory plans for the Group’sentities which must be eventually presented.
Also noteworthy was the significant contribution that the livingwill exercise made to the conceptual delimitation of the Group’srisk appetite and risk profile.
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The risk committee is responsible for proposing to the board theGroup’s risk policy, approval of which corresponds to the boardunder its powers of administration and supervision. Thecommittee also ensures that the Group’s activities are consistentwith its risk tolerance level and establishes the global limits forthe main risk exposures, reviewing them systematically andresolving those operations that exceed the powers delegated inbodies lower down the hierarchy.
The committee is of an executive nature and takes decisions inthe sphere of the powers delegated in it by the board. It ischaired by the third vice-chairman of Grupo Santander and fourother board members are also members of the committee.
The committee met 99 times during 2011, underscoring theimportance that Grupo Santander attaches to appropriatemanagement of its risks.
The main responsibilities of the board’s risk committee are:
• Propose to the board the risk policy for the Group, whichmust, in particular, identify:
• – The different types of risk (operational, technological,financial, legal and reputational, among others) facing theGroup.
• – The information and internal control systems used tocontrol and manage these risks.
• – Set the level of risk considered acceptable.
• – The measures envisaged to mitigate the impact of identifiedrisks, in the event that they materialise.
• Systematically review exposures with the main customers,economic sectors, geographic areas and types of risk.
• Authorise the management tools and risk models and befamiliar with the results of the internal validation.
• Ensure that the Group’s actions are consistent with thepreviously decided risk appetite level.
• Know, assess and monitor the observations andrecommendations periodically formulated by the supervisoryauthorities in the exercise of their function.
• Resolve operations beyond the powers delegated to bodieslower down the hierarchy, as well as the global limits of pre-classification of economic groups or in relation to exposuresby classes of risk.
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1. Corporate governanceof the risks function
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The board’s risk committee delegates some of its powers in riskcommittees which are structured by geographic area, businessand types of risk, all of them defined in the corporategovernance risk model.
In addition, both the executive committee and the Bank’s boardpay particular attention to management of the Group’s risks.
The Group’s third vice-president is the maximum executive inrisk management. He is a member of the board and chairman ofthe risk committee. Two directorates-general of risks, which areindependent of the business areas, both from the hierarchicaland functional standpoint, report to the third vice-president. The organisational and functional framework is as follows:
• The general directorate of risk (GDR) is responsible for theexecutive functions of credit and financial risk managementand is adapted to the business structure, both by customertype as well as by activity and country (global/local vision). TheGDR is structured around two fundamental functions, whichare replicated locally and globally.
• The GDR is configured in two blocks:
• – A corporate structure, with global scope responsibilities(“all risk, all countries”), entrusted with establishing thepolicies, methodologies and control. In this block, alsodenominated “intelligence”, and Global Control, are theareas/functions of solvency risks, market risk andmethodology.
• – A structure of businesses, focused on executing andintegrating management of the risk functions in the Group’slocal and global commercial businesses. In this block, alsodenominated execution and integration in management,the following areas/functions are grouped: management ofstandardised risks, management of segmented companyrisks, global recoveries, management of wholesale bankingrisk, management of Santander Consumer Finance risks andmanagement of global business risks.
• – Complementing the three corporate structure areas and thesix business areas is a seventh area of global and systemicgovernance, which supports and advises the GDR, and isresponsible for implementing the organisational model,overseeing effective execution of internal control and thesystems model.
• – These functions have a global action sphere, i.e. theyintervene in all the units where the risk division acts andthere is a reflection of the same structure in the local units.The main elements through which the global functions arereplicated in each of the units are corporate frameworks.These are central elements to communicate and transferglobal practices, reflect the criteria and policies for each ofthe areas and set the Group’s compliance standards to beapplied in all local units.
• – Generally speaking it is possible to distinguish the mainfunctions developed respectively by the GDR’s global areasand by the units:
• – – The general directorate of risks establishes risk policies andcriteria, the global limits and the decision-making andcontrol processes; it generates management frameworks,systems and tools; and adapts the best practices, both thebanking industry's as well as those of the different localunits, for their implementation in the Group.
• – – The local units apply the policies and systems to the localmarket: they adapt the organisation and the managementframeworks to the corporate frameworks; they contributecritical and best practices and lead the local sphereprojects.
• General directorate of integral control and internalvalidation of risks, with global reach responsibilities and ofcorporate nature and support for the Group’s governancebodies, which are:
• – Internal validation of credit, market and economic capitalrisk models in order to assess their suitability formanagement and regulatory purposes. Validation involvesreviewing the model’s theoretical foundations, the quality ofthe data used to build and calibrate it, the use to which it isput and the process of governance associated.
• – Integral control of risks, whose mission is to supervise thequality of the Group’s risk management, guaranteeing thatthe management and control systems of the various risksinherent in its activity comply with the most demandingcriteria and best practices observed in the banking industryand/or are required by regulators, and verifying that theprofile of effective risk assumed is adjusted to what seniormanagement has established.
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Grupo Santander launched in 2008 the function of integralcontrol of risks, anticipating the new regulatory requirements,then being discussed in the main organisations and forums— Basel Committee, CEBS, FSF, etc,— as well as therecommendations on best risk management practicesformulated by various public and private bodies.
Organisation, mission and features of the functionThe organisation of this function is part of the directorategeneral of integral control and internal validation of risk. Thisfunction supports the Group’s governance bodies in riskmanagement and control.
Particular attention is paid to credit risk (including the risks ofconcentration and counterparty); market risk (including liquidityrisk as well as structural risks of interest rates and exchangerates); operational and technology risks and risk of complianceand reputational risk.
Integral control of risks is based on three complementaryactivities:
1) Ensure that the management and control systems of thevarious risks inherent in Grupo Santander’s activity meet themost demanding criteria and the best practices observed inthe industry and/or required by regulators.
2) Ensure that senior management has at its disposal an integralvision of the profile of the various risks assumed and thatthese risks are in line with the previously agreed appetite forrisks; and
3) Supervise appropriate compliance in time and form with therecommendations drawn up for risk management mattersfollowing inspections by internal auditing and by thesupervisors to whom Santander is subject.
Internal control of risk supports the work of the risk committee,providing it with the best practices in risk management.
The main features of this function are:
• Global and corporate scope: all risks, all businesses, allcountries;
• It is configured as a third layer of control, following the oneby the person responsible for managing and controlling eachrisk in the sphere of each business or functional unit (firstlayer of control) and the corporate control of each risk(second layer). This ensures the vision and thus integralcontrol of all risks incurred during the year in Santander’sactivity.
• Special attention is paid to the development of best practicesin the sphere of the financial industry, in order to be able toincorporate within Santander and at once any advancesdeemed opportune.
• Both the information available as well as the resources thatGrupo Santander assigns to controlling the various risks areoptimised, avoiding overlapping.
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2. Integral control of risk
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Methodology and toolsThis function is backed by an internally developed methodologyand a series of tools that support it, in order to systemise theexercise of it and adjust it to Santander’s specific needs. Thisenables application of the methodology to be formalised andtraceable. The methodology and the tools of the three activitiesare articulated through the following modules:
Module 1A guide of tests or reviews exists for each risk, divided in spheresof control (for example, corporate governance, organisationalstructure, management systems, integration in management,technology environment, contingency plans and businesscontinuity, etc).
Applying the tests and obtaining the relevant evidence, which isassessed and enables the parameters of control of the variousrisks to be homogenised, is done every 12 months. New testsare incorporated where needed. The tests were fully reviewedduring 2011, using as a reference the most recent best practicesobserved in the banking industry and/or required by theregulators, and also taking into account the experience garneredin previous years in this sphere.
The support tool is the risk control monitor (RCM), which is arepository of the results of each test and its work papers. Areview of the situation of each risk is also conducted every sixmonths, with monitoring of the recommendations that emanatefrom the annual report of integral control.
Module 2Senior management is able to monitor the integral vision of thevarious risks assumed and their adjustment to the previouslyformulated risk appetites.
Module 3In order to monitor proactively the recommendations made byinternal auditing and by the supervisors regarding risk controland management, there is the SEGRE. This also enables therecommendations arising from integral control to be registered.
The Bank of Spain can access these tools if it so wishes and thusalso the work papers used to develop the function of integralcontrol of risks.
During 2011(a) The third cycle of reviewing the various risks was completed
in close contact with the corporate areas of control,contrasting and assessing the control and managementsystems of these risks. Improvements were identified andmade into recommendations —with their correspondingschedule for implementation agreed with the risk areas—,along with half yearly monitoring of the progress achieved inthe recommendations made in 2010.
(b) The board and the executive committee were regularlyinformed and given an integral vision of all risks, and the riskcommittee and the audit and compliance committee werealso informed of the function.
(c) Work continued on extending the integral control of risksmodel to the Group’s main units, also coordinating theinitiatives in this sphere in the various countries; and
(d) There was also participation, in coordination with the publicpolicy and other areas, in representing the Group in forumssuch as the Financial Stability Board (FSB) and Eurofi inmatters such as transparency in information on risks.
***
We will now look at the Group’s main risks: credit, market,operational and reputational.
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3.1 Introduction to the treatment of credit riskCredit risk is the possibility of losses stemming from the failureof clients or counterparties to meet their financial obligationswith the Group.
The Group’s risks function is organised on the basis of the typeof customer in order to distinguish during the risk managementprocess companies under individualised management fromstandardised customers.
• Those under individualised management are assigned, mainlybecause of the risk assumed, a risk analyst. This categoryincludes the companies of wholesale banking, financialinstitutions and some of the companies of retail banking. Riskmanagement is conducted through expert analysis backed upby tools to support decision-making based on internal modelsof risk assessment.
• Standardised: a customer who has not been specificallyassigned a risk analyst. This category generally includesindividuals, individual businessmen and retail bankingcompanies that are not segmented. Management of theserisks is based on internal models of assessment and automaticdecisions, complemented where the model does not go farenough or is not sufficiently precise by teams of analystsspecialised in this type of risk.
156 ANNUAL REPORT 2011
3. Credit Risk
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:17 Página 156
3.2 Main magnitudesand evolutionThe Group’s credit risk profile is characterised by diversifiedgeographic distribution and predominantly retail bankingactivity.
A. Global map of credit risk, 2011The table below sets out the global credit risk exposure innominal amounts (except for derivatives and repos exposurewhich is expressed in equivalent credit) at December 31, 2011.
The year 2011 was characterised by small growth of 0.8% in thecredit risk exposure due, on the one hand, to a change in themethod for consolidating a Group companies in the US, whichmainly reflects a drop in the effective credit amount by customerand, on the other, the combination of two factors: reduction indisbursements by customer (-0.2%), as a result of the lowervolume of committed lines in an economic environment ofweaker demand for loans in the main units; and growth in theeffective amount with credit institutions (13.6%).
Excluding the exchange rate impact during 2011 of the maincurrencies against the euro, and the change in theaforementioned consolidation method, the increase in theexposure would be 2.8%.
Spain was still the main unit as regards exposure to credit risk,although 1.4% less than at the end of 2010. Of note in the restof Europe, which accounts for more than one-third of the creditexposure, is the presence in the UK. Overall, Europe, includingSpain, accounted for 71% of the total exposure.
In Latin America, which accounted for 22% of the exposure,97% of the exposure to credit risk is classified as investment-grade.
The US accounted for 6.1% of the Group’s total credit exposureat the end of 2011.
157ANNUAL REPORT 2011
Spain
Parent bank
Banesto
Others
Rest of Europe
Germany
Portugal
UK
Others
Latin America
Brazil
Chile
Mexico
Others
United States
Rest of world
Total group
% of total
% change. s/Dec. 10
252,165
151,644
73,184
27,337
341,350
30,413
25,858
248,425
36,655
148,579
88,398
27,888
18,101
14,192
43,107
774
785,975
64.6%
-0.2%
55,526
42,075
7,674
5,777
50,232
536
6,036
39,500
4,161
56,992
40,804
7,103
7,501
1,584
15,271
72
178,094
14.6%
-0.2%
Outstandingto customers
Sovereign fixedincome
(excluding trading)
Private fixedincome
(excluding trading)
Outstandingto creditentities
Commitmentsto creditentities
Derivativesand Repos
(REC) Total
32,318
21,025
7,223
4,070
6,292
0
3,734
0
2,558
20,079
13,194
1,948
3,376
1,562
1,437
2
60,129
4.9%
-0.2%
8,040
5,356
1,129
1,555
4,664
93
1,744
2,679
148
5,879
4,857
527
324
171
10,577
1
29,160
2.4%
-1.3%
33,092
25,094
6,178
1,820
33,374
2,492
1,698
27,757
1,428
30,849
23,760
3,527
1,600
1,961
2,766
115
100,196
8.2%
13.6%
3,465
3,236
218
10
0
0
0
0
0
0
0
0
0
0
0
0
3,465
0.3%
132.4%
36,535
30,232
5,658
646
11,840
8
2,171
8,961
700
9,919
5,305
2,414
1,874
327
559
0
58,854
4.8%
-2.8%
421,142
278,663
101,264
41,215
447,754
33,541
41,241
327,321
45,651
272,297
176,317
43,406
32,777
19,797
73,717
964
1,215,874
100.0%
0.8%
Grupo Santander - Gross exposure to credit risk classified in accordance with legal company criteriaMillion euros. Data at December 31, 2011.
ECR (equivalent credit risk: net value of replacement plus the maximum potential value. Includes mitigants)
Balances with customers include contingent risks and exclude repos (EUR 8,467 million) and other customer financialassets (EUR 20,137 million)
The total fixed income excludes the portfolio of trading and investments of third party takers of insurance.
Sovereign fixed income refers to securities issued by public administrations in general, including the state, regional andlocal administrations and institutions that operate with the guarantee of the state.
Balances with credit entities and central banks include contingent risks and exclude repos, the trading portfolio and otherfinancial assets. Of the total, EUR 81,611 million are deposits in central banks.
Commitmentsto customers
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:17 Página 157
B. Evolution of the magnitudes in 2011 The evolution of non-performing loans reflect the impact of thedeterioration of the economic environment, while the reductionin the cost of credit during 2011 underscores the prudent andanticipative management of risk, enabling Santander, ingeneral, to maintain both figures lower than those of itscompetitors. As a result, the Group maintains a significant levelof coverage and available generic provisions.
The NPL ratio was 3.89% at the end of 2011 (+34 b.p). Growthin this ratio slowed down in the last few quarters. NPLs declinedin Santander Consumer Finance and Sovereign and rose in the
countries most affected by the crisis (Spain and Portugal) and, toa lesser extent, in those with a better situation in the economiccycle, such as the UK. In the whole of Latin America, the rise inthe NPL ratio went hand in hand with the growth in lendingwhile maintaining a stable cost of credit. NPL coverage was61.4% compared to 72.7% at the end of 2010.
Specific provisions for loan losses, net of bad debt recoveries,amounted to EUR 11,137 million, 1.41% of the average creditexposure with customers (the year’s average lending plusfinancial guarantees), down from 1.56% in 2010.
158 ANNUAL REPORT 2011
Continental Europe
Santander Branch Network
Banesto
Santander Consumer Finance
Portugal
United Kingdom
Latin America
Brazil
Mexico
Chile
Puerto Rico
Colombia
Argentina
Sovereign
Total Group
Memo item
Spain
364,622
118,060
78,860
63,093
30,607
255,735
159,445
91,035
19,446
28,462
4,559
2,568
4,957
43,052
822,657
271,180
370,673
126,705
86,213
67,820
32,265
244,707
149,333
84,440
16,432
28,858
4,360
2,275
4,097
40,604
804,036
283,424
2011 2010 2011 2010 2011 2010 2011 2010 2011(2)
Credit risk withcustomers(*)
(million euros)NPL ratio
%Coverage
%
Spec. prov net ofrecovered write-offs (**)
(million euros)
Credit cost of risk(3)
%
2010(1)
5.20
8.47
5.01
3.77
4.06
1.86
4.32
5.38
1.82
3.85
8.64
1.01
1.15
2.85
3.89
5.49
4.34
5.52
4.11
4.95
2.90
1.76
4.11
4.91
1.84
3.74
10.59
1.56
1.69
4.61
3.55
4.24
55.5
39.9
53.1
113.0
54.9
38.1
97.0
95.2
175.7
73.4
51.4
299.1
206.9
96.2
61.4
45.5
71.4
51.8
54.4
128.4
60.0
45.8
103.6
100.5
214.9
88.7
57.5
199.6
149.1
75.4
72.7
57.9
4,569
1,735
778
1,503
283
779
5,379
4,554
293
395
95
14
29
416
11,137
2,821
6,190
2,454
1,272
1,884
105
826
4,758
3,703
469
390
143
15
26
479
12,342
4,352
1.10
1.42
0.96
1.43
0.90
0.32
3.57
5.28
1.63
1.40
2.25
0.59
0.67
1.04
1.41
1.04
1.62
1.89
1.52
2.85
0.30
0.34
3.53
4.93
3.12
1.57
3.22
0.68
0.72
1.16
1.56
1.53
Grupo Santander - Risk, NPLs, coverage, provisions and cost of creditMillion euros
(*) Includes gross loans to customers, guarantees and documentary credits (ECR EUR 8,339 million)
(**) Bad debts recovered.
(1) Excludes the incorporation of AIG in Santander Consumer Finance Poland.
(2) Excludes the incorporation of Bank Zachodni WBK.
(3) (Specific provisions-bad debts recovered)/Total average credit risk.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:17 Página 158
C. Distribution of credit riskThe charts below show the diversification of Santander’s loansby countries and customer segments. The Group isgeographically diversified and focused on its main markets.
Grupo Santander’s profile is essentially retail (85.6% retailbanking), and most portfolios are products with a real guarantee(e.g. mortgages).
159ANNUAL REPORT 2011
Customer loans (gross)% of operating areas
Distribution of credit risk by type of risk%
Standardised risks%
BY GEOGRAPHIC AREA BY SEGMENT
Sovereign 5%
Chile 3%Mexico 3%
Brazil 11%
Portugal 4%
Germany 4%CommercialPoland 1%Rest ofEurope 4%
Rest ofLatin America 2%
UK 34%
Spain 29%
Individuals 57%
Companies and SMEs 25%
Global wholesale14%
Public sector3%
Others1%
BY GEOGRAPHIC AREA BY PRODUCT
Santander Consumer
Finance 16%
Latin America 16%
United States 3% Spain 16%
Portugal 4%
UK 44%
Poland 1%
Mortgages 65%
Consumer 23%
Cards 3%
SMEs and others 9%
The distribution by geographic area and product of lending inthe segment of standardised risks is set out below.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 159
3.3 Metrics and measurement toools
A. Rating toolsThe Group has been using since 1993 its own models forassigning solvency and internal ratings (known as internalratings or scoring), which measure the degree of risk of a clientor transaction. Each rating or scoring corresponds to a certainprobability of default or non-payment, determined on the basisof the entity’s past experience, except for some termed lowdefault portfolios, where the probability is assigned usingexternal sources. More than 200 internal rating models used inthe admission process and risk monitoring existed in the Group.
Global rating tools are used for the segments of sovereign risk,financial institutions and global wholesale banking. Theirmanagement is centralised in the Group, both for determiningtheir rating as well monitoring the risk. These tools assign arating for each customer resulting from a quantitative orautomatic module, based on balance sheet ratios ormacroeconomic variables, and supplemented by the expert viewof an analyst.
In the case of companies and institutions under individualisedmanagement, the parent company of Grupo Santander hasdefined a single methodology for formulating a rating in eachcountry. The rating is determined by an automatic model whichreflects a first intervention by the analyst and which can or notbe later complemented. The automatic model determines therating in two phases, one quantitative and the other qualitativebased on a corrective questionnaire which enables the analyst tomodify the automatic scoring by a maximum of ±2 points ofrating. The quantitative rating is determined by analysing thecredit performance of a sample of customers and the correlationwith their financial statements. The corrective questionnaire has24 questions divided into six areas of assessment. The automaticrating (quantitative +corrective questionnaire) can be changedby an analyst by writing over it or by using a manual assessmentmodel.
The ratings accorded to customers are regularly reviewed,incorporating new financial information available and theexperience in the development of the banking relation. Theregularity of the reviews increases in the case of clients whoreach certain levels in the automatic warning systems and inthose classified as special watch. The rating tools are alsoreviewed so that their accuracy can be fine-tuned.
In the case of standardised risks, both for companies as well asindividuals, there are scoring tools which automatically assessthe operations.
These admission systems are complemented by performanceassessment models which enable the risk assumed to be betterpredicted. They are used for both preventative activities as wellas sales and assigning limits
B. Paramenters of credit riskThe assessment of a customer or operation, through ratings orscorings, constitutes a judgement of the credit quality, which isquantified via probability of default (PD in the terminology ofBasel).
As well as the probability of default, quantifying credit riskrequires other parameters to be estimated such as exposure atdefault (EaD) and the percentage of EaD that might not berecovered (loss given default or LGD). Other aspects are alsoincluded such as quantifying off-balance sheet exposures, whichdepend on the type of product, or analysis of expectedrecoveries, related to the guarantees existing and other featuresof the operation: type of product, maturity, etc.
These factors comprise the main credit risk parameters. Theircombination enables the probable or expected loss (EL) to becalculated. This loss is considered as one more cost of theactivity as it reflects the risk premium and should beincorporated into the price of operations.
The following charts show the distribution of failed consumerloans and mortgages since 2001 on the basis of the percentagerecovered after discounting all the costs —including thefinancial —of the recovery process.
160 ANNUAL REPORT 2011
Spain-parent bank. MortgagesDistribution of operations by the percentage recovered
<=10%
>10%&
<=20%
>20%&
<=30%
>30%&
<=40%
>40%&
<=50%
>50%&
<=60%
>60%&
<=70%
>70%&
<=80%
>80%&
<=90%
>90%
70%
% ope
ratio
ns
% recovered
% recovered
% ope
ratio
ns
60%
50%
40%
30%
20%
10%
0%
Spain- parent bank. Consumer-retail. Distribution of operations by the percentage recovered
<=10%
>10%&
<=20%
>20%&
<=30%
>30%&
<=40%
>40%&
<=50%
>50%&
<=60%
>60%&
<=70%
>70%&
<=80%
>80%&
<=90%
>90%
60%
50%
40%
30%
20%
10%
0%
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 160
The risk parameters also calculate the regulatory capital inaccordance with the rules derived from Circular 3/2008 of theBank of Spain on determining and control of minimum equityand subsequent changes. The regulatory capital is the differencebetween the unexpected and the expected loss.
The unexpected loss is the basis for calculating the capital andmakes reference to a very high level of loss, but not veryprobable, not considered recurrent and which must be met withequity.
In portfolios where the internal experience of defaults is scant,such as banks, sovereigns or global wholesale banking,estimates of the parameters come from alternative sources:market prices or studies by external agencies which draw on theshared experience of a sufficient number of institutions. Theseportfolios are called low default portfolios.
For the rest of portfolios, estimates are based on the institution’sinternal experience. The PD is calculated by observing NPLentries and putting them in relation to the final rating assignedto the customer or with the scoring assigned to the operations.
The LGD calculation is based on observing the recovery processof operations not fulfilled, taking into account not only therevenues and costs associated with this process, but also themoment when they are produced and the indirect costs incurredin recovery activity.
The estimation of the EaD comes from comparing the use of thelines committed at the moment of default and a normalsituation.
The parameters estimated for global portfolios are the same forall the Group’s units. A financial institution with a rating of 8.5will have the same PD regardless of the unit in which itsexposure is recorded. On the other hand, retail portfolios havespecific scoring systems in each unit of the group. This requiresseparate estimates and specific assignment in each case.
The parameters are then assigned to the operations present inthe balance sheet of units in order to calculate the expectedlosses and the capital requirements associated with theirexposure.
C. Master scale of global ratingsThe following tables are used to calculate regulatory capital.They assign a PD on the basis of the internal rating, with aminimum value of 0.03%.
These PDs are applied uniformly throughout the group inaccordance with the global management of these portfolios. Ascan be seen, the PD assigned to the internal rating is not exactlyequal for a same rating in both portfolios, although it is very similarin the tranches where most of the exposure is concentrated (i.e. intranches of rating of more than six).
D. Distribution of EaD and expected loss(EL) associatedThe table below sets out the distribution by segments of theoutstanding credit exposure to customers in terms of EaD. PD,LGD and EL. Approximately 78% of total risk with clients(excluding sovereign, counterparty risks and other assets)corresponds to companies, SMEs and loans to individuals,underlining the retail focus of business and of Santander’s risks.The expected loss from customer exposure is 1.30% (1.05% forthe Group’s total credit exposure), which can be considered as amedium-to-low risk profile.
161ANNUAL REPORT 2011
8.5 to 9.3
8.0 to 8.5
7.5 to 8.0
7.0 to 7.5
6.5 to 7.0
6.0 to 6.5
5.5 to 6.0
5.0 to 5.5
4.5 to 5.0
4.0 to 4.5
3.5 to 4.0
3.0 to 3.5
2.5 to 3.0
2.0 to 2.5
1.5 to 2.0
< 1.5
8.5 to 9.3
8.0 to 8.5
7.5 to 8.0
7.0 to 7.5
6.5 to 7.0
6.0 to 6.5
5.5 to 6.0
5.0 to 5.5
4.5 to 5.0
4.0 to 4.5
3.5 to 4.0
3.0 to 3.5
2.5 to 3.0
2.0 to 2.5
1.5 to 2.0
< 1.5
0.030%
0.033%
0.056%
0.095%
0.161%
0,271%
0.458%
1.104%
2.126%
3.407%
5.462%
8.757%
14.038%
22.504%
36.077%
57.834%
Internalrating PDPD
Wholesale Banking
Internalrating
0.030%
0.039%
0.066%
0.111%
0.186%
0.311%
0.521%
0.874%
1.465%
2.456%
4.117%
6.901%
11.569%
19.393%
32.509%
54.496%
Probability of default
Banks
Sovereign debt
Counterparty
Public sector
Corporate
SMEs
Mortgages (individuals)
Consumer loans
Credit cards of individuals
Other assets
Memorandom item customers(2)
Total
EaD(1)
159,775
51,574
14,654
155,702
163,005
330,435
124,913
32,374
17,465
821,083
1,049,897
15.2%
4.9%
1.4%
14.8%
15.5%
31.5%
11.9%
3.1%
1.7%
78.2%
100%
0.14%
0.27%
1.44%
0.94%
5.44%
3.10%
7.94%
4.74%
3.73%
3.93%
3.17%
13.9%
59.6%
14.8%
39.9%
30.5%
8.9%
55.1%
64.8%
27.5%
33.1%
33.0%
0.02%
0.16%
0.21%
0.37%
1.66%
0.28%
4.38%
3.07%
1.02%
1.30%
1.05%
Segmentation of credit risk exposureMillion euros %
Data at December 2011.(1) Excluding doubtful loans.(2) Excluding sovereign debt, banks and other financial entities and other assets.
%PD.
AverageLGD
Average EL
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 161
3.4. Loss observed: measurements ofcredit costAs well as using these advanced models, other usual measuresare employed which provide prudent and effective managementof credit risk on the basis of the loss observed.
Grupo Santander’s cost of credit is measured by various means:change in net entries (final doubtful loans —initial doubtfulloans + write offs —recovered write offs), net loan-lossprovisions (net specific provisions – recovered write-offs) and netwrite-offs (write offs – recovered write-offs).
The three approaches measure the same reality and,consequently, converge in the long term although theyrepresent successive moments in credit cost measurement: flowsof non-performing loans (non-performing loans managementvariation, NPLMV), coverage of doubtful loans (net loan-lossprovisions, NLLPs) and becoming write offs (net write-offs),respectively. And this without detriment that in the long termand within the same economic cycle, the three show differencesat certain times, particularly significant at the start of a changeof cycle. These differences are due to the various moments atwhich the losses are calculated, which are basically determinedby accounting rules. In addition, the analysis can be complicatedby changes in the policy of coverage and entry into write offs,composition of the portfolio, doubtful loans of entities acquired,changes in accounting rules, sale of portfolios, etc.
162 ANNUAL REPORT 2011
Note: The data for 2009 reflects the incorporation of A&L and in 2010 Sovereign. December 2011 does not include the incorporation of Bank Zachodni WBK.
Grupo Santander´s total cost of credit% of average portfolio
Net write-offs: 0.66%Net LLPs: 0.82%
Change in net enties: 0.98%
Average 2002-2011
0.1%
1.9%
1.6%
1.3%
1.0%
0.7%
0.4%
2.5%
2.2%
DEC. 02 DEC. 03 DEC. 04 DEC. 05 DEC. 06 DEC. 07 DEC. 08 DEC. 09 DEC. 10 DEC. 11
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 162
The following charts reflect the cost of Grupo Santander’s creditrisk in its main areas of activity in 2011 and the comparison withprior years, measured in various ways:
163ANNUAL REPORT 2011
Net write-offsChange in doubtful loans plus net write-offs (% of average balances)
Net loan-loss provisionsNet specific provisions less recovered write offs (% of average balances)
Net entriesWrite-offs less recovery of write-offs (% of average balances)
6.25
4.67
3.802.852.61
1.36 1.41 1.361.371.170.540.53
1.34
0.370.23
1.931.49
1.961.67
0.34
2.35
1.73 1.801.62
0.70
Latin America (incl. Brazil)Rest of EuropeUKSpainGroup
4.91
3.863.81
3.70
2.28
0.95 1.18 1.160.65
0.460.44 0.330.550.250.23
1.181.51 1.261.41
0.73
0.15
1.57 1.561.16
0.50
4.56
3.68
3.28
2.441.67
0.52 0.47 0.360.170.20
0.911.10
0.640.360.43
0.550.73
0.94
0.200.16
1.17 1.231.32
0.72
0.43
2008 2009 2010 20112007
2008 2009 2010 20112007
2008 2009 2010 20112007
Note: Data drawn up in accordance with legal company criteria. 2011 does not include BankZachodni WBK, and in the case of net provisions also does not include Santander Consumer USA.The figures for 2010 reflect the incorporation of Sovereign. 2008 excludes A&L and 2009 excludes Sovereign and Venezuela.
The general trend over the past few years has been to maintainthe cost of Santander’s credit at low levels. In 2011, the declineof 15 b.p. in the cost of credit was due to the still significantdeterioration of the economic environment and of the mix ofretail portfolios which, although with a higher expected loss,have higher levels of direct and indirect profitability and a morepredictable nature of risk.
Latin America (incl. Brazil)Rest of EuropeUKSpainGroup
Latin America (incl. Brazil)Rest of EuropeUKSpainGroup
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 163
3.5 Credit risk cycleRisk management consists of identifying, measuring, analysing,controlling, negotiating and deciding the risks incurred by theGroup’s operations. The process involves risk takers and seniormanagement, as well as the risk areas.
The process emanates from senior management, via the boardof directors and the risk committee; they set the risk policies andprocedures, the limits and delegating of powers, and approveand supervise the framework of the risks function.
The risk cycle has three phases: pre-sale, sale and after sale:
• Pre-sale: this includes the planning and setting of objectives,determining the appetite for risk, approving new products,studying the risk and rating loans, and establishing limits.
• Sale: this covers the phase of decision-making both foroperations under pre-classification as well as one-offtransactions.
• After sale: monitoring, measurement, control and recoverymanagement.
A. Planning and setting limitsSetting limits is a dynamic process which identifies the Group’srisk appetite by discussing business proposals and the opinion ofrisks.
The global plan of limits, the document drawn up on the basisof consensus which provides complete management of thebalance sheet and of the inherent risks, establishes the riskappetite in the various factors.
The limits are based on two structures: customers/segments andproducts.
The most basic level in individualised management is thecustomer and when certain features are present —generally ofrelative importance— an individual limit (pre-classification) is set.
A pre-classification model based on a system for measuring andmonitoring economic capital is used for large corporate groups.A more simplified version is used for those companies who meetcertain requirements (high knowledge, rating, etc).
In the sphere of standardised risk, the planning and setting oflimits is done through credit management programmes (CMPs),a document reached by consensus between the business andrisk areas and approved by the risk committee or committeesdelegated by it. The CMPs set out the expected results ofbusiness in terms of risk and return, as well as the limits towhich activity is subject and management of the associatedrisks.
B. Risk study and processof credit rating The study of risk is obviously a prior requirement for authorisingcustomer operations by the Group.
This study consists of analysing the capacity of the customer tomeet their contractual obligations with the bank. This entailsanalysing the customer’s credit quality, risk operations, solvencyand return in accordance with the risk assumed.
The risk study is carried out every time there is a new customeror operation or with a pre-established regularity, depending onthe segment. In addition, the rating is studied and reviewedevery time there is an alert or something that affects thecustomer/operation.
C. Decisions on operationsThe purpose of the decision-making process is to analyse andresolve operations, taking into consideration both the riskappetite as well as those elements of the operation that arerelevant in the search for the balance between risk and return.
The Group has been using RORAC methodology (return on riskadjusted capital) since 1993 to analyse and set prices foroperations and businesses.
D. Monitoring As well as the tasks carried out by the internal auditing division,the directorate general of risks, through local and global teams,controls credit quality by monitoring the risks and has theresources and specific people to do it.
The monitoring is based on a continuous process of permanentobservation, which enables incidents to be detected in advancein the evolution of risk, operations, customers, and theirenvironment in order to take steps to mitigate them. Themonitoring is conducted on the basis of customersegmentation.
The Group has a system called companies in special watch(FEVE) which identifies four levels on the basis of the degree ofconcern arising from the circumstances observed (extinguish,secure, reduce, monitor). The inclusion of a company in FEVEdoes not mean there have been defaults, but rather theadvisability of adopting a specific policy toward that companyand establishing the person and time frame for it. Clients inFEVE are reviewed at least every six months, and every quarterfor the most serious cases. A company can end up in specialwatch as a result of monitoring, a review conducted by internalauditing, a decision of the person responsible for the companyor the entry into functioning of the system established forautomatic warnings.
164 ANNUAL REPORT 2011
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Ratings are reviewed at least every year, but if weaknesses aredetected, or on the basis of the rating, it is done more regularly.
As regards the risks of standardised clients, the main indicatorsare monitored in order to detect shifts in the performance of theloan portfolio with respect to the forecasts made in the creditmanagement programmes.
Payment restructurings and agreementsThe restructuring of debts is part of the continuousmanagement of risks with customers although it is duringperiods of economic downturn when this practice assumesgreater importance. It arises when the customer is not in acondition to comply with the payment obligations contractedwith the bank and so the possibility of adjusting the debt to thecustomer’s new payment capacity and/or improve theguarantees is contemplated.
The use of debt restructuring by Grupo Santander’s banksmakes it necessary to establish common practices, which enablethese risks to be overseen. With this in mind, the corporatepolicy for restructuring the debts of customers was created,approved by the risk committee, which incorporates a series ofdefinitions, general principles and policies that must be appliedby all the Group.
Within the activity of continuous monitoring, the riskdepartments and the business area of recoveries, in coordinationwith the business areas, carry out centralised actions to identifythose customers who might need to restructure their debts. Thepayment capacity is the central factor of analysis, given that thepurpose of restructuring is that the customer continue to payback their loans. The factors taken into consideration areindicative of the changes in the economic situation and, thus,signify a deterioration in the customer’s payment capacity.
The risk departments, in coordination with the business area ofrecoveries, are entrusted with approving the restructuringoperation, modifying the terms of the loan and improvingguarantees, if possible, as well as analysing the risks assumed.
Grupo Santander restricts these operations, with rigorous andselective criteria, to:
• viable operations, which in origin do not have a very severedeterioration;
• where the customer wishes to pay;
• that improve the bank’s position in terms of expected loss;
• and where restructuring does not discourage additionalefforts by the customer.
In standardised customers, the general principles stated beloware applied rigorously, tending to exceptional circumstanceswhen necessary. In the case of segmented customers, theseprinciples can be used as an element of reference, butparticularly important is individualised analysis of each case.
• The customer’s overall risk is assessed.
• The risk with the customer does not increase.
• All the refinancing alternatives are assessed and their impact,ensuring that their results would be better than those likelyto be obtained if this process was not carried out.
• Particular attention is paid to guarantees and the possiblefuture evolution of their value.
• Their use is restricted, rewarding the restructuring of riskswith additional efforts by customers and avoiding actions thatonly postpone the problem.
• Monitoring of these operations is carried out in a special way,and maintained until the total extinction of the debt.
• For segmented customers, a very detailed analysis is carriedout, case by case, where the expert opinion enablesadjustment of the most appropriate conditions.
As well as close monitoring of these portfolios by the Group’srisk management teams, both the various supervisory authoritiesto which Grupo Santander is subject and the internal audit ofthe Group pay particular attention to control and appropriateassessment of the restructured portfolios.
Depending on the management situation in which operationsunder restructuring find themselves in, we distinguish two typesof operation:
• Those for customers under normal classification (without non-performing loans) who, due to a change in their economicsituation, could suffer an eventual deterioration in theirpayment capacity. This contingency can be resolved byadapting the debt conditions to the customer’s new capacity,thereby facilitating compliance with the payment obligation.These operations are not the subject of concern, but a one-offcircumstance to tackle within the normal customerrelationship. Moreover, as there was no need to anticipatepossible losses, it is not necessary to make loan-loss provisionsto cover these operations. Once the conditions have changed,there is a certainty that the customer will comply with thepayment periods with no problems and continuously.
• Loans classified as non-performing, due to delays in paymentor other situations, are known as refinancing.
165ANNUAL REPORT 2011
Note: 2011 shows the application of the FEVE tool in Poland. The classification of risk in FEVE isindependent in each institution and responds to the various criteria for classification of these risks andmanagement of them on the basis of the category in which they are classified.
(*) Not applicable.
Retail banking Spain
Banesto
Portugal
Poland
United Kingdom
Sovereign
Latin America
Total
Extinguish
4,760
7,467
394
1,112
235
1,678
1,339
16,984
485
151
247
N.A.(*)
60
46
437
1,426
11,250
2,018
987
N.A.(*)
844
1,167
1,876
18,142
12,649
11,154
2,221
417
1,923
2,002
7,248
37,614
29,143
20,790
3,848
1,529
3,062
4,894
10,901
74,166
Ratings of risk balances according to the FEVE monitoringsystemMillion euros at December 2011
Secure Reduce Monitor Total
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 165
A particularly important product in the real estate promotionportfolio is mortgage loans to real estate developers. At the endof 2011, this amounted to EUR 7,467 million and representedaround 0.9% of Grupo Santander’s total credit portfolio. Thereduction in the exposure to this product accelerated during 2011(24% compared to 20% in 2010 and 9.3% in 2009).
At the end of 2011, this portfolio of loans had a low degree ofconcentration and an appropriate level of guarantees andcoverage.
The situation was as follows:
• Developments completed and with the final certificate ofwork: 79.2% of outstanding risk.
• Developments more than 80% completed: 6.4% ofoutstanding risk.
• Developments between 50% and 80% completed: 5.2% ofoutstanding risk.
• Developments less than 50% completed: 9.2%.
Furthermore, close to 86% of this financing of real estatedevelopments is totally completed or close to it, havingovercome the risk of construction.
Policies and strategies established for management ofthese risksThe policies in force for managing this portfolio, regularlyreviewed and approved by the Group’s senior management, arecurrently focused on reducing and securing the exposure,without overlooking new business identified as viable.
In order to manage this credit exposure, Grupo Santander hasspecialised equipment that not only fits within the risk areas, butalso complements its management and covers the whole lifecycle of these operations: their commercial management,juridical treatment, eventuality of recovery management, etc.
As already commented on in this same point, anticipativemanagement of these risks enabled the Group to reduce itsexposure significantly (-45% in mortgage loans for promotersbetween 2008 and 2011) and attain a granular portfolio anddiversified by territories where the volume of loans for secondhomes is very low.
Mortgages for land not developed account for only 6% of themortgage exposure, with the rest already classified as developedland or land that can be developed.
In the event of loans for homes not yet completed, the significantreduction in the exposure of 24% in 2011 was due to variousactions. As well as the already existing specialised channels,campaigns were conducted supported by teams of specificmanagers for this function which, in the case of the SantanderBranch Network, were directly supervised by the business area ofrecoveries, where direct management of them with promotersand buyers applying criteria of sale price reductions and adaptingto the financing conditions to the needs of buyers, enabledsubrogations of already existing loans to be made. Thesesubrogations diversify risk in a business segment that has a clearlylower NPL ratio.
The admission processes are managed by specialised teams whocoordinate directly with commercial teams, and have welldefined policies and criteria:
• Promoters with an ample solvency profile and with provenexperience in the market.
• Strict criteria of parameters inherent in operations. Exclusivefinancing for the cost of building, high percentages of salesaccredited, financing of the first residence, etc.
• Support for the financing of social housing with accreditedpercentages of sale.
• Restricted financing of land, reduced to the re-establishmentof the appropriate level of coverage in already existingfinancings or an increase in the guarantees.
As well as the permanent control by teams of monitoring theGroup’s risks, there is a technical team specialised in monitoringand controlling this portfolio in relation to progress in building,compliance with plans and control of sales, as well as with thevalidation and control of disbursements through certifications.Santander has specific tools created for this purpose. All themortgage distributions, disbursements for any type of concept,changes to the grace periods, etc, are authorised on acentralised basis.
In the case of projects under construction with some kind ofproblems, the criterion to be followed is to guaranteecompletion in order to have buildings that can be sold. In orderto achieve this, each project is analysed individually so that themost effective series of measures can be adopted for each case(payment structures to suppliers that guarantee completion ofthe work, setting schedules of specific disbursements, etc).
In those cases that require as a result of the analysis some kindof restructuring of the exposure, the restructuring is carried outjointly between risks and the business area of recoveries,anticipating non-payment situations, with criteria centred onproviding the projects with a payments structure that producesa good result. These authorisations are conducted on acentralised basis and by expert teams ensuring strict criteria areapplied in line with the Group’s principles of prudence in riskmanagement. Recognition of the possible losses materialiseswhen they are identified, classifying the positions withoutwaiting for non-payment in accordance with the rules set by theBank of Spain, with the corresponding provision giving coverageto the expected loss in these positions.
Companies specialised in selling properties (Altamira SantanderReal Estate and Promodomus) manage real estate assets, backedup by the commercial network structure. Sales are made withprice reduction levels reflecting the market’s situation and withthe levels of provisions of this portfolio.
169ANNUAL REPORT 2011
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d. Real estate foreclosedIn the last instance, one of the mechanisms used in Spain tomanage risk efficiently is the purchase and foreclosure of realestate assets. The net balance of these assets at the end of 2011was EUR 4,274 million, the result of a gross amount of EUR8,552 million and provisions of EUR 4,278 million.
In accordance with the Group's usual criteria of prudence andanticipating future regulatory changes regarding coverage ofthese properties, at the end of 2011 EUR 1,800 million was setaside for real estate risk, of which EUR 1,517 million was usedto constitute an additional fund, which raised coverage of allthese assets to 50%.
The following table shows the structure at the end of 2011 ofproperties foreclosed by the main businesses in Spain:
Of the total amount, 45% corresponds to completed buildingsavailable for sale and of the total land 94% is developed or canbe developed.
In the last few years, the Group regarded acquisition/foreclosureas an efficient tool for resolving unpaid loans as against goingthrough systems of legal processes. In both 2010 and 2011, netentries of foreclosed and acquired properties continued to fall,due to a faster pace of sales (+12%) than entries (+8%). In thefourth quarter of 2011, the balance of these assets was slightlylower and this trend was expected to continue in the comingyears.
e. New regulatory requirementsAfter approval of Royal Decree Law 2/2012, which establishesthe new requirements for provisions for real estate assets in theSpanish financial system, the Bank announced that the amountthat Grupo Santander needed to cover to meet therequirements was EUR 6,100 million.
These additional needs will be entirely met in 2012 as follows:
• EUR 1,800 million was charged against the Group's fourthquarter 2011 earnings, of which EUR 1,517 million wasassigned to an additional fund to the one already existing forcoverage of foreclosed properties and which lifted coverageof these assets to 50%.
• EUR 2,000 million are a capital buffer required by the rulesand which are covered by capital already held by the Group.
• The remaining EUR 2,300 million will be covered throughcapital gains which may be obtained during the year—including EUR 900 million from the capital gain on the sale ofBanco Santander Colombia— and through ordinarycontributions to provisions during 2012.
170 ANNUAL REPORT 2011
Finished buildings
Buildings under construction
Developed land
Land that can be developed
Other land
Total
Spain: Foreclosed propertiesMillion euros
3,753
521
2,661
1,339
279
8,552
39%
51%
58%
61%
62%
50%
2,272
256
1,120
521
105
4,274
Gross amount Coverage Net amount Amount of provisions
Additional provisions under new rules at 31.12.2011
Against results 2011
Buffer covered with surplus of existing capital
Provisions pending
Financing of new provisions in 2012
Charged to capital gains from the sale of Santander Colombia
Charged to other capital gains and ordinary allowances 2012
Impact on Grupo Santander of the financial reform in SpainMillion euros
6,100
-1,800
-2,000
= 2,300
2,300
900
1,400
Gross entries
Sales
Difference
Spain: Foreclosed propertiesBillion euros
2.3
1.3
1.0
2.1
1.1
1.0
8%
12%
2011 2010
Foreclosed propertiesBillion euros
5.2
2.3
4.5
2.0
4.3
0.54.8
6.5
7.5Net volume
Coverage
2010
4.3
4.3
8.6
201120092008
Foreclosed properties:Coverage ratio
31%
31%
10%
2010
50
%
201120092008
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 170
Analysis of the mortgage portfolio in the UKAs well as the risk portfolio in Spain, of note in standardisedrisks and because of its importance in Grupo Santander’s totallending is the UK mortgage portfolio.
This portfolio consists of first home mortgages distributed in UKterritory, as there are no operations that entail second orsuccessive charges on mortgaged properties.
Most of the mortgages are in Greater London, where housingprices are more stable even during a period of economicslowdown.
All the properties are assessed by authorised valuers before eachoperation is approved, in accordance with the principlesestablished by the Group for risk management and in line withthe methodology defined by the Royal Institution of CharteredSurveyors.
The portfolio performed favourably during 2011. Its NPL ratio was1.46% (1.41% in 2010), the result of both the constantmonitoring and control as well as the strict credit policies whichinclude, among other measures, maximum loan-to-value criteriain relation to properties in guarantee. On the basis of thesepolicies, since 2009 no mortgages have been granted with LTVsof more than 100%. The average LTV is 53%.
There is no risk appetite for loans considered as high risk(subprime mortgages). The credit risk policies explicitly forbidthis type of loan, establishing tough requirements for creditquality, both the operations as well as customers. Buy-to-letmortgages with a higher risk profile account for a smallpercentage of the total volume of the portfolio (barely 1%).
The following charts give the structure in LTV terms of and thedistribution in terms of the income multiple:
The following table shows the distribution by type of loan:
An additional indicator of the portfolio’s good performance isthe small volume of foreclosed homes (EUR 160 million at theend of 2011, only 0.07% of the total mortgage exposure).Efficient management of these cases and the existence of adynamic market for this type of property which enables sales totake place in a short period contributed to the good results.
E. Control functionThe management process is also aided during the variousphases of the risk cycle by the function of control. This providesa global vision of the Group’s portfolio of loans with thesufficient level of detail, enabling the current risk position and itsevolution to be assessed.
The objective of the control model is to assess the risk ofsolvency assumed in order to detect focuses of attention andpropose measures that tend to correct eventual deterioration. Itis therefore vital that to the control activity in the proper senseof the word is added an analysis component that facilitatesproactivity regarding early detection of problems and thesubsequent recommendation of action plans.
The evolution of risk with regard to budgets, limits andstandards of reference is constantly and systematically controlledand the impact in future situations evaluated, both exogenousas well as those arising from strategic decisions, in order toestablish measures that put the profile and volume of theportfolio of risks within the parameters set by the Group.
The control function is conducted by assessing risks from variousperspectives and establishing as the main elements control bycountries, business areas, management models, products andprocesses. This facilitates the detection of focuses of specificattention for decision-making.
The control processes, which ensure compliance with theGroup’s corporate criteria in credit risk management, werestrengthened in 2011. Meanwhile, the homogeneous nature ofthe control model enabled standards in the flow of informationto be established, their analysis by portfolios and monitoring ofthe main management metrics, in an exercise of coordinationbetween the global area and the various units in whichprogrammes were created with specific targets that enable thesituation of each of the units to converge with the globalmodel.
In 2006, under the corporate framework established in theGroup for complying with the Sarbanes-Oxley Act, a tool wascreated in the Group’s intranet to document and certify all subprocesses, operational risks and controls that mitigate them. TheRisks Division, as part of the Group, evaluates every year theefficiency of internal control of its activities.
171ANNUAL REPORT 2011
First time buyer:customers who buy a home for the first time.Mover: customers who change home with or without changing the bank that granted the mortgage.Remortgage: customers who transfer their mortgage from another bank.
(1) Indexed(*) Loan to value: Relation between the amount of the loan and the appraised value of the mortgagedproperty. Income multiple (opposite of affordability rate): Relation between the total original amountof the mortgage and the borrower’s gross annual income. The figures are only for the loans grantedin the year.
Loan to value(1) Average: 52.6%
61.4%
25.7%
12.8%
75% - 90%
> 90%
< 75%
Income multiple Average: 3.1
34.5%
34.9%30.6%
3.0 - 3.99
> 4.0
< 3.0
Residential mortgages
First Time Buyer
Mover
Remortgage
198,789
33,010
71,295
94,484
Portfolio
December 2011
Portfolio of residential mortagagesMillion euros
82.1
13.6
29.4
39.0
% of total UKportfolio
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 171
Analysis of scenariosAs part of its management of monitoring and continuouscontrol, the Group conducts simulations of its portfolio usingadverse scenarios and stress tests in order to assess the Group’ssolvency in the face of certain situations in the future. Thesesimulations cover all the Group’s most relevant portfolios andare done systematically using a corporate methodology which:
• Determines the sensitivity of risk factors (PD, LGD) to certainmacroeconomic variables.
• Defines reference scenarios (at the global level as well as foreach of the Group’s units).
• Identifies rupture scenarios (levels as of which the sensitivityof risk factors to macroeconomic variables is moreaccentuated) and the distance of these scenarios from thecurrent situation and the reference scenarios.
• Estimates the expected loss of each scenario and theevolution of the risk profile of each portfolio in the face ofmovements in certain macroeconomic variables.
The simulation models use the data of a complete economiccycle to measure the performance of risk factors in the face ofchanges in macroeconomic variables.
The scenarios take into account the vision of each unit as well asthe global vision. The macroeconomic variables include:
• The unemployment rate
• Property prices
• GDP
• Interest rates
• Inflation
The analysis of scenarios enables senior management to betterunderstand the foreseeable evolution of the portfolio in the face ofmarket conditions and changing situations, and it is a key tool forassessing the sufficiency of the provisions established for stressscenarios.
The analysis of the baseline and acid scenarios for the wholeGroup and for each unit, with a time frame of three years, showsthe strength of the balance sheet to different market andmacroeconomic situations.
EU Stress test exercisesIn order to assess the solvency and resistance of banks to anadverse scenario, the European Banking Authority (EBA), incooperation with the Bank of Spain, the European Central Bank,the European Commission and the European Systemic RiskBoard, conducted in 2011 a stress test on 91 banks representing65% of the total assets of the European banking system.
The EBA’s stress test analysed the level of capital that banks wouldreach in 2012 and their evolution since the end of 2010 (thestarting point) in two types of scenario: a benchmark scenario andan adverse one. The exercise assumed that the balance sheetremained without changes over its starting position, the businessmodel remained constant by countries and product strategies, andthere are no acquisitions or disposals. It therefore does not reflectthe estimate that the bank’s management could have of thedevelopment of the Group’s results over the next two years. Thebanks submitted to the test had to have, initially, a Tier 1 core ratioof at least 5% in the most adverse scenario.
In the case of Santander, the stress tests showed the strength andvalidity of its business model. The results published on July 15,2011 show that even in the most adverse scenario, the Group isable to generate profits, distribute dividends and continue togenerate capital. Santander will end 2012 with a Tier 1 capital of8.4% in the most adverse scenario and 8.9% including genericprovisions.
These results compare very well with those of our competitors.Santander will be the bank that will post the most profits in themost adverse scenario (EUR 8,092 million in 2011 and 2012).
F. Recovery activityRecovery management is a strategic element in the bank’s riskmanagement.
In order to carry out this function, which is essentially a businessactivity, the bank has a corporate model of management whichsets the guidelines and general rules to be applied in thecountries where it operates, with the necessary adjustments onthe basis of local business models and the economic situation ofthe respective environments.
This corporate model basically establishes procedures andmanagement circuits on the basis of customers’ features,making a distinction between massive level management withthe use of multiple channels and a more personalised orsegmented management with specific managers assigned.
As a result, with this segmentation in management, variousmechanisms were established to ensure recovery managementof customers in non-payment situations from the earliest phasesto the writing off of the debt. The sphere of action of therecovery function begins the very first day of non-payment ofthe loan and ends when it has been paid or reclassified.Preventative management is conducted in some segmentsbefore a non-payment situation arises.
172 ANNUAL REPORT 2011
Sufficiency of capital (million euros)Risk weighted assets (constant balance sheet assumption)Common equity according to EBA definition
Of which ordinary shares subscribed by the governmentOther existing subscribed government capital (before December 31, 2010)Core Tier 1 capital (constant balance sheet assumption)Tier 1 ratio (%)Results (million euros)Net interest incomeTrading incomeOther operating incomeOperating profit before impairmentsOperating profit after impairments and other losses from the stress test Other incomeNet profit after tax
2011613,27947,002
00
47,0027.7%
27,918895
1,53021,95411,192-1,8387,246
2012622,57159,374
00
59,3749.5%
29,005895
1,12822,63914,280-1,7979,545
2011626,92145,053
00
45,0537.2%
27,919352
2,32322,2077,205-2,1144,088
2012650,97954,364
00
54,3648.4%
27,168352
2,35521,4876,716-1,7084,004
Stress test results. Grupo Santander
Baseline scenario Adverse scenario
Source: European Banking Authority (EBA).
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 172
Recovery activity, understood as an integral business, issupported by constant reviewing of the management processesand methodology. It is backed by all the Group’s capacities andwith the participation and cooperation of other areas(commercial, resources, technology, human resources) as well asthe development of technology solutions to improveeffectiveness and efficiency.
In recoveries we have a practical and hands on training planwhich deepens knowledge, facilitates the exchange of ideas andbest practices and professionally develops teams, while alwaysstriving to integrate recovery activity into the Group’s ordinaryand commercial activity.
During 2011, the indicators for management of loan recoveriesunderscored the difficult economic situation of some countrieswhere the Group operates, with a change in net entries thatwas higher than in 2010, mainly due to the local economicconditions and, consequently, greater difficulty in obtainingrecovery results in these units. The management capacity hasbeen ensured and new strategies implemented to increase therecovery of non-performing loans.
Nevertheless, the results for the recovery of written-off assetswere very good. Action plans were put in place in countriesdesigned to improve this line of activity, with proactive strategiesdefined at the level of each customer and type of portfolio. Thismade possible a greater degree of recovery in this line of activitythan in previous years, and in relation to the evolution in thedeclaration of write offs.
As a way of early recognition and rigorous management ofproblematic loans in the portfolio, Grupo Santander takes intoconsideration portfolio sales as a possible alternative solution tobe assessed. This activity, via a process of evaluation andcommercialisation, enables the recovery results with recurrencevocation to be accelerated.
In addition, portfolio sales provide the following advantages:
• Avoid possible future deteriorations from changes in themacroeconomic environment.
• Avoid costs with low return.
• Reduce or adjust structures.
• Improve liquidity for other businesses.
• Ensure revenue recurrence in case of sales flows.
The Bank has specialised teams in this activity. They areresponsible for relations with investors, identification of theportfolio, valuation (and subsequent back testing), managementof the back office, as well as evaluating the legal and fiscalcontingencies. In 2010, the creation of units specialised in thismanagement was strengthened in the Group, particularly inSpain.
3.6 Other standpoints of credit riskThere are spheres and/or specific points in credit risk thatdeserve specialised attention and which complement globalmanagement.
A. Risk of concentrationControl of risk concentration is a vital part of management. TheGroup continuously tracks the degree of concentration of itscredit risk portfolios using various criteria: geographic areas andcountries, economic sectors, products and groups of clients.
The board’s risk committee establishes the policies and reviewsthe appropriate exposure limits for appropriate management ofthe degree of concentration of credit risk portfolios.
The Group is subject to the Bank of Spain regulation on largerisks. In accordance with Circular 3/2008 (on determining andcontrol of minimum equity) and subsequent changes, the valueof all the risks that a credit institution contracts with the sameperson, entity or economic group, including that in the partwhich is non-consolidatable, cannot exceed 25% of its equity.The risks maintained with the same person, whether anindividual or a company or an economic group, are consideredlarge risks when their values exceeds 10% of the equity of thecredit institution. The exception from this treatment areexposures to OECD governments and central banks.
At December 31, 2011, there were several financial groups thatexceeded 10% of shareholders’ funds: three EU financialinstitutions, two US financial entities and an EU centralcounterparty entity. After applying risk mitigation techniquesand the rules for large risks, all of them were below 3.5% ofeligible equity.
At December 31, 2011, the 20 largest economic and financialgroups, excluding AAA governments and sovereign securitiesdenominated in local currency, represented 5.0% of theoutstanding credit risk of the Group’s clients (lending plusguarantees), which compares favourably with the 6% in 2010.
The distribution of the portfolio of companies by sectors isadequately diversified. The chart below shows the distribution ofthe credit exposure in the Group’s main units.
173ANNUAL REPORT 2011
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 173
The Group’s risks division works closely with the financialdivision to actively manage credit portfolios. Its activities includereducing the concentration of exposures through varioustechniques such as using credit derivatives and securitisation tooptimise the risk-return relation of the whole portfolio.
174 ANNUAL REPORT 2011
OTC derivatives: distribution by equivalent credit risk and market value including mitigation impactMillion euros at December 31, 2011
CDS Protection Acquired
CDS Protection Sold
TRS Total Return Swap
CDS Options
Total credit derivatives
Equity Forwards
Equity Options
Equity Swaps
Equity Spot
Total equity derivatives
Fixed-income Forwards
Fixed-income Options
Fixed-income Spot
Total fixed income derivatives
Asset Swaps
Exchange-rate Options
Exchange-rate Swaps
Other Exchange-rate Derivatives
Total exchange rates
Asset Swaps
Call Money Swaps
IRS
Forward Interest Rates
Other Interest-rate Derivatives
Interest Rate Structures
Total interest-rate derivatives
Commodities
Total commodity derivatives
Total otc derivatives
Collateral
Total
Trading Hedging
Total ECRTotal market value
including mitigation impact(*)
Total Trading Hedging Total
397
34
0
0
431
1
512
0
0
513
30
0
0
30
1,312
302
4,346
2
5,962
0
349
20,432
16
1,215
229
22,240
287
287
29,464
0
29,464
117
0
0
0
118
118
778
643
0
1,539
99
0
0
99
2,360
264
11,655
2
14,281
412
52
16,596
21
1,574
599
19,254
111
111
35,402
-11,508
23,894
515
34
0
0
549
119
1,290
643
0
2,052
130
0
0
130
3,672
566
16,001
4
20,243
412
401
37,028
37
2,789
828
41,494
398
398
64,866
-11,508
53,358
1,627
-1,735
0
0
-107
0
-107
0
0
-107
0
0
0
0
-22
-168
437
-1
246
0
-187
562
-25
871
135
1,357
235
235
1,623
79
-68
0
0
10
-8
-245
340
0
88
75
0
0
75
311
-24
1,256
0
1,543
134
14
5,186
-19
-848
-434
4,034
8
8
5,759
1,706
-1,803
0
0
-97
-8
-352
340
0
-19
75
0
0
75
289
-192
1,693
-1
1,789
134
-173
5,748
-43
23
-298
5,391
243
243
7,381
Distribution of risk by sector Grupo Santander%
Rest 17%Other business services 3%
Elect. Gas and water prod. and distr. 3%
Construction and public works 4%
Transport andcommunications 4%
Commerce and repairs 5%
Real estate activity
8%
Individuals 56%
*Rest includes sectors with concentration below 2%.
(*) Market value used to take into account the impact of mitigating agreements in order to calculate the exposure by counterparty risk.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 174
B. Credit risk by activitiesin financial marketsThis section covers credit risk generated in treasury activitieswith clients, mainly with credit institutions. This is developedthrough financing products in the money market with differentfinancial institutions, as well as derivatives to provide service tothe Group’s clients.
Risk is controlled through an integrated system and in real timewhich enables us to know at any moment the exposure limitavailable with any counterparty, in any product and maturityand in all of the Group’s units.
Risk is measured by its prevailing market as well as potentialvalue (value of risk positions taking into account the futurevariation of underlying market factors in contracts). Theequivalent credit risk (ECR) is the net replacement value plus themaximum potential value of these contracts in the future. Thecapital at risk or unexpected loss is also calculated (i.e. the loss
which, once the expected loss is subtracted, constitutes theeconomic capital, net of guarantees and recovery).
The total exposure to credit risk from activities in the financialmarkets was 59.6% with credit institutions. By product type, theexposure to derivatives was 59.4%, mainly products withoutoptions, and 40.6% to liquidity products and traditionalfinancing.
Derivative operations are concentrated in high credit qualitycounterparties; 56.6% of risk with counterparties has a ratingequal to or more than A. The total exposure in 2011 in terms ofequivalent credit risk amounted to EUR 53,358 million.
175ANNUAL REPORT 2011
1 year 1-5 years 5-10 years Over 10 years Total REC
CDS Protection Acquired
CDS Protection Sold
TRS Total Return Swap
CDS Options
Total credit derivatives
Equity Forwards
Equity Options
Equity Swaps
Equity Spot
Total equity derivatives
Fixed-income Forwards
Fixed-income Options
Fixed-income Spot
Total fixed income derivatives
Asset Swaps
Exchange-rate Options
Exchange-rate Swaps
Other exchange-rate Derivatives
Total exchange rates
Asset Swaps
Call Money Swaps
IRS
Forward Interest Rates
Other Interest-rate Derivatives
Interest Rate Structures
Total interest-rate derivatives
Commodities
Total Commodity derivatives
Total OTC derivatives
Collateral
Total
19
8
0
0
26
1
314
0
0
315
30
0
0
30
985
211
1,549
2
2,747
0
167
353
16
1
35
573
122
122
3,813
9
0
0
0
9
118
319
296
0
733
99
0
0
99
1,902
254
1,782
2
3,941
2
27
636
21
107
57
850
45
45
5,676
28
8
0
0
35
119
633
296
0
1,048
129
0
0
129
2,887
465
3,331
4
6,688
2
195
989
37
108
92
1,422
166
166
9,489
226
17
0
0
243
0
196
0
0
196
0
0
0
0
323
90
1,666
0
2,079
0
156
4,169
0
21
83
4,429
146
146
7,092
11
0
0
0
11
0
392
344
0
736
0
0
0
0
442
11
5,821
0
6,274
36
12
5,120
0
468
106
5,742
66
66
12,829
237
17
0
0
254
0
588
344
0
931
0
0
0
0
765
101
7,487
0
8,353
36
168
9,289
0
488
189
10,171
212
212
19,921
27
9
0
0
36
0
3
0
0
3
0
0
0
0
4
0
1,132
0
1,136
0
12
5,201
0
117
25
5,354
20
20
6,548
58
0
0
0
58
0
58
3
0
61
0
0
0
0
16
0
2,045
0
2,421
77
12
3,871
0
468
31
4,460
0
0
7,000
85
9
0
0
94
0
61
3
0
64
0
0
0
0
20
0
3,536
0
3,556
77
24
9,072
0
584
56
9,814
20
20
13,549
126
0
0
0
126
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
14
10,079
0
1,076
85
11,884
0
0
12,011
39
0
0
0
40
0
9
0
0
9
0
0
0
0
0
0
1,647
0
1,647
297
0
6,970
0
531
405
8,202
0
0
9,897
166
0
0
0
166
0
9
0
0
9
0
0
0
0
0
0
1,647
0
1,647
297
14
17,678
0
1,608
490
20,087
0
0
21,908
397
34
0
0
431
1
512
0
0
513
30
0
0
30
1,312
302
4,346
2
5,962
0
349
20,432
16
1,215
229
22,240
287
287
29,464
0
29,464
117
0
0
0
118
118
778
643
0
1,539
99
0
0
99
2,360
264
11,655
2
14,281
412
52
16,596
21
1,574
599
19,254
111
111
35,402
-11,508
23,894
515
34
0
0
549
119
1,290
643
0
2,052
130
0
0
130
3,672
566
16,001
4
20,243
412
401
37,028
37
2.789
828
41,494
398
398
64,866
-11,508
53,358
T H Total T H Total T H Total T H Total T H Total
Notional OTC derivative products by maturityMillion euros at December 31, 2011
H = HedgingT = Trading
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 175
The distribution of risk in derivatives by type of counterparty was46% with banks, 33% with large companies and 9% with SMEs.
As regards the geographic distribution of risk, 13% is withSpanish counterparties, 18% with UK counterparties (mainlySantander UK’s operations), 30% the rest of Europe, 10% theUS and 14% Latin America.
Actividad in credit derivativesGrupo Santander uses credit derivatives to cover loans,customer business in financial markets and, to a lesser extent,within trading operations. The volume of this activity is smallcompared to that of our peers and, moreover, is subject to asolid environment of internal controls and minimisingoperational risk.
The risk of these activities is controlled via a broad series oflimits such as VaR, nominal by rating, sensitivity to the spread byrating and name, sensitivity to the rate of recovery and tocorrelation. Jump-to-default limits are also set by individualname, geographic area, sector and liquidity.
In notional terms, the CDS position incorporates EUR 57,220million of acquired protection and EUR 51,212 million of soldprotection.
At December 31, 2011, for the Group’s trading activity, thesensitivity of lending to increases in spreads of one basis pointwas minus EUR 0.3 million, and the average VaR during the yearwas EUR 10.6 million. Both were significantly lower than in2010 (sensitivity of –EUR 1.5 million and average VaR of EUR17.2 million).
C. Country riskCountry risk is a credit risk component in all cross-border creditoperations for circumstances different to the usual commercialrisk. Its main elements are sovereign risk, the risk of transfer andother risks which could affect international financial activity(wars, natural disasters, balance of payments crisis, etc).
The exposure susceptible to country-risk provisions at the end of2011 was EUR 380 million, of which EUR 19 millioncorresponded to intragroup operations. At the end of 2010, thetotal country risk in need of provisions was EUR 435 million.Total provisions in 2011 stood at EUR 55 million compared withEUR 69 million in 2010.
The country risk management principles continued to followmaximum prudence criteria, assuming country risk in a veryselective way in operations clearly profitable for the Group,and which strengthen the global relationship with customers.
176 ANNUAL REPORT 2011
Rating
AAA
AA
A
BBB
BB
B
Rest
Distribution of risk in OTC derivativesby rating of counterparty
%
11.7
9.8
35.1
19.4
21.0
2.3
0.7
Distribution of risk in OTC derivatives by type of counterparty
Securitisation4%
Corporate 33%
Companies 9%
Sovereign 6%
Pub. & priv. inst. 2%
Banks 46%
Distribution of risk in OTC derivatives by geographic areas
UK18%Spain 13%
Others 15%
US10%
Latin American14%
Rest of Europe 30%
Evolution of country-risk subject to provisions andprovisions assignedMillion euros
DEC 02 DEC 03 DEC 04DEC 05 DEC 06 DEC 07 DEC 08 DEC 09 DEC 10
43
5
DEC 11
38
0
44
4
5,4
22
91
6
97
1
71
0
1,4
37
97
7
81
0
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 176
D. Sovereign riskAs a general criterion, sovereign risk is that contracted intransactions with a central bank (including the regulatory cashreserve requirement), the issuer risk of the Treasury or theRepublic (portfolio of state debt) and that arising fromoperations with public institutions with the following features:their funds only come from institutions directly integrated intothe state sector; and their activities are of a non-commercialnature.
At December 31, 2011, according to Santander’s criteria,Europe accounted for 56.3% of total risk, Latin America 35.4%,the US 7.3% and others 1.0%. Of note in Europe were Spain(29.8%), the UK (16.1%) and in Latin America Brazil (24.3%)and Mexico (6.6%). Total risk was higher than in 2010 largelybecause of the increase in sovereign risk positions with Spain,Germany, the US and Mexico, and the incorporation of thepositions of Banco Zachodni (concentrated in Poland) to theperimeter of consolidation, which were partly offset by areduction of positions with the UK and Switzerland.
As regards the European peripheral countries, their share of thetotal portfolio is low: Portugal (2.0%), Italy (0.4%), Ireland(0.02%) and Greece (0.04%).
Latin America’s exposure to sovereign risk mainly comes fromthe obligations to which our subsidiary banks are subject forconstituting certain deposits in the corresponding central banksas well as from fixed-income portfolios maintained as part of thestructural interest rate risk management strategy. Theseexposures are in local currency and are financed by locallycaptured customer deposits, also denominated in local currency.The exposures to sovereign risk of Latin American issuersdenominated in currencies other than the official one of thecountry of issue amounted to EUR 2,462 million (3.5% of totalsovereign risk with Latin American issuers).
E. Environmental riskAnalysis of the environmental risk of credit operations is one ofthe main aspects of the strategic plan of corporate socialresponsibility. It revolves around the following two large points:
• Equator principles: this is an initiative of the World Bank’sInternational Financial Corporation. It is an internationalstandard for analysing the social and environmental impact ofproject finance operations. The assumption of these principlesrepresents a commitment to evaluating, on the basis ofsequential methodology, the social and environmental risks ofthe projects financed:
• – For operations with an amount equal to or more than $10million, an initial questionnaire is filled out, of a genericnature, designed to establish the project’s risk in the socio-environmental sphere (according to categories A, B and C orgreater to lower risk, respectively) and the operation’sdegree of compliance with the Equator Principles.
• – For those projects classified within the categories of greaterrisk (categories A and B), a more detailed questionnaire hasto be filled out, adapted according to the sector of activity.
• – According to the category and location of the projects asocial and environmental audit is carried out (byindependent external auditors). Specific questionnaires havebeen developed for those sectors where the bank is mostactive. The bank also gives training courses in social andenvironmental matters to risk teams as well as to thoseresponsible for business.
• VIDA tool: used since 2004, its main purpose is to assess theenvironmental risk of corporate clients, both current andpotential, through a system that classifies in seven categorieseach of the companies on the basis of the environmental riskcontracted. In 2011, 39,575 companies were assessed by thistool in Spain (total risk of EUR 59,770 million).
Low or very low environmental risk accounts for 78.3% of totalrisk. In 2011, there was a sharp fall in medium environmentalrisk (54.4% less than in 2010).
177ANNUAL REPORT 2011
Environmental risk classificationBillion euros
VL L- L+ M- M+ H- H+
Note: VIDA companies assessed in the retail banking network in Spain.VB: very low; L: low; M: medium and A: high.
25
30
20
15
10
0
5
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 177
4.1 Activities subject tomarket riskThe perimeter for measuring, controlling and monitoring thearea of market risk covers those operations where equity risk isassumed. This risk comes from the change in interest rates,exchange rates, shares, the spread on loans, raw material pricesand from the volatility of each of these elements, as well as theliquidity risk of the various products and markets in which theGroup operates.
On the basis of the finality of the risk, activities are segmented inthe following way:
a) Trading: this includes financial services for customers and thebuying and selling and positioning mainly in fixed-income,equity and currency products.
b) Balance Sheet Management: Interest rate and liquidity riskarises from mismatches between maturities and repricing ofassets and liabilities. It also includes active management ofcredit risk inherent in the Group’s balance sheet.
c) Structural risks:
• Structural Exchange-Rate Risk/Hedging of Results: Exchangerate risk, due to the currency in which the investment ismade, both in companies that consolidate and do notconsolidate (structural exchange rate) and exchange raterisk arising from the hedging of future results generated incurrencies other than the euro (hedging of results).
• Structural equity: This covers equity stake investments infinancial and non-financial companies that do notconsolidate, generating risk in equities.
The Treasury area is responsible for managing the taking oftrading activity positions.
The Financial Management area is responsible for the centralisedmanagement of these structural risks, applying standardisedmethodologies, adapted to each market where the Groupoperates. In the area of convertible currencies, financialmanagement directly manages the parent bank’s risks andcoordinates management of the rest of the units which operatein these currencies. The management decisions for these risksare taken by each country’s ALCO committee and, in the lastinstance, by the markets committee of the parent bank.
The aim of financial management is to inject stability andrecurrence into the net interest margin of commercial activityand the Group’s economic value by maintaining appropriatelevels of liquidity and solvency.
Each of these activities is measured and analysed with differenttools in order to show in the most precise way their risk profile.
4.2 Methodologies
A. Trading ActivityThe standard methodology that Grupo Santander applied totrading activities during 2011 was Value at Risk (VaR), whichmeasures the maximum expected loss with a certain confidencelevel and time frame. The standard for historic simulation is aconfidence level of 99% and a time frame of one day. Statisticaladjustments are applied enabling the most recent developmentsthat condition the levels of risk assumed to be efficiently andquickly incorporated. A time frame of two years or at least 520days from the reference date of the VaR calculation is used.1
Two figures are calculated every day, one applying anexponential decline factor which accords less weight to theobservations furthest away in time and another with the sameweight for all observations. The reported VaR is the higher ofthe two.
The VaR is not the only measure used. It is used because it iseasy to calculate and is a good reference for the Group’s level ofrisk. There are also other measures that allow greater control ofrisks in all the markets where the Group operates.
They include analysis of scenarios which define alternatives forthe performance of different financial variables and provide theimpact on results. These scenarios can replicate criticaldevelopments or circumstances that happened in the past (suchas a crisis) or determine plausible alternatives that are notconcerned with past events. A minimum of three types ofscenario are given: plausible, severe and extreme, and a VaR isobtained as well as a much fuller picture of the risk profile.
The market risk area, at the level of each unit and globally andfollowing the principle of independence of the business units,carries out daily monitoring of positions, through an exhaustivecontrol of the changes that take place in the portfolios in orderto detect possible new developments for immediate correction.The daily preparation of the income statement is an excellentindicator of risk levels, as it enables us to identify the impact ofchanges on financial variables in the portfolios.
178 ANNUAL REPORT 2011
4. Market risk
1. Since October 2011, the stressed VaR began to be calculated with the same methodology as forthe usual VaR, but using as a time frame a fixed frame of one year, which covers a representativemarket crisis period for the trading portfolio of each unit within the perimeter of the internal model .
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 178
Lastly, in order to control derivative activities and creditmanagement, because of its atypical nature, specific measuresare conducted daily. In the first case, sensitivity to the pricemovements of the underlying asset (delta and gamma), volatility(vega) and time (theta) is controlled. In the second case,measures such as the spread sensitivity, jump-to-default, andconcentration of positions by rating levels, etc, are systematicallyreviewed.
As regards the credit risk inherent in trading portfolios and inline with the recommendations of the Basel Committee onBanking Supervision and prevailing regulations, an additionalmeasurement began to be calculated (incremental risk charge,IRC), in order to cover the risk of default and rating migrationthat is not adequately captured in the VaR, via changes inlending spreads. The controlled products are basically fixed-ratebonds, both public and private sector, derivatives on bonds(forwards, options, etc) and credit derivatives (credit defaultswaps, asset backed securities, etc). The method for calculatingthe IRC is based on direct measurements of the tails of thedistribution of losses to the appropriate percentile (99.9%). TheMonte Carlo methodology is used, applying a millionsimulations.
B. Balance sheet managementInterest rate riskThe Group analyzes the sensitivity of net interest margin andmarket value of equity to changes in interest rates. Thissensitivity arises from gaps in maturity dates and the review ofinterest rates in the different asset and liability items.
On the basis of the positioning of balance sheet interest rates,as well as the situation and outlook for the market, the financialmeasures are agreed to adjust the positioning to that desired bythe bank. These measures range from taking positions inmarkets to defining the interest rate features of commercialproducts.
The metrics used by the Group to control interest rate risk inthese activities are the interest rate gap, the sensitivity of netinterest margin and of net worth to changes in interest rates,Value at Risk (VaR) and analysis of scenarios.
a) Interest rate gap of assets and liabilitiesInterest rate gap analysis focuses on lags or mismatchesbetween changes in the value of asset, liability and off-balancesheet items. It provides a basic representation of the balancesheet structure and allows for the detection of interest rate riskby concentration of maturities. It is also a useful tool forestimating the impact of eventual interest rate movements onnet interest margin or equity.
All on- and off-balance sheet items must be disaggregated bytheir flows and looked at in terms of repricing/maturity. In thecase of those items that do not have a contractual maturity, aninternal model of analysis is used and estimates made of theduration and sensitivity of them.
b) Net interest margin sensitivity (NIM)The sensitivity of net interest margin measures the change in theshort/medium term in the accruals expected over a particularperiod (12 months), in response to a shift in the yield curve.
It is calculated by simulating the net interest margin, both for ascenario of a shift in the yield curve as well as for the currentsituation. The sensitivity is the difference between the twomargins calculated.
c) Market value of equity sensitivity (MVE)This is an additional measure to the sensitivity of the net interestmargin.
It measures the interest risk implicit in net worth (equity) on thebasis of the impact of a change in interest rates on the currentvalues of financial assets and liabilities.
d) Value at Risk (VaR)The Value at Risk for balance sheet activity and investmentportfolios is calculated with the same standard as for trading:maximum expected loss under historic simulation with aconfidence level of 99% and a time frame of one day. As for thetrading portfolios, a time frame of two years, or 520 dailyfigures, is used, obtained from the reference date of the VaRcalculation back in time.
e) Analysis of scenariosTwo scenarios for the performance of interest rates areestablished: maximum volatility and severe crisis. Thesescenarios are applied to the balance sheet, obtaining the impacton net worth as well as the projections of net interest marginfor the year.
Liquidity riskLiquidity risk is associated with the Group’s capacity to financeits commitments, at reasonable market prices, as well as carryout its business plans with stable sources of funding. The Grouppermanently monitors maximum gap profiles.
The measures used for liquidity risk control in balance sheetmanagement are the liquidity gap, liquidity ratios, stressscenarios and contingency plans.
a) Liquidity gap The liquidity gap provides information on contractual andexpected cash inflows and outflows for a certain period of time,for each of the currencies in which the Group operates. The gapmeasures the net need or net excess of funds at a particulardate, and reflects the level of liquidity maintained under normalmarket conditions.
Two types of liquidity gap analysis are made, on the basis of thebalance sheet item:
1. Contractual liquidity gap: All on-and off-balance sheetitems are analysed provided they contribute cash flows placed inthe point of contractual maturity. For those assets and liabilitieswithout a contractual maturity, an internal analysis model isused, based on statistical research of the historical series ofproducts, and which determines what we call the stability andinstability impact for liquidity purposes.
2. Operational liquidity gap: This is a scenario in normalconditions of liquidity profile, as the flows of the balance sheetitems are placed in the point of probable liquidity and not in thepoint of contractual maturity. In this analysis defining thebehaviour scenario —renewal of liabilities, discounts in sales ofportfolios, renewal of assets— is the fundamental point.
179ANNUAL REPORT 2011
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 179
b) Liquidity ratiosThe liquidity coefficient compares liquid assets available for sale(after applying the relevant discounts and adjustments) withtotal liabilities to be settled, including contingencies. Thiscoefficient shows, for currencies that cannot be consolidated,the level of immediate response to firm commitments.
Net accumulated illiquidity is defined as the 30-day accumulatedgap obtained from the modified liquidity gap. The modifiedcontractual liquidity gap is drawn up on the basis of thecontractual liquidity gap and placing liquid assets in the point ofsettlement or repos and not in their point of maturity. Thisindicator is calculated for each of the main currencies.
In addition, other ratios or metrics regarding the structuralposition of liquidity are followed:
• Loans/net assets.
• Customer deposits, insurance and medium and long-termfinancing/lending.
• Customer deposits, insurance and medium and long-termfinancing, shareholders’ funds and other liabilities/the sum ofcredits and fixed assets.
• Short-term financing/net liabilities.
• Survival horizon.
c) Analysis of scenarios/Contingency planThe Group’s liquidity management focuses on taking all thenecessary measures to prevent a crisis. Liquidity crises, and theirimmediate causes, cannot always be predicted. Consequently,the Group’s contingency plans concentrate on creating modelsof potential crises by analyzing different scenarios, identifyingcrisis types, internal and external communications and individualresponsibilities.
The contingency plan covers the sphere of activity of a local unitand of central headquarters. It specifies clear lines ofcommunication at the first sign of crisis and suggests a widerange of responses to different levels of crisis.
As a crisis can occur locally or globally, each local unit mustprepare a contingency financing plan. The contingency plan ofeach local unit must be communicated to the central unit at leastevery six months so that it can be reviewed and updated. Theseplans, however, must be updated more frequently if marketcircumstances make it advisable.
Lastly, Grupo Santander continues to actively participate in theprocess opened by the Basel Committee and other internationalinstitutions to strengthen the liquidity of banks2, with a two-pronged approach: on the one hand, participating in calibratingthe regulatory changes raised —basically, the introduction oftwo new ratios: Liquidity Coverage Ratio (LCR) and Net StableFunding Ratio (NSFR)— and, on the other, being present in thedifferent forums to discuss and make suggestions on the issue(European Banking Federation, etc), maintaining in both casesclose co-operation with the Bank of Spain.
C. Structural exchange-rate risk/Hedging ofresults/Structural equity These activities are monitored by position measures, VaR andresults.
D. Additional measuresBack-testingBack-testing is an a posteriori comparative analysis betweenValue at Risk (VaR) estimates and the “clean” daily resultsactually generated (results of the portfolios at the end of the dayvalued at the next day’s prices). The purpose of these tests is toverify and measure the precision of the models used to calculateVaR.
The back-testing analysis carried out by Grupo Santandercomplies, as a minimum, with the BIS recommendationsregarding the verification of the internal systems used tomeasure and manage market risks. In addition, back-testingincludes the hypothesis test: tests of excess, normality,Spearman rank correlation, measures of excess average, etc.
The valuation models are fine-tuned and tested regularly by aspecialized unit.
Analysis of scenariosThe potential impact on results of applying different stressscenarios on all the trading portfolios and using the samesuppositions by risk factor is calculated and analysed regularly(at least every month).
In addition, there are triggers for global scenarios, on the basisof the historic results of these scenarios and the capitalassociated with the portfolio in question. If these triggers aresurpassed those in charge of managing the portfolio are notifiedso that the pertinent measures can be taken. The results ofstress exercises at the global level, as well as the possibleexcesses on the triggers are regularly reviewed by the globalcommittee of market risk, so that, if necessary, seniormanagement can be informed.
Coordination with other areasEvery day work is carried out jointly with other areas to offsetthe operational risk. This entails the conciliation of positions,risks and results.
180 ANNUAL REPORT 2011
2. Basel III: International framework for liquidity risk measurement, standards and monitoring (BaselCommittee on Banking Supervision, December 2010).
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 180
4.3. Control system
A. Definition of limitsThe process of setting limits takes place together with thebudgetary process, and is the means used by the Group toestablish the level of equity that each activity has available. Theprocess of definition of limits is dynamic, and responds to thelevel of risk appetite considered acceptable by seniormanagement.
B. Objectives of the structure of limitsThe structure of limits require a process that takes into accountthe following aspects, among others:
• Identify and define, efficiently and comprehensively, the maintypes of risk incurred so that they are consistent with themanagement of business and with the strategy drawn up.
• Quantify and inform the business areas of the risk levels andprofile that senior management believes can be assumed, inorder to avoid undesired risks.
• Give flexibility to the business areas to build risk positionsefficiently and opportunely according to changes in themarket, and in the business strategies, and always withinthe risk levels regarded as acceptable by the entity.
• Allow the generators of business to assume prudent risksbut sufficient to attain the budgeted results.
• Define the range of products and underlying assets withwhich each treasury unit can operate, bearing in mindfeatures such as the model and valuation systems, theliquidity of the tools used, etc.
4.4. Risks and results in 2011
A. Trading activityQuantitative analysis of VaR in 2011The Group’s risk performance with regard to trading activity infinancial markets during 2011, as measured by VaR, was asfollows:
VaR during 2011 fluctuated between EUR 12 million and EUR 34million. It rose as of the end of April to a maximum for the yearof EUR 33.2 million on May 24, due to an increase in interestrate and exchange rate risk in Spain and Brazil. The increase inVaR during the first half of July was due to the rise in exchangerate risk and volatility in Brazil. As of then, dynamicmanagement of portfolios, together with a reduction inexchange rate and interest rate risk in the treasuries of Madridand Brazil, produced a downward path until the end of the year.
The VaR reported as of November 15, 2011 excludes the riskfrom changes in the credit spreads of securitisations andportfolios affected by credit correlation. For regulatory reasons(BIS 2.5), these exposures are considered as banking book forcapital purposes. This change caused a decline in risk in VaRterms, both at the total level as well as by credit spread.
The average VaR of the Group’s trading portfolio in 2011 (EUR22.4 million) was lower than in 2010 (EUR 28.7 million), eventhough volatility remained high in markets because of Europe’ssovereign debt crisis. Meanwhile, in relation to othercomparable financial groups, the Group has a low trading riskprofile. Dynamic management of it enables the Group to adoptchanges of strategy in order to exploit opportunities in anenvironment of uncertainty.
181ANNUAL REPORT 2011
03 Jan
.
22 Jan
.
10 Feb
.
20 M
ar.
08 Apr.
27 Apr.
16 M
ay.
04 Jun
.
23 Jun
.
12 Jul.
31Jul.
19 Aug
.
07 Sep
.
26 Sep
.
15 O
ct.
03 Nov.
22 Nov.
11 Dec.
30 Dec.
34
30
26
22
18
14
10
Max. (33.2)
Min. (12.0)
Evolution of VaR during 2011Million euros. VaR at 99% with a time frame of one day
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 181
The histogram below shows the distribution of average risk interms of VaR during 2011. It was between EUR 16.5 million andEUR 30.5 million on 81.9% of days. The higher values of EUR30.5 million (3.5%) were concentrated in the central months ofthe year, mainly due to the increased volatility in the Brazilianthe euro zone’s sovereign debt crisis.
Risk by factorThe minimum, average, maximum and year-end 2011 values inVaR terms are shown below:
The average VaR was EUR 6.3 million lower than in 2010. Thereduction was in all risk factors, particularly in the credit spreadand equities, which dropped from EUR 20.9 million and EUR 8.0million to EUR 15.0 million and EUR 4.8 million, respectively.
The evolution of VaR during 2011 highlighted the Group’sflexibility and agility in adapting its risk profile on the basis ofchanges in strategy caused by a perception different to that ofexpectations in the markets.
Distribution of economic risks and resultsOf note were the transitory balances in VaR by exchange rate,caused by the significant changes in the positions opened inforeign currencies. The drop in VaR by credit spread as ofNovember 15 is explained by the aforementioned exclusionfrom the risk spread of securitisations and the correlation ofcredit which as BIS 2.5 are considered as banking book for thepurposes of regulatory capital.
182 ANNUAL REPORT 2011
VaR risk histogramNumber of days (%)/ VaR in million euros. VaR at 99% with a time frame of one day
2.7
11.9 14.6
20.0
26.9
23.516.5<13 34.030.527.0
26.2
14.2
3.5
Total Trading Total VaR
Diversification effect
Interest Rate VaR
Equity VaR
FX VaR
Credit Spread VaR
Commodities VaR
Latin America Total VaR
Diversification Effect
Interest Rate Var
Equity VaR
FX VaR
US and Asia Total VaR
Diversification Effect
Interest Rate VaR
Equity VaR
FX VaR
Europe VaRD Total
Diversification Effect
Interest Rate VaR
Equity VaR
FX VaR
Credit Spread VaR
Commodities VaR
Global Activties Total VaR
Diversification Effect
Interest Rate VaR
Credit Spread VaR
FX VaR
12.0
(12.2)
8.6
2.2
1.3
6.7
0.2
4.9
(2.4)
5.3
1.3
0.6
0.6
(0.1)
0.5
0.0
0.2
8.3
(8.2)
5.9
1.5
0.9
2.7
0.2
6.5
(0.5)
0.3
6.0
0.0
22.4
(21.8)
14.8
4.8
9.0
15.0
0.6
11.7
(6.4)
11.2
3.5
3.7
1.2
(0.5)
0.9
0.1
0.6
15.5
(15.1)
11.5
3.9
8.5
6.0
0.6
10.5
(1.1)
0.4
10.3
0.9
Minimum Average Maximum Year-end
33.2
(34.7)
21.8
22.7
24.1
23.0
3.9
23.7
(12.5)
18.5
9.6
19.2
3.0
(2.4)
2.2
2.9
1.7
24.7
(25.0)
18.9
17.4
15.2
11.4
3.9
15.9
(4.1)
0.7
17.0
2.3
15.9
(16.7)
14.6
3.7
4.2
9.6
0.4
10.7
(8.7)
10.5
2.2
1.2
0.9
(0.4)
0.9
0.1
0.4
10.1
(13.0)
11.9
3.6
3.9
3.3
0.4
9.7
(0.9)
0.5
8.4
1.8
VaR statistics by risk factor3
Million euros. VaR at 99% with a time frame of one day
3. The VaR of global activities includes operations that are not assigned to any particular country, suchas Active Credit Portfolio Management and Non-core Legacy Portfolio.
Distribution of economic risks and results in 2011Million euros. VaR at 99% with a time frame of one day
02 Jan
.
21 Jan
.
08 Feb
.
28 Feb
.
19 M
ar.
07 Apr.
26 Apr.
15 M
ay.
03 Jun
.
22 Jun
.
11 Jul.
30 Jul.
18 Aug
.
06 Sep
.
25 Sep
.
14 O
ct.
02 Nov.
21 Nov.
10 Dec.
29 Dec.
30
25
20
15
10
5
0
Interest rate VaR FX VaR Credit spread VaR
Equity VaR Commodities VaR
In Latin America, the US and Asia the credit spread VaR and the commodities VaR are not shownseparately because of their scant or zero materiality.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 182
a) Geographic distributionLatin America contributed on average 28.3% of the Group’stotal VaR in trading activity and 34.5% in economic results.Europe, with 49.2% of global risk, contributed 70.8% of results,as most of its treasury activity focused on professional andinstitutional clients. Global activities, with 22.2% of the Group’stotal VaR, contributed a negative 6.3% in economic results, hitby the euro zone’s sovereign debt crisis and the general rise infinancial credit and corporate spreads.
Below is the geographic contribution (by percentage), both inrisks, measured in VaR terms, as well as in results (economicterms).
b) Monthly distribution of risks and resultsThe next chart shows the risk assumption profile, in terms ofVaR as opposed to results. The average VaR remained stableuntil September and then declined, while results evolved in amore irregular way during the year. The first months werepositive until March and then negative until November whenthey were well below the annual average due to the worseningof the euro zone’s sovereign debt crisis.
The following histogram of frequencies shows the distributionof daily economic results on the basis of their size. The dailyyield4 was between -EUR 5 and +EUR 15 million on 70% of dayswhen the market was open.
183ANNUAL REPORT 2011
4. Yields “clean” of commissions and results of intraday derivative operations.
Risk statistics 2011 %. VaR at 99% with a time frame of one day
Latin America
80
70
60
50
40
30
20
10
0
Average VaRAnnual economic results
Europe US and Asia Globalactivities
Histogram of the frequency of daily results MtM Number of days (%)
1.9 2.3
14.2
20.8
24.6
8.1
<-2
0
-20
to
-1
5
-15
to
-1
0
-10
to
-5
-5 t
o 0
0 t
o 5
5 t
o 1
0
10
to
15
15
to
20
>2
0
17.3
6.9
1.9
1.9
Distribution of risk by time and results in 2011% of annual total. VaR at 99% with a time frame of one day
Monthly economic resultAverage monthly VaR
Jan
Feb
Mar
Ap
r
May
Jun
Jul
Aug
Sep
Oct
No
v
Dec
15
10
5
0
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 183
Risk management of structured derivativesmarketStructured derivatives activity is mainly focused on designinginvestment products and hedging risks for clients.
These transactions include options on equities, fixed-income andexchange rates.
The units where this activity mainly takes place are: Madrid,Banesto, Santander UK, Brazil and Mexico, and, to a lesserextent, Chile and Portugal.
The chart below shows the VaR Vega5 performance ofstructured derivatives business in 2011. It was downward in thefirst part of the year. In the second, there were two episodes ofsignificant increase in the VaR: the first, during the first half ofAugust, after the increase in volatility in equity markets becauseof the euro zone’s crisis and the second, during the second halfof September, because of the increased volatility of Brazil’sinterest rates.
The following table shows the average, maximum and minimumvalues for each of the units where these transactions werecarried out.
The average risk in 2011 (EUR 4.7 million) was lower than in2010 (EUR 7.9 million), due to the decline in the exposureopened in financial instruments linked to volatility.
Regarding VaR by risk factor, the exposure, on average, wasconcentrated in equities, followed by interest rates, exchangerates and commodities. This is shown in the following table:
Gauging and contrasting measuresIn accordance with the BIS recommendations on gauging andcontrolling the effectiveness of internal financial riskmeasurement and management systems, in 2011 the Groupregularly carried out analysis and contrasting measures whichconfirmed the reliability of the model.
There were three exceptions of VaR at 99% in 2011 (days whenthe daily loss was higher than the VaR): August 4 and August 8,mainly due to the sharp rise in credit spreads, the abrupt fall instock markets and the depreciation of most currencies againstthe US dollar, because of the worsening of the euro zone’ssovereign debt crisis and the renewed fears of strong downturnin the global economy, and September 12, due to the significantincrease in credit spreads, mainly financial and Greece’s.
184 ANNUAL REPORT 2011
10
8
6
4
2
Evolution of risk (VaR) of the business of structuredderivatives in 2011Million euros. VaR at 99% with a time frame of one day
03 Jan
.
22 Jan
.
10 Feb
.
20 M
ar.
08 Apr.
27 Apr.
16 M
ay.
04 Jun
.
23 Jun
.
12 Jul.
31 Jul.
19 Aug
.
07 Sep
.
26 Sep
.
15 O
ct.
03 Nov.
22 Nov.
11 Dec.
30 Dec.
Structured derivatives risk (VaR) in 2011 by risk factorMillion euros. VaR at 99% with a time frame of one day
Total VaR Vega
Diversification impact
Interest rate VaR
Equity VaR
FX VaR
Commodities VaR
2.6
(1.6)
1.1
1.9
0.2
0.1
4.7
(2.9)
2.0
4.1
1.2
0.3
Minimum Average Maximum Year-end
9.9
(5.8)
3.2
8.7
8.8
0.7
4.9
(3.7)
2.0
5.2
1.0
0.4
Structured derivatives risk (VaR) in 2011 by unitMillion euros. VaR at 99% with a time frame of one day
Total VaR Vega
Madrid
Banesto
Santander UK
Brazil
Mexico
2.6
1.4
0.8
0.5
0.1
0.5
4.7
2.9
2.3
1.4
0.8
1.2
Minimum Average Maximum Year-end
9.9
6.9
5.9
4.4
6.1
3.0
4.9
2.8
2.4
2.7
0.3
1.1
5. Vega, a Greek term, means here the sensitivity of the value of a portfolio to changes in the price ofmarket volatility.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 184
Analysis of scenariosVarious scenarios were analyzed and calculated regularly in2011 (at least monthly), at the global and local levels,particularly trading portfolios and using the same suppositionsby risk factor.
The chart below shows the results at December 31, 2011 for ascenario of maximum volatility, applying six standard deviationsin various market factors for the trading portfolios.
Maximum volatility scenarioThe table below shows, at December 31, 2011, the results byrick factor of (interest rates, equities, exchange rates, spreads onloans, commodities and the volatility of each one of them), in ascenario in which volatility equivalent to six standard deviationsin a normal distribution is applied. This scenario is based ontaking for each risk factor the movement that represents agreater potential loss in the global portfolio. For the year-end,this scenario involved rises in interest rate in Latin Americanmarkets and falls in core markets (“flight into quality”), declinesin stock markets, the depreciation of all currencies against theeuro, greater volatility and spreads on loans.
The stress test shows that the economic loss suffered by theGroup in its trading portfolios, in terms of the Mark to Market(MtM) result would be, if the stress movements defined in thescenario materialized, EUR 131 million, a loss that would bedistributed between Europe (equities, exchange rates andspreads on loans), Latin America (interest rate) and globalactivities (credit spreads).
185ANNUAL REPORT 2011
02 Jan
.
21 Jan
.
11 Feb
.
08 M
ar.
21 M
ar.
09 Apr.
28 Apr.
17 M
ay.
05 Jun
.
24 Jun
.
13 Jul.
01 Aug
.
20 Aug
.
08 Aug
.
27 Sep
.
16 O
ct.
04 Nov.
23 Nov.
12 Dec.
31 Dec.
0
-10
-20
-40
Backtesting of business portfolios: daily results versus previous day´s value at riskMillion euros
10
20
30
40
50
-30
P&L Clean VaE 99% VaE 95%VaR 99% VaR 95%
Total trading
Europe
Latin America
US
Global activities
-51.4
-5.5
-44.7
-1.4
0.2
-35.2
-26.4
-8.7
-0.1
0.0
-19.9
-16.7
-2.4
-0.8
0.0
-23.4
-5.6
0.0
0.0
-17.8
-1.0
-1.0
0.0
0.0
0.0
-130.8
-55.2
-55.7
-2.2
-17.7
Interestrates
Equities Exchangerates
Creditspread
CommoditiesTotal
Maximum volatility stress test9
Million euros
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 185
B. Balance sheet management6
B1. Interest rate risk
a) Convertible currenciesAt the end of 2011, the sensitivity of net interest margin at oneyear to parallel rises of 100 basis points was concentrated in thesterling interest rate curve, with Santander UK contributing themost (£191 million). In the euro interest rate curve the risk wassubstantially reduced over the end of 2010 to EUR 96 million,stemming from the greater concentration from the sensitivity ofthe consumer unit in Germany (EUR 66 million, excluding itssubsidiaries in Austria and Belgium). As regards the US dollarcurve, the greater concentration comes from the US subsidiary($76 million). The sensitivity of the rest of convertible currencieswas not very significant.
At the same date, the sensitivity of equity to parallel rises in theyield curve of 100 basis points in the euro interest rate curvewas EUR 723 million, most of it in the parent bank, althoughlower than at the end of 2010. As regards the curve in sterling itwas £376 million.
In accordance with the current environment of low interestrates, the Bank maintains a positive sensitivity, both in netinterest margin (NIM) and to interest rate rises.
b) Latin America
1. Quantitative analysis of risk The interest rate risk of Latin America’s balance sheetmanagement portfolios, measured in terms of net interestmargin (NIM) to a parallel movement of 100 basis points, in theyield curve remained during 2011 at low levels.
In terms of equity sensitivity, interest risk fluctuated in a range ofbetween EUR 753 million and EUR 1,036 million. The sensitivityincreased as of April mainly because of growth in lending andthe ALCO portfolio in Brazil and the rise in fixed-rate loans inMexico, after incorporating the portfolio of loans acquired fromGeneral Electric.
At the end of 2011, the region’s risk consumption, measured byequity sensitivity to 100 basis points, was EUR 957 million (EUR763 million in 2010), while that of the net interest margin atone year, measured by its sensitivity to 100 basis points, wasEUR 79 million (EUR 45 million in 2010).
Interest rate risk profile at the end of 2011The gap tables show the risk maturity structure in Latin Americaat the end of 2011.
186 ANNUAL REPORT 2011
Money and securities market
Loans
Permanent equity stakes
Other assets
Total assets
Money market
Customer deposits
Debt issues and securitisations
Shareholders’ equity and other liabilities
Total liabilities
Balance sheet Gap
Off-balance sheet structural Gap
Total structural Gap
Accumulated Gap
112
86,049
19,688
105,849
–
–
–
87,606
87,606
18,243
–
18,243
–
81,408
106,135
73,954
261,497
64,325
39,455
78,021
60,906
242,708
18,789
(11,451)
7,337
7,337
6,471
8,896
52
15,420
2,585
17,773
21,781
920
43,059
(27,639)
17,952
(9.687)
(2,350)
2,679
1,352
54
4,085
300
10,004
13,666
595
24,564
(20,479)
10,663
(9,816)
(12,165)
16,287
1,050
63
17,400
56
14,247
9,872
935
25,109
(7,709)
5,416
(2,293)
(14,459)
106,845
117,546
86,049
93,811
404,250
67,265
81,478
123,340
150,962
423,045
(18,795)
22,579
3,785
–
Notsensitive
Up to 1year 1-3 years 3-5 years
More than 5 years Total
Maturity and repricing gaps as of december 31, 2011Structural gap parent bank-holding. Million euros
6. Includes all the balance sheet except the trading portfolios.
Latin American risk profile evolutionSensitivity of NIM and MVE to 100 p.b.
1,200
1,000
800
600
400
200
0
MVE NIM
Dec 11
79
957
Sep 11
94
904
Jun 11
119
987
Mar 11
81
753
Dec 10
45
763
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 186
2. Geographic distribution
Financial margin sensitivityFor the whole of Latin America, the consumption at the end of2011 was EUR 79 million (sensitivity of the financial margin atone year to rises of 100 b.p.). The geographic distribution isshown below.
More than 90% of the risk was concentrated in three countries:Brazil, Chile and Mexico.
Market Value of equity sensitivityFor the whole of Latin America, the consumption at the end of2011 was EUR 957 million (sensitivity of MVE to a parallelmovement of rises of 100 b.p in interest rates). The geographicdistribution is shown below.
About 90% of risk is concentrated in three countries: Brazil,Chile and Mexico.
Balance sheet management risk in Latin America, measured inVaR terms at one day and at 99%, amounted to EUR 137.1million at the end of 2011. The chart shows that most of it wasconcentrated in Brazil.
B2. Structural management of credit riskThe purpose of structural management of credit risk is to reducethe concentrations that can naturally occur as a result ofbusiness activity through the sale of assets. These operations areoffset by acquiring other assets that diversify the credit portfolio.The financial management area analyses these strategies andmakes proposals to the ALCO in order to optimise the exposureto credit risk and help create value.
In 2011 and as part of the Group’s liquidity management:
• EUR 73,000 million of assets were securitised, of whicharound one-third were placed in the market and the restretained by the Group’s various units. These retainedsecuritisations increased the Group’s liquidity position throughtheir discounting capacity in central banks.
• Repurchases were made in the secondary market ofsecuritisation bonds of the higher tranches of Group issuers(around EUR 100 million).
187ANNUAL REPORT 2011
NIM sensitivity by countries%
Chile 10.1%
Mexico 24.9%
Other countries (*): 8.5%
Brazil 56.5%
(*) Other countries: Argentina, Colombia, Panama, Peru, Puerto Rico, Santander Overseasand Uruguay.
MVE sensitivity by countries%
Chile 12.7%
Other countries(*) 10.6%
Mexico 15.1%Brazil 61.5%
(*) Other countries: Argentina, Colombia, Panama, Peru, Puerto Rico, Sanander Overseas and Uruguay.
Structural interest rate risk of the balance sheet (VaR)%. VaR at 99% with a time frame of one day
Chile 5.6%
Argentina 21.2%
Other countries(*) 0.5%
Mexico 5.6%
Brazil 67.0%
(*) Other countries: Colombia, Puero Rico, Santander Overseas and Uruguay.
Local currency
Assets
Liabilities
Off-balance sheet
Gap
Dollar
Assets
Liabilities
Off-balance sheet
Gap
59,192
71,196
-2,956
-23,083
5,295
5,658
-3,890
-4,253
98,801
115,340
115,017
102,782
32,182
30,718
-108,056
-106,593
16,141
24,017
253
-2,541
3,887
4,247
-617
-976
35,702
13,731
2,406
22,485
3,695
5,009
-847
-2,162
29,106
10,833
-1,622
15,674
8,397
10,043
313
-1,333
239,073
235,117
113,099
115,317
53,455
55,675
-113,097
-115,317
Notsensitive 0-6 months 6-12 months 1-3 years
More than 3 years Total
Structural Gap in Latin AmericaMillion euros
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 187
B3. Management of financing and liquidity risk
Banco Santander’s business model has enabled it to have acomfortable liquidity position during the financial crisis years. Inthis environment, the framework of managing financing andliquidity risk continued to function correctly, which gave theBank a considerable competitive edge.
The great capacity to attract customer deposits, combined withstrong issuance activity in institutional markets via subsidiarieswith the responsibility and capacity to cover their own needs,has given the Group the necessary liquidity to finance theacquisition of new units in the last few years. It has also helpedto bolster the bank’s capacity to create value, while at the sametime continue to improve the diversification of financingsources.
The Group’s liquidity management framework and its situationat the end of 2011 is set out below.
1. Management frameworkLiquidity management is based on three fundamental pillars:
A) Organisational model: governance and the board.A solid model of governance that ensures the involvement ofsenior management and the board in taking decisions andfacilitating their integration with the Group’s global strategy.
B) Management.Adapted to each business’s liquidity needs, in accordancewith the decentralised organisational model.
C) Balance sheet analysis and liquidity risk management.Profound analysis of the balance sheet and its evolution inorder to support decision-taking.
A. Organisational and governance modelDecision-taking regarding structural risks is done by local ALCOcommittees in coordination with the markets committee. Thelatter is the highest decision-taking body and coordinates allglobal decisions that influence measurement, management andcontrol of liquidity risk.
The markets committee is headed by the chairman of the bankand comprises the second vice-chairman and CEO, the thirdvice-chairman (who is the maximum executive responsible forthe Group’s risks), the chief financial officer and the senior vice-president of risks and those responsible for the business andanalysis units.
There are ALCO committees for convertible currencies (basically,euros, the US dollar and sterling) as well as for the currencies ofemerging countries.
The financial management area is responsible for managingstructural risks, including liquidity, while control is theresponsibility of the global market risk areas. Both areas supportthe ALCO committees, providing analysis and managementproposals and controlling compliance with the limits set.
In line with the best practices of governance, the Groupestablishes a clear division between executing the financialmanagement strategy (the responsibility of the financialmanagement area) and monitoring and control (theresponsibility of market risks).
188 ANNUAL REPORT 2011
Organisation modelArea of decision
Markets’ Committee
Convertiblecurrencies LatAm currencies
ALCOLocal 1
ALCOLocal 1
ALCOLocal 2
ALCOLocal 2
ALCOLocal 3
ALCOLocal 3
Management and control areas
Financial management
Responsible for executingand monitoring their
decisions
Global market risk
Responsible for monitoringand controlling risks and
limits
Strong capacity to capture retail deposits (close to15,000 branches) and wholesale funding (morethan 10 issuing subsidiaries) in the three maincurrencies.
Good liquidity situation in 2011 which is reflected inthe ratios (loan-to-deposit ratio of 117%), in thescant dependency on short-term wholesale funding(less than 2% of the balance of liquidity) and in thehigh structural surplus of liquidity (more than EUR120,000 million).
Intense activity in medium- and long-term issuancein an unfavourable environment: in 2011, issuescovered 124% of maturities and amortisations.
A high capacity of recourse to central banks ismaintained: at the end of 2011, it was around EUR100,000 million of total capacity.
The Group faces 2012 in a comfortable liquidityposition: without concentration of maturities andwith favourable business trends in some countriesthat generate liquidity.
Informe_Gestion Riesgos 2011_ENG_V17:esp 28/02/12 11:18 Página 188
B. Management Structural liquidity management aims to finance the Group’srecurring activity in optimum conditions of maturity and costand avoid assuming undesired liquidity risks.
Liquidity and financing management is based on the followingprinciples:
• Wide and very stable base of customer deposits and funds onthe balance sheet (including retail commercial paper): morethan 85% of the deposits are retail and are captured in theGroup’s core markets by various units.
• Financing via medium and long-term issues of the balancesheet’s stable liquidity needs (the gap between loans anddeposits), establishing a surplus of structural financing in orderto be able to meet possible adverse situations.
• Diversification of financing sources to reduce the risk inrelation to:
• – instruments/investors
• – markets/currencies
• – maturities
• Strict control of short-term financing needs, within theGroup’s policy of minimising the degree of recourse to short-term funds.
• Autonomy and responsibility of subsidiaries in managing thefinancing of liquidity, with no structural support from theparent bank.
In practice, and applying these principles, the Group’s liquiditymanagement consists of:
• Drawing up every year the liquidity plan based on thefinancing needs derived from the budgets of each businessand the methodology stated in the risks report of this annualreport (market risk-balance sheet management-liquidity risk).On the basis of these needs and bearing in mind prudentlimits on recourse to short-term markets, the year’s issuanceand securitisation plan is established by financialmanagement.
• During the year the evolution of the balance sheet andfinancing needs is regularly monitored, giving rise to changesto the plan.
• Maintain an active presence in a wide and diversified series offinancing markets. The Group has more than 10 significantand independent issuance units, which avoid dependence ona specific market and maintain available a wide capacity ofissuance in various markets.
• And backed by all this, the Group has an adequate structureof medium and long-term issues, well diversified by products(senior debt, subordinated, preferred shares, bonds) with anaverage conservative maturity (4.2 years at the end of 2011),to which are added the securitised bonds placed in themarket.
• All of this results in moderate needs of recourse to short-termwholesale financing at the Group level, which, as reflected inthe accompanying balance of liquidity, represented less than2% of net funds in 2011, down from 3% in 2010, and 5% in2009. This percentage would be below 2% if the retailcommercial paper placed by the commercial networks inSpain as products to replace customer deposits is excluded.
The subsidiaries have a large degree of autonomy to managetheir liquidity within Grupo Santander’s decentralised andcoordinated financing model. Each one must budget theirliquidity needs and assess their own capacity of recourse to thewholesale markets in order to establish, always in coordinationwith the parent bank, the issuance and securitisation plan.
Only in the case of Santander Consumer Finance does theparent bank (Banco Santander) supplement the necessaryliquidity and always at the market price taking into account thematurity of the finance and the internal rating of the relevantunit. The Group, within the strategy of optimising the use ofliquidity in all units, has managed to reduce to one-third (to EUR5,000 million from EUR 15,000 million in 2009) the recourse ofSantander Consumer Finance to the parent bank in the last twoyears.
C. Analysis of the balance sheet and measurement of liquidity riskTaking decisions on financing and liquidity is based on a deepunderstanding of the Group’s current situation (environment,strategy, balance sheet and state of liquidity), the future liquidityneeds of businesses (projection of liquidity), as well as access toand the situation of financing sources in the wholesale markets.
The objective is to ensure the Group maintains optimum levelsof liquidity to cover its short and long-term needs, optimisingthe impact of its cost on the income statement.
This requires monitoring of the structure of balance sheets,forecasting short and medium-term liquidity and establishing thebasic metrics, in line with those reported in the next section.
Various stress tests are also conducted taking into account theadditional needs that could arise from various extreme, althoughpossible, events. These could affect the various items of thebalance sheet and/or sources of financing differently (degree ofrenewal of wholesale financing, deposit outflows, deteriorationin the value of liquid assets, etc), whether for global marketreasons or specific ones of the Group.
All of this enables the Group to respond to a spectrum ofpotential, adverse circumstances, anticipating the correspondingcontingency plans.
These actions are in line with the practices being fomented fromthe Basel Committee in order to strengthen the liquidity ofbanks, whose objective is to define a framework of principlesand metrics that is still being analysed and discussed.
189ANNUAL REPORT 2011
Analysis of the balance sheet and measurement ofliquidity risk
1. Group strategy 2. Current situation of liquidity
3. Projection ofthe balancesheet and needfor liquidity
5. Financingmarkets in stress conditions
4. Balance sheet in stressconditions
Analysis ofthe liquidity
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2. Current state of liquidityThe Group has an excellent structural position, with the capacityto meet the new conditions of stress in the markets. This isunderscored by:
A) The robust balance sheet.
B) The dynamics of financing.
A. Robust balance sheetThe balance sheet at the end of 2011 was solid, as befits theGroup’s retail nature. Lending, which accounted for 77% of thenet assets of the balance of liquidity, was entirely financed bycustomer deposits and medium and long-term financing,including securitised bonds placed in the market. Equally, thestructural needs of liquidity, represented by loans and fixed assets,were also totally financed by structural funds (deposits, mediumand long-term financing and capital).
As regards financing in wholesale markets, the Group’s structureis largely based on medium and long-term instruments (90% ofthe total).
Together with special financing from the Federal Home LoanBanks in the US and securitised bonds in the market, the bulk ofmedium- and long-term financing are issues of debt whoseoutstanding balance at the end of 2011 was around EUR162,000 million, with an average maturity of more than fouryears and an adequate distributed profile (no year concentratesmore than 20% of the outstanding balance).
Short-term financing is a marginal part of the structure (less than2% of total funds) and it amply covered by liquid assets. At theend of 2011, the surplus structural liquidity (equivalent to thesurplus of structural funds over loans and fixed assets) was EUR119,000 million.
If within this short-term financing the retail commercial paperplaced by the commercial networks in Spain in 2011 to replacedeposits is excluded, the structural surplus of liquidity wouldamount to EUR 125,000 million.
This solid structural position is complemented by the Group’s greatcapacity to obtain immediate liquidity through recourse to thecentral banks of the countries where the Group has operatingsubsidiaries. Of note among these central banks are the threeinstitutions that control the three main currencies in which theGroup operates: the euro, sterling and the US dollar.
At the end of 2011, total eligible assets which could bediscounted in the various central banks to which the Group hasaccess via its subsidiaries amounted to around EUR 100,000million. This amount, similar to that at the end of 2010, is theresult of an active strategy of generating assets that can bediscounted, backed by development of customer businesses,which enable both the maturities of the existing assets as wellas the increasing cuts in the value of guarantees by centralbanks when supplying liquidity to be compensated.
We now set out the framework of the balance of liquidity of theconsolidated group as well as the main metrics for monitoringthe structural position of liquidity:
Metrics
Loans/net assets
Customer deposits, insuranceand medium and long-termfinancing/loans
Customer deposits, insuranceand medium and long-term financing,shareholders’ funds and otherliabilities / total loans and fixed assets
Liabilities/total loansand fixed assets
Short-term financing/net liabilities
2011
77%
113%
114%
2%
117%
2010
75%
115%
117%
3%
117%
Monitoring metrics%
2009
79%
106%
110%
5%
135%
As in the Group, the balance sheets of the units of convertiblecurrencies and of Latin America have the same principles, withinthe philosophy of independence and responsibility in theirfinancing.
A good example is that in the Group’s main units, apart fromSantander Consumer Finance, all customer lending is financedby customer deposits plus medium- and long-term wholesalefunding.
B. Dynamics of financingSantander maintained in 2011 the solid structural liquidityposition reached in 2010 in an environment of maximumpressure in both the retail and wholesale spheres.
As well as the aggressive competition for retail deposits in themain European markets already begun in 2010, euro zonewholesale markets were closed in the second half of the yeardue to the crisis of confidence in the solvency of sovereign debtand in the growth capacity of countries on the periphery ofEurope. This difficulty in wholesale issuance raised the appetitefor retail deposits while complicating access to short-term dollarmarkets.
In this context of high stress, the Group maintained its liquidityratios, after absorbing the financing needs derived from the newunits incorporated. The Group’s loan-to-deposit ratio remainedat around 117% in 2011 (including the retail commercial paper),after the sharp reduction from 150% in 2008. The ratio ofdeposits plus medium- and long-term financing to loans was113% (115% in 2010), well above the 104% in 2008.
This evolution is the result of managing the two basic drivers ofthe Santander model: the high capacity to capture customerfunds and the wide and diversified access to wholesale financemarkets.
190 ANNUAL REPORT 2011
Customer loans
Fixed assets
Financial assetsShort-term financing
Shareholders’ funds and other liabilities
Customer deposits andmedium and long-termfinancing
(*) Balance sheet for the purposes of liquidity management: total balance sheet net of tradingderivatives and interbank balances.
Grupo Santander’s balance sheet of liquidity at theend of 2011 (*)
%
9%14%
77%
12%
2%86%
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As regards the capacity, in 2011 the Group’s main unitscontinued to increase their customer deposits as the basis forfinancing growth in lending. Growth rates in the Latin Americanunits were higher, although without offsetting the strong rise inlending in the region, especially in Brazil and Mexico, which ledto the elimination of the traditional surplus of deposits. On theother hand, developed countries undergoing deleveraginggenerally registered lower growth in deposits although higherthan that of lending, which enabled them to keep on reducingtheir commercial gap.
As an exception, the commercial units in Spain which, after thebig effort made in 2010 to capture deposits, reduced thevolume of deposits in 2011 after giving priority to recoveringspreads by not renewing the most expensive deposits andissuing commercial to attract new funds from retail customers.The fall in the volume of deposits and on-balance sheet funds,however, was less than the reduction in loans, which continuedto improve the commercial gap in Spain.
As regards the second driver, the Group maintained a high volumeof issuance throughout the year, more continuously in thecountries and businesses least affected by the euro zone’s issuancedifficulties after the summer. The diversity of issuers by marketsand currencies, and exploiting the windows offered by the euromarkets, particularly in the first half of the year, enabled Santanderto capture EUR 40,000 million in medium- and long-term issues inthe market (more than in 2010), which covered 124% of thematurities and amortisations envisaged for the year.
Medium- and long-term issues, basically senior debt andmortgage bonds, were concentrated in Spain and the UK (72%of the total between the two), followed by Latin America, led byBrazil, which increased its participation to 24% of the year’stotal issues.
As regards securitisation, in 2011 the Group’s subsidiaries madesales in the market of securitised bonds and structured medium-and long-term operations with customers whose collateral issecuritised bonds or mortgage bonds amounting to close to EUR25,000 million. Of note along with the strong activity in the UKmarket, which concentrates more than half of the placements,was the growing issuance of Santander Consumer Finance,strongly backed by investor appetite for these securities. Thisdemand increased the number of Santander Consumer Financeunits which accessed the wholesale markets and contributed tothe opening of new markets. A good example of this wasNorway, where the Group made the first securitisation of autoloans in the country.
This high issuance capacity shown by the parent bank and itssubsidiaries in various types of debt was backed by the Group’snotable credit quality. In February 2012, after the successivedowngrading of Spanish sovereign debt by rating agencies,Grupo Santander had the following credit ratings: A from Fitch,A+ from Standard & Poor’s and Aa 3 from Moody’s.
Also noteworthy was that, in all cases, the Group’s issuancecapacity was adjusted to investors’ appetite for securities atplacement prices that recognised the higher credit quality of theGroup and its subsidiaries. A good example of this was theparent bank’s EUR 2,000 million issue of 3 year mortgage bondsin February 2012, which reopened the Spanish market afteralmost six months of no activity for these volumes. Itsplacement, with a high demand (x4) was done at a spread of210 b.p. over mid swap, below that of the Bank’s CDS in thedays before and which was close to the levels before thetightening of markets in August 2011.
In short, sustained growth in deposits except in some marketsbecause of the greater focus on spreads, wide access tomedium and long-term wholesale markets and generation ofliquidity by businesses in economies undergoing deleveragingexplain the Group’s continued solid structural liquidity positionduring 2011.
Santander thus begins 2012 with a comfortable liquidity situationand with fewer issuance needs in the medium- and long-term.There are no concentrations of maturities in the coming years,when annual maturities are less than the issues made in 2011 andfurthermore the different business dynamics by areas and marketsdo not make it necessary to cover all issues. This will make theGroup develop differentiated strategies in each one of them.
In any case, and while the current environment of uncertaintypersists, Santander will continue to pursue a conservative policyin issues, as it did in 2011, in order to bolster its already solidposition.
C) Structural exchange-rate risk/hedgingof resultsStructural exchange rate risk arises from Group operations incurrencies, mainly related to permanent financial investments,and the results and the dividends of these investments.
This management is dynamic and seeks to limit the impact onequity of currency depreciations and optimise the financial costof hedging.
As regards the exchange-rate risk of permanent investments, thegeneral policy is to finance them in the currency of theinvestment provided the depth of the market allows it and thecost is justified by the expected depreciation. One-off hedging isalso done when a local currency could weaken against the eurobeyond what the market estimates.
At the end of 2011, the largest exposures of a permanentnature (with potential impact on net worth) were concentratedin Brazilian reales, followed by sterling, US dollars, Mexicanpesos and Polish zloty. The Group covers part of these positionsof a permanent nature with exchange-rate derivatives.
In addition, financial management at the consolidated level isresponsible for exchange-rate management of the Group’sexpected results and dividends in those units whose currency isnot the euro.
191ANNUAL REPORT 2011
(*) Excludes securitisations
GROUP ISSUES GROUP MATURITIES
Group issues and maturities of medium- and long-term debt Grupo Santander (*)
Billion euros
2011
40
2012
32
30
24
2013 2014
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D) Structured finance operationsDespite the complicated economic environment, Santanderachieved growth of 13.2% in this activity in 2011 to a committedexposure of EUR 22,017 million at the end of the year,7
corresponding to 727 operations, and increased both thediversification by sectors and the internationalisation of business.Leadership in project finance was strengthened with an exposureof EUR 13,528 million among 514 operations, (risk reduced toEUR 12,198 million if we discount the exposure ceded to twoCLOs signed in 2008 and 2009), followed by EUR 4,434 millionin acquisition finance (50 transactions), of which EUR 1,746million related to 12 margin calls and, lastly, leveraged buy-outs(LBOs) and other structured financings amounted to EUR 4,055million (154 transactions).
As a result of integrating Alliance & Leicester into the group in2008, a portfolio of structured operations is maintained. It is adiversified portfolio of specialised finance operations. Theexposure at the end of 2011 was £4,167 million (EUR 4,989million) corresponding to 214 transactions. This exposure was15.5% less than at the end of 2010.
E) Exposures related to complex structuredassetsGrupo Santander continues to have a very limited exposure toinstruments or complex structured vehicles, reflecting amanagement culture one of whose hallmarks is prudence in riskmanagement. At the end of 2011, the Group had:
• CDOs and CLOs: the position is still very insignificant at EUR301 million, 38% less than at the end of 2010. A significantpart of it is the result of the integration of the Alliance &Leicester portfolio in 2008.
• Non-Agency CMOs and pass-through with underlyingmortgage alt-A8: without exposure. The EUR 818 million ofpositions at the end of 2010, mainly from the integration ofSovereign Bank in January 2009, were sold in the fourthquarter of 2011.
• Hedge funds: the total exposure is not significant (EUR 469million at the end of 2011) and most of it is through financingthese funds (EUR 233 million), as the rest is direct participationin portfolio. This exposure has low levels of loan-to-value ofaround 30% (EUR 1,552 million of collateral at the end of2011). The risk with this type of counterparty is analysed caseby case, establishing the percentages of collateral on the basisof the features and assets of each fund.
• Conduits: No exposure.
• Monolines:Santander’s exposure to bond insurance companieswas EUR 196 million9 at the end of 2011,mainly indirectexposure, and EUR 173 million by virtue of the guaranteeprovided by this type of entity to various financing or traditionalsecuritisation operations. The exposure in this case is doubledefault, as the primary underlying assets are of high creditquality (mainly AA). The small remaining amount is directexposure (for example, via purchase of protection from the riskof non-payment by any of these insurance companies through acredit default swap). The exposure was 29% lower than in2010.
In short, the exposure to this type of instrument, the result ofthe Group’s usual operations, continued to decline in 2011 andthis was mainly due to the integration of positions of institutionsacquired in 2011, such as Alliance & Leicester and Sovereign (in2008 and 2009, respectively). All these positions were known at the time of purchase, having been duly provisioned.
These positions, since their integration in the Group, have beennotably reduced, with the ultimate goal of eliminating themfrom the balance sheet.
Santander’s policy for approving new transactions related tothese products remains very prudent and conservative; it issubject to strict supervision by the Group’s senior management.Before approving a new transaction, product or underlying asset,the risks division verifies:
• The existence of an appropriate valuation model to monitorthe value of each exposure: Mark-to-Market, Mark-to-Modelor Mark-to-Liquidity.
• The availability in the market of the necessary inputs to beable to apply this valuation model.
And provided these two points are always met:
• The availability of appropriate systems, duly adapted to calculateand monitor every day the results, positions and risks of newoperations.
• The degree of liquidity of the product or underlying asset, in orderto make possible their coverage when deemed opportune.
4.5. Internal modelGrupo Santander had, at the end of 2011, approval from theBank of Spain for its internal market risk model for calculatingregulatory capital in the trading portfolios of units in Spain, Chileand Portugal. The Group’s objective is to gradually increaseapproval to the rest of units.
As a result of this approval, the regulatory capital of tradingactivity is now calculated via advanced methods, using VaR asthe fundamental metric and incorporating new metrics ofstressed VaR and incremental risk capital charge, which replacesincremental default risk, in line with the new capitalrequirements demanded by Basel 2.5.
We closely co-operate with the Bank of Spain in order toadvance in the perimeter susceptible of entering into theinternal model (at the geographic and operational levels), as wellas in analysis of the impact of new requirements, in line withthe documents published by the Basel Committee to strengthenthe capital of banks.10
192 ANNUAL REPORT 2011
7. Including the exposure to Banesto.
8. Alternative A-paper: mortgages originated in the US market which for various reasons areconsidered as having an intermediate risk level between prime and subprime mortgages (not havingall the necessary information, loan-to-value levels higher than usual, etc).
9. Guarantees provided by monolines for bonds issued by US states (municipal bonds) are notconsidered as exposure. As a result of the acquisition of Sovereign Bank, the Group incorporated aportfolio of these bonds which amounted to EUR 1,341 million at the end of 2011.
10. “Basel III: A global regulatory framework for more resilient banks and banking systems” and “BaselIII: International framework for liquidity risk measurement, standards and monitoring.”
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Definition and objectivesGrupo Santander defines operational risk (OR) as the risk oflosses from defects or failures in its internal processes,employees or systems, or those arising from unforeseencircumstances. They are, in general, purely operational events,which makes them different from market or credit risks,although they also include external risks, such as naturaldisasters.
The objective in control and management of operational risk isto identify measure/valuate, control/mitigate and monitor thisrisk.
The Group’s priority, is to identify and eliminate risk focuses,regardless of whether they produce losses or not. Measurementalso helps to establish priorities in management of operationalrisk.
Grupo Santander opted, from the beginning, to use thestandard method for calculating regulatory capital byoperational risk, envisaged in the BIS II rules. The Group isweighing up the best moment to adopt the focus of advancedmodels (AMs), bearing in mind that a) the short-term priority inmanagement of operational risk centres on its mitigation; and b)most of the regulatory requirements established for being ableto adopt the AMs must be incorporated into the standardmodel (already achieved in the case of Grupo Santander’soperational risk management model).
Management modelThe organisational model for controlling and managing risks isthe result of adapting to the new BIS II environment, whichestablishes three levels of control:
• First level: control and management functions conducted bythe Group’s units.
• Second level: supervision functions carried out by thecorporate areas.
• Third level: integral control functions by the risks division-integral control area and internal validation of risk.
This model is constantly reviewed by the internal auditingdivision.
Control of operational risk in the first and second levels is carriedout by the technology and operations division, and is part of theGroup's strong risk management culture. Within this division,the corporate area of technological and operational risk,established in 2008, defines policies as well as managing andcontrolling these risks. The implementation, integration andlocal adjustment of the policies and guidelines established bythis area is the responsibility of local executives in each unit.
This structure for operational risk management is based on theknowledge and experience of executives and professionals ofthe Group’s various units. Particular importance is attached tothe role of local executives responsible for operational risk.
Management is based on the following elements:
The different phases of the technological and operational riskmanagement model entail:
• Identify the operational risk inherent in all activities,products,processes and banking systems.
• Measure and assess the operational risk objectively,continuously and in line with the regulatory standards (BaselII, Bank of Spain) and the banking industry, establishing risktolerance levels.
• Continuously monitor the exposure of operational risk inorder to detect the levels of unassumed risk, implementcontrol procedures, improve internal knowledge and mitigatelosses.
• Establish mitigation measures that eliminate or minimiseoperational risk.
• Produce regular reports on the exposure to operational riskand the level of control for senior management and theGroup’s areas/units, as well as inform the market andregulatory bodies.
• Define and implement systems that enable operational riskexposures to be watched over and controlled and integratedinto the Group’s daily management, taking advantage ofexisting technology and seeking the maximumcomputerisation of applications.
193ANNUAL REPORT 2011
5. Operational risk
of ri
sks
Policies, procedures and
Iden
tific
atio
n
methodologies support
tool
s
Technolo
gica
l
Assessment Mitigation
Control
Information
Measurement
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• Define and document operational risk management policies,and introduce methodologies for managing this risk inaccordance with regulations and best practices.
Grupo Santander’s operational risk management modelcontributes the following advantages:
• Integral and effective management of operational risk(identification, measurement/assessment, control/mitigationand information).
• Better knowledge of existing and potential operational risksand assigning responsibility for them to the business andsupport lines.
• Operational risk information helps to improve the processesand controls, reduce losses and the volatility of revenues.
• Facilitates the establishment of operational risk appetite limits.
Implementing the model: global initiatives and resultsThe main functions, activities and global initiatives adopted seekto ensure effective management of operational andtechnological risk are:
• Define and implement the framework for corporatemanagement of technological and operational riskmanagement.
• Designate coordinators and create operational riskdepartments.
• Training and interchange of experiences: continuation of bestpractices within the Group.
• Foster mitigation plans: ensure control of implementation ofcorrective measures as well as ongoing projects.
• Define policies and structures to minimise the impact on theGroup of big disasters.
• Maintain adequate control on activities carried out by thirdparties in order to meet potential critical situations.
• Supply adequate information on this type of risk.
The corporate function enhances management of technologicalrisk, strengthening the following aspects among others:
• The security of the information systems.
• The contingency and business continuity plans.
• Management of risk associated with the use of technologies(development and maintenance of applications, design,implementation and maintenance of technology platforms,output of computer processes, etc).
Almost all the Group’s units have been incorporated to themodel with a high degree of uniformity. However, due to thedifferent pace of implementation, phases, schedules and thehistorical depth of the respective data bases, the degree ofprogress varies from country to country.
On a general basis, all the Group’s units continue to improve allaspects related to operational risk management as can be seenin the annual review by the internal auditing unit.
• Data bases of operational incidents that are classified arereceived every month. The capturing of events related tooperational risk are not truncated (i.e. without exclusions forreasons of amount and with both the accounting impact -including positive effects - as well as the non-accountingimpact).
• Self-assessment questionnaires filled in by almost all theGroup’s units are received and analysed.
• A corporate system of operational risk indicators is in place. Itis in continuous evolution and coordination with the internalcontrol area.
• The main and most frequent events are identified andanalysed, and mitigation measures taken which, in significantcases, are disseminated to the Group’s other units as a bestpractices guide.
• Processes are conducted to conciliate data bases withaccounting data.
By consolidating the total information received, the Group’soperational risk profile is reflected in the following chart:
In addition, the Group’s units in 2011 continued to advance inconducting self-assessment risk exercises regarding theintroduction of estimates of frequency and loss given default andworst case scenarios. Specifically, experts from the variousbusiness and support areas assessed the risk associated withprocesses and activities and estimated the average frequency ofoccurrence in the materialisation of risks as well as the averageloss given default. The exercise also incorporated evaluation ofthe largest loss in addition to the average loss, as well asassessment of the environment of control.
194 ANNUAL REPORT 2011
Grupo Santander: distribution of amount andfrequency of events by category (2011)
Amount of events Frequency of events
VII12.8% 40.2%
VI
0.2%
1.6%
V
1.7%
1.1%
IV
39.0%
14.6%
IIIII
45.0%
42.2%
I
0.7%
0.6%
0.1%
I. Internal fraudII. External fraudIII. Employment, health and security practices at workIV. Practices with clients, products and businessV. Damage in physical assetsVI. Interruption of business and failures in systemsVII. Execution, delivery and management of processes
0.2%
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All of this will enable limits to be established on the basis of thedistribution and modelisation of expected/unexpected loss.
The Group completed in 2011 the installation of a new corporatesystem which supports almost all the operational riskmanagement tools and facilitates the functions and informationand reporting needs, both at the local and corporate level. Themost noteworthy features are:
• The following modules are available: registry of events, riskmap and assessment, indicators and reporting systems.
• Application tool for all the Group’s entities.
• All operational risk management processes are automated.
• The following improvements will be incorporated to theplatform during 2012:
• – Methodology for analysing scenarios that supplements thecurrent methodologies in the Group and enables potentialrisks of greater loss to be assessed.
• – Strengthen the procedures for active management ofoperational risk via implementation and follow up ofmitigation measures.
The Group has been exercising supervision and control oftechnological and operational risk via its governance organs,The board, the executive committee and the Group’smanagement committee have been regularly includingtreatment of relevant aspects in the management andmitigation of operational risk.
Meanwhile, the Group, through their approval in the riskcommittee, formalizes every year the operational risk profiles andlimits. It establishes a risk appetite, which must be situated in lowand medium-low profiles, which are defined on the basis of thelevel of various ratios. Limits are set by country and limits for theGroup on the basis of gross loss/gross income.
Moreover, the areas of local resources hold monitoringcommittees with the corporate area every month and by country.In February 2011, the anti-fraud corporate committee wascreated which analyses the situation in the Group andimplements the corrective measures for its reduction.
Lastly, ACRTO-CIVIR committees were held every three months.They examined relevant issues of operational risk managementand control from the standpoint of integral control of risk.
Analysis and monitoring of controlsin market operationsDue to the specific nature and complexity of financial markets,the Group considers it necessary to strengthen continuouslyoperational control of this activity, thereby enhancing the verydemanding and conservative risk and operating principles thatGrupo Santander already regularly applied.
Over and above monitoring all aspects related to operationalcontrol, in all the Group’s units the attention paid to thefollowing aspects is reinforced:
• Review of the valuation models and in general the valuationsof portfolios.
• Processes to capture and validation independent of prices.
• Adequate conformation of the operations withcounterparties.
• Review of cancellations/modifications of operations.
• Review and monitoring of the effectiveness of guarantees,collateral and risk mitigants.
Corporate informationThe corporate area of technology and operational risk controlhas an integral management information system for operationalrisk, which consolidates every quarter the information availablein each country/unit in the sphere of operational risk, so that ithas a global view with the following features:
• Two levels of information: corporate with consolidatedinformation and the other individualized for eachcountry/unit.
• Dissemination of the best practices between GrupoSantander’s countries/units, obtained through a combinedstudy of the results of qualitative and quantitative analysis ofoperational risk.
Information on the following points is also drawn up:
• Operational risk management model in Grupo Santander.
• Human resources and perimeter of activity.
• Analysis of the database of errors and incidents.
• Operational risk cost and accounting conciliation.
• Self-assessment questionnaire
• Indicators
• Mitigating/active management measures
• Business continuity and contingency plans
• Regulatory framework: BIS II
• Insurance
This information is the basis for complying with the reportingneeds to the risk committee, senior management, regulators,rating agencies, etc.
Insurance in the management of operational riskGrupo Santander regards insurance as a key element inmanagement of operational risk. The area responsible foroperational risk has been closely cooperating with the Group’sinsurance area since 2004 in all those activities that entailimprovements in both areas. For example:
• Cooperation in the exposure of the Group’s operational riskcontrol and management model to insurance and reinsurancecompanies.
• Analysis and monitoring of recommendations and suggestionsto improve operational risks made by insurance companies, viaprior audits conducted by specialised companies, as well as theirsubsequent implementation.
• Exchange of information generated in both areas in order tostrengthen the quality of the data bases of errors and theperimeter of coverage of the insurance policies for the variousoperational risks.
• Close cooperation between local operational risk executivesand local coordinators of insurance to strengthen mitigationof operational risk.
• Regular meetings on specific activities, states of situation andprojects in both areas.
• Active participation of both areas in global sourcing ofinsurance, the Group’s maximum technical body for definingcoverage strategies and contracting insurance.
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Grupo Santander defines reputational risk as that linked to theperception of the bank by its various stakeholders, both internaland external, of its activity, and which could have an adverseimpact on results, capital or business development expectations.This risk relates to juridical, economic-financial, ethical, socialand environmental aspects, among others.
Various of the Group’s governance structures are involved inreputational risk management, depending on where the riskcomes from. The audit and compliance committee helps theboard to supervise compliance with the Group’s code ofconduct in the securities markets, the manuals and theprocedures to prevent money-laundering and, in general, theBank’s rules of governance and compliance. It formulates theproposals needed for their improvement.
Management of reputational risk which might arise from aninadequate sale of products or an incorrect provision of servicesby the Group is conducted in accordance with the corporatepolicies for reputational risk management derived from thecommercialisation of products and services.
These policies aim to set a single corporate framework for allcountries, all businesses and all entities: (i) strengthening theorganisational structures; (ii) ensuring the decision-makingcommittees vouch not only for approval of products andservices, but also for monitoring throughout their life; and (iii)establish the guidelines for defining homogeneous criteria andprocedures for all the Group for the commercialisation ofproducts and services, covering all the phases (admission, pre-sale, sale and post-sale).
The specific developments and adaptations of these policies tolocal reality and to local regulatory requirements are handled via local internal rules in the Group’s various units, followingauthorisation from the corporate area of compliance andreputational risk.
The new version of the procedures manual for thecommercialisation of financial products (henceforth, the manual)is a specific adaptation of the corporate policies of selling toSpain’s reality and to the requirements of local rules (forexample, the Markets in Financial Instruments Directive) and,thus, applicable to Banco Santander and to its subsidiaries inSpain as they do not have their own manual.
This manual covers financial products, ranging from securitiesand other fixed income and variable financial instruments tomoney market instruments, participations in collectiveinvestment institutions, traded derivatives and OTC anduntypical financial contracts. The corporate committee ofcommercialisation can include other products in the manual’ssphere of procedures.
The reputational risk management that can arise from theinadequate sale of products or an incorrect provision of servicesby the Group is carried out by the following organs:
The risk committee (RC)This committee is the responsibility of board, as part of itssupervisory function. It defines the Group’s risk policy.
As the maximum body responsible for global management ofrisk and of all types of banking operations, the committeeassesses, with the support of the division of the secretarygeneral, reputational risk in its sphere of activity and decisions.
Corporate committee of commercialisation (CCC)This committee, which is the maximum decision-making bodyfor approving and monitoring products and services, is chairedby the Group’s secretary general and integrated byrepresentatives of the divisions of risk, financial management,technology and operations, secretariat general, generalintervention and control, internal auditing, retail banking,Santander Global Banking & Markets, private banking, assetmanagement and insurance.
The committee pays particular attention to adjusting theproduct or service to the framework where it is going to be soldand especially to ensuring that:
• Each product or service is sold by someone who knows howto sell it.
• The customer is given the necessary and adequateinformation.
• The product or service fits the customer’s risk profile.
• Each product or service is assigned to the appropriate market,not only for legal or fiscal reasons, but also to meet themarket’s financial culture.
• When a product or service is approved the maximum limitsfor placement are set. They meet the requirements of thecorporate policies of commercialisation and, in general, theapplicable internal or external rules.
Local commercialisation committees (LCC), in turn, are created,which channel to the CCC new product approval proposals,after issuing a favourable opinion, and approve products thatare not new and marketing campaigns.
In the respective approval processes, the marketing committeesoperate with a risk focus and from the double perspective ofbank/customer.
The corporate commercialisation committee held 19 meetings in2011 and analysed 203 new products/services.
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6. Reputational risk
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Global consultative committee (GCC)The global consultative committee (GCC) is the advisory bodyfor the corporate committee of commercialisation andcomprises representatives of areas that contribute vision ofregulatory and market risks. This committee meets every quarterand can recommend the review of products affected bychanges, in markets, deterioration of solvency (country, sectorsand companies) or by changes in the Group’s vision of marketsin the medium and long term.
Corporate committee of monitoring (CCM)A weekly meeting takes place as of 2009 to monitor productspresided by the secretary general in which internal auditing,legal advice, compliance, customer attention and the affectedbusiness areas (with permanent representation of thecommercial network) participate. Specific questions related tothe commercialisation of products and services are raised andresolved.
The CCM held 42 meetings in 2011 where it resolved incidentsand analysed information on the monitoring of products andservices, at both the local level of retail banking in Spain as wellas at the consolidated Group level.
Corporate office of reputational riskmanagementIntegrated in the corporate area of compliance and reputationalrisk, this office provides the corresponding organs ofgovernance with the necessary information to: (i) adequatelyanalyse the risk to be approved, with a two-pronged purpose:impact on the Bank and on the customer; and (ii) monitoring ofproducts throughout their life cycle.
The office approved during 2011 68 products/servicesconsidered as not new and resolved 108 consultations fromvarious areas and countries. The products approved by the officeare successive issues of products previously approved by theCCC or the LCC, after having delegated this faculty in this office.
At the local level, reputational risk management offices arecreated, which are responsible for fostering the culture andensuring that the functions of approval and monitoring ofproducts are developed in their respective local sphere, in linewith the corporate guidelines.
In 2011, the various reputational risk management officesmonitored the approved products. The information iscoordinated by the corporate office, which reports to the CCM.
In addition, in reputational risk matters, Grupo Santander has acompliance programme which is described in the appendix ofthis report.
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Grupo Santander participated during 2011 in impact studiespromoted by the Basel Committee and the European BankingAuthority (EBA), and coordinated at the local level by the Bankof Spain to calibrate the new regulations denominated Basel IIIand whose implementation involves establishing new standardsfor capital and liquidity, with stricter criteria and standardised atthe international level.
Santander has very solid capital ratios, adjusted to the businessmodel and to its risk profile, putting it in a comfortable positionto comfortably meet Basel III. The impact analysis shows nosignificant affects on the Group’s high solvency ratios, whichbenefit from a considerable organic capital generation capacity.The part of the new regulations known as Basel 2.5 referring tothe additional requirements for securitisations and market risk,which came into force on December 31, 2011, did not have anysignificant impact on the Group’s solvency. The new regulationson capital will be gradually implemented between 2013 and2019.
Grupo Santander has proposed adopting, during the next fewyears, the advanced internal ratings based (AIRB) models ofBasel II for almost all its banks (up to covering more than 90%of net exposure of the credit portfolio under these models).Meeting this objective in the short term will also be conditionedby the acquisition of new entities as well as by the need ofcoordination between supervisors of the validation processes ofinternal models. The Group operates in countries where thelegal framework among supervisors is the same as in Europe viathe capital directive. However, in other jurisdictions, the sameprocess is subject to the collaboration framework between thesupervisor in the home country and that in the host countrywith different legislations. This means, in practice, adapting todifferent criteria and calendars in order to attain authorisationfor the use of advanced models on a consolidated basis.
With this objective, Santander continued during 2011 togradually install the necessary technology platforms andmethodological developments which will make it possible toprogressively apply advanced internal models for calculatingregulatory capital in the rest of the Group’s units. At themoment, Grupo Santander has the supervisory authorisation touse advanced focuses for calculating the regulatory capitalrequirements by credit risk for the parent bank and the mainsubsidiaries in Spain, the UK and Portugal, and certain portfoliosin Mexico, Brazil, Chile and Santander Consumer Finance Spain(close to two-thirds of its total exposure at the end of 2011).The strategy of implementing Basel in the Group is focused onachieving use of advanced models in the main institutions in theAmericas and consumer banking in Europe.
As regards the rest of risks explicitly envisaged in Pillar 1 ofBasel, in market risk we have authorisation to use its internalmodel for the trading activity of Madrid treasury and during2010 we obtained authorisation for the units in Chile andPortugal, thus continuing the gradual installation for the rest ofthe units presented to the Bank of Spain.
In operational risk, the Group believes that development of theinternal model should be largely based on the accumulatedexperience of the entity via the corporate guidelines and criteriaestablished after assuming their control and which are verymuch hallmarks of Santander. The Group has made manyacquisitions in the last few years that make necessary a longerperiod of maturity to develop the internal model based on themanagement experience of the various entities. However,although for the time being Grupo Santander has decided toadhere to the standard approach for calculating regulatorycapital, it envisages the possibility of adopting the advancedmanagement approach (AMA) once it has gathered sufficientinformation on the basis of its own management model in orderto strengthen to the maximum the virtues that characterise theGroup.
As regards Pillar II, Grupo Santander uses an economic capitalapproach to quantify its global risk profile and its solvencyposition within the process of self-evaluation conducted at theconsolidated level (PAC or ICAAP in English). This process, whichis supplemented by the qualitative description of the riskmanagement and internal control systems, is revised by theinternal audit and internal validation teams, and is subject to acorporate governance framework that culminates with itsapproval by the board. Furthermore, the board establishes everyyear the strategic elements regarding risk appetite and solvencyobjectives. The economic capital model considers features notincluded in Pillar 1 (concentration, interest rate and businessrisks). The Group’s diversification compensates the additionalcapital required for these risks.
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7. Adjustment to the newregulatory framework
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Grupo Santander, in accordance with the capital requirementsset out in the European Directive and the regulations of theBank of Spain, publishes every year the Report with PrudentialRelevance. This report, published for the first time with data atDecember 31, 2008, clearly shows the transparencyrequirements requested by the Bank of Spain regarding Pillar III.Grupo Santander regards the requirements of providing themarket with information as vital for complementing theminimum capital requirements demanded by Pillar 1, and thesupervisory exam process conducted via Pillar II. It isincorporating to its Pillar III report the recommendations of theCommittee of European Banking Supervisors (CEBS) in order tobecome an international benchmark in matters of transparencyto the market as already happens in its Annual Report.
As well as the process of implementing the advanced models invarious of the Group’s units, Santander is carrying out anambitious training process on Basel at all levels which is reachinga large number of employees in all areas and divisions, with aparticular impact on those most affected by the changesresulting from adopting the new international standards inmatters of capital.
Internal validation of internal risk modelsAs well as a regulatory requirement, internal validation acts as afundamental support for the risk committee and for the localand corporate risk committees in their responsibilities ofauthorising the use (management and regulatory) of models andregular revision.
Internal validation of the models involves a specialised unit ofthe Bank, with sufficient independence, obtaining a technicalopinion on the adequacy of the internal models for thepurposes used, whether internal management and/or of aregulatory nature (calculation of regulatory capital, levels ofprovisions, etc), concluding whether they are robust, useful andeffective.
Santander’s internal validation covers both credit risk andmarket risk models and those that set the prices of financialassets as well as the economic capital model. The scope ofvalidation includes not only the most theoretical ormethodological aspects but also the technology systems and thequality of data that make implementation effective and, ingeneral, all relevant aspects for management of risk (controls,reporting, uses, involvement of senior management, etc).
The function of internal validation is located, at the corporatelevel, within the area of integral control and internal validationof risk which reports directly to the Group’s third vice-chairmanand chairman of the board’s risk committee. The function isglobal and corporate in order to ensure homogeneousapplication. This is done via four regional centres in Madrid,London, Sao Paulo and New York. These centres report to thecorporate centre, which ensures uniformity in the developmentof their activities. This facilitates application of a commonmethodology supported by a series of tools developed internallyin Santander. These provide a robust corporate framework foruse in all the Group’s units and which automate certainverifications in order to ensure the reviews are conductedefficiently.
Moreover, Grupo Santander’s corporate framework of internalvalidation is fully aligned with the criteria for internal validationof advanced models issued by the Bank of Spain. The criterionof separation of functions is maintained between the units ofinternal validation and internal auditing which, as the lastelement of control in the Group, is responsible for reviewing themethodology, tools and work done by internal validation and togive its opinion on its degree of effective independence.
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The concept of economic capital has traditionally beencontrasted with that of regulatory capital, as this is the onerequired for the regulation of solvency. The Basel capitalframework clearly brings both concepts together. While Pillar 1determines the minimum regulatory capital requirements, Pillar IIquantifies, via economic capital, the Group’s global solvencyposition.
The Group’s model of economic capital quantifies theconsolidated risk profile taking into account all the significantrisks of activity, as well as the consubstantial diversificationeffect on a multinational and multi-business group likeSantander. This economic capital model serves as the Group’sbase for preparing its self-assessment of capital report inaccordance with Bank of Spain regulations under the Basel IIPillar 2 framework.
The concept of diversification is fundamental for appropriatelymeasuring the risk profile of a global activity group. Although itis an intuitive concept and one present in risk management sincebanking began, we can also explain diversification as the factthat the correlation between various risks is imperfect and sothe largest events of losses do not happen simultaneously in allportfolios or by types of risk. The sum of the economic capital ofthe different portfolios and types of risk, considered in isolation,is more than the Group’s total economic capital. In other words,the Group’s overall risk is less than the sum of its partsconsidered separately.
In addition, within the framework of the model formeasurement and aggregation of economic capital, the risk ofconcentration for wholesale portfolios (large companies, banksand sovereigns) is also considered both in its dimension ofexposure as well as concentration by sectors and countries. Theexistence of concentration in a country or a product in retailportfolios is captured by applying an appropriate model ofcorrelations.
The economic capital is also particularly adapted to internalmanagement of the Group, allowing objectives, prices, businessviabilities, etc, to be assessed and helping to maximise theGroup’s profitability.
Global risk analysis profileThe Group’s risk profile at December 31, 2011, measured interms of economic capital, is distributed by types of risk and themain business units, is reflected below:
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8. Economic capital
Distribution of economic capitalBy business units
Distribution of economic capitalBy types of risk
Financialmanagementand equitystakes 11%
Material assets 2%
FX structural 5%
ALM 8%
Business 7%
Equity nontrading 4%
Credit 64%
Trading 1%Operational 9%
Brazil 21%Rest of Latin America 13%
Sovereign 6%
UK 10%
Continental Europe 39%
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The distribution of economic capital among the main businessunits reflects the diversification of the Group’s activity and risk.This diversification was affected during 2011 by thedifferentiated growth of countries, the acquisition of SEB’sbusiness in Germany, the acquisition of Bank Zachodni WBK inPoland and, to a lesser extent, the partial sale of insurance inLatin America.
Continental Europe accounts for almost 40% of the Group’scapital, Latin America including Brazil (21%) more than one-third, the UK 10%, and Sovereign 6%, while the corporate areaof financial management and equity stakes, which assumes therisk from the structural exchange-rate position (derived fromstakes in subsidiaries abroad denominated in non-eurocurrencies) and most of the equity stakes, accounts for 11%.
The economic capital at December 31, 2011 was EUR 45,838million, including minority interests.
The benefit of diversification envisaged in the economic capitalmodel, including both the intra-risks (assimilated to geographic)as well as inter-risks, amounted to around 22% at the end of2011.
The Group also conducts capital planning with the mainobjective of obtaining future projections of economic andregulatory capital and so be able to assess situations of capitalsufficiency in various scenarios. Each scenario incorporates theforecasts of results in a coherent way, both with their strategicobjectives (organic growth, M&A, pay-out ratio, etc) as well aswith the evolution of the economic situation and in the face ofstress situations. Possible capital management strategies areidentified that enable the bank’s solvency situation to beoptimised as well as the return on capital.
Return on risk adjusted capital (RORAC) andcreation of value Grupo Santander has been using RORAC methodology in itscredit risk management since 1993 in order to:
• Calculate the consumption of economic capital and the returnon it of the Group’s business units, as well as segments,portfolios and customers, in order to facilitate optimumassigning of economic capital.
• Budget the capital consumption and RORAC of the Group’sbusiness units, including them in their remuneration plans.
• Analyze and set prices during the decision-taking process foroperations (admission) and clients (monitoring).
RORAC methodology enables one to compare, on a like-for-likebasis, the return on operations, customers, portfolios andbusinesses, identifying those that obtain a risk adjusted returnhigher than the cost of the Group’s capital, aligning risk andbusiness management with the intention of maximising thecreation of value, the ultimate aim of the Group’s seniormanagement.
The Group regularly assesses the level and evolution of valuecreation (VC) and the risk adjusted return (RORAC) of its mainbusiness units. The VC is the profit generated above the cost ofthe economic capital (EC) employed, and is calculated asfollows:
Value creation = Profit – (average EC x cost of capital)
The economic profit is obtained by making the necessaryadjustments to attributable profit so as to extract just therecurrent profit that each unit generates in the year of itsactivity.
The minimum return on capital that an operation must attain isdetermined by the cost of capital, which is the minimumrequired by shareholders. It is calculated objectively by adding tothe free return of risk the premium that shareholders demand toinvest in our Group. This premium depends essentially on thedegree of volatility in the price of the Banco Santander share inrelation to the market’s performance. The cost of capital in2011 applied to the Group’s various units was 13.862%.
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A positive return from an operation or portfolio means it iscontributing to the Group’s profits, but it is not really creatingshareholder value unless that return exceeds the cost of capital.
The performance of the business units in 2011 in value creationvaried, declining in Europe and maintaining itself in theAmericas. The creation of value and the RORAC for the Group’smain business areas are shown below:
The Group’s RORAC comfortably exceeded the cost of capitalestimated for 2011 and stood at 16.3%. The creation of value(i.e. the economic profit less the average cost of capital used toachieve it) amounted to EUR 1,181 million.
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Main segments Million euros
Continental Europe
UK
Brazil
Rest of Latin America
Sovereign
Subtotal of operating areas
Financial management and equity stakes
Group total
16.2
23.0
31.1
37.2
18.3
23.7
-37.9
16.3
RORAC (%) Creation of value
437
456
1,751
1,410
128
4,181
-3,001
1,181
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Santander has a corporate school of risks. Its purpose is to helpto consolidate the risk management culture in Santander andensure that all employees in the risks area are trained anddeveloped with the same criteria.
The school, which gave a total of 31,028 hours of training to6,195 employees in 2011 in 125 activities, is the base forstrengthening Santander’s leadership in this sphere andcontinuously enhancing the skills of its staff.
It also trains staff from other business segments, particularly inthe retail banking area, and aligns the requirements of riskmanagement with business goals.
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9. Risk training activities
Hours of training
21,479 26,665 3
1,0
28
201120102009
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